In the 2011 Budget, the Minister of Finance forecasts a small budget surplus in 2015-16. Our analysis of the projections shows that this outcome is highly unlikely  We project a deficit of $8 billion in 2015-16.

Economic Assumptions

The federal government continues to use the average private sector economic forecast for budget purposes.  As shown in Table 1, the economic forecast is changed very little from that used in the October 2010 Update.  Nominal GDP is slightly higher in 2010 and this carries forward. 

There is no discussion in the budget on the range of the private sector views, so it is difficult to assess the risks inherent in this “average” forecast. There is some acknowledgement of the global economic and geopolitical risks, with the result that the Government lowered the private sector forecast for nominal GDP by $10 billion in each year.  This translates into about $1.5 billion of “prudence”, less than 0.3 per cent of total revenues and expenses. This is clearly inadequate, and is sharp contrast to the amount of prudence ($4.5 billion in year one, rising to $6 billion by year five) included in the previous government’s budget plans.

We have argued in the past[1]that the Minister of Finance should use the Department of Finance’s economic forecast instead of the average private sector forecast.  The latter is not a “consensus” forecast but simply an average of the private sector economists surveyed. Furthermore, few of the private sector forecasters provide forecasts for the medium term, concentrating solely on the short term.  If the Department of Finance feels that the range of views is too diverse and/or the risks too great, it adds  “risk adjustments”, based on its analysis. One wonders why then they do not use their own forecast rather than adjusting the private sector average forecast.

In addition, it is the Department of Finance that allocates nominal GDP into its various components and it is these components that are used in the forecasting of federal revenues. The Parliamentary Budget Officer and  3dpolicy have argued that the various components of nominal GDP should also be published in order that a proper assessment of the economic forecast can be made. No details on the components were provided in the budget.  It will be interesting to see if a request for such information is refused under the “Cabinet Confidence”, given the recent ruling by the Speaker of the House of Commons.

Fiscal Projections

The deficit for 2010-11 is now estimated to be $40.5 billion; $4.9 billion lower than forecast in the October 2010 Update (see Table 2).  We had expected an improvement of at least $7 billion[2], (www.3dpolicy.ca) given the financial results for the first ten months of 2010-11 and the impact of “extra-ordinary” adjustments, which inflated the deficit in 2009-10[3].   

Virtually all of the improvement in the $4.9 billion deficit was due to “economic” factors ($4.7 billion), as the reprofiling of $1 billion of infrastructure funding from 2010-11 to 2011-12 slightly offset  the net impact of the loss in the Government’s sale of common equity in GM.

With the ending of most of the stimulus funding in 2011-12, the deficit is projected to fall to $29.6 billion, marginally lower than that projected in the October 2010 Update.  Higher revenues and lower expenses resulting from the improvement in nominal GDP, coupled with the saving measures implemented in the Budget are just sufficient to offset the impact of the new policy initiatives.  Thereafter, the positive impact of the higher level of nominal GDP and the saving measures more than offset the fiscal cost of the policy initiatives, resulting in lower deficits than those forecast in the October 2010 Update to 2014-15, and a somewhat higher surplus in 2015-16.

There are a few things of interest in the current budget projections.  An expense of $1.3 billion is included in 2011-12 due to transfer protection payments.  This protects provinces from a decline in major transfers received from the federal government.  This transfer protection provision poses a major risk to the forecast, especially if Ontario continues to be eligible for Equalization.

Budget 2011 indicates that the Employment Insurance (EI) Account will be in a cumulative balance by 2015. In the October 2010 Update, premium rates (employee rates) were assumed to increase by 10 cents per year from 2012 to 2015.  However, in Budget 2011, EI premium revenues are $1.1 billion lower than forecast in the October 2010 Update in 2015-16.  This suggests that premium rates will not increase in 2015.  However, it should be noted the EI Account is forecast to generate an annual surplus of about $4 billion in 2015-16), as current legislation requires that premium rates be kept high to compensate for previous years’ deficits in the Account.  The budgetary surplus in 2015-16 is, therefore, entirely to the annual surplus in the EI Account.

How Credible is the Budget Deficit Forecast?

