OPEN LETTER TO THE MINISTER OF FINANCE: PRE-2013 BUDGET SUBMISSION THREE BUDGETS TO GO TO IMPROVE YOUR LEGACY
Dear Minister Flaherty:
Mr. Minister, you have stated recently that you intend to stay on as Minister of Finance until the next election or when the deficit is eliminated, whichever comes first. In your November 2012 Update of Economic and Fiscal Projections, the deficit was forecast to be eliminated in 2016-17, one year later than forecast in the March 2012 Budget. The Prime Minister quickly “updated” your forecast to say that the deficit would still be eliminated by 2015-16. Given that the next election is likely to be in the fall of 2015, your 2015 Budget will likely show a surplus for 2015-16, since the final outcome will not be known until the fall of 2016.
Assuming that you remain Minister of Finance until the 2015 election, you would have served in that portfolio for 10 years. This compares to 7 years for Mr. Wilson, under Prime Minister Mulroney, and 8 years for Mr. Martin under Prime Minister Chretien. There have been other Ministers of Finance during this period, but their tenures were relatively short.
Both Mr. Wilson and Mr. Martin established credible policy legacies during their tenures as Ministers of Finance. Mr. Wilson introduced major reforms to the personal and corporate income tax systems, replaced the federal manufacturers’ sales tax with the Goods and Services Tax, privatized several Crown corporations, and helped negotiate NAFTA. These were major structural reforms, which had a positive impact on economic growth, especially over the medium and long term. Many questioned the timing of these initiatives, given the economic and fiscal environment at that time. But he persisted, believing in their long-term economic benefits.
Mr. Martin averted a major fiscal crisis, eliminated the deficit in three years, reduced the government’s debt, strengthened the Canadian banking system, and reformed the Canada Pension Plan. With the deficit eliminated and with growing budget surpluses, he also implemented major structural reforms, especially in education, research and innovation. He also put transfers to the provinces on a more sustainable basis and began the progress of lowering personal and corporate income taxes in the 2000 budget.
So far your legacy after 7 years is not that credible. Fortunately, you still have three more budgets through which you can enhance your legacy as Minister of Finance. More importantly in the 2013 budget you could be forecasting surpluses beginning in 2015-16. How you use these future surpluses will go a long way to determining not just your credibility, but also the government’s credibility, in the lead-up to the 2015 election.
At the start of your current round of budget consultations, you asked Canadians for suggestions on how to “strengthen our economy in the face of global economic threats”; with “cost-neutral or low-cost measures”, focusing on “more efficient and effective spending” that builds on the “government’s belief of respecting taxpayers’ dollars” and “encourages private sector growth and leadership”. These are pretty much the same questions that you raised in last year’s pre-budget consultations.
Since the recession, the Government has had a number of expenditure review exercises focusing on eliminating waste and inefficiencies. Now you are asking Canadians to identify even more. Were the previous expenditure review exercises a failure? How often can the government go to the “efficiency/effectiveness well” before one finds it is bone dry?
The real purpose of your budget consultations seems to be an opportunity for photo ops, quotes, and conditioning for the upcoming budget? We note that the Prime Minister has now decided to get into the pre-budget consultation exercise. Rarely do your “public” consultations ever lead to any policy actions. In fact, in the past most major fiscal actions have been taken without consultation.
For example, you did not consult with your provincial counterparts before announcing the change to the Canada Health Transfer escalator? In fact it wasn’t even an item at the federal/provincial finance ministers’ meeting. You caught everyone by surprise.
Did the Prime Minister consult with Canadians before announcing that the elderly benefit system was financially unsustainable and the age of eligibility had to be raised? No he didn’t, even though the Department of Finance had concluded in its own analysis that the system did not threaten the long-term financial sustainability of the federal government.
What about the House of Commons Standing Committee on Finance? In its 2011 pre-budget report, the Finance Committee recommended that the government take action to simplify the tax system. So far nothing has happened, notwithstanding that tax simplification would meet all the criteria that you have set out. In 2011, the Finance Committee recommended major changes to the Scientific Research and Experimental tax credit. The 2012 budget included only small tinkering that tax experts agree will have no positive affect.
On December 12, 2012, the Finance Committee tabled its pre-2013 budget consultations report “Jobs, Growth, Productivity and Demographic Change: Challenges and Opportunities for Canada”. The Committee report contained sixty recommendations covering a wide range of areas. Once again the Committee recommended that the Government undertake a comprehensive review of the tax system and proposed that a royal commission be established. Will you once again ignore this recommendation?
