BANCED BUDGET LEGISLATION WOULD BE A BIG MISTAKE
Finance Minister Joe Oliver announced in a speech to the Economic Club of Canada in Toronto that the government would introduce balanced budget legislation (BBL); this would fulfill a commitment made in the September 2013 Speech from the Throne. Reaction by the media quick and most financial commentators was largely negative, and not surprisingly so, because it is a very bad idea.
Nevertheless, you have to give Mr. Oliver for having a good sense of humour. His entire speech was like a stand up comedy routine. It would have been even hilarious if he had made the speech on April 1. You have to love the delicious irony around the announcement of the BBL. After all, this is a government that has never recorded a surplus in seven years, despite its shrill rhetoric that deficits and debt are “evil”. In that time the net federal debt under the Conservatives has increased $150 billion.
Of course, this last minute attempt at “redemption” has absolutely nothing to do with creating a sound policy framework for budget making, which it doesn’t. The proposed BBL is all about politics. It is aimed at the Conservative base, which is becoming concerned about the government’s commitment to Conservative fiscal principles. And it is aimed at Trudeau to see how he will respond and to attack him as a “tax and spend” Liberal just like his father in the 1970s. This strategy was clearly laid out in the Toronto speech and it will be an attack theme during the election.
The BBL will be included as part of the 2015 Budget. But what are chances that it will receive Royal Assent before Parliament recesses for the summer? Virtually zero. Legislation to enact the changes to the Universal Child Care Benefit was introduced on March 27th, because it had to be passed before the summer recess, otherwise they would not be able to issue the checks before the election. They couldn’t take a chance by including it in the Budget. Not so for the BBL.
If the Government were truly serious about the BBL, they could have easily tabled it earlier in March to ensure passage before the election, but they didn’t.
Why is the BBL such a bad idea? Simply put, it would result in bad fiscal policy, and whereever it has been tried it has failed for good reason; it is impossible to enforce.
Experience in provinces and other countries with balanced budget legislation, or other types of legislative fiscal rules, has been to say the least, very disappointing. It has failed everywhere. In most cases when deficits emerged, the legislation was amended, scrapped altogether, or creative accounting procedures were adopted, when adherence to these rules was at risk. Check out the record in the EU and the EURO area.
In other words government’s will simply cheat to avoid the BB legislation. A study conducted by the Department of Finance examining fiscal rules in several jurisdictions concluded that fiscal rules (i.e., BBL) were largely ineffective if there wasn’t the political will, and unnecessary if there was. The only government in Canada to have demonstrated fiscal political will was the Chretien/Martin government in 1995. The Harper government certainly hasn’t demonstrated political will.
In his speech, Mr. Oliver stated that the only acceptable deficit would be one that responds to a recession or to extraordinary circumstance, that is a war or natural disaster, with a cost exceeding $3 billion in a year.
Oliver went on to say that within 30 days of a published deficit, the Finance Minister would be required to testify before the House of Commons Committee on Finance and present a plan with concrete timelines to return to a balanced budget. That plan would include an automatic freeze on operating spending and a 5 per cent cut in the salaries of Cabinet Ministers and Deputy Ministers, until the budget is again balanced. If they helped create the deficit, their budgets would be cut.
This vague description of the proposal raises a number of critical questions as to how the Conservative government expects the BBL to work.
Recessions are never of a distant duration. The government posted deficits in every year since 2008-09. The deficits in 2008-09, 2009-10 and 2010-11 were definitely due to the 2008-09 and 2009-10 recession and the stimulus measures implemented. But what about the deficits that were incurred in the following years?
The economy was no longer in recession but economic growth was not strong enough to get the government out of deficit. Under BBL would these deficits have to be offset by spending reductions? Would there be an automatic freeze on departmental operating budgets and salary reductions for Cabinet Ministers and their deputies? Who determines how long a recession lasts? Should only structural deficits be outlawed and if so, who determines if the deficit is caused by structural factors and by how much?
According to Mr. Oliver the first $3 billion of any deficit, regardless of its cause, would have to be offset by spending reductions. This would be extremely disruptive to sound financial management.
Departments would continually be subject to operating budget freezes, making planning extremely difficult. Extraordinary factors were identified as being deficits caused by a war or natural disaster. But what about another bailout like the one for Chrysler and General Motors? Would these have to be offset as well or would they be classified as an extraordinary circumstance?
Government departments and agencies are rarely responsible for a deficit. They are appropriated funds by Parliament. They are not allowed to exceed their appropriations. If they do, penalties are imposed. The lapse – the difference between the amount actually spent during the year and the amount appropriated for year – has increased significantly clearly indicating that departments are not the cause of deficits. Yet, it is government departments that will be penalized.
The proposal refers to “published deficits” but does this mean “forecast deficits” or final “published deficits”. Forecast deficits can result from overly optimistic economic assumptions and/or errors in the fiscal forecast. The latter could result from under estimating the costs of new policy initiatives, failure to fully capture the impact of changes in taxation behaviour to tax changes, to mention a few possibilities. The Minister of Finance and his department are ultimately responsible for the economic and fiscal forecasts. Yet the proposed legislation would penalize departments and agencies for these errors, even though they have no input into the budgetary process.
For the BBL to have any credibility, it will be important that there be adequate monitoring and enforcement by an independent body. Such a body already exists – the Parliamentary Budget Office (PBO). The proposed BBL should include adjustments to PBO’s mandate to include the dating of the economic cycle, estimating the cyclically-adjusted and the structural balance, verifying the costs of the extraordinary circumstances, measuring the government’s compliance to the law, among others.
This is definitely not likely to happen. Potential cheaters don’t like to be monitored.
In proposing balanced budget legislation, the Harper Government has indicated that the debt-to-GDP ratio will continue to decline below its target of 25 per cent of GDP. The government provides no rationale for this and it is certainly a debate Canadians should have. It is highly unlikely that the majority of Canadians want the federal government to continue tom decline in relevancy. However, in order for this not to happen the government would have to run ongoing deficits to stabilize the debt ratio. This, however, would not be permitted under the proposed BBL.
Fortunately all of this is purely hypothetical. BBL is not going to happen because it is not in the political interest of any of the political parties to have it happen.
What will be interesting during the upcoming election is how the Conservatives defend the BBL against their failed fiscal record for the last seven years..