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What constrains Flaherty's budget Add to ...

The fiscal chickens have come home, and are roosting uneasily on Jim Flaherty's shoulders.

Last fall, the federal Finance Minister cut taxes by roughly $9.4-billion in the upcoming year, and almost $60-billion over six years. Those splashy cuts included a reduction of one percentage point in the GST - on top of a previous reduction, and against the advice of virtually every economic expert. That move alone accounted for $34-billion in lost revenue. Now the cupboard is bare as the economy slows, and the Conservatives have only themselves to blame.

Even last fall, the surplus cash for future years was in worryingly short supply. True, Mr. Flaherty was rolling in money for 2007-08, partly because of a resource-revenue boom. But for 2008-09, he foresaw

a measly surplus of $1.4-billion (after setting aside $3-billion for debt reduction), followed by a $1.3-billion surplus in 2009-10. That was so then. Now the United States is

on a recession watch. Meanwhile, Statistics Canada reported last

week that our export and manufacturing sectors dropped dramatically in December. The situation is so

dicey that Toronto-Dominion Bank economists predict the trade surplus could disappear this year for the first time in more than three decades.

Such tidings have badly eroded Ottawa's revenues, and Mr. Flaherty's bottom line. Dale Orr, chief economist for Global Insight (Canada), figures the slowdown has evaporated the planned 2008-09 surplus and eaten away about half of the $3-billion earmarked for debt. He estimates that the general tax base, which is effectively the same as nominal GDP, will be $20-billion less than Mr. Flaherty forecast for 2008-2009 and $28-billion less in the following year. So tax revenues will likely be $3-billion lower than expected this year, and at least $4-billion less in 2009-10. Even the upside to this news is bad. Mr. Orr says that although the tax base has eroded, it "has not yet eroded to the point where a deficit is forecast - but it is getting very close." There's a word - deficit - that many Canadians hoped they would never hear again.

Uneasily aware of this arithmetic, Mr. Flaherty vowed last week that his Feb. 26 budget would be prudent and that he was "not going to be the finance minister that puts our country back into deficit." As his officials warned that there would be no significant new spending or tax measures, the minister added that he would not "throw money around." That is precisely the problem. Having thrown money around last fall, he has precious little cash now to help manufacturers write off new equipment faster or to boost research and development - and that's what is really needed to pull Canada out of its slump.

Perhaps finance ministers have grown accustomed to dispensing large surpluses in the 11 years since the Liberals balanced the budget for the first time in almost three decades. Free spending is a habit that they will have to break. The minister may be able to earmark a portion of the 2007-08 surplus for use in 2008-09, but that could be technically and politically difficult. His options are far narrower now. His leeway is lost. The GST was the wrong tax to cut, at the wrong time. Now Mr. Flaherty has to pinch pennies.

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