We have responded to your requests for pre-budget submissions for each of the past four budgets (www.3dpolicy.ca). Not surprisingly none of our recommendations have been acted upon. We have worked as policy advisers to several Ministers of Finance for over thirty years. During that time we were fortunate to have Ministers of Finance who wanted to hear advice and engage in discussion, before they made their decisions. It is this policy discussion and debate that eventually leads to good policy decisions.
We are, therefore, once again forwarding to you our pre budget submission. Some of our recommendations have been forwarded to you before. We are submitting them again, because we believe the issues are important enough to bear repeating, more discussion, and eventually maybe even acceptance.
Our most important recommendation is that you implement a “real strategy” to support economic growth and job creation and not focus on more tax expenditures. Private sector demand and economic growth are slowing and the unemployment rate remains stubbornly high at 7.2 percent. Despite this, your sole goal is to eliminate the deficit by 2015-16, even though there is no fiscal crisis. Indeed there is no serious fiscal problem at all. Your own budget forecast numbers show the deficit declining rapidly and the debt burden falling. In our recommendation we suggest a strategy, which could provide resources to fund tax reductions and/or new investments to modernize Canada’s infrastructure. This strategy would strengthen economic growth, and create jobs, while maintaining a sustainable fiscal structure.
We also make a number of simple but important recommendations, which if implemented would go a long way to restoring transparency, accountability, and credibility to the budget process. These recommendations, which would be easy to implement, would contribute significantly to restoring your legacy as a Minister committed to these principles.
Make Sure the Budget is Based on Realistic Assessment of Economic Prospects
The IMF report to the G-20 at its meeting last November in Mexico observed, “A modest reacceleration of activity is expected, assuming policies are sufficiently supportive. Recent developments so far support staff’s projection of a slow reacceleration of growth. The WEO’s forecast of a pickup in activity is however predicated on two critical assumptions. The first is that policies are implemented decisively in the euro area to gradually restore confidence and ease financial conditions. The second assumption is that U.S. policymakers will effectively avoid the fiscal cliff and raise the debt ceiling. Absent such actions, the world could slide into another downturn, with deep recession in the euro area periphery, and contraction or stagnation in the core and other advanced economies.”
Uncertainty with respect to global economic prospects has not diminished since then. The EURO area is in recession for the second year and any significant strengthening in economic growth in the next year or two seems remote. EURO leaders have shown some progress in “committing “to institutional reform and there has been some shrinkage, or at least no worsening, in bond yields in the peripheral countries. Institutional reforms will take years if not decades to implement and so will the internal structural reforms necessary to restore competitiveness within the EURO area. Don’t expect much support for global economic growth from the EU for some time.
For the rest of the G-7, both the U.K and Japan are in recession and no one really knows for how long. The U.S. partially escaped a self-imposed “fiscal” cliff only to run into the self-imposed “debt ceiling cliff”. It remains to be seen if and when the U.S. will actually get around to dealing with its longer-term fiscal problems and economic challenges. It seems somewhat ironic the G-7 is now confronted with dysfunctional decision-making in the EURO area, the U.K., Japan, and the U.S. I think your claim that “Canada is the best in the G-7” will be good for some time, primarily because of the failure of politicians in the G-7 countries to act.
This is unfortunate since Canada’s economic prospects depend critically on the U.S. and to a somewhat lesser extent on those in Europe and Japan and those prospects don’t seem that good. Nor do the prospects in emerging market countries look very strong. The same IMF report above concluded “G-20 emerging economies will remain an engine of growth, but the rate of expansion is expected to drop to 5.6 percent this year from 7.1 percent in 2011, before rebounding to 6.2 percent in 2013. However, growth could be much lower if either of the two critical policy assumptions is not satisfied.”
This kind of conditional outlook is not promising for Canada. Canada’s economic growth has been slowing and forecasts are being reduced. The Deputy Governor of the Bank of Canada, just recently expressed his concern about Canada’s economic prospects.
In your Fall Update the private sector average forecast was for growth of 2.1 per cent in 2012 and 2.0 per cent in 2013. The forecast for 2013 was down significantly from the Budget 2012 forecast of 2.4 per cent. But even this outlook is based on those key policy assumptions in the EURO area and the U.S. mentioned in the IMF report. Just as important there was a significant deterioration in the terms of trade since the spring of last year as a result of falling energy and commodity prices. This had a significant impact on the budgetary revenues and the deficit.
You will soon be meeting with your group of private sector forecasters to get their view of economic prospects. We have recommended, in the past, that you use the Department of Finance’s forecast, in part because the Department has greater expertise, and in part because the Department’s forecasts have been shown to be more accurate by independent reviewers. No doubt you will continue to use the private sector average. We would still recommend that you provide more detail on the components of both the economic and budget forecast, to allow for independent review and analysis.
