Balanced budget requires tough choices, not wishful thinking

“There’ll be no doubt that we’re balanced in 2015,” federal Finance Minister Jim Flaherty told reporters after recently meeting with a group of private sector economists. This is among Mr. Flaherty’s most categorical statements to date on his plan to achieve a balanced budget in 2015-16. But in light of recent economic forecasts and potential threats to the government’s revenue projections, he would be well-advised to focus on further spending restraint – something he can fully control – in order to deliver on his promise.

Since 2009-10, Flaherty’s plan to eliminate the deficit has largely relied on limiting spending growth and hoping revenues increase sufficiently to balance the budget. This has proven to be a risky approach as the government’s timelines for eliminating the deficit have shifted many times since.

And a series of recent economic forecast downgrades for the short- to medium-term suggest that economic growth and robust revenues cannot be solely counted upon to close the government’s deficit. That’s why a more prudent plan would take further action on the spending side thereby giving Mr. Flaherty more control over his own fiscal destiny.

While this month’s Economic and Fiscal Update will reveal the government’s latest economic growth projections and give Canadians a better sense of its fiscal outlook, it’s important to note the government’s growth projections have consistently fallen over the past 12 to 18 months. The trend since Budget 2012 to the most recent projections from June has been declining or flat lining particularly for 2013 and 2014.

The federal government isn’t alone; reputable forecasters have also lowered their growth projections. The Bank of Canada and private banks such as TD Bank and Scotia Bank have consistently revised downward their projections for 2013 and 2014 over the same period.

The key takeaway is that economic growth projections for the short-term have been volatile and trending downward. If the economy further slows, this would translate into lower tax revenues for the government, thus increasing its deficit or extending its timeline for returning to a balanced budget. This is because economic growth, which is a major indicator of the tax base, is inextricably tied to the government’s capacity to raise revenue.

In fact, according to a recent report by TD Economics, current economic sluggishness is being reflected in slumping corporate profits and this could manifest itself in lower-than-projected corporate tax revenue for the government.

A blip in corporate tax or other revenue would spell trouble for Mr. Flaherty’s deficit elimination target. After all, his fiscal plan, as set out in Budget 2013, relies on annual total revenue growth of 4.6 per cent per year with corporate tax revenue growing at 5.5 per cent per year.

Perhaps in recognition of the risks to its revenue projections, the government announced in the Throne Speech new commitments to restrain the growth of spending including an operating budget freeze, some steps to reduce the generosity of public service benefit plans, and balanced budget legislation. Whether these measures go far enough is still unknown and we look forward to seeing the details unveiled in due course.

One thing is for certain: the government could truly take control of its fiscal destiny if it adopted more conservative revenue projections and more aggressively curbed spending growth. This would reduce the risk associated with evolving economic conditions and place the government’s return to balance firmly in its control.

This month’s Economic and Fiscal Update is a good opportunity for the government to reset its fiscal plan along these lines. Let’s hope Mr. Flaherty makes the tough decisions to make it happen.