September 2012 Fiscal Monitor Raises Questions About the 2012-13 Deficit Outlook
For the first six months of fiscal year 2012-13, the federal government posted a deficit of $8.9 billion, down $2.9 billion from the $11.8 billion reported in the same period in 2012-13. Of the $2.9 billion year-over-year improvement, budgetary revenues were up by $3.4 billion, public debt charges declined by $1.1 billion, while program expenses were up by $1.6 billion.
Nearly two-thirds of the increase in budgetary revenues was attributable to higher personal income tax revenues, with the remainder largely due to higher sales and excise tax revenues and employment insurance premiums. The decline in public debt charges reflects lower effective interest rates, as the stock of interest-bearing debt is higher. Within program expenses, major transfers to persons were up $1.1 billion, primarily due to higher old age security payments, reflecting an increase in the number of recipients and higher inflation, as benefits are indexed to quarterly changes in the consumer price index, major transfers to other levels of government were up $0.6 billion, reflecting legislative increases; while direct program expenses declined by $0.2 billion, as lower “other transfer" payments more than offset increases in departmental/agency operating costs.
On November 13th, the Minister of Finance presented the Government’s “Update of Economic and Fiscal Projections”. The deficit for 2012-13 was revised to $26.0 billion, up $4.9 billion from the March 2012 Budget estimate of $21.1 billion. As a result, the revised deficit for 2012-13 is expected to be virtually unchanged from the final outcome of $26.2 billion for 2011-12. This implies a deficit of $17.1 billion over the balance of the year, compared to a deficit of $14.4 billion over the same period last year.
However, the underlining deficit for the balance of this fiscal year is closer to $20 billion, when the incremental impact of the restraint measures for 2012-13 is removed; an increase of about $5 billion over the same period last year.
The September financial results raise the question of what would have to happen over the remainder of the fiscal year in order to produce the November Update deficit forecast for 2012-13. There are a number of possibilities or combination of possibilities.
1. Nominal economic growth would have to slow very dramatically over the balance of the year – much more than assumed in the November 2012 Update. The third quarter national accounts results indicated continued weakness. The OECD has recently lowered its nominal GDP forecast for Canada, which is now below the risk adjusted level used in the November 2012 Update. So that this is a distinct possibility.
2. The accrual adjustments to date, especially for personal and corporate income tax revenues, may be understated. Correcting for this would result in significant downward adjustments over the balance of the year, especially in the end-of-year accounting period.
3. Increased uncertainty over liabilities, which could result in large adjustments at year-end.
4. Increased prudence built into the current forecast to ensure that the deficit for 2012-13 will not exceed the revised forecast.
5. Some combination of the above.
If none of these were to occur, then the deficit for 2012-13 will come in lower than forecast in the November update. If the deficit for 2012-13 comes in below the November Update forecast then the deficit outlook for 2013-14 would also be lower than in the Fall Update.
If, on the other hand, the Government believes its deficit forecast for 2012-13, this also raises issues about the deficit outlook for 2013-14. In the November 2012 Update, the deficit is forecast to decline by $9.5 billion in 2013-14 from 2012-13, of which about $3.5 billion is attributable to the impact of incremental restraint measures. The balance, about $6 billion, would have to come from growth in the economy. However, nominal gross domestic product (GDP) is projected to grow only slightly faster in 2013 than 2012, a year in which no improvement in the deficit outlook is expected. This suggests that either the deficit outlook for 2012-13 is overstated or that of 2013-14 understated.
On November 29, 2012, the Office of the Parliamentary Budget Officer (PBO) provided its assessment of the Government November 2012 Update. The PBO questioned the extent of the upward revisions to the March 2012 Budget deficit forecasts, given the projected downward revisions to the economic forecast. We raised these same questions in our assessment of the November 2012 Update (“November 2012 Update: Don’t Bet on a Surplus over the Medium-Term” www.3dpolicy.ca). The Prime Minister, in his recent comments about balancing the budget before the next election, also appears to agree with PBO and not his Minister of Finance. .
On November 26th, the Government announced a $500 increase to the annual contribution limit for tax-free savings accounts. This came just two weeks after the release of the November 2012 Fall Update. This raises two questions. Why was this not included as a measure in the November 2012 Update as it does imply a loss in federal revenues, albeit relatively small and over the medium term? And why was this change allowed to proceed, when other promised tax initiatives have to await the achievement of a balanced budget?