RUNNING OUT OF SURPLUSES: WHAT CAN A NEW GOVERNMENT DO?
It should be clear to all political parties that, after 2015, there will be little in the way of “surpluses” for the federal government to deal with critical policy challenges. The modest surpluses that are currently projected to begin in 2015-16 will be rapidly used up and the potential for economic growth will be unable to generate future sizeable annual surpluses (“We’re Not Out Of The Fiscal Woods Yet” iPOLITICS February 24, 2014). The “surplus” budgets of the 1990s and the years up to 2007-08 will not to be repeated.
Budget 2014 forecast surpluses of $6.4 billion in 2015-16, $8.1 billion in both 2016-17 and 2017-18 and $10.3 billion in 2018-19. Surpluses of around $10 billion are projected by the Finance Department until 2025-26.
The Government has already committed much of these surpluses - $3 billion per year for debt reduction and another $3 billion annually for their 2011 election commitments, including: income splitting for families with children under the age of 18 ($2.7 billion); doubling of the children’s fitness tax credit ($100 million); and, a new adult fitness tax credit ($500 million).
In addition, the government has re-profiled over $6.5 billion of defense spending to sometime in the future – the years yet to be announced. These commitments, if fulfilled, would exhaust the entire surplus in 2015-16 and leave little room for other initiatives over the next five years and beyond.
The government elected in 2015 will have to confront the question of whether, and how, to raise new “financial” resources. So what are the options for the government after the 2015 election? Whatever the fiscal strategy chosen, maintaining fiscal sustainability will be absolutely critical.
What is fiscal sustainability? Fiscal sustainability, as defined by the OECD (Organization for Economic Co-operation and Development) and the IMF (International Monetary Fund), is a situation in which a government has a “low” and “stable”, or declining, debt burden (the ratio of debt to GDP). This definition raises the question of what is a “low” debt burden? Why is a debt burden of 25 per cent (the government’s current target) better than a target of 30 per cent, or 40 per cent, or even 60 per cent, the current target for EURO countries?
One possible fiscal strategy for a new government would be to “do nothing” or to “do little” to address the policy challenges that will most certainly emerge: challenges relating to an ageing population; a deteriorating infrastructure; a fractured health care system; a worsening of aboriginal problems; the protection of the environment; the continued disappearance of the manufacturing sector; the inadequate education and training of young Canadians; to mention only a few of the many challenges.
A “do nothing” or a “do little” fiscal strategy would, in some respects, represent a continuation of the ideological approach of the current Conservative government. It would reflect the view that most of these policy challenges are provincial responsibilities; and, that the best way for the federal government to contribute would be to continue the existing trend towards a smaller federal government. This in turn would imply that that provincial governments would have to absorb the tax room vacated by the federal government.
The fiscal projections in Budget 2014 provide a reasonable approximation of what might happen under such a “do nothing” or “do little” fiscal strategy. Program spending, as a share of GDP, is forecast to decline from 13.5 per cent in 2013-14 to 12.4 per cent in 2018-19. In other words, the federal government is expected to continue to decline in size and influence. With the Harper’s Government use of tax expenditures, revenues as a share of GDP is forecast to remain relatively stable at about 14.5 per cent.
Most importantly, the debt burden of the federal government is forecast to fall from 33.0 per cent in 2013-14 to 25.5 per cent in 2018-19. It is expected to continue falling to 25 per cent in 2021-22, the government’s target, if not earlier. It is unclear what the federal government would do at this point. To date, the federal government has been silent on this.
In the absence of any change in spending and taxation policies, the federal debt burden would continue to fall until the government eventually became a net creditor. The federal government would then simply be irrelevant.
Of course, there is no theoretical, practical, or empirical reason to support such a fiscal strategy. What then would a new government have to do to stabilize the debt burden, whatever the target chosen?
In order to stabilize the debt-to-GDP ratio, for example, at 25 per cent, the government’s current target, debt must begin to grow at the same rate as nominal GDP. In other words, the government would not only have to start running deficits, it would have to incur ever-increasing deficits.
This would present Conservatives, who are ideologically against all deficits, with a fiscal conundrum. How could the Conservative Party adopt a fiscal strategy of increasing deficits and growing debt in order to stabilize the debt burden at 25 per cent?
The reality is it can’t, because the Conservative base would never accept it. In last October’s Speech from the Throne, the government rejected such fiscal strategy by committing to “balanced-budget legislation and to a further diminishing in the role and size of the federal government.
The reality is, however, that the policy challenges are simply too important to be ignored or continually downloaded onto the provinces and the private sector. Inevitably, the federal government would have to consider alternative fiscal strategies that would create financial resources.
One possible fiscal strategy for a new government (most certainly, a non-Conservative government) would simply be to raise taxes, preferably the GST. We know this is not going to be part of any 2015 election platform. Both the Conservatives and the Liberals have taken a “political oath” against raising any taxes, at least before the election. The NDP have said they would only raise corporate taxes, which would be one of the worst taxes to increase.
