Don’t Play Tories’ Game on “Risk” of Deficit

Acres of newsprint have been devoted in recent weeks to the possibility that lower oil prices might push the federal budget back into a deficit position.  As I argue in my column in today’s Globe and Mail, this drama is mostly political theatre — and progressives should be cautious about accidentally accepting the Conservative frame for this debate.

Provincial governments in the oil-producing provinces face a huge fiscal risk from lower oil prices (since they rely, to varying degrees, on petroleum royalties to directly fund current public services — not exactly a wise fiscal strategy).  Ottawa, in contrast, has little direct stake in oil prices: the feds collect no royalties, and corporate taxes from the oil industry were reduced (even when oil prices and profits were high) by the Tories’ cuts in the corporate tax rate (down by over one-third under the Harper government).  Indirectly, however, lower oil prices will clearly affect federal revenues.  Lower nominal prices reduce nominal GDP and hence the nominal tax base; this week the Parliamentary Budget Office estimated that a $48 oil price would knock $7 billion per year off total revenues from 2015 going forward.  If the oil price keeps falling (as it is), the hit gets bigger.

Things get worse if real economic activity also starts to shrink.  (The PBO report was based solely on the nominal price-level effect, assuming no real GDP deceleration).  Lower oil prices have a broad and mixed range of real effects.  The biggest negative will come from the huge reduction in petroleum investment spending that is already visible.  Since the oil industry accounted for close to 30% of all business capital spending in Canada, this will be a significant hit on demand and activity (regardless of the dubious long-run economic and environmental effects of those energy mega-investments).  Current petroleum production, in contrast, will not be significantly affected by the plunge in oil prices: if anything, volumes are going to increase (as previously started projects continue to come on stream).  Another significant hit to real GDP could come in the form of real spending restraint by governments in the petroleum-producing provinces.

The PBO report concludes that the federal budget (without other changes in revenue or spending) could fall slightly into deficit for 2015-16.  Surpluses in subsequent years (already dramatically reduced by the government’s big tax cuts announced in October) shrink to near zero.  The PBO estimates are mostly consistent with forecasts published by several major banks and the Conference Board.

It is tempting for critics of the Harper government to pounce on this development, and highlight the risk of imminent deficits as a sign of the government’s fiscal mismanagement. However, for two reasons I am dubious of this line of attack:

1. It implicitly accepts the view that deficits (especially on the scale small possible for 2015-16) are somehow a problem.  They are not.

2. It overstates the possibility that a deficit will actually be booked.  It won’t.

The government has invested a great deal of political capital in its deficit-elimination timetable.  On top of damaging the government’s general claim of good economic and fiscal stewardship, the government explicitly committed (back in 2011) that future tax cuts were contingent on achieving the balanced budget.  Deficits on the scale anticipated by the PBO and other forecasters could and would be erased with the stroke of an accountant’s pen (adjusting the timing of future expenditures, adjusting the value of booked liabilities, or adjusting any number of other parameters).  In the coming budget and associated election campaign, there is no chance the government will show a deficit for 2015-16.  The more phony public “suspense” is created over whether or not the budget is balanced, the greater will be their “triumph” when they inevitably declare their phony victory.

This is not to say that the government’s fiscal performance has been either worthy or credible.  I think that a more fruitful and principled line of attack on the government’s approach would focus on these obvious fiscal and economic errors by the government:

  • The October tax cuts were premature; it is tax cuts, not oil prices, which have jeopardized the attainment of a balanced budget.  The Conservatives broke their own promise in implementing tax cuts before the budget was even balanced.  (Breaking their promise, not running a small deficit per se, is their key point of vulnerability.)  In fact, as I show in the Globe and Mail column, the federal budget would be balanced right now, even with lower oil prices, were it not for the accelerated first-year tax cuts which the government was so anxious to rush out the door before the election.
  • The October tax cuts are socially and economically damaging.  The CCPA’s fabulous analysis of the perverse distributional effects of income splitting (here and here) is already making this case in spades.
  • The government’s response to falling oil prices has revealed confusion and internal division.  Joe Oliver delayed his budget to some unspecified future date (April or even later); perhaps he will actually “table”the budget on the hustings .  Oliver has said that there will be no further spending cuts to offset the loss in revenue, and that the government can use its (phony) $3 billion contingency fund to protect the balanced budget.  Employment Minister Jason Kenney, in contrast, said the exact opposite in public: suggesting that incremental spending cuts might be required, and that the $3 billion cushion would not be drawn down (since it is intended, he argued, for true “emergencies”).  Treasury Board President Tony Clement, meanwhile, also hinted at surprise reductions in spending — channeling Pierre Trudeau in saying “Just watch us” reduce spending.  Clement’s record in consistently underspending authorized operational budgets (part of the government’s “austerity by stealth” strategy).  These mixed messages indicate a breakdown of discipline within Conservative ranks, and send confusing signals to consumers and investors alike.
  • Most fundamentally, the government’s macroeconomic and industrial emphasis on making Canada an “energy superpower,” investing so much fiscal and political capital to facilitate energy megaprojects (including fruitless pipeline proposals), vilifying critical voices, and inadequately responding to the negative side-effects of the oil boom on other sectors, has left Canada’s economy unduly vulnerable to an oil price decline that was always inevitable.

