Flaherty's deficit delay no surprise

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Appeared in the Financial Post
With the release of its economic and fiscal update, the Conservative government finally confirmed it will not meet its 2014-15 target for balancing the budget.

No surprise here.

For nearly two years, we have repeatedly noted that the government's plan to balance the budget was fraught with risk. To reach its 2014-15 target, the Conservatives were pinning their hopes on robust revenue growth averaging 5.6% per year, while planning to hold program spending increases to an average rate of 2.0%. The revenue targets were in part based on solid U.S. economic growth projections averaging 3.1% or more in each of the next five years.

Given these rosy projections and the Conservative government's record of excessive spending, our point was simple: Their plan was full of risk.

The Conservative government had plenty of history to draw from in constructing its plan. During the 1980s and early 1990s, the Progressive Conservative government, like the incumbent Conservatives, was at least notionally predisposed to lower levels of government spending and balanced budgets. But failure to eliminate the deficit came from the Progressive Conservatives' inability to restrain spending growth and revenues that were lower than expected. That ultimately resulted in ongoing deficits, mounting debt, and a serious fiscal crisis in the mid 1990s.

Tuesday's economic and fiscal update confirms that history could be repeating itself. In its update, the Conservatives downgraded their inflation-adjusted economic growth projections for Canada and the U.S. and pushed back their target for balancing the budget by one year.

Private-sector forecasters, upon whom the government relies, now believe that the Canadian economy will grow at 2.2% in 2011 and 2.1% in 2012, rather than the more optimistic 2.9% and 2.8% used to generate the June budget. Over the medium term, the average economic growth projection has been reduced to 2.4% from 2.7%.

As a result, revenues are projected to be about $53-billion lower over the next five years and the government is now estimating that a balanced budget won't come until 2016-17 (2015-16 if it hits its targeted savings). Lower-than expected revenues result in larger deficits for a longer time period and much higher levels of government debt - both of which are significant drags on the economy.

In its June budget, the Conservatives projected an increase in the federal debt to $610-billion by 2015-16 from $533-billion in 2010-11, an increase of $57-billion in five years. Now, just months later, the debt is expected to reach $641-billion by 2015-16. Now think about what would happen if the global economic outlook worsens.

But the government's plan doesn't account for that. Instead, it continues to base its balanced budget strategy on robust revenue growth of 4.6% over the next five years with spending growth of 2.2% (an unlikely rate given this government's historical spending). In other words, there's still significant risk in the Conservatives' fiscal plan.

To reduce the risk, the Conservatives should put forth an austerity budget in 2012, one that actually reduces program spending and delivers a balanced budget in two years instead of five.

The first step: Ensure that program spending is returned to pre-stimulus levels. This can be achieved by greatly expanding the government's Strategic and Operating Review, currently a one-year review of program spending - excluding transfers to individuals and governments - which proposes to find a mere $7.1-billion in savings from the $353.3-billion in departmental spending planned from 2012-13 to 2014-15.

The expanded Strategic and Operating Review should prioritize spending so that important areas are spared deep cuts, while lower-priority areas carry a greater burden of the spending reductions. The Chopping Block series on this page has offered up numerous ways that Ottawa can and should cut spending, from reducing or eliminating subsidies to the CBC, axing Canada Health Infoway, eliminating regional development spending, reforming public-sector compensation, and reducing and reforming transfers to provincial governments.

A two-year balanced-budget plan would substantially reduce the risks associated with another round of downgraded economic projections and leave the Conservatives with upside potential. That is, if revenues rebound robustly, the government could implement a much needed multi-year plan to reduce taxes.

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