The stimulus spending never stopped

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Appeared in the Financial Post

The key litmus test for the Harper government’s 2013 budget was always going to be how realistic it was with respect to achieving a balanced budget by 2015-16. The governing Tories have staked both their economic and political credibility on being able to balance the budget. The current plan, which mirrors previous budgets, relies on controlling the growth in spending and hoping revenues increase sufficiently to balance the budget.

The governing Conservatives plan to increase program spending by a restrained 0.8 per cent, and remain tight-fisted for the next two years, increasing program spending by only 1.2 per cent and 2.6 per cent respectively in the coming years. Last year, program spending increased by 2.9 per cent but to their credit, the Conservatives have been able to restrain the growth in program spending over the last three years, increasing, on average, by only 0.9 per cent.

As in previous years, the risk lies mainly on the revenue side. The Conservatives are expecting revenues to grow by 3.8 per cent this year compared to 2.2 per cent last year. They expect even stronger growth in subsequent years: 5.9 per cent in 2014-15 and 5.5 per cent in 2015-16.

The Conservatives’ record on forecasting revenues raises concerns. The actual revenues collected have been less than the amount budgeted in every budget since 2008 except one since. The average difference between budget and actual revenues has been almost $5 billion. Relying on strong revenue growth to balance the budget is risky since events outside of Canada, particularly the U.S., can knock the budget off course.

The less risky approach to balancing the budget relies on spending reductions. As illustrated in the accompanying chart, actual program spending spiked in 2009-10, increasing by $37 billion in one year. The key to understanding the deficit today, however, lies in the spending post-2009-10.

One of many problems with stimulus spending is that the spending never stops. It simply becomes the base from which future spending grows, and that’s essentially what happened in Canada.

For reference, the dashed line represents program spending adjusted for population growth and increases in prices based on 2008-09 spending. It assumes the level of per person spending in 2008-09 is maintained over time. This provides us with one reference point to gauge whether or not actual program spending returned to its pre-stimulus levels.

What’s clear from the chart is that it didn’t. And this shouldn’t be surprising. Almost all governments that enacted stimulus subsequently spent from the new, higher levels because it is very difficult for governments to reduce spending politically.

Had the federal government returned to its prior spending levels, the 2013-14 deficit would come in at about $3.1 billion rather than its expected $18.7 billion. And deficits don’t come in isolation: higher deficits become higher debt levels, and higher debts become a greater burden for the population to pay off in future years.

Another consideration and one that is included in the budget, albeit in a limited way, is the opportunity for improved economic growth through tax reform. The economy can be improved by strengthening economic incentives. Reducing or eliminating special privileges, loopholes, and other goodies in the tax code allow the government to reduce marginal personal income tax rates, which remain internationally uncompetitive and a key impediment to additional investment, work effort, and entrepreneurship.

Since 2006, for example, a number of new tax credit programs have been introduced, ranging from credits for children’s fitness to employment to public transit. These tax credits alone cost an estimated $7.9 billion in 2012. Reducing or eliminating these programs provides resources to reduce marginal tax rates without affecting the overall deficit. The government indicated a willingness to close some loopholes but the resulting revenue gains, an expected $4.4 billion over five years, will simply augment existing revenues. In other words, the government is closing these loopholes to gain revenues.

The status quo budget delivered on Thursday was largely as expected. The basic plan calls for spending restraint coupled with the hope of rising revenues. A less risky approach and one that would certainly entail less debt would actually reduce program spending to bring it in line with revenues, achieving a balanced budget sooner and with less risk.

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