Checking your winter coat and looking between the cushions

Finance Minister Flaherty tabled his budget this week. As expected, it was essentially the same budget that had been tabled in March, with a few additions and tweaks including the end of the per vote subsidy, and HST compensation for Quebec.

While there were no surprises, the one issue which is sure to generate a great deal of discussion over the next year is the government's objective to cut $4 billion from public sector spending. Note, I did not say the government's plan.

Why? There isn't one. What we have instead is a process that is supposed to identify these cuts, with the plan being presented in the 2012 budget.

Heads-up, you do not find $4 billion between the cushions and in your winter coat. Yet, this is in many respects the tone used by the Finance Minister in response to questions about whether such cuts were possible.

As discussed in this blog many times, the government has taken the following things off of the table when it comes to fighting the deficit:

- no increase to taxes, including the GST
- no cuts in transfers to provinces
- no cuts in transfers to individuals

Add to this the certainty that the government will not be abandoning its crime agenda and the expenditures it will require, and you have the focus squarely turned on a broad basket of government spending. Areas such as the environment, defence, culture and the CBC, foreign affairs, trade, and federally funded social programs are now on the table.

Mr. Flaherty thinks that the $4 billion objective is not ambitious, and in fact is less challenging than what the private sector might set as an objective. I am not sure I agree.

The private sector has as its goal profit maximization. The government does not. What we should expect from government is better efficiency in its operations; in its spending of our money. This does not necessarily mean cuts or the elimination of programs.

Further, the responsibilities of government are broad and varied, and in some cases the weight of those responsibilities trumps questions of cost. This does not mean waste is ok, but it does mean that the cost-benefit model of government is by definition different than that of the private sector.

So what would I like to see? To start, a terms of reference of sorts. I would like to know with more definition what structure and parameters the government has set for this exercise. For example:

- We know the dollar objective in terms of an overall reduction in spending, but what are the criteria against which a program or initiative will be assessed?

- On what basis will decisions be made to reduce or eliminate spending in one area or another?

- Is the sale of government assets on the table? If so, which ones and why does government believe these should no longer be in public hands?

I think we also need to discuss the more long-term "what next?". Say we are successful and through economic growth and targeted cuts we balance the budget. What next? Ask yourself the following:

- Are we well-positioned to deal with the demographic time bomb in front of us (e.g. fewer workers, higher social costs)?

- Are we fiscally equipped to deal with the economic fallout from climate change (e.g. erratic/catastrophic weather)?

- Are we prepared for the shifts already well-underway in global trade, and the growing dominance of countries like China, India and Brazil?

Addressing these issues will require thought, dialogue and money. We are discussing climbing out of a hole, but when we are out there is a mountain in front of us. This should be part of our national dialogue.

By taking options off the table and downplaying the challenges in front of us, we have taken the wholly reasonable question of fiscal responsibility and turned into a discussion on government waste. That won't do.

What do you think?

So Mr. Flaherty, where do we go from here?

On Tuesday the Minister of Finance, Jim Flaherty, will release the government's fall economic and fiscal update. We're being told to expect something straightforward and containing no mini-policy announcements, say like the one that nearly lost the government the confidence of the House in 2008. So far, so good.

What we can expect to hear is that the government's finances are poor and that the deficit has grown. However, the Minister will reaffirm the government's commitment to balancing the books by around 2015. The question to ask Mr. Flaherty is "how?"

The government's strategy has rested on three things: the rollback of stimulus; stronger tax revenue through growth in the economy; and cuts in government spending. Let's consider this a moment.

Stimulus spending will end, likely before the next budget - though the Minister has a left a small window open that this timetable may change depending on how soft the global recovery turns out to be. However, the end of stimulus will not restore the nation's financial health, it will mainly stem the bleeding from the state coffers.

Ok, so how about the projected growth in government revenue as the economy begins to expand? The challenge here is that the government's projections assume a recovery and pace of economic growth similar to that which occurred after previous recessions. Unfortunately, this does not seem likely.

Our major trading partner is continuing to falter and in fact could fall back into recession. Other OECD countries (Germany is an exception) are faring poorly, and the spectre of sovereign defaults in the European Union continues to loom. While their growth and resilience is impressive, emerging markets like China and India cannot compensate for this loss of economic output in the West (never mind the fact that the West has been the biggest consumer of emerging market exports).

So, if the end of stimulus is akin to us no longer digging a hole, and the prospects for "normal" growth must be tempered, where does that leave us? Spending, that's where.

The government will need to look at spending if it is serious about balancing the books. Let's not forget that the Conservatives spent heavily before the recession (defence, Quebec) and they have cut taxes - corporate, personal and consumption in the form of the GST. These steps have seriously limited their maneuverability - and that of any other party aspiring to power.

We will not hear much tomorrow about "the plan." However, we can now count on entering a period of trial balloons and ground softening to prepare us for an austerity budget.

Thoughts?

The $15 billion swing...

