TWO-THIRDS UPDATE, ONE-THIRD BUDGET

After listening to the Finance Minister and reading the 233-page fall Economic Statement (Update), one cannot help but wonder why the Minister delivered such an Update.  Given that we are still in the pandemic and with all its uncertainties why bother at all? How much reliability can you attach to an economic and fiscal Update in these circumstances?

There is no legal requirement that the government have an Update. The new COVID -19 expenditures don’t require an Update, nor do the proposed tax changes. The tax changes can be implemented through a Ways and Means Motion, with legislation to follow at a later date. The new expenditures can be implemented through legislation, after consultation with the opposition parties, as was the case with earlier COVID expenditures.

It would appear, from the outside, that the Minister wanted an Update that would achieve the two objectives that traditional Updates normally do, but that at the last moment, someone “higher up” decided to impose a third completely unrelated and unnecessary objective on the Update.

The First objective of the Update was to show Canadians what the government has done to mitigate the impact of the COVID-virus on families and businesses. Canadians are extremely anxious about the virus, but they are also concerned about the size of the deficit and the increase in debt, and rightly so. The government confronted these concerns by focusing on 2020-21 and 2021-22  (the year of the vaccine).

The Second objective of the Update was to present a medium-term economic and fiscal forecast to demonstrate the fiscal uncertainties the government is facing as it prepares its spring budget.  Starting with a deficit of $381,6 billion in 2020-21, the deficit declines significantly to $121.2 billion in the following year, as temporary Covid-19 programs come to an end. The deficit then declines rapidly reaching $24.9 billion (0.9% of GDP), in 2025-26.  Not bad if you can believe it.

The Minister of Finance could have, and should have, stopped there.  Clearly the economic and fiscal prospects showed there was a need for new stimulus to support a stronger economic recovery. But the questions of how much stimulus and in what form the stimulus should take could have, should have, been left to the spring budget

Unfortunately, someone decided that making a premature announcement as to the size of stimulus would be a good idea, without a careful assessment of what the consequences might be. The Update includes a commitment to spend $70 to $100 billion over the three years - 2021--22 to 2023-24 - to support the recovery once the virus is controlled.

The Update also indicates that the “measures that the government takes now will be a down payment on investments to come.” In other words the stimulus could amount to over $100 billion and last longer. Nevertheless, the $70 to $100 billon is the minimum amount of new spending the government is prepared to undertake in the upcoming budget.  As such, it takes one budget headline off the table. But it does more than that. It tells us the size of deficit and debt burden the government is prepared to accept over the medium term.

No funds for this commitment were explicitly set aside and included in the Update’s fiscal projections.  It’s hard to understand why the Finance Minister, and the Prime Minister, made this commitment in the Update rather than in the budget.  It may be in reaction to calls from the opposition for measures to jump start the economy, given that other countries have already made stimulus announcements. 

In the Update, the Minister presents four fiscal scenarios as to how the $70 billion or $100 billion could be allocated over the three years (2021-22 to 2023-24).  One of the scenarios allocates $100 with  $20 billion to 2021-22, $50 billion to 2022-23 and $30 billion to 2023-24.

This profile assumes, as does all the others, that the government already has some idea of what the measures will be. No additional funds are allocated to the remaining two years of the fiscal forecast. Applying the funding to the baseline forecast shows a deficit averaging around $105 billion annually (around 4.5 per cent of GDP) and a debt ratio averaging around 55 per cent and slowly declining.

Assuming (quite realistically) that the stimulus measures will likely be ongoing, new spending of at least $30 to $50 billion could be added to both 2024-25 and 2025-26. The deficit in 2025-26 would then be about $60 billion (3% of GDP), and the debt ratio would be stuck at just under 55%.
We can expect a budgetary track close to this in the upcoming spring budget. The government could easily commit to a deficit not to exceed 3% of GDP and a debt ratio not to exceed 60% of GDP. These could become the new fiscal guardrails or anchors for the government.

In effect, the Update states that the government intends to follow the same fiscal strategy as before the virus; an on-going structural deficit, (albeit much larger); and a stable and slowly declining debt ratio, (albeit much higher). A debt ratio of 30 % is out of the question. This means significantly higher program spending in the fiscal framework.
There is an important policy issue that the government does not want to address.  Should all of the stimulus deficit be debt financed simply because long-term interest rates are currently at historically low levels and are expected to remain low for the foreseeable future?  Expenditures that can lead to stronger long-term productivity and economic growth would fit this category. But new spending or tax initiatives that benefit only current households do not. They should be financed out of new tax revenues and/or reduced program spending. If there was ever a time to consider restoring the 2 points to the GST that were eliminated in 2006, this is it.

So where does the Update leave the Minister’s fiscal credibility? Keep in mind that the Finance Minister, like her predecessor, probably had to hold off a Prime Minister and Cabinet with much larger spending ideas than she has.
In our view, the fiscal credibility of the Update should be judged against four principles: first, the Update should use  “realistic” economic assumptions; second, the Update should be “responsible” by demonstrating that the Minister is prepared to make tough political decisions; third, the Update should include adequate“ prudence ”against unforeseen events; and fourth, the Update should be “transparent” in presenting all the relevant information, so that the Minister and the government can be held accountable?
Generally speaking the Update does quite well on the first two principles; is passable on “prudence” but is quite inadequate when it comes to “transparency”. 

The economic forecasts are based on an average of 14 private sector forecasts. These forecasts show a greater degree of consensus than only a few months ago.  There are simply too many unknowns about the future structure, behavior and growth, of both the domestic and global economies to make reliable forecasts.

In the Update the Minister is prepared to take responsibility not just for the pandemic spending but also for the commitment for significant stimulus spending. The Minister has signaled that she is prepared to run a fiscal strategy with higher program spending and a higher structural deficit and debt burden than in the past. She has rejected completely the debunked policy of  “growth through austerity” followed by Stephen Harper after the 2008 financial recession. Bottom line; don’t expect a commitment to a balanced budget as a fiscal anchor in the upcoming budget.

Regrettably the fiscal forecasts do not include any “prudence” factor to allow for the very high possibility that the forecasts could be worse than in the base case. However, in a post pandemic economy it is hard to know what size of prudence factor would be adequate. It doesn’t take much of a change to the economic forecast to completely change the fiscal forecast. The Minister will have to take this high level of uncertainty into account as she plans the spring budget.

The Update falls extremely short when it comes to transparency. There are a number of important policy announcements, such as major changes to the stabilization program, a national childcare program and the Canadian Human Rights Tribunal regarding First Nations children’s right, for which no costing is provided.

Also, the question of the size of the Employment Insurance Operating Fund and the implied premium rate increases is not even raised.  In previous budgets a projection of the EI premium rate, which would balance the account over a seven-year period was included. Such a projection was not included in this Update. The Prime Minister has indicated that the EI premium rate would be frozen to 2021 and 2022 at its 2020 rate. However, based on the projection of EI premium revenues in the Update, EI premiums would be expected to increase significantly in the last three years of the projection period. Freezing the rate would significantly increase the deficit.

Looking forward, the spring budget is going to be very challenging. It is not an overstatement to say that the spring budget will be just as important for the Trudeau government as the Martin 1995 budget was for the Chretien government. The Martin Budget set the fiscal course for the next 10 years. The Freeland 2021 budget will have to do the same.