My response, therefore, to the question “Will low oil prices push Ottawa into a deficit,” is therefore: “Who cares? The real issue is the government’s failure to use its fiscal and other tools to strengthen the recovery and create jobs. That’s the real mismanagement.”


  • I think Keynesian economists need to do a better job explaining government finances to the general public.

    People tend to believe the false line that a government has to “live within its means.” That is, they equate government finances with household finances.

    Of course, a household is not an economy.

    A household can reduce its spending while maintaining its income. In an economy, one’s person spending is another person’s income — and the government makes up a big slice of what people spend (funded by progressive taxation.)

    So when the economy is in a slump, and people are not spending, government cuts will either prolong the slump or cause a recession. (We are presently in a 7 year slump — at least. It’s more like a 15 year slump if one looks at GDP growth since 2001, even with the illusory prosperity created by the housing/derivatives bubble in the 2000s.)

    Not only that, governments are not spending on frivolous things. We’ve faced three decades of continuous government cutbacks. The fat was cut out long ago. Now we are cutting into the bone. For one, we have amassed a $125-billion infrastructure benefit (crumbling roads, bridges, etc.)

    In the post-war Keynesian era, governments spent big. Republican president Dwight Eisenhower raised taxes on the rich to 91% to fund an interstate highway system. This and similar endeavors created phenomenal economic growth and rising living standards. This brought in enough tax revenues that governments paid down most of their WW2 debts.

    After 30 years of continuous tax cuts that primarily benefited the rich — coupled with big spending cuts — government debt is back up close to WW2 levels. GDP (economic) growth over the past 35 years is half of what it was during the post-war Keynesian era (1945-1980.)

    As Keynes pointed out 80 years ago: “the boom, not the slump, is the time for austerity.”

  • People also need to realize Harper’s fiscal agenda. It is best summed up by neoliberal economist — er, “economic scientist” — Stephen Gordon. He calls it “starving the beast.”

    He boils it down to a 4-step program:

    1. Make big cuts to taxes

    2. Create a budget crisis

    3. Make big cuts to spending

    4. Go to 1.

    This is obviously what Harper has been doing.

    In his 2009 budget, he outlined $45-billion a year in tax cuts. (Tax revenues for the country are down over $90-billion a year since the 1990s. Back then revenues were 35% GDP, according to the OECD. Now 30%.)

    This created a massive deficit which he used to justify massive cuts to government spending.

    Now he’s back to step 1 making a new round of tax cuts (to be followed by new spending cuts, etc.)

    Unfortunately, the Liberal party has been an enabler of this corrupt neoliberal agenda that began with Mulroney. Instead of undoing the damage, they cement it in place. Trudeau Jr. is certainly no exception to the rule.

  • Last there is obviously a huge fiscal imbalance between the federal government and the provinces, which allows the fed to cut taxes by tens of billions a year and still come up with a balanced budget. This is the result of continuous cuts to transfers since 1991.

    The Harper Government has been using a creative accounting shell game to make it appear transfers have been going up.

    Neoliberal economist Kevin Milligan recently cited these cooked stats to bash Mulcair for daring to state the obvious.

    Milligan refers to data in (now terminated) CANSIM table 380-0007. He calls this “Outgoing Transfers to Other Governments as Share of Own Revenue.”

    It shows the big cuts to transfers in 1997 from the Chretien/Martin Liberals. But from 2006 to 2011, transfers miraculously skyrocket to the highest they’ve ever been.

    I say “miraculously” because the money didn’t show up in the provinces’ books. Non-resource provinces struggled with big deficits during this time.

    Data from the same table 380-0007 tells the real story: what Milligan calls “Share of Total Government Spending”. The federal share has been on a steady decline since 1991: 40% to 30% by 2011 (last year in the table.) Back in 1961, it was 50%.

    Harper’s recent unilateral change to health care transfers will reduce funding by $36-billion. What’s worse is that the variable transfers (related to NGDP) are pro-cyclical. Meaning, the funding drops during recessions and slumps. Government spending is supposed to act as an economic stabilizer: that is, run counter-cyclical to the business cycle.

    This means the provinces will be hit hard by recessions and the federal government will get a big break. (Which it can use to provide more “tax relief” to the wealthy.)

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