We continue to express concerns about the likelihood of a surplus in 2015-16. We raised these concerns in our assessment of the October 2010 Update (How Credible is the October 2010 Fall Economic and Fiscal Update? October 2010: www.3dpolicy.ca). First, we questioned the calculation of the fiscal impact of the reductions to the employment insurance premium rates and feel that they were overstated. Second, we felt that the forecast of “other revenues” in the October 2010 Update was overly optimistic.  This component can be very volatile from year-to-year due to special transactions (asset sales, royalty payments to Newfoundland and Labrador and Nova Scotia, exchange fluctuations, etc.), which are extremely difficult to forecast.  The Office of the Parliamentary Budget Officer (PBO) raised the same concern in its update[4].  In the March 2011 Budget, further upward adjustments were made to this component, which we feel are not justified.

Third, the October 2010 Update reduced “direct program expenses” in 2012-13 and beyond, from that forecast in the March 2010 Budget, without providing any explanation.  This results in what we believe is an unrealistic profile for “direct program expenses” in those years. The PBO also questioned this profile for direct program expenses.  This profile was not corrected in the March 2011 Budget.

In the March 2010 Budget, the Government announced a number of measures to reduce administrative costs.  However, ask the Chief Financial Officer in any department/agency and they will say that they are always looking for administrative savings to reallocate to meet other priorities, such that additional savings will be difficult to achieve. 

Fourth, as departments are not permitted to exceed their Parliamentary appropriations, they usually spend less than what they are appropriated.  With departments required to find these administrative savings, they will now be forced to operate closer to their appropriations. However, in setting the expenditure track for a budget, the Department of Finance assumes that departments will not be spending all of their appropriations, through what is known as the “lapse” adjustment.  The required administrative savings will, therefore, result in an offsetting reduction in the lapse adjustment, which the Department of Finance did not take into account in either the 2010 or 2011 Budgets. We have reduced the lapse accordingly. We do not believe that these administrative savings will result in any significant net savings for the deficit, as claimed in the 2010 Budget.

Finally, we have adjusted public debt charges to account for the net impact of these changes.

Making these corrections result in a higher deficit profile over the 2012-13 to 2015-16 period than in the March 2011 Budget.  Rather than a small surplus in 2015-16, we expect a deficit of $8.0 billion (see Table 3).

How realistic are our deficit projections?  Following the October 2010 Update, both the PBO and the International Monetary Fund (IMF)[5]forecast that the federal government would still be in deficit in 2015-16, by $11.0 billion and $5.4 billion, respectively.  Updating these forecasts for a slightly improved economic outlook would not significantly change those forecasts – deficits in 2015-16 would still be projected. 

Eliminating the Deficit Earlier?

The budget announced that the government would embark on a comprehensive one-year “Strategic and Operating Review” across all government departments. This review would focus on trying to find savings through improvements in efficiency and effectiveness. This review would affect about $80 billion of direct program spending and the government is targeting a 5% reduction. The President of the Treasury Board and a special committee of Ministers will lead the review.

We support such a review but we do not believe that savings of $4 billion annually can be found through operating efficiencies. What will be required is the elimination of programs, something this government has been reluctant to do.

It is highly unlikely that the deficit will be eliminated in 2015-16, let alone a year earlier.

[1] Private Sector Economic Survey for December 2010: Time to Change Budgetary Process – www.3dpolicy.ca

[2] Deficit for 2010-11 still expected to be $7 billion lower than Forecast – February 2011 www.3dpolicy.ca

[3] See: Financial Results Clearly Indicate that Deficit Will Be $2 Billion Lower Than Forecast: March 2011 www.3dpolicy.ca.

[4] “Economic and Fiscal assessment, 2010”, Office of the Parliamentary Budget Officer, November 3, 2010.

[5] International monetary Fund: Canada Staff Report for 2010 Article IV Consultations – Supplementary Information. December 2010

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� ��Kef4" name="_ftn4" title="">[4] “Economic and Fiscal assessment, 2010”, Office of the Parliamentary Budget Officer, November 3, 2010.

[5] International monetary Fund: Canada Staff Report for 2010 Article IV Consultations – Supplementary Information. December 2010