Righting the Course: A Shadow Federal Budget for 2018.

Author:Robson, William B.P.
 
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THE STUDY IN BRIEF

The C.D. Howe Institute's Shadow Federal Budget for 2018 looks past the deficits the federal government has deliberately created in the near term, and urges the government to think longer term, with a framework that will reassure Canadians about the sustainability of fiscal policy while responding to sharper competitive pressure on trade and taxation. Balancing astute spending measures and cost savings with revenue generation can inspire confidence that the country is ready for the longer-term challenges of slower growth and an aging population--a good backdrop for measures that support economic growth and job creation, and promote opportunities for all Canadians.

This Shadow Budget responds to competitive pressures from US tax reforms with some immediate measures, and lays the foundation for more fundamental reforms that will have a lasting impact on Canadian productivity and incomes. Two quick changes to accelerate write-offs of business investment will signal Canada's readiness to restore some of our lost competitiveness for new investments. Longer term, establishment of an allowance for corporate equity that relieves ordinary returns to capital from corporate income tax would make Canada more attractive for domestic and foreign investors.

This Shadow Budget holds the line on the federal government's own operating costs and eliminates some poorly designed or targeted tax preferences. It improves environmentally motivated taxation by establishing a higher GST rate on transportation fuels and eliminating the aviation fuel tax. It reorients infrastructure spending toward projects on which the federal government can move quickly and efficiently. It further improves the transparency of government finances and the ability of legislators to control public money.

Other policies advancing Canada's openness to trade and competition, and supportive of higher student achievement, will further strengthen the country's economic capacity. This Shadow Budget also expands individual opportunities by facilitating the movement of human talent to where job prospects are brighter and rewards greater, and by fostering more saving opportunities and income security for our seniors, now and in the future.

On the spending side, this Shadow Budget proposes to dispose of non-core assets and increase private investment in infrastructure by selling selected airport leases, reduce punitive personal income taxes, continue to invest in education for Indigenous children, and provide a more generous tax treatment for nondiscretionary medical expenses.

In summary, this Shadow Budget promotes economic growth with reforms that will attract investment, promote international trade, and encourage work and saving. It sets federal finances on a longer-term course back to balance, assuring Canadians that they can pursue their lives and work, save and invest with confidence.

C.D. Howe Institute Commentary[C] is a periodic analysis of, and commentary on, current public policy issues. James Fleming edited the manuscript; Yang Zhao prepared it for publication. As with all Institute publications, the views expressed here are those of the authors and do not necessarily reflect the opinions of the Institute's members or Board of Directors. Quotation with appropriate credit is permissible.

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A recurrent theme at budget time is uncertainty over the immediate and long-term economic outlook.

Responsible budgets respond to this uncertainty with a disciplined approach to spending, ensuring flexibility in the near and longer term to deal with negative surprises, while ensuring that the expected path creates room for reforms that will spur economic growth and raise living standards for all Canadians.

In the run-up to the 2018 federal budget, developments abroad and at home have created near-term concerns with long-term implications. The combination of uncertainty over Canada's access to US markets and inputs under the NAFTA and the greater attractiveness of the United States to business investment following recent tax reforms affect Canada's fiscal priorities. At home, recent tax changes and rhetoric suggesting that Canadians who succeed economically are making gains at the expense of others are encouraging entrepreneurs and managers to look abroad for opportunities. Moreovei the lack of a firm budget framework has deprived the government of tools with which to prevent demands of various stakeholders from driving spending and borrowing beyond responsible limits.

This Shadow Budget puts a framework of sustainable finance front and centre. It balances increases in spending with revenue generation and cost-saving measures. It is designed to provide Canadian families and businesses with confidence that the country will successfully meet the challenges of slow growth, lower commodity prices and an aging population. By establishing this trust through prudent fiscal management, Ottawa can support economic growth and job creation, and promote opportunities for all Canadians, thereby improving prosperity.

Tliis Shadow Budget puts forward tax policies responding to competitive pressures from the US reform in the very short term, and lays the foundation for more fundamental reforms that will have a lasting impact on productive capacity, thereby benefiting all Canadians. Other policies advancing our openness to trade and competition, and supportive of educational improvements, will further strengthen economic capacity. The Shadow Budget supports fiscal sustainability through prudent restriction of federal expenses, the exploration of new revenue streams and improving the accountability of government finances. It would also expand individual opportunities by facilitating the movement of human talent to where it is most needed and where job prospects are brighter, and by creating the conditions for greater financial stability for our seniors, now and in the future.

Parallel with the promise to give Canadians confidence in the federal government's fiscal framework should be a commitment to greater budget transparency (Busby and Robson 2017). In addition to offering financial reporting improvements and producing estimates that are consistent with the budget, our Shadow Budget moves the fiscal plan summary--buried in an annex on page 251 of Ottawa's 2017 budget--to the front (See Table 1).

ECONOMIC AND FISCAL FRAMEWORK

Strong economic growth in 2017 produces expectations for higher revenues going forward than were anticipated in the 2017 federal budget. The 2017 growth spurt means that fiscal revenues grow from a larger base, enhancing the federal government's fiscal room throughout the projection period.

A Subdued Outlook

While 2017's rapid growth may spur investments that increase Canada's productive capacity by more than anticipated a year ago, however its main effect was to reduce economic slack faster than expected, and recent indicators of labour-market pressure and prices suggest that Canada's economy is now operating at, or slightly above, capacity. As a result, growth expectations for 2018 and 2019 are not higher. Slower growth of productive capacity, with demographics being a notable constraint, mean that Canadian governments cannot depend on robustly rising tax revenues to finance spending commitments. A confidence-inspiring budgetary framework begins with prudent forecasting.

This Shadow Budget uses as its baseline the economic and fiscal projections from the Department of Finance's October 2017 "Fall Economic Statement" (Canada 2017). Overall, real and nominal GDP for 2017 is higher than anticipated in the 2017 budget by more than one percentage point. Looking ahead, the average of economic forecasts used by Finance Canada puts real growth at 2.1 percent for 2018 and 1.6 percent in 2019. As for nominal growth, the forecasts anticipate that it will be 4.0 percent in 2018 and a meagre 3.4 percent in 2019 (Table 2).

Projections in the fall statement are based on the average of the forecasts in the September survey of private-sector economists. The Finance department has been surveying private-sector economists and using the average of their forecasts in setting baseline budgetary economic expectations for more than 20 years now.

Despite a great deal of variability in economic growth forecast errors year-over-year, private sector economists' growth forecasts have been relatively good on average over the last 21...

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