On Friday (of course on a Friday), the Department of Finance released Canada's Annual Financial Report for the 2008-2009 fiscal year. Basically, how we did from April 1, 2008 through to March 31, 2009.

In case you were wondering, we did poorly.

At the beginning of the fiscal year, Canada had a budgetary surplus of $9.6 billion. 12 months later, we had a deficit of $5.8 billion. Yes, that's right. National finances suffered a $15.4 billion swing. In the wrong direction.

Now, I don't know about you but if I my household finances suffered a swing of similar proportions, there would be a heck of a conversation looming...

Being a Department of Finance document, there were lots of other statistics - the vast majority of which I won't bore you with (geeks go here: http://www.fin.gc.ca/afr-rfa/2009/afr-rfa09-eng.pdf).

Now, for those concerned about the national debt (i.e. 1 of the 2 people who have commented here), we are still sitting at a comfortable 29% debt-to-GDP ratio. This is one of the numbers I suspect will get bandied about as the government is challenged on the deficit.

It gets at the ability of a country to serve its debt, and by all measures Canada is in good shape (and for that matter in much better shape than other G7 countries). Expect the government to play this up.

But let's go back to our question of the deficit and more importantly how it can be eliminated. As noted in previous blogs, it is unlikely that economic growth will take care of things for the government. Most economists expect this deficit to grow over the next few years until it approaches the $50 billion level. If we believe this needs to be addressed, what's the solution?

I'll put some thoughts down:

• As mentioned in earlier posts, increase the GST. It is consumption oriented and the previous cuts only favoured those who spend more on luxury items. Increase the tax and make sure to carve out those items which are not luxury (key foodstuffs, baby items, books - most of this is already done, but address any remaining items).

• Continue to increase consumption taxes for cigarettes and alcohol.

• Review federal assets, including foreign real estate holdings, to identify savings through divestiture.

Will any of this do the trick? Not any one item. The biggest bang will come from the GST, but I would worry about two things. First, the courage of any government to move on a tax increase. Second, the fact that for all of the spending cuts or revenue increases a government can get in place, there will be a long line of other financial asks waiting in the wings.

What I am trying to say is that the politician who tells you no tax increases is likely wrong. The politician who says no cuts to programs is also wrong. For Canada to get out of this hole the government (whoever is in charge) will need to raise taxes. They will need to cut spending (if only to make room for spending in new areas). It won't be fun, but it will be interesting...

Thoughts?

Uh, we seem to have lost several billion dollars. Has anyone seen them?

Yes, we have a deficit. And yes, it's big and growing. So what should we do?

In answering, I think it is important to consider how we arrived at the current state of affairs. Without question the economic stimulus introduced though Budget 2009 (or Canada's Economic Action Plan if you prefer the marketing approach to government policy) accounts for a lot of the deficit.

But what else? Well, increased government spending pre-economic crisis ranks right up there. Over the past several years, under both Conservative and Liberal governments, federal expenditures have steadily risen.

For a time, this was ok as the economy and government revenues (through taxes) were growing more quickly. The GST alone was bringing in billions each year. Eliminate the deficit - sure! Need a Canada Foundation for Innovation? No problem! Pay down debt? Bingo!

Things were so good, in fact, that in 2006 the decision was made to reduce that cash cow of cash cows. The cuts the Conservatives made to the GST (in two phases) took billions out of the government's coffers.

Ok, fine. So what about spending? Did government adjust for this loss in revenue? In a word, no. Corporate and personal taxes were lowered, thereby reducing revenues further. And overall program spending rose (defence was a big leader), further chipping away at the remaining surplus.

The result was that Canada was close to or more likely in deficit this time last year. Pre-crisis. The ensuing stimulus measures, combined with a sharp reduction in government tax revenue as the economy faltered, then took things to the levels we see today.

I raise this because knowing how we got there should help us figure out how we get out. It's like when you lose your keys. The first thing someone says is, "Well, where did you last see them? Retrace your steps."

In our case, we have "lost" billions. Retracing our steps leads us, from my perspective, to this conclusion. Spending must be lowered and selected taxes must go up.

Ok, that was the easy part. Now for the challenge. What spending gets cut? What tax gets raised?

For me, returning the GST to pre-2006 levels - while not a political winner - may be the route to go. I would not be surprised if at some point the Liberals float this one to see how it plays.

On spending, the winding down of the stimulus measures will help. However, there are big ticket items out there including a new spending accord with the provinces on health care. You think saving GM and Chrysler were expensive, try health care on for size.

Then you have the Liberals, who having moved away from the green shift are now looking to invest heavily in a green economy. That can't be done on the cheap.

I raise this because for every expense that is cut, there are 5 new unfunded ideas lining up and needing money to get them going. That isn't to say they aren't good ideas or the right things to do. It's just that they are expensive and money will be tight.

This is the challenge facing anyone who wants to be PM and form a government. Still want the job, Mr. Ignatieff?