A Fis­cal Pol­icy Per­spec­tive on Bud­get 2018: Is it Cred­i­ble? Is it Ac­count­able?

Policy - - In This Issue - Kevin Page and Salma Mo­hamed

As the Par­lia­men­tary Bud­get Of­fi­cer, Kevin Page de­vel­oped a na­tional rep­u­ta­tion for hold­ing the pre­vi­ous gov­ern­ment ac­count­able. In his cur­rent role as pres­i­dent of the In­sti­tute for Fis­cal Stud­ies and Democ­racy at the Univer­sity of Ot­tawa, Page says Bill Morneau de­serves credit for the 2018 bud­get, with a cou­ple of se­ri­ous as­ter­isks. Here’s his as­sess­ment, with an as­sist from Univer­sity of Ot­tawa stu­dent Salma Mo­hamed.

Sa­muel Adams, the Amer­i­can found­ing fa­ther and philoso­pher, coined the phrase “give credit to whom credit is due”. Fi­nance Min­is­ter Bill Morneau de­serves credit. When the Lib­er­als won the fall 2015 elec­tion, the econ­omy was hurt­ing. There was no eco­nomic growth. The un­em­ploy­ment rate stood above 7 per cent. Much has changed since 2015 and much is good.

On Fe­bru­ary 27, Morneau tabled his third bud­get. It must have felt like get­ting to the top of a large hill. As he stood in the House of Com­mons to de­liver his speech, the year-over-year growth in GDP stood above 3 per cent and the un­em­ploy­ment rate be­low 6 per cent. Many eco­nomic in­di­ca­tors are mov­ing in the right di­rec­tion. Growth is now balanced be­tween the goods and ser­vices sec­tor. In­vest­ment in ma­chin­ery and equip­ment and wages are mov­ing on up. The em­ploy­ment rate is fi­nally trend­ing up af­ter years of rest­ing in the dol­drums since the 2008 fi­nan­cial cri­sis. “Give credit to whom credit is due”. The gov­ern­ment said they would run mod­est deficits on the backs of sig­nif­i­cant ex­pen­di­tures that would sup­port the “mid­dle class” and pub­lic in­fra­struc­ture. They did all of this. Growth in con­sump­tion and pub­lic in­vest­ment have con­trib­uted to over­all eco­nomic growth.

Nel­son Man­dela, the late South African leader said he “dis­cov­ered the se­cret that af­ter climb­ing a great hill, one only finds that there are more hills to climb.” While it is im­por­tant to en­joy the vista and re­flect on the jour­ney, Man­dela cau­tioned that “the long walk is not ended.” For Morneau and the Lib­eral gov­ern­ment, their long walk will be to the fed­eral elec­tion Oc­to­ber, 2019.

The eco­nomic and fis­cal en­vi­ron­ment in 2018 is very dif­fer­ent than 2015. Risks are evolv­ing. Af­ter three fed­eral bud­gets, it would seem to be a fair ques­tion to ask whether the gov­ern­ment’s fis­cal pol­icy is cred­i­ble look­ing for­ward, not through a rearview mir­ror. How might Cana­di­ans hold the gov­ern­ment ac­count­able from a fis­cal pol­icy per­spec­tive in the next fed­eral elec­tion?

Bud­gets are first and fore­most sup­posed to be fis­cal plan­ning doc­u­ments. Par­lia­men­tar­i­ans and Cana­di­ans need to know what is the fis­cal plan to move for­ward on the gov­ern­ment’s pol­icy pri­or­i­ties given the state of the econ­omy and the na­tion’s fi­nances, the out­look and re­lated risks. Fis­cal pol­icy re­lates to how the gov­ern­ment will ad­just spend­ing and tax­a­tion to in­flu­ence the econ­omy.

We have a $2.2 tril­lion econ­omy. To­tal fed­eral bud­getary rev­enues and ex­pen­di­tures ex­ceed $300 bil­lion. The gov­ern­ment has heft. How the gov­ern­ment al­lo­cates its tax re­sources or whether it runs a sur­plus or deficit im­pacts eco­nomic growth rates and the stan­dard of liv­ing of Cana­di­ans.

