Stagnant economy may mean more cuts to come

The federal government released its annual fall update on the country’s finances today. Despite the upbeat messaging around the “Update of Economic and Fiscal Projections” there are concerning underlying trends with the country and its finances.

For regular Canadians, there is no explosive growth expected in the job market to make up for the crash after the 2008-2009 recession. There has been no revision to the unemployment rate projections for next year which remain at 7.2%, slightly below the current rate of 7.4%.

Most Canadians may not have noticed but stagnant growth has now become the norm. Real GDP growth has been significantly revised downwards from 2.4% next year (2013) to only 2%. In the past, closer to 3% real growth was the norm. In previous recessions, job growth significantly lagged behind GDP growth during the recovery but at least GDP growth did recover. That is not the case this time around. While it’s certainly positive that real GDP growth isn’t negative, it remains stagnant and looks like it will continue to be so for years to come.

As for government finances, future deficits have been revised upwards. There are several items at play here but the most significant is a drop in revenues going forward. It now appears that the government has over-estimated revenues in the neighbourhood of $6 to $8 billion a year over the entire forecast horizon out to 2017. The Update doesn’t provide a breakdown of what is causing such a revision except vague statements about international commodity prices so it isn’t clear whether corporate, personal or consumption (HST) revenues are the parts that were revised. A change in accounting standards makes comparisons to previous estimates difficult. However, at first glace, it looks like it’s the personal side that’s down.  Income growth isn’t as large as expected and as such, the revenue generated from income taxes based on personal incomes are also down.

This over-estimation of revenues combined with a bigger “risk-adjustment” (take whatever the actual deficit figure is and -$3 billion) has made deficits worse from anywhere from $5 to $7 billion a year compared with similar estimates in March. From an economic perspective, this isn’t anything to be particularly concerned with. For every year after 2012-13 the debt-to-GDP ratio actually goes down because the deficits are small compared to even the meagre growth that the Canadian economy is experiencing. Canada already has the lowest debt ratio in the G8 and even with small deficits we extend our lead (if that were the only goal of public policy making). In fact, we could run deficits of ~$30 billion a year indefinitely and have our debt ratio remain constant in the low 30%, again still in first place in the G8. So there is plenty of fiscal room to boost growth without runaway debt.

My concern isn’t so much an economic one as it is a political one. The federal government has made reaching surplus an important pre-requisite before the implementation of expensive new programs. If we look out a couple of years to the next likely election date in 2014 or 2015, there are still deficits in both of those years and they are much bigger than they were in March. In March, the deficit for 2014-15 was estimated at $1 billion. There were a few fudge factors in there that would make that a surplus if push came to shove. That figure has now been revised to $9 billion and its difficult to fudge your way out of that. The situation is slightly better the following year 2015-16, in March there was an expected surplus of $3 billion but that has now been revised to a $2 billion deficit.  The margin for error on getting to surplus is much smaller now than it was in March.

The revision downward of revenue estimates is not dramatic in overall terms, but it may seem to the government that they need to cut again before 2014 to assure that they’ll be in the “correct” position politically, irrespective of the consequences. The austerity cycle that Europe is all too familiar with, that government cuts lead to slower growth which leads to more government cuts, could start to play out here in Canada. We don’t have the fiscal problems that European governments have, but we may have a political impetus, getting to surplus, that stands in for real fiscal problems. The result may be even more cutbacks to regulatory agencies, benefits for low-income Canadians and the like in the coming years if these deficit projections remain intact.

After the 2012 Budget in March I figured successive rounds of cuts, however large, would be over. Now I’m not so sure that there won’t be a second round.

David Macdonald is a senior economist with the CCPA.