Lessons From The October Fiscal Update

  • National Newswatch

Poor Mr. Morneau, his credibility as Finance Minister already in the tank, desperately needed to do something in his Economic and Fiscal Update to begin restoring it. And there was a lot for him to brag about.The economy is doing well; in fact the Canadian economy has been doing better than any other G7 country. In response to his deficit-elimination obsessed critics, the Finance Minister is absolutely right when he says the federal government's finances are in good shape.  The budget deficit for 2017-18 is now forecast to come in substantially below forecast and then to decline to about 0.5% of GDP by 2022-23. This is smaller than most deficits in the last 50 years. The debt burden is also on a downward trajectory to reach 28.5% in 2022-23 down from 31.2% in 2016-17.There are those who are arguing that too much stimulus could raise the specter of rising inflation, because the economy is operating close to full capacity. This would mean higher interest rates. But there is absolutely no evidence of renewed inflation, either in Canada, or in any other G7 country.There is a debate raging in the economics profession as to whether the traditional model of inflation is valid in today's circumstances. On Wednesday, the Bank of Canada once again did not raise interest rates. Finally, for some time the Finance Department has been engaged in a strategy of locking into long-term debt at historical low interest rates, thereby minimizing the impact of higher interest rates on public debt charges.Unfortunately, Tuesday's Update wasn't simply an Update; it was really a mini- budget including new tax and spending initiatives along with a tedious review of accomplishments since taking office. As in most budgets, it was an attempt to remind everyone of what the government has done for “the middle class” for the last two years.  The Finance Minister and Prime Minister seem to think that middle-class Canadians, or for that matter Canadians in general, actually read these documents.The fall Update process has changed significantly since Finance Minister Paul Martin first introduced it in the mid-1990s.  Initially, the fall Update was viewed as a consultation document to be presented to the House of Commons Standing Committee on Finance. Its sole purpose was to provide updated economic and fiscal projections, to be used as a starting point for a debate about the upcoming budget. Normally it asked a number of questions on how best to address short- and long-term structural issues. The Committee had the opportunity to ask detailed questions and challenge the Finance Minister and his officials.The Harper Government changed this completely first by ignoring the Finance Committee and presenting the fall Update outside Parliament in party-friendly venues and second by including policy initiatives. The Update became mini budget, but with little accountability.In his latest Update, Minister Morneau has continued the practice of announcing new policy initiatives in the fall Update.  Some of these initiatives had been already announced prior to the Update but cost estimates were provided in the Update.  For example, the Update/Mini Budget included the early indexation of the Canada Child Benefit, which had been announced earlier in the year. There was absolutely no reason why this announcement could not have been made in the 2018 budget.The already announced and completely unnecessary (and costly) cut to the small business tax rate was also included, as were the re-announcement of the government's very messed up changes to CCPCs.  These changes could also have been delayed until the 2018 Budget.The Update also included a large number of spending initiatives (about $10 billion over six years), thereby ensuring that these initiatives would be included in Main Estimates for 2018-19 as part of efforts to increase transparency and accountability between the budget expenses and the Main Estimates expenditures. For 2018-19, the fiscal cost of these initiatives is about $1.2 billion, which would only account for a minor portion of the difference between the two spending estimates.The fall Update/mini-budget provided little information on most of the various spending initiatives. However, it appears that of the nearly $10 billion in new spending initiatives over six years, the majority relate to Program Integrity issues, increasing departmental/agency operating budgets most affected by the Harper Government spending restraint measures.  Included in that amount is $2.9 billion over six years of “non-announced” measures which includes ”provisions for anticipated Cabinet decisions not yet made and funding decisions related to national security, commercial sensitivity and litigation rules”.  No other information is provided. This provides Treasury Board with a “slush fund” for additional spending measures.The new spending initiatives were financed by reductions in forecast spending for “direct program expenses”. These changes are not significantly affected by economic developments, with the exception of changes in the interest rate forecast on federal employees' future benefits, such as pensions, death benefits, etc. It appears that based on the final outcome for 2016-17, the Department of Finance decided to significantly increase its estimate of the “lapse”, the amount of appropriations not committed by year end.  This may be a major risk to the forecast, unless delays in the implementation of proposed initiatives continue to occur.Regrettably, the fall Update did not commit to a specific fiscal anchor. It noted that the debt-to-GDP (gross domestic product) ratio is on a downward track. However, it did not commit to a specific target that the Government would take actions if necessary to ensure the target is in fact met. The Harper government had committed to a debt/GDP target of 25%.As well, no mention was made as to when the budget would be balanced.  By 2022-23, the deficit is projected at $12.5 billion.  This includes a $3 billion Contingency Reserve, thereby implying an underlying deficit of only $9.5 billion.Based on the Fall Update's economic and fiscal projections, the budget could be in balance by 2025-26.  The Harper Government originally set a deficit elimination target of “over the medium term”, without specifying an actual date. They later set a specific date (2015-16).  However, to meet that date, they undertook questionable measures (delaying the selling of the remaining GM shares).Although we agree that the Government should not set a specific date for budget balance, the Government should make a stronger commitment to the elimination of the deficit.Finally, the Government continues to remain silent on the use of the Contingency Reserve, in the event it is not required to offset some or all of the impact adverse economic developments or errors in translating the economic forecast into a budget forecast.  The Harper Government stated that if the Contingency Reserve is not required, it would be used to reduce the debt.  However, this rule was not consistently applied and it was also used to fund new initiatives.We would encourage Minister Morneau to commit the Contingency Reserve to debt reduction if it is not required to ensure the deficit projections are met.  It should not be used to fund new initiatives. This would imply that any new funding be sourced internally and/or from better-than expected fiscal outcome after appropriate allowance is made for the Contingency Reserve. This commitment would be more credible if included in budget legislation.Where does all this leave the Finance Minister? Mr. Morneau has a credibility problem, in part due to his failure to manage ethical issues related to his personal finances, and to his failure to understand the broader policy and political implications of his tax proposals for CCPCs.These failures have broader implications for his credibility, as the Minister responsible for the management of the government's finances and the economy. To restore this credibility, he will need to set out clearly the principles he intends to follow in managing the government's fiscal framework and he needs to go before the House of Commons Standing Committee on Finance to explain and debate them. Equally important, he needs to get back to his primary responsibility as a Finance Minister, which is to strengthen the long-term growth performance of the Canadian economy.C. Scott Clark held a number of senior positions in the Canadian Government, including Deputy Minister of Finance from 1998-2001.  He has a PhD in Economics from the University of California at Berkeley and is currently President of C. S. Clark Consulting.From 1990 to 2005, Peter C. DeVries served as Director, Fiscal Policy Division, at the Department of Finance.  In that capacity he was responsible for overall preparation of the federal budget.  He is currently a consultant in fiscal policy and public management issues.Their Blog is 3dpolicy.ca