Why the Liberals and NDP shouldn’t bank on having surpluses to spend

If you’re buying into Harper’s surpluses, you’re also buying into Harper’s austerity program


 
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(Shutterstock)

(Shutterstock)

The fiscal update projects a small deficit in the current 2014-15 fiscal year, and ever-increasing surpluses in the following four years. These surpluses are being viewed by some as manna, and that the next election will be fought on the question of how they should be allocated: tax cuts, spending increases or some combination. But we are by no means back to the days of the early 2000s, when federal revenues were embarrassingly abundant. The surpluses in today’s fiscal update are based on projections that assume that the pattern of the last five years of spending restraint will be repeated over the next five years. Briefly put, if you’re buying into the CPC government’s surpluses, you are also buying into its austerity program.

The best way to view movements in government revenues and expenditures over time is as a fraction of GDP. On the revenue side, this is relatively straightforward: revenues will increase as the economy expands.  This is equally true—but less straightforward—on the expenditures side. It turns out that in addition to increasing revenues and everything else being equal, economic growth also increases the cost of providing a given level of services. Here’s why:

GDP growth can be decomposed in three components:

1. Inflation: Everything else being equal means that the buying power of wages paid to federal civil servants remains constant. As prices increase, so do the cost of paying public sector workers.
2. Population growth: Everything else being equal, a larger population implies an increased demand for public services.
3. Real, per-capita economic growth: Everything else being equal, real-per-capita economic growth translates into an increase in real wages. If real wages are increasing in the private sector, public sector employers will be required to match those gains.

This, incidentally, explains my eye-rolling dismissal of Justin Trudeau’s “The answer is growth” in his economics video. Economic growth does increase revenues, but unless you’re planning on depriving civil servants of the benefits of economic growth, it also increases costs.

I’ve gone over the mechanics of the Conservatives’ long-term budget agenda several times, most recently here. There are three main components:

1. Transfers to persons have been pegged at a constant fraction of GDP, and so have increased with the size of the economy.
2. Transfers to other level of governments (mainly provinces) have also been pegged at a constant fraction of the economy.
3. Direct program expenditures—that is, wage costs and spending on goods and services—have generally been held constant. Since GDP has been increasing, this means that direct program expenditures expressed as a share of GDP have been gradually declining.

This chart shows the projections for direct program expenditures for the past few budgets:

direct_gdp

This gradual erosion has manifested itself in several years of grinding austerity throughout the federal public service. And the fiscal update calls for more of the same, as far as the eye can see. The recognition that this pattern of austerity is baked into the government’s projections changes—or at least, should change—your perception of those projected surpluses. This is not free money that will fall into the government’s lap; it’s money that is to be carved out of future program spending.

I’m going to reproduce the exercise I went through last February: what if direct program spending were projected to increase with GDP after the current 2014-15 fiscal year? This doesn’t mean that previous reductions in spending as a share of GDP would be reversed, just that no new ones would be made. Here is what happens to the projected budget balances during the fiscal update’s projection horizon:

counterfactual_budget_balance_update

Without continued austerity, those projected surpluses are transformed into projected deficits.

The Conservatives are presumably comfortable with the idea of using those projected surpluses to finance tax cuts and to continue to hold the line on direct program spending. But the Liberals and NDP should be wary about incorporating these projections into their plans. Saying that you want to use those “surpluses” to finance new spending is the same thing as saying that you’re going to cut back elsewhere.


 
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Why the Liberals and NDP shouldn’t bank on having surpluses to spend

  1. This article gets to the heart of the matter: you can’t undo the damage Hurricane Harper has caused without actually undoing the damage.

    Harper has created a fiscal straight jacket with $50-billion a year in “starve the beast” tax cuts. If a leader promises to strap it on, he or she will only be able to wriggle out token measures, not make real change.

    In fact, over the past 15 years we’ve seen continues tax cuts that only the rich have benefited from. The top 1% now pay the lowest total tax rate of all groups. Canada has the lowest effective corporate tax rate in the universe.

    As a percentage of GDP, tax revenues have fallen from an average of 35.3% in the 1990s to 30.4%. This 5 point drop costs Canadians over $90-billion a year.

    Instead of giving free money to the rich, we need to restructure the tax code and put scarce economic resources to better use. Investing the money in public benefits like universal daycare and pharmacare will not only put more money in people’s pockets, boosting the economy, it will increase employment.

    Making post-secondary education and worker training more accessible will create good-paying jobs which are needed to reverse the hollowing out of the middle class due to income polarization caused by globalization.

    In short, we need a future government to take real action. Free-market trickle-down economics don’t work. They increase inequality and kill economic growth. Harper’s low-tax legacy is a terrible one. Most Canadians find him disgusting. Small government is the problem.

    How Canada ranks when it comes to taxes
    http://democraticvotingcanada.blogspot.ca/2014/10/daycare-by-numbers-quebecs-progressive.html#taxes

  2. These surpluses are being viewed by some as manna, and that the next election will be fought on the question of how they should be allocated: tax cuts, spending increases or some combination.

    What about paying down debt?

    Also, according to this data, the GDP grew from 1.02 trilion US$ (2005) to 1.83 trillion US$ (2014). That’s 80% increase in US$, even more when you correct for CAN$.
    http://www.tradingeconomics.com/canada/gdp

    Let’s not forget the very significant changes in the denominator (GDP) over the period under discussion when calculating percentages.

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