There could be three budgets before the next general election in the fall of 2015.  The sole objective of these budgets will be to eliminate the deficit by 2015-16. This has been the objective of the government for some time, not because there is serious deficit problem, but because the government is betting its “good management” reputation on its achievement prior to the next election.  Whether the deficit will actually be eliminated in 2015-16 will not be known until the fall of 2016, when the final audited results are published, but by that time the election will be over.

Slowing Economic Growth for the Next Couple of Years

Eliminating the deficit by 2015-16 may not be that easy.  Since the November 2012 Update of Economic and Fiscal Projections, economic growth has slowed.  Minister Flaherty will meet with private sector economists on March 9 to get their most recent views.  On average, they are now forecasting economic growth for 2013 of 1.8 per cent down from 2.0 per cent in their October 2012 survey. The International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) have also lowered their growth prospects for Canada to 1.8 per cent for 2013.  Most economists are forecasting a pick-up in growth in the latter half of 2013.  This has been a common theme in most of the recent forecasts, but has yet to be realized
In the November 2012 Update, the Minister of Finance reduced the average private sector economic forecast for 2012 from 2.0 per cent to 1.8 per cent . Prior to the release of the fourth quarter national accounts, private sector economists were forecasting economic growth averaging 1.8 per cent for 2013, down from 2 per cent forecast in the November 2012 Update.  With thye release of the fourth quarter results, which posted somewhat more weakness than expected, they could well lower their expectations for 2013 even farther.  The Minister willagain make “an adjustment” to the private sector forecast by reducing it by a further 0.2 percenatge point. This would mean an additional reduction in nominal gross domestic product (GDP) by $20 billion per year and a corresponding reduction of $3 billion in budgetary revenues.    

These adjustments to the private sector forecast are warranted since the risks to the current forecast remain significant.  Although the U.S. avoided the “fiscal cliff”, there is still no resolution of the sequestration, amounting to $85 billion in across-the-board spending cuts affecting non entitlement programs. In addition, the debt ceiling will need to be raised by the summer and longer-term fiscal challenges still need to be addressed in the upcoming U.S. budget. The U.K., Japan and the EURO area are all in recession, and growth in developing economies has slowed.  Budget planning should not be based on the assumption of a strong recovery in global economic growth.

It will be difficult to eliminate the Deficit by 201-5-16.

Based on the current monthly financial data for the first nine months of 2012-13, the final deficit outcome for the year as a whole should come in lower than the $26.0 billion estimated in the November 2012 Update. 

The final outcome, which will not be known until the fall of 2013, will largely be determined by the end-of-year accrual adjustments and corporate income tax collections in the months of February and March.  To the extent that the outcome for 2012-13 is lower, some of the improvement should carry forward into 2013-14 and beyond.

However, some or all of this improvement should be offset by the downward adjustment to economic growth.  In addition, the “risk adjustment factor” applied to nominal GDP will lower budgetary revenues by $3 billion per year.

We have expressed concerns about the sharp decline of $9.5 billion in the deficit outlook for 2013-14 forecast in the November 2012 Update.  Adjusting for the “risk adjustment factor” would result in an even larger underlying decline of $11.5 billion.  Of this amount, restraint measures introduced in previous budgets account for $3.5 billion.  The balance of $8 billion would have to come from economic growth, which, in the current circumstances appears overly optimistic. To the extent this decline is not realized, it would have a negative affect on the deficit forecasts for 2014-15 and 2015-16.. 

We have also questioned the impact of the restraint measures on direct program expenses – total expenses less public debt charges and major transfers to individuals and other levels of government.  According to the Government, efficiency gains are expected to account for most of the savings announced in the 2012 budget.  Our experience has been that such efficiency gains are not sustainable and that, without the elimination of programs and/or changes to the terms and conditions of current programs, incremental funding will be required. 

Budget 2012 included, as part of the restraint measures, an updating of capital defence funding, amounting to savings of $2.3 billion over the 2011-12 to 2016-17 period. This not appear to be realistic. In the budget,  capital is expensed on an accrual basis, i.e. capital costs are amortized over its economic life, usually 20 to 30 years.  In the March 2012 Budget, the forecast for ``capital amortization`` was little changed from the previous budget`s forecast. This suggests that the savings are on a cash basis, which if they do relate to capital reprofiling would not significantly affect the current expense forecast.  To generate such savings, the reprofiling measures would have to affect defence operations and not capital.

After the restraint measures are fully in place, the growth in direct program expenses are expected to increase by only 0.7 per cent per year. This in an environment of expected wage and salary increases of 1.5 per cent per year, wage bracket creep and inflation averaging 2 per cent per year. The current forecast for direct program expenses appears overly optimistic unless there is further restraint on the growth in wages and salaries once current collective agreements expire.

On balance, we do not believe that the November 2012 Update fiscal forecast was credible and coupled with the slowdown in economic growth in 2013, the possibility of a balanced budget for 2015-16 is seriously at risk, unless additional significant restraint measures are implemented.

Potential New Initiatives: A Lot of “Tinkering”

In his recent remarks to the media on the fourth quarter economic results, the Minister of Finance stated that he would not be undertaking risky large spending initiatives in the upcoming budget.  Thank goodness because there was more than enough in his previous budgets, including the proliferation of tax expenditures (which are really spending programs but delivered through the tax system), various initiatives included in the Economic Action Plan, among others).

However, some new spending may be unavoidable.  The Aboriginal community will be expecting incremental funding to address their concerns.  The key issue will be how much will be required.  There has been some preconditioning on new funds for apprenticeship programs.

There will also be pressure to continue funding for the Building Canada Fund post March 31, 2014.  Budget 2007 allocated $8.8 billion to the Building Canada Fund to finance projects over the 2007-08 to 2013-14 period.  It appears that the government grossly overestimated the take up of these funds.. Based on the Public Accounts and Estimates, total actual and planned spending for the Canada Building Fund over the 2008-09 to 2013-14 period is estimated at $5.8 billion, leaving over $3 billion unallocated.  This amount could be reprofiled to future years. We believe that funds are already incorporated in the November 2012 Update spending forecast, so that, depending upon the amount allocated, extending this program will no or little impact on the bottom line.

There may also be pressure to extend PPP Canada beyond March 2014.  In the 2007 Budget, $1.25 billion over five years was allocated to this program. Again, we believe that funds to extend this program are already ``booked`` in the current spending forecast.

In the last election, the Conservative promised additional tax expenditure, amounting to $3 billion a year, once the budget is balanced.  Given the current risks to achieving a balanced budget by 2015-16, these will not be incorporated in the upcoming budget.  However, it is expected that they will be re-announced by the 2015 Budget.

If Only the Government had $14 Billion

The Minister of Finance has indicated that additional spending cuts could be forthcoming in order to achieve a balanced budget in 2015-16.  We do not believe that any more efficiency, back office gains, etc. are achievable or would be credible.  As noted above, we doubt that the savings announced to date will be sustainable. Any addition spending reductions will require the elimination of programs in order to be credible.

As we have indicated, the achievement of a balanced budget in 2015-16 is not an economic or fiscal imperative, although the Government has made it a political imperative. As the Government is quickly realizing, it is virtually impossible to hit a single year deficit target over which it has little control.  Economic developments determine how much revenue the government collects and how large public debt charges will be. Wouldn’t it be nice to have that $14 billion in GST revenues back?


This blog was prepared by "the very well known" and the "less well-known".

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