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The Tories' spending problem

Appeared in the Financial Post
Authors:
Release Date: November 15, 2012

While some economists take great satisfaction when their forecasts come true, I am not in that camp.

As Terence Corcoran noted on this page Wednesday ("On track for more deficits"), for the past several years my colleagues and I have warned that the federal government's plan to balance the budget has been based on risky projections - optimistic forecasts of revenue growth (averaging 5.6% per year) and unrealistic plans for spending restraint (average increases of just 2.0% per year).

Balancing the budget over time by slowing the growth in spending while hoping for significantly higher revenues failed miserably in the 1980s and early 1990s and contributed to a debt crisis in Canada.

We noted on this page last year "we hope Mr. Flaherty's plan works;" it unfortunately has not.

In 2009, when the federal government engaged in deficit-financed spending in the name of stimulus, it assured Canadians the budget would be balanced by 2013-14. During the 2011 election, the Conservatives promised the budget would be balanced in 2014-15. By the fall of 2011, the date was pushed back to 2015-16. Now we're told the budget will not be balanced until 2016-17.

In each of those years, revenue forecasts were revised downward and/or spending growth came in above forecast. That is why the projected deficit continues to increase with each successive budget and the balanced budget date continues to get pushed back.

So, what have Mr. Flaherty and the federal government learned?

In his remarks on Tuesday, the finance minister said: "We are not immune to the economic uncertainty beyond our borders and the economic challenges faced by some of our largest trading partners."

Indeed, last week he noted that if the U.S. president and Republican-controlled House of Representatives in Congress cannot strike a deal before Jan. 1 to avoid the so-called "fiscal cliff" (automatic tax increases and spending cuts), the U.S. and therefore the Canadian economy would be pushed back into a recession.

And yet, Tuesday's Update of Economic and Fiscal Projections noted that private-sector economists upon whom the federal government relies "are generally assuming that the full implementation of all budgeted tax and spending measures will be avoided through some form of political compromise."

While that eventually may be true, the coming "lame duck" session of the U.S. Congress (when one Congress meets after its successor is already elected) will likely kick the can into 2013, adding to the uncertainty that has crippled investment, business expansion, and economic growth in the United States. Additionally, the Update emphasized that "the global economic environment remains highly uncertain" with slower growth expected in China, a recession and continued uncertainty in Europe, and lower-than-expected commodity prices over the next several years.

But not to worry. Mr. Flaherty said Canada has a contingency plan should the United States go off the fiscal cliff and/or the Eurozone's debt crisis worsens. While he provided no details, let's hope it's not more deficit spending.

Perhaps most concerning is that despite all this uncertainty and the experience of the past few years, Ottawa is still forecasting revenue growth of 5.0% next year and 4.7% on average for the next five years. The plan to get back to a balanced budget continues to rely on optimistic revenue projections rather than spending reductions.

The government is forecasting to hold program spending (total spending minus interest payments) growth at 1.2% in 2013-14 and then hold future increases to 2.5%.

What is the likelihood of this actually happening? In its 2012 budget, the Conservative government proposed to hold program spending growth to 1.4% this year (2012-13). Now just five months later, it is projecting that spending will increase by 2.8% this year. Put differently, the federal government has doubled its projection for spending growth in less than a half a year.

Given the trend of successive budgets increasing the expectation for spending, it's unlikely the government will actually hold the line on spending increases.

The bottom line is that the Conservative government is simply not budgeting in a conservative manner. Not only is it failing to conservatively forecast GDP growth and revenues, or to put forth realistic spending projections, it is not dealing with the root cause of the deficit: excessive spending.

Program spending (total spending minus interest costs) today remains $19-billion higher than spending prior to the recession (adjusted for population growth and inflation). A conservative plan to balance the budget would return spending to pre-stimulus levels and balance the budget in two years - just as the Liberals did in their reform budget of 1995.

But unfortunately the Conservative government is sticking to its plan, and therefore increasing the risk that we will see deficits beyond 2016-17. Again, I'll take no pleasure if I'm right since we'll be saddled with significantly more government debt and much higher interest costs - all of which are a drag on the economy and place an unfair burden on young Canadians.



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