How to evaluate the Liberals’ first budget

It’s both easier and harder than it seems, writes economist Stephen Gordon


How are we to evaluate the new Liberal government’s first budget? This question is both harder and easier than it looks.

Harder, because policy analysis requires a counterfactual. In order to assess the effects of a new policy, it’s not enough to look at its effects; you have to compare those results with what we would have seen if the policy had not been put in place. The challenge of doing policy analysis is putting together that alternative scenario.

Easier, because in this case, we already have the counterfactual. In budget after budget, Stephen Harper’s Conservatives advanced their fiscal agenda of lower taxes and lower federal spending, in an almost completely predictable manner. The basic plan was to let transfer payments to persons and to governments grow with GDP, and to slowly reduce direct program spending—salaries and purchases of goods and services—as a share of GDP. Spending restraint combined with revenue growth was supposed to balance the budget over the next five years.

Astonishingly enough, this five-year plan was carried out to almost to the letter. Given this track record, we can be pretty confident about our counterfactual: if the Conservatives were still in power, they’d be following the path set out in the 2015 budget. So figuring out the effects of the policy changes introduced in the 2016 budget is simply a matter of comparing the two sets of projections over the next four or five years.

In order to make the comparison more direct, I’m going to express everything in terms of per cent of GDP. Since government tax revenues are strongly correlated with economic activity, using shares of GDP strips out the effects of changes in the economic outlook.

One thing that has not changed is revenues. The Conservatives’ goal was to reduce taxes, and they succeeded, mainly due to the two-percentage-point reduction in the GST. When they left office, federal revenues were less than 15 per cent of GDP, the lowest ratio since before the Second World War. So far, the Liberals seem disinclined to reverse this legacy. The tax changes they’ve introduced are modest, and the decrease in personal income tax rates in the middle of the income distribution roughly cancels out the increase at the top end. The Liberals are projecting federal revenues well below 15 per cent of GDP, just as the Conservatives did.

The most striking contrast is on the spending side, and here the differences are twofold. Not only is the spending path in the 2016 budget higher than what it was in the 2015 budget, it’s also higher than what the Liberals promised in their 2015 campaign platform. Continuing spending restraint was baked into the last Conservative budget, and this was the baseline scenario upon which the Liberal platform was based.

The Conservative plan projected direct spending to decline from 5.8 per cent of GDP to 5.6 per cent by 2017-18; the Liberals are projecting this ratio to increase to 6.6 per cent over the next two years. The various charts and tables show direct program spending declining after a peak in 2017-18, but this reduction appears to be largely one of conjecture, not based on any numbers. The budget documents provide detailed projections for the descent into deficit, but there is only a promise to “set a timeline for balancing the budget when growth is forecast to remain on a higher track.” It is here that the contrast with Stephen Harper’s government is starkest: it’s hard to imagine a Conservative government initiate a descent into deficit while giving so little thought about how to get out of it.

The budget does not specify what sort of growth rates will trigger a timeline for bringing the budget back to balance, but it would appear that the threshold of real GDP growth is above the 2.2 per cent in the projections. If 2.2 per cent were enough, the budget would have presumably included that timeline to balance. The Liberals seem to be relying on their stimulus measures to provide that extra growth, and the budget documents provide a set of estimates for multipliers from the Department of Finance’s model as support for that hope.

But what if those hopes are dashed? To my mind, those multipliers say more about the sort of models used by the Department of Finance than they do about the possible effects of the budget measures on economic growth. Fiscal policy is ineffective in a small, open economy with a floating exchange rate—that is to say, an economy like Canada’s. Even in a closed economy, the best estimate for the fiscal multiplier when the economy is operating close to potential—again, like in Canada—is zero. If the Liberals are hoping for their measures to trigger the higher growth rates they’re hoping for, they should prepare to be disappointed.

Like it or not, the Conservative agenda was predictable and sustainable. In contrast, the Liberal agenda is unpredictable and unlikely to be sustainable. But the Liberals’ problem isn’t necessarily that they have diverted too much from the Conservatives’ path; the real issue is that they have not matched measures to increase spending with offsetting measures to increase in tax revenues. If you’re going to stick with Stephen Harper’s levels of revenue, it’s hard to do anything else but stick with Stephen Harper’s level of spending.


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