Put Ideology Aside: Adopt a Pro-Growth/Pro-Jobs Policy Strategy.
You have commented that the 2013 budget will be a “bare-bones’ budget. By this you presumably mean a budget without much, if any, new spending. Given your government’s ideological commitment to smaller government and to eliminating the deficit by 2015-16, this is not surprising. Despite the rhetoric of the government that it is committed to jobs and growth, the reality is that there is no such strategy. The government, for example, allowed another increase in the EI premium rate in January, an action that hardly promotes job creation. The government allowed this increase because it needs the EI revenue to hit its deficit elimination target. The only goal of this government is to eliminate the deficit.
In your request for public consultations, you asked for suggestions that would be “cost-neutral and encourage private sector growth and initiative”. In our submission to you last year, we recommended that the government undertake a substantive review of tax expenditures with the goal of simplifying the tax system. Last December, the House Standing Committee on Finance recommended that the government create a Royal Commission to review the tax system.
We are sure that you understand that the current personal and corporate tax systems have become overly complex and inefficient. Today the current tax system, with the addition of the latest technical tax bill, is close to 4,000 pages including regulations and commentary. The income tax system distorts market decisions, creates inefficiencies, and reduces productivity and economic growth.
Your government has constantly claimed that it is the government of lower taxes. Indeed you have lowered taxes, although not the right ones. In addition, you have unfortunately also chosen to provide special tax expenditures for specific groups, picking winners and losers, which have only added to the complexity of the tax system without enhancing economic growth or tax fairness.
We recognize that there have been few attempts at tax simplification because tax simplification comes at great political risk. Tax simplification means eliminating special tax expenditures for specific groups, individuals, industries, and sectors that can no longer be justified or were never justified in the first place.
A tax simplification review would take time and require political commitment. But the payoff in financial and economic terms would be substantial. A conservative estimate would be that tax simplification could yield savings of almost $6 billion annually.
This could be re-invested in the economy to support economic growth through lower income taxes for all middle-income Canadians, or by allocating the savings to modernize Canada’s infrastructure.
Both you and the Prime Minister have stated that were there to be another global recession the government would be prepared to implement a second round of temporary stimulus spending. We agree that this would be the appropriate policy response. The 2011-12 deficit of $26.2 billion is only 1.5 per cent of GDP and there is plenty of fiscal room to take appropriate fiscal action.
In the past, you have stated that the government has done all that it could to support the private sector and that it was now up to the private sector to step up and support economic growth. Both you and the Governor of the Bank of Canada have lectured and criticized the private sector for having too much “dead capital”.
The reality is that the private sector support for economic growth is very weak. The trade sector is recording record deficits; households are cutting back on their borrowing, which is what the government and the Bank of Canada want; the housing sector is weakening steadily; the federal and provincial governments are withdrawing support for growth; and companies are worried about economic prospects and are not expanding.
The Bank of Canada’s estimate of the output gap for the third quarter of 2012 was 0.8 per cent of GDP. The unemployment rate for the third quarter was stalling out at 7.2 per cent. With forecast growth of 2 per cent, neither the output gap or unemployment rate can be expected to decline in the next two years. And the risks are clearly on the downside that the output gap will widen and the unemployment rate will increase. Despite this, you seem to be quite satisfied that there is nothing for the government to do. As we said in an earlier blog on www.3dpolicy.ca, you have set policy on autopilot.
The only sector that has the fiscal capacity to provide support to the economy is the federal government, but your ideology and commitment to eliminating the deficit by 2015-16 is preventing you from doing so.
We believe that the Government should put aside its sole policy commitment of eliminating the deficit by 2015-16, and introduce a medium-term strategy to support job creation and economic growth. The federal government has the fiscal room to act to support such a strategy. There is no fiscal crisis. There is not even a serious fiscal problem. Your own fiscal numbers show this to be the case. In your most recent budget forecast the deficit in 2015-16 is forecast to be only 0.1 per cent of GDP. Even if you are unwilling to simplify the tax system you could start a new medium-term program to modernize Canada’s infrastructure. A 10-year program at $5 billion a year would only raise the deficit to 0.3 per cent of GDP in 2015-16. The deficit would likely be surplus the following year. However, combining this with annual savings from tax simplification of $6 billion would give the government the resources to both cut income taxes for middle-income Canadians and modernize Canada’s infrastructure.
Yes the year of deficit elimination would be delayed, perhaps by one year, and yes Canada’s debt would rise. But the debt burden would fall, productivity would increase, jobs would be created and the unemployment rate would decline. Without this you will be stuck with an unemployment rate of 7 per cent or higher when the next election comes around.
