TD Bank's chief economist Don Drummond and his director of ecnomic analysis Derek Burleton take a look today at the books of federal and provincial governments [PDF] and, though they've been among the gloomiest of forecasters during this recession, their latest report, while grim, is not the most dire in the world. They conclude that, if federal and provincial governments want to get back in the black by fiscal 2016 — which they believe to be an ambitious target — it can be done but governments will have to slow growth in government spending to 2 per cent year. Of course, as they point out, no government in office has demonstrated anything close to that kind of discipline.
Jim Flaherty, despite the fact that he's a Conservative, has had to boost spending in the current fiscal year to fight the effects of recession, something which many small-c conservatives were upset about but which which found favour with most mainstream economists. Indeed, Flaherty was named international finance minister of the year by some European finance and economy mag (a magazine which no one in Canada had heard of until the Tories pointed us to it after Flaherty got their award. But I digress …)
But here's Flaherty's spending record since taking over as finance minister for the full fiscal year of 2006-2007.
| Year | Transfers To Persons | Transfers to Other Levels of Govt | National Defence | Other | All Program Expenses | Debt Charges | All Expenses |
| 2006–07 | 5.7% | 4.2% | 4.6% | 11.5% | 7.5% | 0.5% | 6.3% |
| 2007–08 | 4.6% | 8.6% | 10.2% | 4.6% | 6.0% | -1.8% | 4.8% |
| 2008–09 | 5.9% | 0.8% | 8.3% | 4.0% | 4.2% | -7.0% | 2.6% |
| AVERAGE | 5.4% | 4.5% | 7.7% | 6.7% | 5.9% | -2.8% | 4.6% |
While Flaherty's spending on debt charges has been good (and the uncharitable will chalk those declines up to very favourable and historically unique low interest rates) the size of the federal government, measured by all program expenses has grown by nearly 6 per cent a year during his first three years. It will be up by about 14 per cent this year because of special stimulus spending.
But back to Drummond and Burleton — here are the key points they make in the report today:
- Deep recession and stimulus will propel the combined federal and provincial deficit to at least $90 billion in FY 09-10
- Relative to GDP, the overall deficit (6%) and debt (64%) will still fall short of the levels in the mid-1990s, when they hit 9% and 102%, respectively.
- However, governments are likely facing fewer degrees of freedom than 10-15 years ago. Trend revenue growth is likely to be slower and age-related spending pressures more intense.
- In order to return the aggregate budget balance to zero by FY 15-16, which is still fairly unambitious, we calculate that trend program spending growth would need to be held to 2%.
- A 2% target doesn’t seem dramatic, but trend annual outlays have been rising by 7% per year. Further, some areas (i.e., health and elderly benefits) are on track to grow much more rapidly, underscoring the risk of significant restraint elsewhere.
- History shows that across-the- board program slashing or large cuts without underlying structural reforms don’t work well.
Here are some other excerpts I've noted as I've read through it:
Keep in mind that many of the deficit estimates shown for FY 09-10 may ultimately be revised upward further. Most vulnerable to revisions are those jurisdictions that have not provided updated fiscal snapshots since their spring budgets in light of the unexpected severity of this year’s recession. In addition, year-end results for FY 08-09 have largely come in on the weak side of government expectations, pointing to a softer starting point into the current year. For these reasons, the combined federal-provincial deficit for FY 09-10 could ultimately hit $100 billion, or 7% of GDP, leading to a corresponding upward revision to the debt count.
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… make no mistake. Restoring balance in the years ahead will be no small feat, especially in provinces where deficit-to-GDP ratios are running in excess of 2%. Other metrics also highlight the magnitude of the problem. Deficits as a share of own-source revenues provide an indication of the degree of over-spending vis-à-vis revenue capacity or under-taxation relative to spending. On this count, a number of provinces are running large deficits of more than 5% of total revenues. Moreover, deficits as a share of only those revenues at a province’s discretion (i.e., own-source revenues) are hovering as high as 10-25% in the Ontario and the Atlantic.
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Over the next 5-10 years, real GDP growth appears set to expand by about 2% per year on a trend basis, rather than the historical rate of closer to 3%. Assuming that economy-wide prices rise at about 2% per year, trend growth in the tax base will be held to a modest 4% per year. [That said, and after doing some economist higgery-jiggery] a reasonable working assumption for governments’ annual revenue take is in the improved, but still moderate 5.5-6.0% range. Furthermore, no jurisdiction in Canada will be immune from these broader economic forces at play.
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the challenge in containing spending growth to such a modest rate (effectively zero in real per-capita terms) will be a tall order. As debt rises and interest rates begin to pull off their lows, public debt service charges will increase. So growth in program spending would likely need to be set at a maximum of 2% per year in order to maintain total spending at 3% per year. Such a pace represents a far cry from the status-quo, where rates have been sustained at 6-7% per year at the federal and provincial levels. But as well, that’s an average rate across all programs. And with certain expenditures running well above this pace – notably those driven by aging trends – and others considered off limits, other areas will need to be reduced substantially.
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The longer the deficit horizon, the greater the chance that plans can get derailed if shocks or nasty surprises emerge. There are also the prospects for a growing fiscal squeeze around the corner resulting from demographic pressures. With health care costs double for individuals over the age of 65 years compared to those under 65, and with an increasing share of Canadians collecting elderly benefits over the next decade, the premium on age-related expenditure growth will only rise further. At the same time, these expenditures will likely need to be funded through a slowing labour force and declining per-capita tax base. In order to prepare for the fiscal costs arising from these intensifying demographic pressures beyond 2020, it is critical that governments successfully address their deficits over the next 3-5 years.
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the planned moves by Ontario
and B.C. to harmonize the retail sales tax with the GST are
examples of good economic policy
the flaw in using deficits and debt as primary operational targets is that their path is determined largely by factors out of government control, notably revenues and GDP. Program spending, by contrast, is under the direct purview of governments, and should in our view, become the operational target. Program spending targets should be absolute, and determined to a large degree exogenously from the pace of economic growth. In recent years, the federal government has been pitching the notion that the rate of program spending growth should, and will be determined by the rate of economic growth. The challenge with such a rule is that it sets fiscal policy to be highly pro-cyclical, since spending is strong when the economy is strong, as opposed to allowing the economic strength to facilitate balancing the budget sooner or even cutting personal income taxes. Conversely, during weak economic times, the government exacerbates the downturn by more aggressively cutting spending.
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To the extent that deficits can’t be brought down through lower spending growth, governments might have to consider revenue-raising measures. If this avenue is undertaken, care must be taken on shifting the tax mix from a reliance on savings, capital and income – which are the most damaging levies on growth – to consumption. While structured as a revenue-neutral reform, the planned moves by Ontario and B.C. to harmonize the retail sales tax with the GST are examples of good economic policy.
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