QUELLE SURPRISE: A LARGE SURPLUS IN 2015-16
On Tuesday, Finance Minister Flaherty released his Update of Economic and Fiscal Projections. As had been widely speculated, the government is now forecasting a surplus of nearly $4 billion for 2015-16, almost $3 billion higher than expected in the March 2013 Budget. Hardly a surprise since the government is betting its political future on eliminating the deficit in 2015-16 and being in a position to implement the tax initiatives promised in the 2011 election.
The government needs a larger enough surplus to fulfill these election commitments. The surplus in the March 2013 Budget simply wasn’t large enough.
As clearly demonstrated when the final financial results for 2012-13 were released, there appears to be lots of wiggle room so that the government would be able to announce a larger surplus in 2015-16. The only question was how large? The final financial results for 2015-16 will not be released until the fall of 2016 - a year after the 2015 election. Until then, the government can project whatever it wants for a surplus in 2015-16.
It is important, however, to understand just how Minister Flaherty is creating this “needed” surplus. The level of nominal gross domestic product (GDP) – a broad measure of the federal tax base – is now lower than forecast in the March 2013 Budget, resulting in lower revenues. Yet the surplus for 2015-16 is significantly larger than forecast in the March 2013 Budget. Just how did the he pull this forecasting trick off?
The Update contains a table (page 46) detailing the changes in the fiscal forecast since the March 2013 Budget. Three factors stick out for 2015-16: a reduction in direct program expenses ($1.6 billion), operating budget freeze ($1.1 billion) and asset sales ($1.5 billion). These increased the surplus by $4.2 billion in 2015-16. The forecast reductions in budgetary revenues and the freeze in employment insurance (EI) premium rates were more than offset by lower EI benefits and public debt charges.
The reduction in direct program expenses is attributable to an increase in the “lapse” – under spending by departments and agencies relative to what was approved or appropriated by Parliament. As departments/agencies cannot exceed their appropriations, they usually spend less. In deriving its forecast for direct program expenses, the Department of Finance incorporates an estimate of the lapse, thereby reducing the level of direct program spending accordingly. The lapse has increased significantly in recent years due to the one-time stimulus measures included as part of the Economic Action Plan. However, many of these programs are now being phased out, so they should have little or no impact on the lapse in future years. In addition, the lapse analysis, provided in the Update, is based on cash appropriations and spending by departments and agencies. However, the Budget projections are on an accrual accounting basis. As a result, under spending on capital projects, which contributed significantly to the increase in the cash lapse in recent years, have only a marginal impact on an accrual basis. As argued in the past, there needs to be a detailed reconciliation between the spending estimates tabled by the President of the Treasury Board and the Budget. Only then can one assess whether or not there is a justification for an increase in the lapse going forward. The “lapse” estimate used in the Update is meaningless.
In the Speech from the Throne, the government announced that it would “freeze the overall federal operating budget, which will continue to restrain hiring”. In the Update, the Finance Minister announced that the freeze would be for two years – 2014-15 and 2015-16. Departments and agencies will once again be required to absorb any wages increases established through collective bargaining. No details were provided as to how departments and agencies would find the required offsets. How realistic is this restraint measure?
First, it will depend upon the timing of the collective agreements and the amount of the wage/salary increases. There is no guarantee that the collective agreements will be concluded in the time period specified. More often than not, few collective agreements are concluded within the time frame specified.
Second, it will depend on the nature of the agreements – how much will departments and agencies need to absorb.
Third, little detail has been provided to date on the restraint measures introduced in previous budgets. Many of the announced savings were to come through “efficiency” savings. The Parliamentary Budget Officer requested details on the impact of these measures with little success to date. How often can one go to the “efficiency well” before they find out it is completely dry? How confident is the government that these new savings can be realized? The estimate of the savings from “freezing the operating budget” is very uncertain.
Finally, Minister Flaherty is counting on asset sales, generating $1.5 billion in 2015-16. From our experience, such sales should only be booked when they are realized and not before. Previous governments have included asset sales in their fiscal plans only to find out that they were not achieved.
This is not the only area where wishful thinking is employed. The forecast for custom import duties assumes the successful conclusion of the Canada-European Union Comprehensive Economic and Trade Agreement in 2016, with an annual cost of $0.5 billion. Normally the fiscal impact of such an agreement would not be booked until a final agreement has been reached and the fiscal costs fully documented. No details on how these cost estimates were derived were provided.
These three factors alone more than account for the larger surplus in 2015-16. But they also present three major potential risks to the achievement of the surplus of $3.7 billion in 2015-16. Why would the Minister Flaherty incorporate such risky adjustments to achieve a sizeable surplus for 2015-16, given the political implications of not honoring the government’s 2011 election commitments? Granted, Minister Flaherty again included a “risk adjustment factor” of $3 billion in his surplus forecast for 2015-16, providing a buffer against any forecast errors and/or adverse economic developments.
There is also another issue that could derail the Minister’s plans for a large surplus in 2015-16. The government has frozen EI premium rates to 2016. However, the government has announced that once the EI Operating Account achieves a balance, a new rate setting process would come into effect. According to the Update, an operating surplus is projected for 2015-16. This would imply a reduction in the premium rate in 2015 from what is currently assumed. This could reduce budgetary revenues by over $1 billion in 2015-16, furthering putting the achievement of a large surplus at risk.
As noted earlier, the final outcome for 2015-16 will not be known until the fall of 2016, well after the 2015 election. Until then, the Minister will be tabling up to two more budgets and possibly one more update, with revised surplus forecasts for 2015-16. Like the 2013 Update, these too will show a surplus in 2015-16 large enough to finance the 2011 election promises. However, these too will have to be assessed carefully, as they too could be based on very weak and inappropriate assumptions.
For the fifth consecutive year, the Minister Flaherty has presented his Update outside Parliament. These Updates should be presented to the House of Commons Standing Committee on Finance for its review and assessment. The Committee has been holding pre-budget consultations to hear the views of Canadians on what should be included in the upcoming budget.
A vital component in these consultations is the government’s updated economic and fiscal projections. However, once again, the government has undermined Parliament and the Committee.