There could be three budgets before the next general election in the fall of 2015. According to Finance Minister Jim Flaherty, 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 a serious deficit problem, but because the government is betting its “good management” reputation on slaying the deficit prior to the next election. We won’t know whether Mr. Flaherty succeeded until the fall of 2016, when the final audited results are published — long after the election is over.
Eliminating the deficit by 2015-16 may not be easy. Since the November 2012 Update of Economic and Fiscal Projections, economic growth has slowed. Flaherty will meet with private sector economists on March 9 to get their latest views. 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 a 2 per cent forecast in the November 2012 update.
With the release of the fourth quarter results, which showed more weakness in the economy than expected, they are likely to lower their expectations for 2013 even further. The International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) also have lowered their growth prospects for Canada to 1.8 per cent for 2013 and they’re also likely to lower their forecasts in the near future.
In the November 2012 update, Flaherty had already reduced the average private sector economic forecast for 2013 from 2.0 per cent to 1.8 per cent. If, as expected, the March 2013 survey of the private sector shows real economic growth at 1.8 per cent for 2013, then Flaherty may once again make an “adjustment” to the private sector forecast by reducing it to 1.5 per cent. 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 there are significant threats to the current forecast. Although the U.S. avoided the “fiscal cliff”, there is still no resolution to the sequestration deadlock, amounting to $85 billion in across-the-board spending cuts affecting non-entitlement programs. The United States’ 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. As we have argued in the past, given the risks, the “risk adjustment factor” should increase over time, rather than remain constant.
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 billion forecast in the November 2012 update.
The final outcome, which will not be known until the fall of 2013, will be determined largely 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, all of this improvement could be offset by the downward adjustments to economic growth that are now being made. In addition, the “risk adjustment factor” applied to nominal GDP will lower budgetary revenues by $3 billion per year.
After the restraint measures are fully in place, the direct program expenses are expected to increase by only 0.7 per cent per year. This, in an environment of anticipated wage and salary increases of 1.5 per cent per year, wage bracket creep and inflation averaging 2 per cent per year. In this context, the current forecast for direct program expenses of 0.7 per cent per year would be highly unlikely — unless there is further restraint on the growth in federal wages and salaries once current collective agreements expire.
On balance, we do not believe that the November 2012 update fiscal forecast was credible — nor do we believe that the deficit will be eliminated by 2015-16 without additional restraint measures. Such measures, however, might only act to worsen the prospects for economic growth and, in turn, the likelihood of eliminating the deficit by 2015-16. It would be better to delay the elimination of the deficit by a year or two.
In his recent remarks to the media on the fourth quarter economic results, Flaherty stated that he would not undertake “risky” large spending initiatives in the upcoming budget. Apparently the minister believes that the economy will somehow turn around on its own, despite all the downside risks and uncertainties.
However, some new spending may be unavoidable. The aboriginal community will be expecting incremental funding to address their concerns; the key question is how much. There has been some preconditioning on new funds for apprenticeship programs.
There also will be pressure to continue funding for the Building Canada Fund after March 31, 2014. Budget 2007 allocated $8.8 billion to the fund to finance projects over the period 2007-08 to 2013-14. 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 over the period 2008-09 to 2013-14 is estimated at $5.8 billion, leaving $3 billion unallocated. This amount could be reprofiled to future years. However, we believe that funds are already incorporated in the November 2012 update expense forecast, so that, depending upon the amount allocated, extending this program would have little impact on the bottom line.
There may be pressure also 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.
Flaherty 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 efficiencies or ‘back office’ gains are achievable. 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.
The elimination of the deficit by 2015-16 is neither an economic nor a fiscal imperative. It is simply a political imperative imposed by the government. 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.
Flaherty probably would like to have that $14 billion in lost GST revenues back. With it, he could elimiate the deficit by 2015-16 and move on.
The decision to cut the GST by two points was originally seen as good politics but bad policy. It appears now that it was both bad policy and bad politics.
Original Article
Source: ipolitics.ca
Author: Scott Clark and Peter DeVries
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