Eliminating the Deficit Won't be so Easy Mr. Scheer

  • National Newswatch

If deficit elimination were so easy, then why haven't there been more years of balanced budgets or surpluses? In the over fifty years between 1966-67 and 2018-19, the federal budget showed a surplus in only 12 years; in 1969-70 and between 1997-98 and 2007-08. The record in other advanced countries isn't any better. The fact is, even if you believe very strongly in a balanced budget, the chances of achieving and maintaining them are very low.There are many reasons for this. Perhaps most important is that there are just too many unpredictable and uncontrollable economic and political variables over which policy makers have no control. Saying you will balance the budget in three years or five years is quite meaningless. Who knows what could happen in five years. Prime Minister Harper wasn't expecting the great recession in 2008 -2009, which led to a major increase in the deficit, part of which was due to his stimulus measures. Despite his best efforts to cut spending afterwards, he never was able to balance the budget.The baseline budget forecast being used to cost the policy platforms of the four major political parties was prepared by the Parliamentary Budget Officer (PBO) last June. It is already out of date. It will have to be updated by the new government. Given recent downward forecasts to global economic activity by the OECD, the World Bank and the International Monetary Fund, the revised economic and fiscal outlook will be much worse. This is what happened to the new Liberal government after the 2015 election.Paul Martin has been the only Finance Minister to successfully eliminate the deficit and sustain a period of budgetary surpluses. He succeeded for several reasons. First, the Jean Chretien-led government in which he served had the support of most Canadians. The Federal government faced a financial crisis of ever-increasing deficits and Canadians knew it. Polling at the time showed that a large plurality of Canadians understood there was a financial crisis and wanted the government to act. This was critical. Without broad public support, deficit elimination is unlikely to succeed. In comparison, at the present time, there is no fiscal crisis and no broad-based public support for deficit elimination.A second reason for that success was that the austerity imposed by the 1995 federal budget was offset by the emergence of China as a driving economic force together with stronger growth in the United States. Economic growth shifted rather easily from domestic led growth to export led growth. This led to a surge in budgetary revenues and a rapid decline in the deficit. In comparison, with increasing evidence of slowing global economic activity and the possibility of a recession, export led growth in the coming years seems unlikely.The third factor critical to the Chretien/Martin success at deficit elimination was the application of a broad-based review of all program spending. All spending was reviewed including transfer programs and statutory spending. Direct program spending (total program spending less major transfers to people and other levels of government) was subject to “Program Review”. Only spending on indigenous programs was excluded. This review led to a major cut in government spending and government employment in the 1995 budget. The “toughness” of the 1995 budget had the immediate affect of establishing the fiscal credibility of the government and the elimination of risk premiums on long-term interest rates. This halted the growth in public debt charges and accelerated the elimination of the deficit. Today, long-term interest rates are already very low without any risk premium. Public debt charges are not a major factor underlying the deficit today.And finally, major structural reforms had previously been implemented by the Mulroney government, including reform of personal and corporate income taxes, the replacement of the federal manufacturer's sales tax by the Goods and Services Tax, reform of the unemployment insurance program, free trade with the U.S. and Mexico and the privatization of a number of Crown corporations. These reforms involved some upfront costs but by the mid-1990s, they provided structural changes to both revenues and expenditures that increased revenues and lowered spending.There are some important lessons from the 1995 budget that Stephen Harper failed to appreciate and it looks like Conservative Party leader Andrew Scheer is at risk of falling into the same traps. First among these lessons: don't impose constraints on the program spending that is to be reviewed. According to the Conservative platform, to balance the budget in 2024-25, they would need to find over $20 billion of restraint measures. Part of this is to come from a “review” of corporate tax expenditures estimated to yield $1.5 billion per year.  Another lesson that seems to have been missed is evident in Mr. Scheer's confidence that increased tax enforcement can yield an additional $3.5 billion by 2024-25.  