“We are committed to eliminating the deficit by 2016.” “Budget 2012”


New Economic Forecast

On October 25th, the Department of Finance released its October 2011 survey of private sector economic forecasts.  The average of the private sector forecasts forms the basis for the economic assumptions used for fiscal planning purposes in the budget and fall update. 

In the short term, economic prospects have weakened compared to those used in the June 2011 Budget.  Real gross domestic product (GDP) is expected to grow more slowly in 2011 and 2012, but thereafter grow in line with the growth rates projected in the June 2011 Budget.  As a result, nominal GDP – the underlying tax base for budgetary revenues – has been lowered throughout the forecast period. However, both short- and long-term interest rates are expected to be lower throughout the entire period.

The upcoming fall update should provide details as to what impact these changes will have on the Government’s pledge to balance the budget in 2014-15.  However, based on our assessment of these revised economic forecasts, we still believe that the Government will not balance the budget in 2014-15 or 2015-16, even if it meets its commitment to find $4 billion in annual savings in its Targeted Strategic and Operating Review Exercise (http://www.3dpolicy.ca/content/don-t-bet-surplus-2014-15-or-2015-16).

Table 1 compares the current forecast of nominal GDP to that used in the June 2011 Budget and the potential impact on budgetary revenues. Nominal GDP is expected to be $13 billion lower in 2012, rising to $22 billion in 2013, with that difference barely increases in the next two years.  However, the June 2011 Budget forecast for nominal GDP was adjusted down by $10 billion in each year of the forecast.  Adjusting the September 2011 private sector average by the same amount, lowers nominal GDP by $23 billion in 2012, rising to $36 billion in 2015. Using the June 2011 Budget average effective tax rates, this implies a potential loss in tax revenues of $3.5 billion in 2012-13, $4.8 billion in 2013, $5.2 billion in 2014 and $5.4 billion in 2015.

Table 1: Nominal Gross Domestic Product ($ billions)

     2011   2012  2013  2014   2015
June 2011 Planning Assumption  1.709 1,794 1,883 1,969 2,058
September 2011Survey     
  Private sector average  1,711  1,781  1,861  1,946  2,032
  Adjustment for risk      -10      -10      -10      -10      -10
  Planning Assumption  1,701  1,771  1,851  1,935  2,022
Difference        -8      -23      -32      -34      -36
Potential loss in revenues       -1.2        -3.5        -4.8        -5.2        -5.4


Table 2 shows the potential impact of the revised forecast for nominal GDP and interest rates and the same adjustment for risk as included in the June 2011 Budget.

Table 2: Impact on Budgetary Balance ($ billions)

   2011-12  2012-13  2013-14  2014-15  2015-16
June 2011 Budgetary Balance        -32.3        -19.4          -9.4          -0.3           4.2
  Change in nominal GDP          -1.2         -3.5           -4.8          -5.2          -5.4
  Change in increase rates                      0.9            1.6            2.1           1.9
  Net impact          -1.2         -2.6            -3.2           -3.1           -3.5
Implied budgetary balance        -33.5       -22.0         -12.6           -3.4            0.7
Targeted Strategic & Operating     
     Review Savings            1.0            2.0            4.0           4.0
Revised Budgetary Balance        -33.5        -21.0         -10.6            0.6           4.7


The revised forecast would only increase the deficit by $2.6 billion in 2012-13, rising to $3.5 billion in 2015-16.  There would be a deficit of $3.4 billion in 2014-15. Somehow despite the slower growth in the economy, and much greater economic uncertainty than in June, this is all offset by the $4 billion in annual expenditure savings. This is “remarkable”!

But how realistic is this revised economic and deficit forecast and is it a good basis for planning the 2012 budget. We don’t think it is.

In a previous blog, we calculated what the deficit would be using the Toronto Dominion (TD) Bank economic forecast released in September. The TD bank is one of the private sector forecasters who met with the Finance Minister on Tuesday. It is also one of the few forecasters who have the capability to prepare medium-term projections. Based on the TD forecast, we calculated that nominal GDP would be $28 billion lower in 2012, $38 billion lower in 2013, $45 billion lower in 2014, and $53 billion lower in 2015 than the levels in the June 2011 budget. These are substantially larger than the losses calculated using the new “average” forecast (Table 1), even before any additional adjustment for prudence (i.e. $10 billion). Not surprisingly, the corresponding revenue losses are also much higher. By 2015-16, the loss in revenues would be over $9 billion when the adjustment used in the June 2011 Budget is included. Using these more realistic revenue numbers would wipe out the surplus in both 2014-15 and 2015-16.

