If Canadians had wanted a Conservative government obsessed with deficit elimination, they would have elected one. Instead, they elected a Liberal government that committed to running the government’s finances in a “realistic, sustainable, prudent, and transparent manner”.

The November Economic and Fiscal Update confirmed “the Government’s realistic approach to fiscal management, based on the principles of sustainability, prudence and transparency”.  In the Speech from the Throne, this approach to fiscal management was replaced by “a fiscal plan that is responsible, transparent and suited to challenging economic times”.

This ambiguity suggests that the government is not sure how it intends to implement its “fiscal management strategy”. This can cause real problems. It needs to be clarified.

On Monday, the Finance Minister tabled a Ways and Means Motion to implement a reduction in the personal income tax rate from 22% to 20.5% for those earning between $45,282 and $90,563 and to increase the rate to 33% for taxpayers earning over $200,000.  During the election, the Liberals had claimed that the tax changes would be revenue neutral.

 A number of commentators questioned this, arguing that the net shortfall could be as high as $2.8 billion. The Finance Minister has now acknowledged that there could now be a shortfall of about $1.2billion annually.

This is not a large error on a budget of about $400 billion. But it has become a major political and policy problem, when added to an already worsening deficit outlook. In his November Update, the Finance Minister acknowledged that the deficit outlook had worsened substantially since the 2015 Budget. Even so, the Finance projections were actually far more optimistic in the outer years than those released earlier by the Parliamentary Budget Officer (PBO).

This raised questions about whether the Finance projections represented a “realistic” assessment of the government’s fiscal prospects.  In the Update, the Finance Department did not provide any explanation as to why its revenue projections were so much stronger than those of the PBO. Following the Update, PBO discovered that Finance used higher revenue tax elasticities for the three major tax components (corporate, personal, and GST). No justification for theses optimistic assumptions has been given.

Using the more “realistic” PBO forecast and including the revised costs of the election platform results in a medium-term deficit forecast of  $15 to $20 billion annually. To make the fiscal outlook even more precarious, oil prices have now fallen to $37 a barrel and are expected to fall further.

The Finance Minister reaffirmed on Monday, the government’s commitment to balance the budget in its first mandate.  This would require that nominal GDP in 2019 be $100 billion higher than in the PBO forecast. This is not going to happen.

Every time the Finance Minister says he will balance the budget by 2019-20, his fiscal credibility evaporates just a little bit. At the current rate he may have vey little left by the time of the 2016 budget. Everyone knows the deficit is going to be much higher than the $10 billion commitment made during the election. Some election promises can be delayed, but there is little room for more spending cuts and tax increases are out of the question. 

This raises two related questions: why does the Finance Minister say the deficit will be eliminated; and, why does balancing the budget matter?

The only answer seems to be that the Government is confused about what kind of fiscal policy they actually want to pursue.  They were willing to accept “modest” deficits during the election, but only if they could balance the budget in 2019-20. They wanted to be a proactive government but not too proactive. But now the deficit is not going to go away and the government seems confused as to what to do. 

Both the Prime Minister and the Finance Minister do not seem to understand that their election commitment to “sustainable” fiscal management does not require balancing the budget at some arbitrary date.

The government must demonstrate fiscal discipline. But there are different approaches on how to do this. There is the approach of the previous Conservative government that all deficits (except during recessions) are bad and once governments start spending, they will lack the political will to stop. Better to avoid this “inevitability” by never running deficits.

The adverse consequences on the economy of this approach to fiscal management over the last five years are abundantly clear.

“Sustainable” fiscal management allows the government to take actions to support economic growth subject to the constraint of maintaining a low and a stable or declining debt burden. This constraint will impose a check on the government in terms of the acceptable size of the budget deficit relative to the size of the economy.  A deficit higher than one per cent of GDP ($20 billion) would violate that constraint. The government is getting close to breaking its debt constraint.