MR. MORNEAU’S EMPTY FISCAL CUPBOARD
On the Friday before Christmas, when most Canadians were busy with their last minute shopping, the Department of Finance quietly released its “Update of Long-Term Economic and Fiscal Projections”. This is the first long-term fiscal sustainability report released by the Liberal government, and given its sombre conclusions it is not surprising that the Finance Minister released it hoping that few would notice.
The last long-term fiscal sustainability report was released by the previous Conservative government, as part of its November 2014 Update of Economic and Fiscal Projections. In that report, a surplus of $12.4 billion was forecast for 2025-26, rising to nearly $50 billion in 2035-36 and to $220.4 billion in 2050-51. As a result, the federal debt was forecast to decline throughout the forecast period, moving into a net asset position (i.e., no debt) by 2037-38. By 2050-51, the federal budget was forecast to have of $1.7 trillion in assets.
What a difference two years makes.
According to the new report by Mr. Morneau, the federal deficit will increase to $25.0 billion in 2025-26 and then reach $38.8 billion in 2035-36 before beginning to decline. A balance budget is not expected until 2051-52 three decades from now. Over this period the federal debt will continue to rise, from $746.4 billion in 2021-22 to $1.6 trillion in 2050-51.
The current report provides no explanation for the deterioration in the fiscal situation in only two years. There were certainly factors beyond the control of the government. Most important was the dramatic decline in oil prices in 2015, which resulted in a significant reduction in nominal GDP by 2050-51, of nearly $430 billion. As a result, budgetary revenues were lower throughout the forecast period, reaching a shortfall of $67 billion in 2050-51.
But policy decisions taken by the Liberal government also contributed to the long-term fiscal deterioration. These included the introduction of the Canada Child Benefit and the restoration of the age of eligibility for federal pensions to 65 from 67, coupled with increased infrastructure spending in the March 2016 Budget. These have resulted in higher program expenses throughout the forecast period. Program expenses are now forecast to be about $31 billion higher in 2050-51 than in the November 2014 report.
As a result of both lower revenues and higher program expenses, the primary budget balance (revenues minus program expenses) is projected to be $98 billion lower in 2050-51. This coupled with higher interest rates resulted in public debt charges being nearly $125 billion higher in 2050-51 than forecast in the November 2014 report. The deficit is now forecast to deteriorate by $223 billion in 2050-51, while the federal debt is forecast to be $3.3 trillion higher.
Despite the dramatic turnaround in fiscal fortunes in only two years, federal finances are still considered to be “fiscally sustainable”. According to the Parliamentary Budget Officer (PBO), fiscal sustainability means that, under current policies, government debt should not grow continuously as a share of GDP. In the current forecast, the debt-to-GDP ratio is still expected to decline throughout the forecast period, from 30.4% in 2021-22 to 21.7% in 2050-51. However, in the November 2014 report, the debt-to-GDP ratio was forecast to fall from 21.5% in 2021-22 to a net asset position of 22.4% of GDP in 2050-51.
Mr. Morneau should take the time to read this report very carefully because there are some very important conclusions he should be aware of as he prepares his 2017 budget. First off, he has very little room to address future unexpected developments. And 2017 is a year with a lot of uncertainties: the impact of Brexit; the future of the Euro; economic uncertainty in China; geopolitical uncertainty in Europe; and last but not least, political and economic uncertainty in the U.S. The outlook for global economic growth will likely continue to fall.
Second, if the Liberal government wants to continue to implement its election agenda, then this will mean deficits in the $30 billion to $40 billion range for decades to come. Balanced budgets are wishful thinking and the Finance Minister should drop balanced budgets as a fiscal anchor. Doing this will be a major communication challenge for the government.
Third, on-going (and possibly higher) structural deficits are acceptable provided they are the result of investments to strengthen economic growth, financed by long-term interest rates low enough to make them affordable. Policies that increase government consumption, on the other hand, should not be debt financed. This will also present a major communication challenge for the government
Lastly, in preparing the 2017 budget proposed new policy actions should be carefully reviewed in terms of their absolute need, their priority and their impact on fiscal sustainability. A test for a successful budget is that there should be a long list of disappointed Ministers.
C. Scott Clark, former Federal Deputy Minister of Finance, and Peter C. Devries, former Director of Fiscal Policy, Department of Finance