In the con­text of a strong econ­omy, Bud­get 2018 laid out a fis­cal track that was vir­tu­ally iden­ti­cal to the one Morneau pre­sented in his Fall 2017 Up­date. The bud­getary deficit is pro­jected to de­cline from just un­der $20 bil­lion in 2018-19 to just over $12 bil­lion (Ta­ble 1 next page). As a per­cent­age of the econ­omy (GDP), the deficit falls from 0.9 per cent to 0.5 per cent over this pe­riod.

At this junc­ture, it looks like this is the fis­cal track the gov­ern­ment is

pre­pared, and hopes, to take into the next elec­tion.

When one adds up the deficits gen­er­ated by the lib­eral gov­ern­ment over the plan­ning pe­riod it is equiv­a­lent to $115 bil­lion—a 19 per cent in­crease in the fed­eral debt since 2015-16. The trend of ris­ing fed­eral debt con­tin­ues since the im­pact of the 2008 fi­nan­cial cri­sis (Chart 1). It is a large in­crease in nom­i­nal terms.

As a per­cent­age of GDP, if we as­sume con­tin­u­ous growth over the next five years (i.e., the econ­omy op­er­ates at or above its po­ten­tial), fed­eral debt de­clines from 31 per cent in 201516 to about 28 per cent in 2022-23 (Ta­ble 1). So, planned debt would re­main rel­a­tively mod­est in his­toric terms and com­pares favourably with other Or­ga­ni­za­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment (OECD) coun­tries, as pointed out in fed­eral doc­u­ments.

For econ­o­mists, the fed­eral bud­get deficit is rel­a­tively small and struc­tural in na­ture. It is small with re­gard to the larger bud­getary deficits gen­er­ated in the 1980s-90s. It is struc­tural in the sense that the gov­ern­ment is aware that it will have to raise taxes or re­duce spend­ing to elim­i­nate the deficit. Hey, we are run­ning a deficit and the econ­omy is strong.

The mod­est de­cline in the bud­getary deficit over the next five years re­flects a re­duc­tion in spend­ing growth rel­a­tive to the size of the econ­omy. Rev­enues keep pace with the econ­omy. It may sur­prise some bud­get watch­ers that the Lib­eral gov­ern­ment is “plan­ning” to use the brake ped­als to spend­ing in the years ahead (Ta­ble 1).

Anal­y­sis by the Par­lia­men­tary Bud­get Of­fice and the In­sti­tute for Fis­cal Stud­ies and Democ­racy in­di­cates that the cur­rent fed­eral fis­cal struc­ture is sus­tain­able in the sense that it should not lead to ris­ing debt-toGDP ra­tios over the long run in the face of ag­ing de­mo­graph­ics. This is im­por­tant but the anal­y­sis needs to

be up­dated when the gov­ern­ment makes com­mit­ments re­lated to new ini­tia­tives like phar­ma­care or a na­tional de­fence strat­egy.

Bud­get 2018 al­lo­cated $21.5 bil­lion in new mea­sures over a five-year pe­riod. These mea­sures were fi­nanced by re-al­lo­ca­tions or sav­ings from the planned spend­ing frame­work that were not specif­i­cally iden­ti­fied—al­though we know it comes from di­rect pro­gram spend­ing (i.e., voted ap­pro­pri­a­tions re­lated to grants and con­tri­bu­tions, cap­i­tal and op­er­a­tions).

There are more than a 100 spend­ing sprin­kles to sup­port a wide ar­ray of ini­tia­tives. In this re­gard, Bud­get 2018 may be a pre­lude to Bud­get 2019—the elec­tion bud­get. Keep con­stituents happy.

What is of note is that the gov­ern­ment did not want to raise the deficit track to move for­ward on Bud­get 2018 ini­tia­tives.

