The federal Department of Finance released the final audited financial results for 2011-12 in its Annual Financial Report (AFR) on Friday, October 5, 2012. The deficit for 2011-12 was $26.2 billion; $7.2 billion lower than the final outcome for 2010-12.  This is a significant reduction. However, the deficit for 2011-12 was $1.4 billion higher than the March 2012 Budget forecast of $24.9 billion, due to lower revenues. This outcome will likely impact negatively on the results for 2012-13 and beyond. However, it is not large enough to adversely affect the elimination of the deficit over the medium term, provided the international financial and economic situations do not worsen further.

All of the year-over-year improvement in the deficit was due to higher revenues, up $8.1 billion, as total expenses increased by $1 billion.  Among the major revenue components, personal income taxes increased by $5.8 billion (primarily reflecting a 4.8% increase in wages and salaries coupled with a progressive tax system), corporate income taxes were up $1.7 billion (corporate profits were up 15% but the general tax rate declined from 18% in 2010 to 16.5% in 2011) and employment insurance (EI) premiums rose by $1.1 billion (both the EI rate and insurable earnings subject to the rate were higher).

“Other revenues” declined by $0.9 billion, due to lower profits from Crown corporations.  Goods and Services Tax (GST) revenues were marginally lower, which according to the Department of Finance was due to “timing factors” attributable to input tax credits claimed related to gross GST assessed.  Under accrual accounting, one would have expected that such timing factors would have been adjusted for.

Program expenses were up only slightly by $0.8 billion, as higher transfers to other levels of government (up $4.0 billion) were largely offset by lower direct program expenses (down ($3.5 billion).  Transfers to persons were up slightly (up $0.3 billion), as the impact of higher elderly (up $2.4 billion) and children (up $0.1 billion) benefits were largely offset by lower EI benefits (down $2.2 billion). 

The decline in direct program expenses was primarily attributable to lower other transfer payments (down $5.5 billion), due to the ending of various stimulus measures under the Economic Action Plan.  In contrast, defence expenses rose $1.5 billion while Crown corporation expenses increased $0.6 billion.  All other departmental and agency expenses declined by $0.2 billion in part, reflecting the impact of the restraint measures introduced in the2010 Budget. Public debt charges increased by $0.2 billion, as an increase in the stock of debt was largely offset the effect of lower interest rates.

As noted above, the higher-than-expected deficit outcome for 2011-12, compared to the March 2012 Budget forecast, was entirely due to lower-than-expected revenues. No explanations were provided by the Department of Finance as to the reasons for these revenue shortfalls. Personal income taxes were $1.6 billion lower, corporate income taxes were $0.9 billion lower while GST revenues were $0.7 billion lower.  The end-of-year adjustments for these components were larger-than-expected, indicating that the adjustment factors used to convert monthly cash receipts to accrual revenues during the course of the year for these components were overstated.

Program expenses were $1.5 billion lower than forecast in the March 2012 Budget, with virtually all of the difference due to lower direct program expenses.  It appears that this was primarily due to other transfers. Although other transfers were $0.5 billion higher- than-forecast in the 2012 Budget, the AFR included a reclassification of about $2.2 billion in expenses from Crown corporations to other transfers.  Without this adjustment, other transfers would have been $1.7 billion lower than forecast in the March 2012 Budget.  This component has been over estimated in previous years as well.

Until more details are provided by the Department of Finance and/or contained in the upcoming Public Accounts, it is difficult to assess what impact the higher-than-expected deficit outcome for 2011-12 will have on the deficit outcome for 2012-13 and future years.  In the March 2012 Budget, the Department of Finance would have used their more optimistic estimates for 2011-12 as the base for forecasting revenues and the resulting budgetary balance to 2016-17.  With the revenue results for 2011-12 lower than expected, one would expect that all or some of this deterioration would carry-forward into future years, thereby impacting negatively on the outer year forecasts.  It is not known whether the lower-than-expected outcome for other transfers will carry forward.

Based on the monthly Fiscal Monitor results for 2011-12, we had expected that the deficit outcome for 2011-12 would have been lower-than-forecast in the March 2012 Budget and this would carry forward.  We now expect that the higher-than- expected deficit outcome for 2011-12 will have a negative impact on the deficit forecast for 2012-13 and beyond.  In addition, the economic outlook is much more uncertain now than that expected at the time of the last budget.

These changes alone would not prevent the government from eliminating the deficit over the medium term. However, should the situation in the EURO, the US and in Asia continue to worsen, then all bets will be off.

We await the Minister of Finance's upcoming Economic and Fiscal Update.