There Needs to be More Transparency and Accountability

We have argued in the past that the Department of Finance should be more transparent in its forecasting and more accountable. Without transparency, there cannot be accountability (http://www.3dpolicy.ca/content/time-make-budget-planning-process-more-accountable-transparent-and-prudent). Yesterday’s release of the private sector  “average’ provides no information on the range of forecasts or the assumptions upon which they are based. It is simply not possible to assess the credibility or the usefulness of the “average” forecast as a basis for budget planning.  Using an "average" forecast in an environment when the balance of risks is not evenly distributed males no sense at all.

We have argued before that the Department of Finance should take full responsibility for the economic and fiscal forecasts presented in its budgets and economic and fiscal updates.  The Department of Finance’s detailed economic forecasts should be used to prepare the fiscal forecasts, rather than using the average of private sector forecasts for a selected number of major aggregate.  The Department’s economic forecasts should be compared with the average private sector economic forecasts, with differences fully explained and justified.  Forecast details on both real and nominal GDP should be publicly provided so that assessments can be made on the composition of GDP.  This should be provided on a consistent basis.  Department of Finance officials should appear on a more regular basis before committees of Parliament to explain the impact of current economic developments.  

As noted in the Finance press release, the current forecast process dates back to 1994, following recommendations made by Ernst & Young (E&Y) in their 1994 report entitled “Review of the Forecasting Accuracy and Methods of the Department of Finance[1]”.  Contrary to the press release, E&Y did not recommend that the Finance Department use a private sector average in order to give the forecast process “independence”.

 E&Y recommended that the Department of Finance establish a mechanism to increase the distance between the economic and fiscal forecasts presented in the budget and the political process, by either having the House of Commons Standing Committee on Finance engage a panel of independent reviewers to critique the government’s economic and fiscal forecasts or establish an independent agency to provide the economic and fiscal forecast.  Instead, the government at that time decided to use the average of private sector economic forecasts rather than those produced by the Department of Finance even though E&Y had concluded that the Department’s economic forecasts were consistently better than those in the private sector.  E&Y did not recommend that the government use the average private sector forecasts as stated in the October 25th press release.

More Prudence should be included in the Budget Plan

In preparing the fall economic and fiscal update, the Minister of Finance will have to decide how much prudence to include in his planning framework.  It appears that the new economic forecast assumes an orderly resolution to the EURO crisis and the US Fiscal crisis within the next four years. Based on events to date, most experts are betting on a very difficult and very uncertain future for both the EURO and the EU. Should that be the case, it would have serious global repercussions. That is what the Prime Minister and Minister of Finance are telling Canadians. Economic growth is clearly slowing in the US and few people are expecting a strong recovery over the medium term. This does not appear to be the assumption underlying the new “average” forecast for Canada.

By taking an “average” forecast equal weight is given to all forecasts even though the balance of risks is clearly on the more negative outcome.  To compensate for this the government has introduced a small “prudence” factor of only $1.5 billion.  In the circumstances this is clearly too small. A budget forecast based on the new “average” forecast must include a much larger risk adjustment than $1.5 billion – one that should grow over time and not remain constant.  If the economic risk factor were increased by an incremental $10 billion each year, revenues would be lowered by an incremental $1.5 billion each year reaching $6 billion by 2015-16.  Under this scenario, the budget would not be balanced in either 2014-15 or 2015-16.  Furthermore, as we and others have argued in the past, previous budgets have understated program expenses and overstated “other revenues” in the outer years, with the result that the deficit could be even higher in these years.

Table 3: Impact of Additional Prudence ($billions)

  2011-12 2012-13 2013-14 2014-15 2015-16
Revised Budgetary Balance      -33.5       -21.0      -10.6          0.6          4.7
Additional Prudence                -1.5        -3.0         -4.5        -6.0
Adjusted Budgetary Balance       -33.5       -22.5      -13.6         -3.9         -1.3

The Prime Minister and Minister of Finance continually claim that they have a credible medium-term plan to eliminate the deficit by. 2014-15. But in fact they don’t and they know it.  The government is faced with some very difficult policy and political decisions. To eliminate the deficit in 2015-16, let alone in 2014-15, would require significant further expenditure cuts or a miracle in Europe and in the US.


 Is this government prepared to do that given that it has yet to deliver on the savings promised in either the 2010 budget or the 2011 budget? In the circumstances, we would not recommend it (http://www.3dpolicy.ca/content/we-need-new-economic-action-plan-fiscal-sustainabilty-economic-growth-and-job-creation-not-r).

Probably better to simply delay the date and blame it on uncertainty in the world economy.










[1] Review of the Forecasting Accuracy and Methods of the Department of Finance: Ernst & Young September 1994.

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