What is also of note is that the gov­ern­ment be­lieves it can find sav­ings for the new ini­tia­tives from spend­ing com­po­nents that are grow­ing the least over the plan­ning pe­riod (Ta­ble 2).

There are more than a 100 spend­ing sprin­kles to sup­port a wide ar­ray of ini­tia­tives. In this re­gard, Bud­get 2018 may be a pre­lude to Bud­get 2019—the elec­tion bud­get. Keep con­stituents happy. The large al­lo­ca­tions are in­tended to ad­dress im­por­tant is­sues with pro­gram­ming for Indige­nous peo­ples, vet­er­ans, sci­ence and the en­vi­ron­ment. It is spend­ing with the ob­jec­tive to boost the qual­ity of lives for peo­ple over the long run. Scott Clark, a for­mer deputy min­is­ter of Fi­nance, de­vel­oped a sim­ple frame­work to as­sess the cred­i­bil­ity of fis­cal pol­icy. Clark made the case that cred­i­ble fis­cal pol­icy must be re­al­is­tic, re­spon­si­ble, pru­dent and trans­par­ent. By these yard­sticks, Bud­get 2018 fis­cal pol­icy gets a pass­ing grade but falls well short of a clean bill of health.

Do the Lib­er­als have a re­al­is­tic fis­cal pol­icy? Morneau will make the case that the eco­nomic as­sump­tions un­der­ly­ing the fore­cast are an av­er­age of the pri­vate sec­tor fore­casts, so that it is an in­her­ently balanced view. Oth­ers may quib­ble that this is a goldilocks sce­nario. Pro­jected in­fla­tion rates re­main mod­est de­spite the Cana­dian and U.S. economies op­er­at­ing at or above po­ten­tial. Short and long in­ter­est rates would rise only 100 ba­sis points over the next five years. This is op­ti­mistic.

Bud­get 2018 weighs in at a hefty 370 pages yet there is only one page on up­side and down­side eco­nomic risks. There is re­ally no anal­y­sis on how the fed­eral fis­cal frame­work would be im­pacted by these risks other than the gov­ern­ment’s con­tention that they have a balanced view.

Do the Lib­er­als have a re­spon­si­ble fis­cal pol­icy? Canada does not have any hard fis­cal tar­gets on deficits or spend­ing, un­like many other OECD coun­tries. The Lib­er­als re­main com­mit­ted to keep­ing the debt-to-GDP ra­tio be­low lev­els around the 2015 elec­tion. Let’s be frank, any tar­get that would al­low an in­crease in the stock of debt by $115 bil­lion (i.e., a 19 per cent in­crease) and claim to be on track is a weak tar­get.

Ris­ing debt does have con­se­quences for fis­cal plan­ning. The fastest grow­ing spend­ing com­po­nent in Bud­get 2018 is now in­ter­est on the pub­lic debt (Ta­ble 2). Over the next five years, in­ter­est on the pub­lic debt is ex­pected to rise by al­most 36 per cent—more than twice the cu­mu­la­tive growth in pro­gram spend­ing (up about 15 per cent).

Do the Lib­er­als have a pru­dent fis­cal pol­icy? The gov­ern­ment does have a small con­tin­gency re­serve of $3 bil­lion per year which would pro­vide a cush­ion for a neg­a­tive shock to GDP roughly equiv­a­lent to about 1 per cent of nom­i­nal GDP. This is a use­ful ad­just­ment to the av­er­age pri­vate sec­tor fore­cast but would not likely be able to off­set the po­ten­tial im­pact of neg­a­tive risks briefly high­lighted by the gov­ern­ment re­lated to NAFTA ne­go­ti­a­tions or a shock to hous­ing mar­kets.

Do the Lib­er­als have a trans­par­ent fis­cal pol­icy? No.

