C. Scott Clark is a former federal deputy minister of finance. Peter DeVries is a former federal director of fiscal policy.
Public consultations for the 2017 federal budget are well under way. The House of Commons standing committee on finance began its hearings in September, with its report expected before the December winter break. Finance Minister Bill Morneau has also launched his own consultations, primarily through town-hall meetings, online submissions and his advisory committee on growth.
Mr. Morneau faces two key questions as he prepares next week's economic and fiscal update.
First, have the economic prospects worsened since last March? He recently met with private-sector economists to review the economic planning assumptions to be used in the update. We know that many economists, along with the International Monetary Fund and the Organization for Economic Co-operation and Development, have revised downward their economic forecasts for Canada for 2016 and the next five years, amid continuing worsening in the global economy.
The second question is how much the deficit forecast has subsequently worsened. In his 2016 budget, Mr. Morneau included what most financial commentators called excessive economic prudence. In the budget, nominal gross domestic product was reduced by $40-billion annually throughout the forecast period, implying a fiscal prudence factor of $6-billion a year, twice the normal amount of prudence.
Current forecasts for nominal GDP in 2016 by economists, the OECD and the IMF are still $20-billion to $30-billion higher than March's budget. As a result, there is a strong possibility that not all of the fiscal prudence of $6-billion included in the 2016-17 deficit forecast will be needed.
In addition, the recently released Annual Financial Report showed a final deficit for 2015-16 that was $4.5-billion lower than estimated in the budget, primarily due to higher-than-expected income-tax revenue. Some of this improvement will likely be carried forward to 2016-17 and beyond.
On Monday, the Parliamentary Budget Officer released his latest economic and fiscal outlook. He is now forecasting a deficit of $22.4-billion for 2016-17, which is $7-billion lower than what was forecast in the budget and $4-billion to $5-billion lower for each year to 2020-21. However, the PBO forecast does not include a prudence reserve, arguing that the risks to its forecast are "balanced." Adjusting the PBO forecast to include a $6-billion prudence factor results in a deficit $1-billion lower in 2016-17, but higher each year thereafter.
Most private-sector economists have also lowered their growth prospects over the medium term. This will inevitably use up some of the economic prudence and put the deficit targets for 2017-18 and beyond at risk. In retrospect, it would appear that the minister was right to include $6-billion of annual prudence reserve in his first budget.
He must now decide whether he still wants to maintain that much reserve in his update. Previous governments adopted a budget rule that any unused prudence would be directed to reduce the federal debt and not to fund new policy initiatives. Mr. Morneau, for his own credibility, should make this same commitment, as well as a commitment to maintain a $6-billion prudence reserve.
There will no doubt be significant pressure on the Finance Minister to fulfill some of the government's outstanding election commitments not fully funded in its first budget. For the first two years, the fiscal cost of the election promises corresponds closely to what was promised in the 2015 election.
After that, however, budget commitments relating to health care (specifically the election promise for funding for home care), for expanding employment insurance benefits and for providing employment opportunities for young Canadians fall significantly short of what was promised in the election. Fulfilling these election commitments would cost an additional $1.5-billion annually.
In addition, the election platform promised a review of Canada's international assistance policy framework, but no funding was provided in the budget. Finally, the Finance Minister has to deliver both a credible growth strategy and a credible innovation strategy in his upcoming budget. Although these strategies could be partially funded through expenditure and tax reallocations, they are still likely to have some impact on the bottom line.
In coming weeks, the most important prebudget consultation for Mr. Morneau will be with the Prime Minister and his cabinet colleagues.
Mr. Morneau must convince them that they will face a difficult economic and fiscal situation for the foreseeable future, and that he has he no fiscal room to spare. They will have to make difficult policy tradeoffs if they want to maintain their reputation as a progressive government, but also as sound financial managers as well.
During the election campaign, the government was able to convince Canadians that making new investments and going into deficit was the right thing to do in an environment of continuing weak economic growth. However, strong fiscal commitments were also made in the budget, and the government might face a backlash if the upcoming budget were to show rising deficits and a growing debt-to-GDP ratio.