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glen hodgson

The goal line of a balanced federal budget in 2015 is in sight, just as the Conference Board of Canada projected four years ago. What next? Within the framework of a balanced budget, the next federal government – regardless who forms it – should be investing in growth as its core budget strategy.

Here's the economic context for that advice, which the Conference Board gave to the House of Commons finance committee last week. Canada's economy is expected to grow by 2.2 per cent in 2014 and improve to 2.6 per cent in 2015, on the coattails of a strengthening U.S. economy. However, we do not expect that higher rate of growth to last. Aging demographics are already affecting Canada's labour force, a key driver of growth, and these pressures will only grow as more and more baby boomers prepare to retire. Canada's growth in 2016 and beyond will be slower; our estimate for future long-term growth potential of 2 per cent is a full percentage point below growth potential less than a decade ago.

With these modest prospects, we offered the finance committee three pieces of advice. First, it remains important to balance the federal budget in 2015 and keep it in balance (or even in small surplus) when the economy is growing. Balancing the books in good times strengthens the government's capacity to provide fiscal stimulus and sustain budget deficits and rising public debt in bad times, such as the 2008-09 period. Balanced budget targets help to limit the buildup of public debt and allow the government to stay largely on course even if the economy underperforms.

A debate has emerged (yet again) about whether it is even necessary to actually balance the books. While it is arithmetically possible to reduce the debt-to-GDP ratio over time without achieving fiscal balance (by growing GDP faster than debt), it is a dubious strategy. Governments elsewhere in the developed world, notably in Europe, have demonstrated amply that a failure to balance the books when the economy is growing can become dangerous and painful.

Chronic fiscal deficits mean public debt increases without actually fuelling the economy, while interest charges on that debt steadily eat up more and more of the budget. When crisis or recession occurs, these governments are faced with very tough decisions, just when access to debt financing is squeezed or even cut off. No one wants to experience the recent and continuing public debt nightmare of many EU governments.

Our second piece of fiscal advice is that future federal budgets should be committed to investing in growth. All elements of the federal budget should be examined through the lens of whether they are making a positive contribution to economic growth capacity. Investing in infrastructure should be a top spending priority, to build a foundation under the Canadian economy and ensure that we remain globally competitive as an exporter and creator of wealth. Yet, in the latest World Economic Forum Global Competitiveness Report, Canada's performance dropped on seven out of nine indicators related to infrastructure, contributing to a further slip in overall competitiveness.

The federal government has already committed to a down payment for infrastructure investment in future budgets, but more financial commitment will be required if Canada is to close its obvious infrastructure gap. Sustained and sufficient investment in human capital – notably for postsecondary education, skills development and training – is another key part of a pro-growth federal budget.

Third, we emphasized that it is time for tax reform in support of stronger economic growth. Over the decades, Canada's tax system has become a complex web that distorts incentives and ends up imposing high compliance costs on businesses and individual taxpayers. Comprehensive tax reform would help Canada improve its competitive position, while addressing some of the looming fiscal pressures associated with the aging of our population. The finance committee could show active leadership by encouraging a comprehensive review and reform of the tax system. The Conference Board of Canada is already taking steps to examine the tax system with the launch of its Centre on Tax Analysis, Fiscal Incentives and Competitiveness, which will deliver evidence-based insights on the system currently in place and offer recommendations for reform.

In short, future federal budgets should simultaneously invest in the growth potential of our economy, while managing public debt within the framework of a balanced budget. These dual objectives would support economic growth without passing the public debt burden to future generations.

Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.