ELIMINATING THE DEFICIT JUST GOT EASIER
The Department of Finance released the final audited financial results for 2012-13 in its Annual Financial Report (AFR). The deficit for 2012-13 was $18.9 billion; $7.4 billion lower than the deficit for 2011-12. More importantly, the deficit for 2012-13 was a whopping $6.9 billion lower than the March 2013 Budget forecast of $25.9 billion. This large difference leads to two conclusions: first, fiscal forecasting by the Department of Finance has lost all credibility, and second, the Government is on track to meet its balanced budget commitment for 2015-16 if not sooner.
Change from 2011-12
Most of the year-over-year improvement in the deficit was due to higher revenues, up $7.5 billion and lower public debt charges (down $1.9 billion). Among the major revenue components, personal income taxes increased by $5.2 billion (primarily reflecting a 4.5% increase in wages and salaries with a progressive tax system), corporate income taxes were up $1.3 billion (despite the fact that net operating surplus for corporations declined and the general tax rate declined from 16.5% in 2011 to 15% in 2012), sales and excise taxes were up $0.4 billion (reflecting weakness in GST collections and a decline in other excise taxes and duties), and employment insurance (EI) premiums rose by $1.8 billion (both the EI rate and insurable earnings subject to the rate were higher). “Other revenues” declined by $1.1 billion, due to lower earnings in all the major components, including offshore royalties and Crown corporation profits.
Dampening the impact of the significant improvement in budgetary revenues was a $2.1 billion increase in program expenses, reflecting the inclusion of a $2.1 billion provision for AECL’s environmental liabilities. Among the major components, major transfers to persons were up $1.9 billion, reflecting higher elderly benefit payments, partially offset by lower employment insurance benefits. Major transfers to other levels of government were up $1.6 billion, due to higher transfers in support for health and other social programs (up $2.1 billion) and for fiscal arrangements (up $0.3 billion). In contrast, transfers to cities and communities were down by $0.2 billion and other transfers were down $0.6 billion, due to lower payments under the Offshore Accords.
Direct program expenses, which include other transfers payments, expenses of Crown corporations, and departmental operating and capital expenses, were down $1.4 billion. Other transfers payments declined by $2.9 billion, primarily due to the ending of the stimulus programs under the Economic Action Plan. Crown corporation expenses were up $1.3 billion. However, as noted above, this includes a $2.1 billion environmental liability for AECL. Defense expenses were up marginally, while all other departmental and agency expenses were down slightly, reflecting the impact of the restraint measures introduced in the 2010, 2011 and 2012 budgets. Public debt charges increased by $2.0 billion, as an increase in the stock of debt was more than offset by the effect of lower average effective interest rates.
Why was the Budget 2013 Deficit Forecast so Wrong?
The March 2013 Budget forecast the deficit for 2012-13 at $25.9 billion. The final audited outcome for 2012-13 was $18.9 billion, $6.9 billion below the Budget forecast. Budgetary revenues were $1.9 billion higher, but the biggest difference was in program expenses, which were $5.2 billion lower than forecast in the March 2013 Budget. No detailed explanations were provided by the Department of Finance as to the reasons for these differences.
All of the higher-than-expected budgetary revenues were due to corporate income tax revenues (up $2.0 billion). This was surprising given the reduction in the general corporate tax rate and the sluggishness in corporate operating surpluses in 2012.
Direct program expenses were $4.9 billion lower, accounting for most of the lower-than-forecast for total program expenses. Within direct program expenses, other transfers were $1.5 billion lower-than-expected, Crown corporation expenses were $1.4 billion lower while other departmental and agency expenses were $2.0 billion lower. These components have been overestimated in past budgets as well.
Until more details are provided by the Department of Finance and/or contained in the upcoming Public Accounts, it is difficult to assess what factors accounted for lower-than-forecast direct program expenses. This is a very large forecast error. It appears that either the Department of Finance is unable to forecast direct program expenses, or the Minister of Finance has adopted the previous government’s approach of ensuring that his deficit targets are met or bettered by “hiding” extra prudence in his budget forecasts – an approach he criticized the previous government for.
What Does This Mean for Eliminating the Deficit in 2015-16?
The final audited outcome for 2012-13 is extremely good news for the Minister of Finance. It is expected that most of the better-than-forecast outcome will carry forward in 2013-14 and beyond. The Minister of Finance is currently forecasting a deficit of $18.7 billion for 2013-14, an improvement of only $200 million from the final audited outcome for 2012-13. As noted above, the outcome for 2012-13 includes an extraordinary charge of $2.1 billion for AECL’s environmental liabilities. As such, the underlying deficit outcome for 2012-13 is $16.8 billion.
All indications are that the deficit for 2013-14 will be significantly lower than forecast in the 2013 Budget.
According to the March 2013 Budget, the impact of the incremental restraint measures for 2013-14 announced in previous budgets are estimated at $4.3 billion for 2013-14. Second, it is expected that most of the better-than-expected outcome for 2012-13 will carry forward into 2013-14 and beyond. If these two factors are realized, the 2013-14 deficit could be up to $11.2 billion lower than the underlying deficit for 2012-13. This meansThis means that the Government is on track to meet its balanced budget commitment for 2015-16 if not even earlier.
These results should make Minister Flaherty’s Fall Economic and Fiscal Update very interesting reading.
The final results for 2012-13 and their implications were known to the Government before the Speech from the Throne. Given that direct program expenses came in much lower than expected, why did the Government announce in the Speech that it intended to freeze departmental operating budgets? Or for that matter why did the Government make a commitment to introduce balanced budget legislation when the deficit is disappearing faster than expected? Obviously, they are being done for political reasons only.
An Accounting Policy Change to Settle the Sick Leave Credit Issue
The Government announced in the Annual Financial Report that it had recorded retroactively its obligation for the accumulated sick leave entitlements of its public sector employees that are anticipated to be used in the future. This has had the effect of increasing the federal debt by $1.4 billion and the deficit in 2012-13 by $0.1 billion.
The Government indicated in the March 2013 Budget that it would be examining its sick leave management practices with a view of ensuring its employees receive appropriate services that support a timely return to work . By retroactively including an obligation for sick leave credits, the Government can now negotiate a restriction on sick leave credits with compensation without any direct impact on the budgetary balance. A clever move.