Comments on the Fraser Institute's "Mr. Flaherty, Time to Balance the Budget"
The Fraser Forum January/February 2013 issue contained an article by Niels Velduis and Milagros Palacios entitled “Mr. Flaherty, Time to balance the budget”. They argue that, since 2009, the federal government’s plans to balance the budget have been based on “risky projections, optimistic forecasts of revenue growth and unrealistic plans for spending restraint”, which have resulted in increases in the projected deficit with each successive budget, and the pushing out of the date that the deficit would be eliminated. They argue that the November 2012 Update of Economic and Fiscal Projections follows the same path and that there is an increased risk that there will be deficits beyond 2016-17.
There is no question that there is little confidence in the federal government’s fiscal forecasts. In an earlier blog , we examined the forecast errors over the 2006-07 to 2011-12 period and identified a number of factors that could explain why the “one-year ahead” forecasts were so far off the final outcome. Given the government’s track record, the Fraser Institute is quite justified in questioning why Canadians should believe the Minister of Finance that the budget will be balanced in 2016-17 or the Prime Minister who still claims that the deficit will be eliminated in 2015-16.
In its analysis of the November 2012 Update of Economic and Fiscal Projections, the Fraser Institute claims that the revenue forecasts continue to be optimistic, especially in 2013-14 with revenue growth of 5%. This does appear overly optimistic, as nominal gross domestic product (GDP) – adjusted for the risk adjustment factor - is only expected to increase by only 3.3%. In addition, the revenue forecast for 2013-14 is dampened by a $2 billion increase in the "risk adjustment factor". With a progressive tax system, one would have expected a growth rate of about 3.5% in budgetary revenues, not 5%. Assuming a growth rate in line with forecast growth in nominal GDP for 2013 would imply revenues $4 billion lower than presently forecast by Mr. Flaherty for 2013-14.
As for the outer years, the annual average growth in budgetary revenues matches that in nominal GDP at 4.5%. However, the annual profile fluctuates significantly with annual rates of growth in excess of 5% in both 2014-15 and 2015-16, falling to 4.2% in 2016-17 and 3.6% in 2017-18. This profile reflects in part the operations of the employment insurance (EI) program, with premium rates increasing to 2016 and falling thereafter, as the deficit in the EI Operating Account is “paid off”.
The increase in budgetary revenues in 2013-14 is suspect and this would impact on the forecast for the outer yeaers as well. Part of it may be due to the possibility that revenues for 2012-13 are understated. Financial results to date indicate that budgetary revenues for 2012-13 could be somewhat higher than estimated in the November 2012 Update. The impact this would have on future years is unknown. If some of it carries forward, it would still raise questions about the growth in budgetary revenues in 2013-14 and the level of revenues thereafter.
A better understanding of the budgetary revenue forecast would be achieved if the Minister of Finance provided more details on the economic forecast in his budgets and fiscal updates. The Parliamentary Budget Officer and we have argued that the various components of GDP should be published in the budgets and updates. The different income components of GDP imply different average effective tax rates. Without this information, it is extremely difficult to analyze and understand the revenue forecasts.
With respect to program expenses, the November 2012 Update projected growth of 1.2% in 2013-14, following an increase of 2.9% in 2012-13. Over the period 2014-15 to 2017-18, program expenses are projected to increase on average by 2.5% per year. The key issue is whether the various expenditure reduction exercises implemented since the 2010 Budget will generate the expected savings.
Direct program expenses – total expenses less the major transfers to persons and other levels of government – is projected to increase by 1.3% per year over the 2011-12 to 2017-18 period and average only 0.7% per year over the 2013-14 to 2017-18 period. The forecasts for 2012-13 and 2013-14 may be achievable, given the results to date for 2012-13 and the impact of the incremental restraint measures on 2013-14. However, it will be a real challenge for the Government to hold to average annual increase to only 0.7% thereafter.
The Fraser Institute has raised valid concerns about the Government’s ability to achieve a balanced budget in 2016-17 as forecast by the Minister of Finance, or by 2015-16 as forecast by the Prime Minister.. Without more information, Canadians are left in the dark about the reliability of the Government’s economic and fiscal forecasts.
The Government has committed a great deal of political credibility on eliminating the deficit by 2015-16 in time for the next election. The fact is the final deficit outcome will not be known until the fall of 2016 when the Public Accounts for 2015-16 are published. You can be sure that the 2015 budget will forecast a budget balance in 2015-16. However, final audited results released in the fall of 2016 could tell a different story.