More often than not the expected savings from such “exercises” are not realized. If this were to happen, then additional spending cuts would have to be found.In addition, Mr. Scheer is proposing to find an additional $14.5 billion, or possibly more, in spending cuts; this will be a major challenge. Mr. Scheer has already said that he won't cut the Canada Health Transfer, the Canada Social Transfer and Equalisation or other transfers to the provinces.Mr. Scheer has also ruled out cuts to major transfer to elderly benefits, employment insurance benefits and children's benefits.  These exclusions are not surprising given there is no fiscal crisis to warrant cuts to these programs. But it means that any expenditure cuts for deficit elimination would have to be found in “direct program expenses”, which are projected to total about $165 billion in 2024-25.Eliminating the deficit in 2024-25 would require a 9% cut to direct program expenses. This component of program spending includes defence expenses, international assistance, transfers to First Nations, infrastructure spending, student loans, and assistance to farmers, among others. To eliminate the deficit, the Conservative platform commits to reprioritizing “foreign aid and cancelling annual increases to international agenda”, “prioritizing infrastructure spending” and reducing departmental/agency non-salary operating budgets.The first two spending cuts to direct program expenses would be relatively simple to implement.  The Treasury Board Secretariat (TBS) could adjust the affected departments' budgets accordingly. However, the cut to infrastructure spending appears ironic after the Conservatives have promised to provide federal monies to expand subway lines in Toronto.Finally, the Conservative platform commits to reducing “other non-salary operating expenses while maintaining public service staffing at 2020-21 levels”. They believe mistakenly that they could find a reduction in these expenses of $4.0 billion in 2020-21, rising to $14.5 billion in 2024-25, for a total of $44.2 billion over the five-year period.Despite what some people think, cuts in departmental non-salary operating budgets are not easy.  TBS could either impose across-the-board spending reductions or instead impose targets on each department and agency and let them determine how best to meet those targets. The latter approach was used in the 1995 Program Review exercise.However, there is an additional reduction to department/agency budgets that is buried in the  Platform released last week by Andrew Scheer: the Conservative Party also proposes to provide the Canada Revenue Agency (CRA) with increased resources in order to enhance tax compliance and enforcement.  The funds, however, for this initiative are to come from reallocations from other departments.  The increased enforcement is estimated at $100 million in 2020-21, rising to $750 million in 2023-24 and remaining at that level thereafter.  As a result, the restraint measures affecting non-salary operating budgets would increase by $923 million in 2020-21and by $6.3 billion in 2024-25 for a total increment of $18.0 billion over the five-year period. In the end, the Conservative plan to eliminate the deficit would require a cut to non-salary operating expenses in 2024-25 of almost 23%; hardly a small number.Non-salary operating expenses consist of spending on transportation and communications, information, professional and special services, rentals, repairs and maintenance, utilities, materials and supplies, capital and other subsidies and payments.  It would be very difficult to secure savings from rentals, repairs and maintenance and utilities, materials and supplies, unless major departmental downsizing were undertaken.Based on Public Account data for 2017-18, the last year for which breakdown by standard object is available, the three largest components of non-salary operating expenses (professional and special services, capital and other subsidies and payments) account for about three-quarters of the total non-salary operating budget.  The easiest cut would be to the capital budgets but this will just compound the rust out problem currently existing within departments and agencies.The department that will be most affected by the cut in non-salary operating expenses would be  Defence.  It accounts for about 45% of total non-wage operating budgets. In addition, two other departments -- Foreign Affairs and Public Safety and Emergency Preparedness -- could also be heavily affected. In other words, these Conservative cuts may not be realistic.None of this will matter unless the Conservatives win a majority government on October 21st. Right now a majority (for anyone) doesn't seem likely.With fiscal prospects probably worse than currently expected, with no broad-based support for deficit elimination, and with a possible recession on the short-term horizon it is highly unlikely that any government would be able to balance the budget in five years.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