On April 24th, the Parliamentary Budget Office (PBO) released its latest Economic and Fiscal Forecast.  As usual, it generated some controversy, dismissed by the Government over the impact of the job losses resulting from the proposed spending reductions, but embraced by the Opposition, for acknowledging  the job losses.  The PBO is forecasting that the government is on track to eliminate the deficit by 2015-16.This note examines the PBO’s deficit forecast, how it has changed since November 2011Update and some of the issues underlying it.
Spending cuts- PBO excludes them then includes them
     
PBO’s current fiscal outlook is substantially better than in their November 2011 forecast.  The budgetary balance is $13.1 billion lower in 2011-12, $10.1 billion in 2012-13 rising steadily to $18.1 billion in 2016-17 (see Table 1).  They are now forecasting a surplus of $10.8 billion in 2016-17 rather than a deficit of $7.3 billion. This amounts to a rather sizeable revision of just over $18 billion. You would think the government would be happy with this update.

Table1: Comparison of PBO's April 2012 and November 2011 Fiscal Outlooks

What accounts for these unusually large and unprecedented revisions to the PBO fiscal outlook?  In their November 2011 Update, PBO did not include the spending reductions proposed in the 2010 budget, associated with the two-year departmental operating budget freeze, claiming that the Government had not provided enough detail.  Instead, the PBO assumed that direct program spending would grow at the rate of inflation and population.

However, despite the fact that no additional information was provided with respect to the Budget 2010 freeze and very little information was provided with respect to the Budget 2012 spending reductions, PBO has now decided to include the Budget 2010 operating freeze reductions as well as the Budget 2012 net restraint measures.  With the exception of 2011-12, the inclusion of these measures accounts for about one-third to one half of the improvement in the PBO fiscal forecast since the November 2011 Update.

We continue to have reservations about the feasibility of achieving the 2010 and 2012 proposed spending reductions.  Our concerns were detailed in our assessment of Budget 2012 (see “Budget 2012: The Numbers Just Don’t Add Up” April 2012:  www.3dpolicy.ca.). They included the unexplainable savings from DND capital funding, the expectation that even more savings can be secured through “efficiency” measures, the issue of the lapse adjustment, and finally, the forecast profile for “other transfers”.

PBO now feels that the proposed 2010 and 2012 spending reductions will be achieved, despite the fact that in their note entitled “Budget and Expenditure Reporting to Parliament”, they highlight the substantial risks to actually securing these expenditure reductions.

The PBO should have included have included a risk adjustment in its forecast to reflect these uncertainties.

What Accounts for the Remaining Differences from PBO’s November 2011 Update?

After accounting for the impact of the spending reductions measures, there is still a difference of $12.7 billion in 2011-12, $7.2 billion in 2012-13, rising to $10.2 billion in 2016-17.

In addition to accepting the 2012 Budget estimate of the fiscal impact of the restraint measures without question, PBO also now incorporates the baseline forecast for “Direct program expenses” provided by the Department of Finance.   This lowered PBO’s November 2011 Update fiscal balance by an additional $5.4 billion in 2011-12, $4.0 billion in 2012-13, $3.3 billion in 2013-14, rising to $7.5 billion in 2016-17 (see Table 1). We feel that the outlook for direct program expenses is understated. 

The remaining differences are due to the better-than-expected financial results to date for current fiscal year, as shown in the Fiscal Monitor, and changes to their economic forecast.

Comparison to the 2012 Budget Forecast

PBO’s fiscal forecast is better than the government’s forecast in the first two fiscal years and in 2016-17.  In the interim years, they are somewhat more pessimistic (See Table 2).

In their report, the PBO compares their forecast for nominal GDP to the private sector average.  However, for budget planning purposes, the private sector average was adjusted down for “risk”. This is not acknowledged in PBO’s report.  The PBO forecast does not include any explicit risk factor.

Table 2: Comparison of PBO's April 2012 Updatre to Budget 2012 

Comparing PBO’s forecast for nominal GDP to the Budget 2012 planning assumption, the PBO forecast is slightly lower in the period 2013 to 2015 and virtually identical in the other years. With the exception of 2016-17, changes in the forecast for nominal GDP explain most of the differences in the fiscal forecasts

For 2016-17, Budget 2012 forecasts a decline in the employee employment insurance rate from $1.98 per $100 of insurable earnings in 2015 to $1.95 in 2016, whereas the PBO is forecasting an increase of 5 cents, with the result that their EI premium revenues are $3.3 billion higher.

Including a risk factor in the PBO forecast to allow for uncertainties in achieving spending reductions would eliminate the PBO forecast of a surplus in 2015-16

PBO transparency

In the past, PBO has argued that the Government should publish details of its economic forecast, including the components of nominal GDP.  PBO did publish their components in some of their updates, but did not do so in their recent update.  It is difficult to assess the importance of the individual revenue components without their economic counterparts.  For example, PBO forecasts a significant decline in corporate income tax revenues in 2012-13, of which only part is due to the reduction in the tax rate from 16.5% to 15%, effective January 1, 2012. This implies that they are forecasting a significant decline in corporate profits in 2012. We would encourage them to publish the economic details in future fiscal updates.  We would also encourage the Department of Finance to do the same. However, while we are optimistic that PBO will do so, experience suggests that Finance will not.

Employment Implications of the Spending Cuts

In the April 2012 Update, PBO estimated the potential employment loss associated with the net impact of the policy measures proposed in Budget 2012. The Government took issue with this.  However, in Budget 2012, the Government claimed that the Economic Action Plan created and maintained 248,000 jobs (see page 354 of the 2012 Budget).  So if increased spending creates jobs why wouldn’t a net reduction in spending result in a loss of jobs from what they otherwise could have been?

Fiscal Sustainability – The Need for Long-term Fiscal Projections     

According to the PBO, the federal government’s fiscal structure is currently sustainable over the long term.  PBO believes, and we fully agree, that the Government should provide its analysis on the issue of fiscal sustainability, not only for the federal government but for the provinces and territories as well. In his February 2007 Budget, the Minister of Finance promised to publish such a report in the 2007 Update.  We are still waiting. Long-term economic and fiscal projections are required to focus the policy debate on potential structural changes to government revenues and expenses. Instead, the federal government has introduced changes to programs (Canada Health Transfer, elderly benefits, etc.) in the Budget Implementation Bill, without providing a proper context for the need for change.