BUDGET 2013: BY "HOOK" OR BY "CROOK" - A BALANCED BUDGET IN 2015-16
There were no surprises in Budget 2013. Minister Flaherty had done an excellent job of pre-conditioning on what to expect: a commitment to eliminate the deficit by 2015-16; no new “risky” spending; some funding for infrastructure and skills training; and further restraint measures to offset revenue losses due to slower economic growth in 2013. But is this the right budget for the current economic circumstances and is the plan to eliminate the deficit in 2015-16 credible? The answer to both these questions is no.
This budget, like most of the budgets since 2006, is remarkable for its lack of vision and boldness. There is no narrative that sets out the longer-run economic and social challenges, and there is no discussion of how these challenges are interrelated
Eliminating the deficit has been the cornerstone of the government’s fiscal policy since 2010. It is a political commitment, geared towards its base. The imperative is to show, either by hook or by crook, a balanced budget in 2015-16. This would be fundamental to the next election, currently scheduled for the fall 2015, as it would allow the government to tell Canadians that the era of deficits is behind them. However, whether they will actually meet that commitment will not be known until the fall of 2016, when the Public Accounts for 2015-16 are tabled in Parliament, long after the election. Canadians should not be fooled by unfounded claims about deficit elimination.
Currently, the federal government does not face a fiscal crisis or even a serious fiscal problem. The size of the federal government relative to the size of the economy is substantially smaller than in the 1970s, 1980s and 1990s. According to the budget, program spending as a percent of the economy is forecast to be roughly the same as it was prior to the 2008-2009 financial crisis. The debt-to-GDP ratio stood at 33.8% in 2011-12 and was already projected to decline before the 2013 budget. The deficit was also projected to be eliminated before this budget, and still would have been, only perhaps a year later, in 2016-17. In other words, the government already had a sustainable fiscal structure even before the 2013 budget.
The real issue that was not addressed in the budget is the absence of any economic engine to spur a recovery in growth in 2014 and beyond, The household sector is deep in debt; housing construction has stalled; companies lack confidence and are not investing; the federal and provincial governments are in serious restraint mode; and the export sector is weak and deteriorating. Minister Flaherty should have delivered a budget that recognized these economic realities and introduced measures that would have helped strengthen a weakening economy. The federal government has the fiscal capacity to do this without jeopardizing its long-run fiscal sustainability. Unfortunately political ideology triumphed over common sense.
Don’t Worry Everything is Going to Get Better
Economic growth was lower-than-expected in 2012 and private sector economists expect this to carry forward into the first half of 2013. However, they then forecast a re-bound in growth in the latter half of 2013 and this strength carries forward to 2017. The government has used this same forecast story in the past several budgets, but it has yet to happen. So why do private sector economists feel so confident it will happen this time around? Why should Minister Flaherty adopt this view as a basis for his budget planning? Why is Minister Flaherty prepared to risk his fiscal credibility on their advice, which has proven so wrong in the past?
Budget 2013 continues to use the average of the private sector economic forecasts for budget planning purposes. There is no discussion in the budget on the range of the private sector views, so it is impossible to assess the risks inherent in this “average” forecast. A strong recovery in the Canadian economy in the latter part of 2013 and continuing through 2014 would require that: the U.S. “miraculously” finds political harmony in Congress and solves its fiscal problems; that the EURO area “magically” discovers political unity among 17 countries; that Japan suddenly emerges from a decade of no growth; and that China, finally embraces a non-intervention exchange rate system and adopts policies to promote consumption led growth. A recovery in growth would also require a major turnaround in consumer and investor confidence.
Hope springs internal, but unfortunately there is little basis for hope.
Ignoring Economic Uncertainties is not a Prudent Way to Plan a Budget
As noted, there are a number of downside risks to the economic forecast. These are the same as in previous budgets/updates. These risks have now become reality in 2013. As a result, the average of the private sector economists’ forecast for nominal GDP has been adjusted downwards by $20 billion per year, identical to what was done in the November 2012 Update.
We continue to applaud the inclusion of the “adjustment for risk” in the economic and fiscal forecasts. This recognizes that forecasting is more of an art than an exact science. However, experience shows that risks increase over time, and the “adjustment for risk” included in the budget should reflect this. Increasing the “adjustment for risk” over time could increase the fiscal impact from $3.0 billion in 2012-13 to $9.0 billion in 2016-17. Such a profile would delay the elimination of the deficit to 2016-17, unless the adjustment for risk is not required. A constant “adjustment for risk” over the planning period seriously undermines the likelihood that the deficit will be eliminated in2015-16.
