LESSONS FOR THE 2017 BUDGET
It has been almost a month since the government’s budget. Traditionally, a first budget is a political document that focuses on fulfilling election promises. Given the political nature of a first budget, the Prime Minister’s Office is quite naturally very involved in its preparation. The objective is to get the budget over with and off the front pages quickly. Unfortunately, for the Prime Minister and the Minister of Finance, their first budget is still in the news and not in a favourable way.
The budget is in the news, not because it failed to deliver on political promises, but because it failed the government’s election commitment to “a planning framework that is realistic, sustainable, prudent and transparent”. Its greatest failure was its lack of transparency.
One of the most important rules in budget preparation is that budget documents should contain as much information and explanation as possible. Too little information and explanation will only create problems. Putting the fiscal analysis in an annex may have appeared unimportant, but it was a big mistake. It downgraded the importance of the fiscal numbers and it suggested that the Finance Minister did not believe the fiscal numbers were all that important.
But fiscal numbers are the most important part of any budget. Ask anyone who has ever been in a budget lockup. Last week, the PBO released a report criticizing the government for “making changes to the presentation of its fiscal plan that have made it more difficult for parliamentarians to scrutinize public finances”. This was a criticism often made against Conservative budgets.
In particular, the budget did not provide a detailed reconciliation of the changes due to economic developments and to policy initiatives between the November Update and the March Budget. Past budgets always included detailed reconciliations with five-year projections for major policy aggregates.
In response to a request by PBO for this information, the Finance Department provided the data, but indicated that the information was confidential and could not be made public. This restriction was removed last Friday. On reviewing the data, it is hard to understand why the Finance Department did not include it in the budget in the first place. There was certainly no reason to classify the data as confidential. The first lesson for the Finance Minister for his next budget is to provide a “fiscal plan” that includes as much information and explanation as possible.
The second lesson for the Finance Minister is not to include an excessive level of prudence and to be “transparent” about how the prudence reserve is to be used. Obviously, a budget should include a reasonable amount of “insurance” to guard against forecast errors and unforeseen events. But the amount of prudence in this budget was well over the top.
Nominal GDP was reduced by $40 billion annually resulting in a reduction in revenues of about $6 billion beginning in 2016-17. According to the (PBO), only once between1994 to 2014 did the private sector forecast over predict nominal GDP by more than $40 billion and this was during the 2009 financial crisis. Prudence in past budgets was usually set at $3 billion a year. Including excessive prudence has resulted in a deficit forecast based on unrealistic economic assumptions that no one believes.
It would also be more transparent if the prudence reserve was shown as a separate line item in the budget, and not applied to a reduction in nominal GDP and reduced revenue components. Providing detailed revenue forecasts based on unrealistic economic assumptions makes no sense. Instead, detailed revenue forecasts should be based on the average private sector economic forecast, with the prudence shown afterwards as a separate line item in deriving the final budgetary balance.
A third lesson for the next budget is that the government should be transparent about what the prudence is to be used for. Previous Liberal and Conservative governments stated that the prudence or Contingency Reserve could not be used to finance new policy initiatives. If not needed, it had to be used to reduce the deficit and debt. To date, the Finance Minister has been silent on this issue, suggesting that the “prudence” will be used for new spending. If so, then the government should be transparent and state clearly that the government is including a reserve for future spending initiatives.
A fourth lesson for the next budget concerns transparency and fiscal anchors. There has been criticism of the budget over the failure of the government to fulfill its election promises to keep the deficit below $10 billion and to eliminate the deficit in three years. But the government had already addressed these criticisms in releasing a February fiscal update. There were also criticisms over the failure to fulfill some election promises, but this was to be expected as well.
Nevertheless, the government should accept fiscal reality: the deficit will not be eliminated in the foreseeable future. Right now the government’s challenge is ensure a declining debt/GDP ratio, which won’t be easy given the long list of costly election promises, which were not included in their first budget. In addition, the next budget or fall update should include long-term fiscal sustainability analysis. This will allow financial analysts to assess the impact of the new policy initiatives on the sustainability of government finances.
Perhaps the most important lesson for the 2017 budget is for the Prime Minister to give the Minister of Finance and the Finance Department the responsibility and accountability for preparing the budget. In our experience (a combined 30 budgets) the chances of a successful budget is inversely related to the number of people involved in its preparation. Adopting this lesson would go a long way to ensuring that the first four lessons would also be successfully adopted.