Equipping Canadians for success: a shadow budget for 2014.

Author:Laurin, Alexandre
 
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THE STUDY IN BRIEF

The 2014 edition of the C.D. Howe Institute's annual Shadow Federal Budget reinforces Ottawa's near-term focus on returning to budgetary surplus, and presents a number of measures to foster growth in living standards over the longer term.

Prudent forecasting and greater transparency in budgeting and government spending are two elements of the plan to achieve an early and durable surplus. Spending control is the third--with the dominant thrust being containing the cost of federal employment, and in particular the costs to taxpayers of federal pensions and other postretirement benefits. The Shadow Budget estimates that caps on taxpayers' contributions to federal-employee pensions, the termination of indefinite banking of unused sick days, and a move to 50-50 cost-sharing of post-retirement health benefits can reduce federal spending by some $5.2 billion in fiscal years 2014/15 and 2015/16 alone.

Shadow Budget measures to equip Canadians for success in the longer term fall under three broad headings: the skills of, and opportunities for, Canadian workers; saving and investment; and innovation and entrepreneurship.

Measures to promote skills and opportunities include reducing the pressure of the federal government on Canadian labour markets, investing in new job-information and matching, shifting the tax base from income to consumption taxes, phasing out regionally differentiated Employment Insurance, and promoting longer worklife by increasing the age at which Canadians lose access to tax-deferred saving.

The Shadow Budget contains several measures to improve the treatment of saving, and savings, in tax-deferred vehicles. It also proposes to promote investment by providing more uniform tax treatment of active foreign-investment income, and a regular rolling review of capital-consumption allowances.

As for innovation and entrepreneurship, the Shadow Budget proposes a more favourable tax regime for intellectual property income and making academic excellence the key criterion in supporting basic research. It would reduce ongoing support to many Crown corporations, prepare a slimmed-down Canada Post for a competitive mail market, and create more market discipline for Crown lenders. It would also reduce tariffs, and create a more transparent system for reporting, reviewing and reducing tax expenditures that substitute for formal spending programs.

The 2014 Shadow Budget builds on Canada's relatively good post-crisis performance. It reinforces progress toward surpluses, and so protects Canadians from higher interest rates and reduces the claims of government borrowing on Canadian saving. And it supports economic growth with measures to better deploy Canada's human capital, promote investment, and stimulate income-boosting innovation. In short, it provides the kind of fiscal leadership Canadians need from their federal government.

While economic performance worldwide and in Canada continues to disappoint, relatively favourable circumstances and policies position Canada well to return to budget balance in the short term, and promote economic growth in the longer term.

1 OVERVIEW

This Shadow Budget will pursue the return to federal budgetary surplus anticipated in the federal government's 2013 Economic and Fiscal Update (Fall Update). A return to surplus will be good news for Canadians. Debt paydown will protect Canadian taxpayers from higher interest charges, whether sparked by financial turbulence or simply the gradual return of world interest rates to more normal levels. The end of chronic federal government borrowing will boost confidence and support lower interest rates, alleviating the threat of government competing with the private sector for investable funds, freeing up resources for capital investments and benefiting households struggling with record debt levels. More robust government finances will also help Canadians deal with the pressures of population aging on government finances, especially the crunch on provincial governments, whose level of fiscal preparation is grossly inadequate (Busby and Robson 2013a).

To ensure that the federal government achieves surplus and that the improvement in its fiscal position is durable, this Shadow Budget builds on the progress made in the last three federal budgets to end stimulus spending and put the cost of government operations on a more sustainable path. It also takes steps to make federal fiscal policy more transparent: making the true cost of government operations and tax/transfer policy clearer to Canadians will help ensure value for money for Canadian taxpayers in the future.

The expected near-term return to balanced budgets permits a longer-term focus on growth-fostering fiscal and structural policies that will pay dividends for decades to come. The skills and efforts of Canada's workers and the opportunities available to them to deploy their talents are core drivers of economic performance. This Shadow Budget takes several steps to improve the outlook for Canada's human capital, the tools and equipment at their disposal, and the new technology and ideas that spur innovation.