Notwithstanding all the promises before the election that taxes will not be raised, any new government will eventually have to consider this option. The reason is simple. The government will need additional resources to address the challenges that lie ahead. These challenges cannot be ignored.
Simply restoring the two points of GST cut by the Conservative government would yield $15 billion annually and growing. This could be used to fund a significant reduction in income taxes for all low- and middle-income Canadians, as well as provide funds to address other policy challenges. Furthermore, shifting away from income-based taxation to consumption-based taxation would have significant benefits for economic growth and job creation.
The finances available for this fiscal strategy could also be increased by undertaking a much-needed simplification of the personal and corporate income tax systems. The House of Commons Standing Committee on Finance has recommended this in each of its last three pre-budget reports.
The 1917 Income Tax Act was 11 pages in length. Today, it is some 2,800 pages. It has grown not only in size but also in complexity. Governments have increasingly used the tax system to carry out economic and social policies through tax expenditures, avoiding the scrutiny that that such programs would have if they were part of direct spending. It would be extremely valuable for the federal government to review the hundreds of targeted tax measures to determine their relevancy and need.
Studies have shown that tax simplification could generate savings of up to $5 billion annually which would increase total available funding to $20 billion annually. All that is required is political will.
A second fiscal strategy that could be considered by a new government would be debt financing. In other words, the government would simply go back into deficit to address new policy challenges. Many so-called media experts regard this as worse than raising taxes. To them, and possibly most Canadians, a government should never run a deficit, other than perhaps in an economic downturn.
However, there are other situations where deficits might be justified. Most people would agree that there are certain types of government “investments” that will be used by future generations. This would include, for example, investments in roads, highways, transit systems, educational institutions, research and so on. If future generations are going to “use” these investments, then why shouldn’t they contribute to their cost by absorbing some of the future debt resulting from deficit financing?
Even better, it is possible to design a debt financing strategy that would be consistent with a sustainable fiscal structure. A stable debt-to-GDP ratio, for example the government’s current target of 25 per cent, only requires that debt grow at the same rate as the economy. Assuming nominal GDP growth at 4 per cent annually, then debt would also have to grow at 4 per cent annually.
Debt financing may sound too good to be true and it may very well be. Debt financing would present major challenges to any government. To succeed, the government would always have to balance the “operating budget”; that part of the budget that includes all spending other than “agreed” capital or investment expenditures. This would not be easy. There is nothing to guarantee any government would stick to these conditions. The Liberals didn’t stick to them in the 1970s, nor did the Conservatives in the 1980s and this resulted in a rising debt burden and eventually a financial crisis.
In Alberta a Conservative government has adopted debt financing for major capital initiatives. The budget is separated into three major components: Operational Plan, consisting of operating expenses; Capital Plan, for the financing of long-term provincial and municipal capital assets; and Savings Plan, which sets aside a portion of non-renewal resource revenues each year. The Operational Plan cannot run a deficit. Debt financing can only be incurred for the Capital Plan.
These fiscal strategies will no doubt receive a skeptical response from Canadians. This would not be surprising. Canadians have been told over and over that all deficits and debt are “bad” and once the deficit has been eliminated everything will be just fine. Just be patient, there will be plenty of money, and the current government will give some of you (i.e., 15% of families)) another “tax cut”. The reality is there is not going to be plenty of money and things are not going to be “just fine”.
The next decade will present most Canadians with choices they have not had to make before. In the 1970s, 1980s and early 1990s, the debt burden was rising and the fiscal structure was not sustainable. In the late 1990s and the period up to 2007-08, we had year after year of surpluses thanks to strong global and domestic economic growth. This permitted important new spending on education, research, infrastructure, health care, aboriginals, and equalization. These surpluses also allowed the largest personal and corporate income tax cut in history. All this was done while maintaining a sustainable fiscal structure. This period of surpluses came to an end with the two-point reductions in the GST in 2006 and 2007.
With the restraint actions taken since 2010, primarily to offset the reduction in revenues from the GST cuts, and the prospective elimination of the deficit, the government has once again achieved a sustainable fiscal structure. But there will be no “surplus financing” available in the coming decade to meet the key policy challenges that will lie ahead.
New approaches will need to be considered including debt financing and major tax simplification and tax reform. Both can be done while maintaining a low and stable debt burden. Both can contribute to stronger economic growth. Both could be combined into a single fiscal strategy to deal with the inevitable policy challenges.
The real policy debate Canadians and the political parties should be having in the lead up to the 2015 election is about the role and size of the government and their implications for fiscal policy. Unfortunately, this debate probably won’t happen soon, and maybe not even in the 2015 election. But it will inevitably happen. The only question is when; preferably sooner than later.