You have said over and over that the priority of the Government is jobs and growth. Now is the time for real action and not just slogans.
Provide Leadership for Canada Inc. (Canada and the Provinces)
Whether you like it or not, Canadians see you as the lead Finance Minister for Canada Inc. (federal and provincial governments) and as such you have a responsibility to provide leadership for all governments in dealing with long-term structural issues. The reality is that there is a growing federal-provincial fiscal divide in Canada. Although the federal government is not facing a serious long-term fiscal sustainability problem, the same cannot be said for the provinces.
According to the Parliamentary Budget Office (PBO), the fiscal structure of the provincial-territorial government sector is not sustainable (Fiscal Sustainability Report 2012), given their current debt structures and the pressures that they will face from an ageing population. Provincial governments are now facing the choice of cutting services and/or raising taxes.
What is emerging is a widening “fiscal divide” between a federal government with its diminished size and sound finances, and provincial governments with growing fiscal imbalances resulting from growing spending pressures (e.g., for health, education, infrastructure) and slowing economic growth and revenue growth. This growing federal-provincial “fiscal divide” is not sustainable. Unfortunately, at the present time Canada Inc. is without economic and financial leadership. This is a void that you can and should fill.
One of the benefits of having a sustainable fiscal structure is that it provides a government with the fiscal flexibility to respond to critical policy issues. As we have said above, the federal government now has that flexibility, and the provinces don’t. The federal government needs to start using its fiscal flexibility to refocus its policy priorities to help narrow the federal-provincial “fiscal divide”.
Fix the Timing of the Budget
This is an easy recommendation for you, and it is one that would significantly improve the budget process, budget understanding and Parliamentary accountability. The issue here is the relationship between the Budget and the Main Estimates.
Under current “supply” rules, Main Estimates for the upcoming fiscal year must be referred to the standing committees before March 1st. For the Main Estimates to be relevant, they should be based on the economic and fiscal assumptions in the Budget. This implies that the Budget should be tabled in late January or in early- to mid-February, in order to give the Treasury Board Secretariat time to make the Main Estimates consistent with those presented in the Budget.
Budget 2012 was tabled on March 29, 2012. This meant that Main Estimates, which were tabled by March 1, 2012, were based on economic assumptions presented in the Fall 2011 Update and not in the 2012 budget. It also meant that the expenditure cuts contained in that budget were not included in Departmental spending estimates.
As a consequence, Parliament was asked in June to approve Department spending estimates without knowing exactly what Departments were planning to spend. Five of your seven budgets have been tabled after the Main Estimates.
All this could be avoided if the government simply committed to tabling its budget before the middle of February. We recognize that the fourth quarter GDP numbers might not be available at the time of the budget. However considerable economic and financial data would be available and remaining uncertainty could be allowed for in the “risk adjustment” factor included in the budget.
Provide Greater Transparency and Accountability in Budget Planning; Save the Parliamentary Budget Office (PBO)
For years, we have been urging the government to be more transparent in its budget planning. After all, the government promised greater transparency and accountability in its Federal Accountability Act. Unfortunately, this has not turned out to be the case.
The government has consistently refused requests by the Parliamentary Budget Officer for data. Only recently did the Department of Finance release a study on the long-term sustainability of federal government finances – a study that had been promised in 2007. And it did so only after the Auditor General of Canada brought this issue to light.
However, it only released information relating to the federal government, even though it promised in 2007 to present analyses on the total government sector. The Auditor General has also recommended that the federal government provided long-term sustainability analyses for the total government sector. The International Monetary Fund in its November 2012 report to the Minister also recommended that the Department of Finance publish sustainability analysis for the total government sector.
To date, you have refused to do so. For some mysterious reason you seem more intent with not providing the public with information, rather than engaging Canadians in discussion on critical policy issues. Why would you not provide this information? The analysis already exists in your Department.
Given this lack of transparency, the PBO has proven to be a credible resource to Parliament and Canadians. The term of the current Parliamentary Budget Officer expires in March 2013. The next PBO will need to be someone who understands the budgetary and estimates processes and is willing to stand up to his/her major critics – the Government.
In the 2006 election campaign, the Conservative Party promised an independent office, reporting to Parliament with virtually full access to all relevant information. The government has consistently opposed this; the legislation creating the PBO fell far short of that commitment. It is time that the 2006 election commitment is honored and that the PBO become an officer of Parliament.
