COMPARING FISCAL APPLES TO FISCAL ORANGES
Did the Liberals inherit a small surplus (less than $1 billion) in 2015-16 as recently forecast by the Parliamentary Budget Officer (PBO) or a deficit of $5.4 billion as forecast by the Finance Minister in his 2016 Budget?. That depends on how one interprets the final outcome, which will not be known until the official Public Accounts numbers are released the fall.
Based on our analysis of the financial results to date (April 2015 to January 2016), it is most likely that the federal government will record a deficit in 2015-16, although smaller than forecast in the Budget. However, that deficit will be entirely due to the reversal of policy decisions made by the Conservative Government, which are estimated to have a fiscal cost of $4.6 billion. Without these policy reversals, there would likely be a surplus in 2015-16, although much less than the surplus of over $13 billion that the Liberals left the Conservatives in 2006.
Are the Liberals inflating the deficit projections by billions of dollars as claimed by the PBO? The answer is no they are not. For the years, 2016-17 to 2020-21, the 2016 budget projections include a prudence reserve of $6 billion per year, whereas the PBO’s deficit forecast excludes any adjustment for prudence. Comparing these forecasts is the same as comparing fiscal apples to fiscal oranges.
Excluding the prudence reserve from the Finance budget projections results in an underlying deficit forecast of $23.9 billion in 2016-17, $23.0 billion in 2017-18, $16.8 billion in 2018-19, $11.7 billion in 2019-20 and $8.3 billion in 202-21. This compares to the PBO’s forecast of deficits of $20.5 billion in 2016-17, $$24.2 billion in 2017-18, $18.9 billion in 2018-19, $14.8 billion in 2019-20 and $12.4 billion in 2020-21. In other words, comparing “fiscal apples to fiscal apples” shows that the PBO is actually forecasting a higher deficit in each year except 2016-17. The PBO’s projections of the deficit are, therefore, more pessimistic than those in Budget 2016, contrary to media reports.
This confusion could have easily been avoided if the Finance Department had been more transparent in the manner in which the prudence reserve is presented in the budget. The Finance Department should show the prudence reserve as a separate line item, after the underlying budget forecast, rather than “hiding” it as an adjustment to the underlying budget forecast. This would make the budget forecasts more transparent and avoid confusion.
The Finance Minister could have actually used his underlying budget forecast (based on the average of private sector economic forecasts withoutany adjustment for prudence), which was similar to that of the PBO, as his budget forecast. In fact, PBO believes that no prudence reserve is really necessary because their forecast is already based on a “balance” of the risks on both the upside and downside. This may or may not be true, but if the risks actually turn out not to be “balanced” then it is the Finance Minister’s credibility that would be undermined, not PBOs. These days, Finance Ministers quite naturally want to do better than their budget forecasts, and this means including prudence reserves.
However, Mr. Morneau should have been clearer about what his $6 billion prudence reserve is for. If it to ensure that his deficit targets will be met, in the event the economic forecasts are wrong, then $6 billion is clearly excessive. On the other hand, if the Minister intends to use part of the $6 billion to fund unannounced policy initiatives in future budgets then he should have allocated this amount to a separate reserve. This unwillingness to be clear as to the use of the prudence reserve is undermining the Finance Minister’s credibility.
The credibility of a budget can be judged against four basic principles. First, is the budget based on a realistic and balanced assessment of economic prospects, challenges and risks? By using the average of fifteen private sector economic forecasts, the Finance Minister’s budget satisfies this principle.
A second principle is that the budget forecast includes a reasonable amount of prudence to guard against the underlying economic assumptions and the economic forecast being wrong. In this regard, the Finance Minister not only included prudence but also included an excessive amount of prudence. This has undermined the usefulness and credibility of the resulting deficit forecast.
A third principle is that the budget fiscal framework be sustainable by maintaining a declining or stable debt/GDP ratio. The budget has maintained a stable debt burden. Fiscal sustainability does not require a commitment to deficit elimination at some specified and arbitrary date. Making such a commitment and failing to meet it, either for economic or policy reasons, would only undermine fiscal credibility.
The last principle is budget transparency. This means providing full disclosure of analysis and information since, without this, independent experts and other third parties will not be able to assess how realistic the economic and fiscal forecasts are. Without transparency, there can be no accountability. This budget has failed the transparency principle both in the way prudence was treated in the budget and also in its failure to provide detailed fiscal tables. It is hard to understand how the Finance Department could allow this to happen.