Bud­get 2018 was dis­ap­point­ing even though some new trans­parency mea-

sures were added to help bridge the gaps be­tween the bud­get and the es­ti­mates (i.e., how spend­ing is ap­proved by Par­lia­ment). The source of funds for the $21.5 bil­lion in new bud­get ini­tia­tives is not iden­ti­fied other than par­lia­men­tar­i­ans and Cana­di­ans are told there are sav­ings to be found in di­rect pro­gram spend­ing. Nearly 70 per cent of di­rect pro­gram spend­ing is re­ferred to as op­er­a­tional ex­pen­di­tures. Bud­get 2018 says that these ex­pen­di­tures will es­sen­tially re­main flat over the next five years. They grew 11.1 per cent in 2017-18 (Ta­ble 2). What is the plan to con­strain op­er­a­tional ex­pen­di­tures? No plan is pro­vided. How do par­lia­men­tar­i­ans hold the gov­ern­ment to ac­count when they do not know where the sav­ings are to be found? They can­not.

What is the plan to con­strain op­er­a­tional ex­pen­di­tures? No plan is pro­vided. How do par­lia­men­tar­i­ans hold the gov­ern­ment to ac­count when they do not know where the sav­ings are to be found? They can­not.

It is a fair bet that vot­ers are go­ing to have a hard time in the 2019 fed­eral elec­tion cam­paign as­sess­ing whether the Lib­eral gov­ern­ment fis­cal pol­icy has achieved a pri­mary ob­jec­tive of strength­en­ing and grow­ing the mid­dle class. Ev­ery bud­get and fis­cal up­date since 2015 has in­cluded the ‘mid­dle class’ in its ti­tle. The Lib­eral gov­ern­ment man­date tracker fea­tures new ini­tia­tives it claims will help mid­dle class for­tunes. Yet, the Lib­eral gov­ern­ment has re­fused to de­fine the mid­dle class in any way that would be use­ful to mea­sure progress. Chart 2 il­lus­trates that there has not been fun­da­men­tal change in in­come dis­tri­bu­tion (on an af­ter-tax ba­sis) since the mid 1970s in Canada. It takes a lot to move this dis­tri­bu­tion. While grow­ing in­equal­ity may be­come a crit­i­cal is­sue in the years ahead with ac­cel­er­ated change in tech­nol­ogy, re­al­iz­ing gains in strength­en­ing the mid­dle class as seen by changes in in­come (or net wealth), dis­tri­bu­tion is a longert­erm ex­er­cise.

Morneau should take a vic­tory lap with the tabling of Bud­get 2018. “Give credit to whom credit is due”. The econ­omy has come a long way since 2015.

Do we have cred­i­ble and ac­count­able fis­cal pol­icy that will help the coun­try steer through eco­nomic and fis­cal risks in the years ahead? That is, of course, an open ques­tion. Stephen Harper worked hard to get to bud­get bal­ance in 2015. A fis­cal pol­icy that pro­moted aus­ter­ity in the face of an oil price shock took the heat out of the econ­omy and may have cost the Con­ser­va­tives the elec­tion.

Janet Yellen, the for­mer U.S. Fed­eral Re­serve chair, fa­mously said “eco­nomic ex­pan­sions don’t die of old age.” The cur­rent eco­nomic ex­pan­sion is get­ting long in the tooth. Risks are build­ing. Mar­kets are get­ting jit­tery about the sig­nif­i­cant fis­cal stim­u­lus planned for the U.S. econ­omy. Fears of global pro­tec­tion­ism and a trade shock are in­creas­ing. At the same time as these in­ter­na­tional risks build, our do­mes­tic risks re­lated to house­hold debt out­pac­ing in­come growth and high hous­ing prices in ma­jor eco­nomic cen­tres con­tin­ues.

Fis­cal pol­icy may yet again be­come an elec­tion is­sue in 2019.

Kevin Page, for­mer Par­lia­men­tary Bud­get Of­fi­cer, is Pres­i­dent of the In­sti­tute for Fis­cal Stud­ies and Democ­racy at Univer­sity of Ot­tawa. Salma Mo­hamed is a stu­dent at U of O. kevin.page@ifsd.ca





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