How Does the Government Plan to Eliminate the Deficit?
For 2012-13, the deficit is now estimated to improve by $25.9 billion, virtually unchanged from a deficit of $26.0 billion forecast in the November 2012 Update and from the final outcome for 2011-12. An incremental $2.4 billion was “booked” in 2012-13 for AECL’s environmental liabilities.
However, the slower-than-expected economic growth in 2013 and the accompanying lower level of nominal income in 2013-14 results in a “status quo” (before budget actions) deficit of $18.7 billion Subsequently, the status quo budgetary balance is actually lower that forecast in the November 2012 November Update. The deficit falls to $7.2 billion in 2014-15, compared to $8.6 billion in the November 2012 Update. A balanced budget is forecast for 2015-16, with increasing surpluses thereafter.
This improvement in the budgetary balance is the result of two factors: first, the projected rebound in economic activity in the latter half of 2013 and continuing in 2014; and second, by an increase in the forecast of the “lapse” (the amount of money departments/agencies are not expected to spend related to their approved budgets) by a about $2 billion a year. This is reflected in an equivalent reduction in program spending.
The lapse adjustment is a “painless” way to balance the budget. The Budget justifies the increase in the lapse due to the experience in 2011-12, where departments/agencies spent approximately $10 billion less than they were authorized by Parliament. However, most of this resulted from delays in getting infrastructure and other capital funding out in time. However, the analysis on the lapse was done on a Main Estimates basis. The Estimates are on a cash basis whereas the Budget is on an accrual basis of accounting. As a result, much of the Estimates based lapse would not be reflected on an accrual basis. In addition, as we have argued in previous blogs, the restraint measures introduced since Budget 2010 would have lowered the lapse, given that departments/agencies would be required to operate closer to their approval levels.
In other words, the deficit is being eliminated: first, by simply assuming a rebound in economic growth by ignoring economic and political uncertainties; and second, by simply assuming that government departments will not meet their approved spending levels. Both of these factors raise serious doubts about Minister Flaherty’s revenue and spending forecast, and the likelihood that the deficit will be eliminated by 2015-16.
Budget Measures, a Lot of Talk and Tinkering
As expected, the Budget announced an extension of the Canada Building Fund and PPP Canada. Funding for these initiatives was already earmarked in the November 2012 Update, so there was no incremental impact on the fiscal track. As widely speculated in the media, the government is proposing changes to the Labour Market Development Agreements (LMDA). However, proposed changes still need to be negotiated with the provinces. There is no fiscal cost associated with these changes as LMDA costs are fully funded through employee/employer employment insurance premiums. Incremental funding is being proposed to address a number of First Nation’s priorities. And keeping with themes of previous budgets, the Government continues to pick winners and losers by proposing new tax expenditures.
The net cost of the proposed initiatives is about $1 billion in 2013-14, rising to $1.7 billion once fully implemented.
With the exception of the Canada Revenue Agency (CRA) and the Department of Fisheries and Oceans, departments/agencies were spared any further cuts. Instead, the Government sets CRA loose on tax cheaters by closing a number of loopholes and increasing enforcement and compliance. Changes are also proposed to modernize Canada’s General Preferential Tariff Regime. These changes result in savings of $0.4 billion in 2013-14, rising to $2.1 billion by 2017-18.
As a result, a deficit of $18.7 billion is now forecast for 2013-14 and $6.6 billion for 2014-15. A surplus of $0.8 billion is forecast for 2015-16, rising to $5.1 billion in 2017-18.
Will Parliament be thrown under the “Omnibus “ again? - Probably
The Budget Plan was once again a brick – totalling nearly 450 pages. But as in previous budgets, little detailed information was provided, making it extremely difficult to fully understand what the government is actually proposing to do. When a budget says, “the government will introduce legislation as needed to consolidate operations and eliminate redundant organizations” best to be nervous. There was again a clear lack of transparency and accountability. Parliamentarians and Canadians will have to wait for the tabling of the Budget Omnibus Bill to see what is actually planed.
As we argued on numerous occasions, the budget needs to be much more explicit on the proposed policy initiatives; providing sufficient detail and background information for Parliamentary assessment and for a better understanding by the public at large. Budget Omnibus Bills should be restricted to tax changes only and all proposed spending initiatives should be included in the Estimates or through separate legislation and referred to the applicable Parliamentary Committee for review.