We have never understood your desire, and indeed the desire of the government, to fight with the PBO from its very beginning. In fact in many of these disagreements with PBO your attacks have become personal rather than professional disagreements. This is unbecoming a Minister of Finance. The fact is that the PBO has turned out to be right in every disagreement with you. Unfortunately, this has reduced your credibility and the credibility of the Department.
We would strongly recommend that you work with the new PBO (assuming there will be one), even when there is a disagreement. Your Department is more than capable of engaging the PBO in a professional debate. It will, however, require a greater degree of transparency by your Department and the government. Why did the government delay five years before releasing its analysis on long-run fiscal sustainability? Why not give the PBO the data requested on Departmental cuts? The Liberal government in 1995 made that data on departmental cuts public, and that provided credibility to the expenditure restraint exercise. What have you got to lose, unless of course the information doesn’t exist or it would contradict government statements?
These illogical fights with the PBO inevitably end up making the Government look like it has something to hide and cannot be trusted. Both your credibility and the credibility of the government have suffered as a result.
Provide a Reconciliation of Government Spending Estimates
No one in Parliament, or in the government, can tell Canadians what the government is planning to spend. If you, who is responsible for budget spending and the President of the Treasury Board, who is responsible for the Main Estimates, were both asked about government spending plans, two different answers would be given.
The two of you have no idea what the government is planning to spend. In the budget, program spending is forecast to go up and in the Main Estimates tabled in the same month spending is forecast to go down.
There are explanations for these differences including different accounting concepts and different definitions of what constitutes spending.
There is no reason why the Main Estimates of government spending cannot be on the same basis as the Budget estimates of expenses. Until this is done a detailed reconciliation of any difference between the Budget and the Main Estimates should be provided in the Main Estimates. The last time such reconciliation was provided was in the March 2007 Budget.
Stop Throwing Parliament under the Budget “Omnibus”
The two budget Bills associated with 2012 budget were a disgrace, and an insult to Parliament and Canadians. The use of Budget Omnibus Bills has grown to the point that they seriously undermine the credibility of the budget process and the authority of Parliament. Little information is provided in the Budget, so it has become impossible in reading the budget documents to fully understand what the government is actually proposing to do. There is a clear lack of transparency and accountability.
There is an urgent need to restore the role of Parliament and its committees in assessing, reviewing, and approving proposed legislation. Without sufficient information and clear intention of the proposed initiatives, Parliament and its Committees cannot properly assess the budget. Parliamentary debate is stifled, public involvement ignored and the implementation of good public policy prevented.
The budget needs to be much more explicit on the proposed policy initiatives, providing sufficient details and background information on the proposed initiatives for Parliamentary assessment and for a better understanding by the public at large. Budget Omnibus Bills should be restricted to proposed tax changes only and all proposed spending initiatives should be presented either through the Main Estimates or through separate legislation, submitted to the applicable Parliamentary Committee for review.
Given the vagueness and opaqueness of the 2012 budget and the size and breadth of the two budget ominous bills it is hard for us to understand how a Minister of Finance and the Department of Finance could agree to them.
It is your credibility, as Minister of Finance, that suffers when this happens.
We can only hope that this won’t repeat itself in 2013.
Mr. Wilson and Mr. Martin had significant independence and control in creating their legacies as Ministers of Finance. It appears to us, on the other hand, that much of your legacy so far, has been imposed upon you.
Unlike your predecessors, your legacy so far is one of a Minister of Finance who inherited a surplus and immediately eliminated it with a two point cut in the GST, against the advice of all economists (including the Finance Department), except one - the Prime Minister. The reductions in the GST were clearly political and not economic in nature. You inherited a strong financial system, which you tinkered with somewhat. You freely lectured other Ministers of Finance, both internationally and provincially, but rarely worked constructively with them.
It was you, along with the Prime Minister, who in the fall of 2008 stated that the country would avoid a recession and never go into deficit. We all know what happened after that. You were subsequently forced to become “Keynesian” and bring in a budget, which introduced a major temporary stimulus program. This was the correct decision, but it was one that was imposed upon you by political survival and the G-20. In your 2010 and 2012 budgets you introduced cuts in spending designed to eliminate the deficit over the “medium-term”. This seems to have become the only achievement that you want for your legacy.
We believe that there is an opportunity for you to achieve much more. There is a need now for the federal government to take action to support medium-term growth and job creation, while maintaining a long-term sustainable fiscal framework. The government has the fiscal flexibility to do exactly that.
In your remaining budgets you will need to take actions to restore the authority of Parliament and to recommit to the principles of transparency, accountability, and responsibility that the government so strongly argued for six years ago, but subsequently failed to apply.
We hope that you turn off the policy “autopilot” and take action.
C. Scott Clark