BUDGET FORECASTING AND A FALL MINI BUDGET
It should not have come to anyone’s surprise that the announcement by the Prime Minister that the federal deficit for 2013-14 was $5.2 billion, substantially lower than the $16.6 billion forecast in the February 2014 budget.
Deficit targets have become political targets. The fiscal credibility of a government depends on achieving or doing better on its deficit targets. Failure by a government to hit its deficit targets is not looked on kindly by bond markets or by the rating agencies.
Given this political reality, the Finance Department must ensure that the deficit outcome will always come in better than forecast. This is not that easy. The deficit is the difference between two very large numbers – budy balance. Turning points in the economic cycle are also difficult to forecast. But when things go right, they go really right. Conversely, when they go wrong, they go really wrong, as witnessed during this latest cycle.
During the 1980s, governments consistently missed their deficit forecasts year after year. This failure can be attributed to the assumption made each year by the Finance Department that interest rates would decline over the forecast period. Of course, they never did, for obvious reasons, and by the end of the 1980s, the fiscal credibility of the Finance Department was completely trashed and this was reflected in the risk premiums embedded in ten-year government bond rates.
When Mr. Martin became Minister of Finance, he quickly “announced” (an understatement to say the least) to the Department of Finance that he was not prepared to put up with the kind of forecast errors that had occurred under his predecessors. He wanted to establish his fiscal credibility come “hell or high water”.
Five-year budget forecasts disappeared and were replaced by two-year rolling forecasts. Contingency reserves and economic prudence reserves were included in the budget forecasts to ensure that the deficit target would never be missed.
As a result of actions taken in the 1995 and 1996 budgets, and strong global growth, the deficit was eliminated by 1997-98, much earlier than everyone expected. Fiscal credibility was restored and the ten-year government bond rate plummeted.
After 1997-98, the government began to record growing surpluses much larger than the Finance Department was forecasting. Criticism began to emerge that the Finance department was purposely low-balling the surplus forecast, although the reason why the department would so was never clear.
At the time, Mr. Harper was a strong critic of the government for purposely underestimating the surplus. His dismay with the Finance Department’s forecasting record led to his commitment in the 2006 election, to create a Parliamentary Budget Officer. And we all know how well that has turned out with the Conservative government.
So it would appear we have come full circle.
For the last two years the final deficit outcomes have come in substantially below the budget forecasts. Is the government purposely “highballing” the deficit and “lowballing” the surplus?
What is surprising this latest time is the extent of the underestimate of the deficit? In the February 2014 Budget, the federal government forecast a deficit of $16.6 billion. The final outcome was only $5.2 billion. Notwithstanding this huge “underestimate”, the Prime Minister has said the government still “intends” to have a deficit in 2014-15. A strange choice of words to say the least.
The government must have been aware for some time that the deficit outcome in 2013-14 was going to be much lower than expected. The Fiscal Monitor for April 2013 to March 2014 clearly indicated that the deficit outcome for 2013-14 would be lower than expected. The Parliamentary Budget Officer, in his latest Economic and Fiscal Update, stated that the deficit outcome for 2013-14 could be as low as $11.6 billion. We felt that the outcome could even be as low as $10 billion. (Insert reference) The Minister of Finance, Joe Oliver was completely silent, indicating only that the Government remained on track to a balanced budget in 2015-16.
The Prime Minister indicated that much of the improvement was attributable to “one-time” factors. In the Annual Financial Report, one-time factors could amount to as much as $4 billion. These include: not needing the “risk adjustment factor” of $1.5 billion; a downward adjustment of $1.2 billion with respect to the Government’s liability for the 2013 Alberta floods, and, assets sales of $1.3 billion.
Even after allowing for these one-time adjustments, this still leaves $7.4 billion of the improvement attributable to underlying economic factors. Most of this would be expected to carry forward into 2014-15 and beyond. If all of it carried forward into 2014-15, the underlying surplus this fiscal year would be $2.2 billion. Over the past few years, the government has included a $1.5 billion “risk adjustment factor” in the first year of their budget plan, given that the fiscal year is already half over, and $3 billion in each thereafter. As a result, a surplus of $0.8 billion is possible for 2014-15.
Given the risks involved, the Government may be hesitant in announcing a surplus for 2014-15 and simply stick to its 2015-16 commitment for a surplus.
However, and there is always a however in budget forecasting, something might happen to change the political calculus.
The one thing that might change in the next couple of weeks is that Joe Oliver “miraculously discovers” new revenues (hidden away) that would lead to a substantial surplus this year. In that case all bets off for the Fall Update. The Fall Update could easily become a “Fall Mini Budget “.
This could be politically appealing for the Conservative government for several reasons. First, the income tax changes they are committed to making would take affect in the 2014 tax year, not at the end of 2015.
Late last Friday Joe Oliver was forced table a Ways and Means Motion in Parliament because the Finance Department had inadvertently posted it on the its web site earlier in the day. Among the many proposed tax changes was the doubling of the child fitness tax credit, which the Prime minister had just announced a few days earlier. The tabling of the motion means that Canadians will be able to take advantage of this tax change when they file their 2014 income tax return in early 2015.
This raises the obvious question as to why the government would not table a second Ways and Means Motion, that would include their other proposed tax changes (e.g., income splitting and doubling the Tax Free Savings Account) so that they all could be taken advantage of this year before the 2015 election?
Second, implementing the tax changes early would reduce the surplus available to the Opposition parties to use in their election platforms in the 2015 election. They would either have to accept the Conservative tax cuts or argue they should be rescinded. Neither alternative would be very attractive
Thirdly, a mini-budget would allow the government to table a Budget omnibus bill, which could include a lot of things that, like previous budget omnibus bills, have nothing to do with the budget. This could include, for example, the government’s new desire to allow political parties to use the videos of TV networks in their political attack adds.
Lastly, implementing the tax changes in a mini-budget would still leave substantial surpluses for additional announcements in the 2015 budget.
A mini budget in the fall and a second budget next February could even pave the way to an early election.
As we said above the budget balance is the difference between two very large numbers. A little change here and a little change there, and before you know it, you have a very nice surplus in 2014-15.
We will just have to wait a few more weeks for the fall Economic and Fiscal Update to see how the Government interprets the final outcome for 2013-14 and its effect on 2014-15 and beyond.
Budget forecasting may sound tedious, boring and unimportant to most Canadians.
But nothing could be farther from the truth.
In the coming weeks the budget forecast will fundamentally affect the 2015 political outcome.