On October 29, 2012, the Parliamentary Budget Office (PBO) released its fall “Economic and Fiscal Outlook Update”.  The Update is relatively positive, given the significant  international and domestic economic risks that currently exist(see http://www.3dpolicy.ca/node/212). 
 

The PBO believes  that the federal government has a better than 60 per cent chance of eliminating the deficit by 2015-16, 70 per cent or better by 2016-17, and a 75 per cent chance or better by 2017-18.  All of this of course depends on some very heroic assumptions.

In our earlier commentary on the Parliamentary Budget Office’s (PBO) latest Economic and Fiscal Outlook Update, we stated that economic assumptions were based on a survey of private sector economists.  Although PBO surveys private sector economists on a regular basis, the economic forecasts used for their updates, since June 2011, are based on PBO’s assessment of future economic developments and not those of the private sector economists. Although PBO does not include the details of their economic forecasts in their Updates, they are available upon request. We apologize for any misunderstanding and confusion this might have caused. We have revised our commentary correspondingly
 

Economic Forecast
 

PBO has lowered its outlook for economic growth from its April 2012 Update.  In addition, PBO’s forecast for nominal gross domestic product (GDP) – the broadest measure of the federal tax base - is considerably lower than the average of the private sector economists’ forecasts released by the Minister of Finance on October 29, 2012. For 2012, PBO forecast an increase in nominal GDP of 3.0%; compared to a private sector average of 3.4%. For 2013, PBO forecast growth of 2.9% compared to a private sector average increase of 4.0%. These are significant differences and will have noticeable implications for their respective fiscal forecasts. It will be interesting to see by how much a “risk adjustment factor” the Minister of Finance builds into his fall update nominal GDP forecast.

The PBO must present its economic and fiscal outlooks to the Standing Committee of Finance in the fourth week of October and April of every calendar year.  However, there are no fixed dates for the Minister of Finance to present his fall update or budget.  We would encourage the Finance Committee to reconsider their request for PBO updates in October and April. Instead, we would recommend that the PBO outlooks follow the Minister of Finance’s fall updates and budgets.  This would allow for a detailed assessment of the Government’s fiscal forecasts by the PBO.
 

On October 1, 2012, Statistics Canada introduced a new presentation of the Income and Expenditure Accounts based on the latest international standards.  These changes increased the level of nominal GDP by about $35 billion in 2011.  PBO did not have time to incorporate these revisions into its economic forecast, given its fixed date for release.  As a result, its level of nominal GDP is significantly lower than that of the October private sector economic survey, making comparisons of levels irrelevant.  However, rates of growth can still be compared.
 

Fiscal Outlook
 

For 2012-13, PBO forecasts that the deficit will fall to $18.1 billion, down $8.1 billion from the outcome of $26.2 billion in 2011-12.  It is also $2.1 billion lower than what they were forecasting in their April 2012 Outlook for 2012-13.  This is somewhat surprising, given the slower nominal GDP growth now expected for 2012, the lower-than-expected budgetary revenues in 2011-12, and the current monthly financial results, which suggest lower revenues than forecast in the 2012 Budget for 2012-13.  One would have expected that, in this environment, budgetary revenues would be lower than originally forecast. However, the PBO forecasts virtually no change in the outlook for budgetary revenues for 2012-13. 
 

A critical assumption in PBO’s fiscal outlook relates to its forecast for direct program expenses – transfers payments (excluding major transfers to personas and other levels of government) and the operating costs of government.  This component has been the subject of major restraint measures since the 2010 Budget, including the $5.2 billion in restraint measures announced in the 2012 Budget.  Direct program expenses are expected to be basically frozen to 2017-18.  Although consistent with the 2012 Budget forecast, PBO notes that this is a major risk to their forecast. By 2014-15, most restraint measures are expected to be fully implemented, which implies no incremental restraint measures beyond that date.  Without additional restraint, we would have expected annual increases in line with inflation and population post 2014-15 for this component of expenses.  
 

It should also be noted that annual surpluses in the Employment Insurance Operating Account contribute significantly to the surpluses forecast for 2015-16 to 2017-18.  These annual surpluses are to balance the Operating Account, which posted a cumulative deficit of $8.6 billion at the end of 2011-12.
 

Despite the above, the Government’s goal of eliminating the deficit over the medium term is possible. Whether it will be 2015-16, 2016-17 or 2017-18 is irrelevant.  The structure that is currently in place should ensure a balanced budget and growing surpluses over time, provided the significant downside risks in the U.S. and the EURO area do not materialize. .
 

Fiscal Sustainability
 

PBO’s Outlook summarizes the results of its 2012 Fiscal Sustainability Report.  In that Report, PBO concluded that the federal government’s fiscal structure was sustainable over the long term given recent policy changes such as: reduction in rate of growth in the Canada Health Transfer escalator beyond 2016-17, reductions in direct program expenses and the increase in the age of eligibility for Old Age Security benefits. PBO applauds the Government’s commitment to provide long-term fiscal sustainability reports for the federal government but encourages it to do so for the provinces in total as well, as recommended in the latest Auditor General’s report.
 

It is worth noting that, based on PBO long-term fiscal sustainability for the total government sector, Minister Flaherty’s commitment to eliminate total government net debt is no longer achievable. Total government net debt includes the debt of the federal, provincial-territorial and municipal governments, along with that of the Canada and Quebec Pension Plans. In their forecast to 2086, the total government net debt-to-GDP ratio never falls to below 30%.  As we stated in the past, this was a ridiculous target for the Minister of Finance to set.  He can only directly control federal finances and not that of others. He will have to come up with another, hopefully a much more credible and achievable, fiscal target.  
 

Improving Budget Transparency and Accountability
 

The PBO Outlook document contains a section on how the government could improve budget transparency and accountability.

These include publishing:
• Historical estimates and medium-term projections of the economy’s potential GDP, as well as the methodology and assumptions used;
•  Medium-term projections of the Government’s structural, or cyclically-adjusted budget balance as well as the methodology and assumptions used;
• The assumptions, projections and methods to translate the private sector economic forecasts into its fiscal forecasts; and
• The fiscal sustainability analyses of the provincial-territorial government sector that it prepared.

We strongly support these recommendations, although we would prefer that the Government use the Department of Finance’s internal economic forecasts and publish the assumptions and methods used to translate these into its fiscal forecasts.