Fiscal Warning Lights are Flashing

Finance Minister Bill Morneau is busy putting together his first budget. No date has been announced. First budgets, after an election, often don’t turn out well for Ministers of Finance. It is very hard to live up to election promises and escalating expectations. Mr. Martin faced a fiscal crisis in preparing his first budget, and high expectations that he would fix the problem. Despite some significant fiscal actions in the budget, they were seen as “inadequate” in resolving the fiscal crisis. In the 1995 budget, Mr. Martin made sure this would never happen again.

Mr. Morneau does not have a fiscal crisis. However, he does face the very difficult challenge of trying to fit a long list of very expensive election promises and commitments (e.g., eliminate the deficit in four years) into a fiscal framework that he can claim is realistic, prudent, fiscally sustainable, and transparent. All this is to happen in a period of slowing global economic growth.

The Liberals made a lot promises during the election. Based on their election platform, the net cost of these promises amounts to  $10.5 billion in 2016-17, $11.7 billion in 2017-18; $9.1 billion in 2018-19 and $6.6 billion in 2019-20. Since then, the costs of these promises have been increased by about $1.5 billion annually.

Since the November Update, economic and fiscal prospects have worsened. Oil prices have fallen to around $30 a barrel, well below the oil price assumption assumed by the Department of Finance  ($54 a barrel for 2016) in the November Update. Iran will soon start supplying more oil to an already oversupplied global oil market, and the likelihood that oil prices will recover in the short tem is very low. This will reduce economic growth in Canada even further and could push the deficit (including election promises) to $25 to $30 billion (1.5% of GDP) in the next few years.

A deficit of 1.5 per cent of GDP is not very high by historical or by international comparison. Many economists are now jumping onto the deficit financing bandwagon. Some are recommending that deficits as high as $40 billion (2% of GDP) would be justified in the current economic circumstances. In our view running annual deficits approaching 2 per cent of GDP would be “imprudent” and would put at risk the government’s commitment to a “sustainable” fiscal framework. Mr. Morneau should be very cautious about running a structural deficit approaching 2 per cent of GDP.

During the election, the Liberals committed to a review of existing tax expenditures and programs to generate annual savings of $3 billion. This is a good start but it will not be enough. Some of the election promises were backed by sound research and analysis, addressing a particular need; for example, measures which would increase the potential growth rate of the economy, narrow income inequity, and address health and safety concerns, among others.  Some other commitments, however, were more political in nature, with little or no analysis indicating that there is a particular economic or social need.

As difficult as it might be, the government should review all existing election promises. Such a review might ask the following questions: is there adequate evidence to show there an urgent public need; does it support economic growth; does it serve the public interest; is it a federal responsibility; and is it affordable? Some promises must be kept, especially those contributing to growth; some promises should be delayed until the economic and fiscal situation improves; some promises should be “postponed indefinitely”.

Consider, for example, the following commitments.

The election promises to restore the age of eligibility for Old Age Security (OAS) to 65 and to introduce a new Seniors Price Index for OAS and GIS benefits would both fail a most of the above review questions.    

 Although the initial cost for reducing the age of eligibility beginning in 2023-24 would be low (about $600 million), the cost could rise quickly to about $12 billion by 2029-30. Indexing the OAS/GIS benefits to a new Seniors Price Index is estimated to cost $55 million in 2016-17, rising to $210 million by 2019-20. 

There are sound reasons for increasing the age of eligibility. Canadians are living and working longer. In the future, pension benefits will become a major cost driver for the federal government, which could put pressure on the government to maintain a sustainable fiscal framework. The change in the age of eligibility is being phased in over time, giving people ample time to adjust. New initiatives have been introduced to provide Canadians with more vehicles in order to plan and save for their retirement. The government also plans to expand the Canada Pension Plan. The implementation of the promise to restore the age of eligibility to 65 should be postponed.

The proposal to create a Seniors CPI would fail the first question and the second question. According to the Liberal’s election platform, seniors face higher inflation than the general Canadian population and by non-senior families. Available evidence, however, shows that in fact inflation rates for seniors and non-seniors are roughly similar. The Liberal platform also stated that if a senior’s inflation index turned about to be lower than the national CPI, the general CPI would compensate seniors, not the seniors CPI.  This would put an upward bias in the inflation adjustment for OAS and GIS benefits.  Creating a seniors CPI for inflation adjustment to OAS and GIS cannot be justified on the basis of existing analysis and should also be postponed.

The Liberal platform also promised a number of new tax expenditures, including the Teacher’s Tax Benefit, the Building Trades Equipment Tax Benefit, and the GST rebate for new rental housing construction ($760 million over four years).  These “boutique” tax credits do nothing to generate increased economic activity and further complicate an already overly complex tax system. They would fail all the program review questions and should be postponed. The Liberal platform committed considerable new funding for the cultural agencies ($1.3 over four years). This funding would also fail most of the review questions and could be postponed. 

The commitment to negotiate a new Health Accord was not costed in the Liberal election platform. The previous government reduced the Canada Health Transfer (CHT) escalator from 6% per year to a three-year moving average in nominal GDP growth, with funding guaranteed by at least 3% per year, starting in 2017-18. There is an expectation that the escalator should be restored. According to the Parliamentary Budget Officer, the reduction in the escalator was a major factor in the federal government achieving a sustainable fiscal framework.  Requests to restore the escalator should be rejected. Other time-limited options should be considered, addressing particular needs within the health care sector.

All of the election promises should be reviewed to determine their priority for this budget and future budgets. It is much easier to cut a program or eliminate a tax change that has not been implemented than one that has.

The upcoming budget must promote economic growth, but it also must establish fiscal credibility.







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