Keeping Canada's living standards in the front rank of advanced economies requires growth-oriented fiscal policies adapted to current economic challenges, including: demographic aging that is pushing labour force growth down and healthcare spending up; lower interest rates and investment returns than recorded in previous decades; and a changing global environment for Canadian exports.

2 PRUDENT FISCAL MANAGEMENT

Prudent fiscal management has three main elements: (i) conservatism in the baseline economic and fiscal projections, (ii) financial reporting that allows members of Parliament and Canadians generally to better understand federal finances and respond to developments, and (iii) rigorous control of costs in government operations.

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2.1 Prudent Projections

As in past years, this Shadow Budget uses as its foundation projections from the most recent federal Fall Update (Canada 2013)--projections that reflect input from leading private sector forecasters. Because economic models tend toward equilibrium, these forecasts tend to underestimate growth during booms and overestimate it during busts. (Figure 1 compares budget forecasts for nominal GDP growth over two years with actual outcomes.)

Actual growth exceeded forecasts in the six budgets prior to the 2008 recession, and fell short of them in all but one budget since then.

This pattern has some offsetting consequences for budgetary planning, since interest rates and therefore debt-servicing costs tend to be higher in booms, and lower in busts (Laurin and Robson 2013). The possibility that the economy will again disappoint in the near term nevertheless argues for prudence. So this Shadow Budget continues the recent inclusion of a $20-billion downward adjustment to the private-sector forecast for nominal GDP. This adjustment provides a $3-billion contingency buffer to fiscal revenues in each year (Table 1).

The Shadow Budget baseline does assume that the round of operating budget freezes announced in the Fall Update will succeed. While such an assumption might appear ambitious rather than strictly prudent, recent restraint has reduced Ottawa's non-transfer spending, with operations, including the bill for federal employee's current and deferred compensation, being the main focus. This record shows that the return to budget surplus by 2015/16 is achievable, and is also a useful foundation for further measures.

2.2 Better Transparency

While the bottom-line results show success in cost constraint, the specific cost-cutting actions and initiatives undertaken by government departments have been difficult for outside observers to identify. Parliamentarians also do not receive information on government spending that is easy to understand and reconcile with budget projections or the Public Accounts released after year-end. More transparency and disclosure would facilitate tracking of progress and improve the credibility of the current cost-cutting exercise.

A key step toward better disclosure is reform of the Main Estimates and Supplementary Estimates of spending voted by Parliament. Traditionally, these documents--which are Parliament's main opportunity to scrutinize the government's spending plans--have been tabled after the budget. In recent years, however, the Main Estimates have often been tabled before the release of the budget, at least potentially rendering them obsolete at the outset. And while budgetary initiatives may be reflected in Supplementary Estimates, all these estimates use cash-based accounting. Cash accounting makes them non-comparable with the budgets and the Public Accounts: these documents anticipate, or report, revenues and expenditures during the period when the relevant activity is expected to occur, or occurred--far superior, for example, in spreading the cost of a long-lived asset over the period it will deliver its services instead of recording it all when the cash outlay occurs.

Presenting the main and supplementary estimates on the same accounting basis as the budget would improve transparency and understanding--vitally important for improving legislators' control of, and accountability for, adherence to budget targets (Busby and Robson 2013b). The government will therefore begin preparing the estimates on an accrual accounting basis in fiscal year 2014/15, and will further commit to presenting the federal budget ahead of the tabling of the Main Estimates in Parliament.

2.3 Better Transparency and Value for Money in Federal Government Operations

Rising employment costs help explain much of the rise in federal spending since the early 2000s. Reducing them is essential to the fiscal projections and the longer-term goal of providing good services at reasonable tax rates. Steps to further reduce compensation costs, and make those reductions durable are therefore a major focus of this Shadow Budget.

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