Truth in budgeting

The National Debt is a Very Good Thing and it would be dangerous to pay it off, for fear of Political Economy.-- W C Sellar & R J Yeatman, 1066 And All That

What a surprise: the federal government is on course to record yet another multi-billion dollar surplus -- billions more, yet again, than it had projected just months before. Leading private sector economists say the surplus for the most recent fiscal year, 2004-05, could be $8-billion or more, versus the $3-billion forecast to which the Finance minister was still clinging in the February budget. If so, that would bring the total annual surpluses recorded over the last eight fiscal years to nearly $70-billion, a period in which the feds’ declared aim throughout was nothing more than “balanced budgets or better.”

The persistent tendency of actual surpluses to exceed their projections -- or, if you prefer, the persistent tendency of finance ministers to lowball their forecasts -- is a legitimate cause for concern. While the “cupboard is bare” routine may be an effective way to keep the lid on demands for more spending, it does so at the cost of increased cynicism about politics and government promises. At that, it hasn’t even done much for fiscal discipline: while the Liberals may have faced less pressure to spend from others than they might have had they presented a more honest picture of the government’s finances, that hasn’t stopped them from ramping up spending at a terrific rate on their own. That this has commonly been achieved by stuffing billions of dollars into the previous year’s budget or off-budget “foundations,” in either case eluding Parliament’s oversight, has only added to the impression of a budget process that has become more or less completely disconnected from reality.

Under fire from opposition and media critics, Finance commissioned a study on ways to improve its budget forecasts by Tim O’Neill, the Bank of Montreal’s former chief economist. His report, delivered in June, suggested that the fault lay not so much with the forecasts -- what the government thought its fiscal position would be -- as with the choice of targets: what it wanted it to be. By insisting that deficits must be absolutely avoided at all times, he argued, the government had given the budget process a built-in bias towards surplus: risk-averse bureaucrats were encouraged to add an extra layer of fudge to their forecasts, over and above the formally declared margins for “contingency” and “prudence.” Mr. O’Neill’s headline-making recommendation: drop the no-deficit rule. Aim instead for a small surplus over a longer period, say five to seven years, more in line with the business cycle.

As a matter of pure arithmetic, this argument has some merit. The country would not go up in smoke were the government to run a deficit in any one year, nor is there any special significance to a year, fiscal or calendar, as the period of fiscal reckoning. No one gets alarmed if the government runs a deficit or surplus in any one month. Why should it be any different over twelve? We got ourselves into such a fiscal mess in years past not because we ran a deficit, but because we ran 27 of them. In a row.

But there is also such a thing as political reality. A year may be an arbitrary period, but it’s the one we happen to have. One annual deficit can as easily become two, then three, then four, and before you know it the debt -- the accumulation of all those deficits -- has swollen to quite unmanageable levels, and so has the cost of servicing it. Perhaps the no-deficit rule is merely a taboo, but taboos are often there for a reason.

Certainly financial markets would be inclined to regard any lapse into deficit as an ominous sign -- not least because it’s so ridiculously easy to stay out of it. The Liberals have been running these surpluses, remember, even as they have been increasing spending by 50%. When you are taking in four dollars in revenues for every three dollars in spending, it’s almost impossible not to run a surplus.

The problem, in any case, is not that the government has been running surpluses -- it’s that it hasn’t been upfront about it. Whether unintended or merely unannounced, that $70-billion reduction in the national debt has already paid huge dividends: debt service charges, at 18 cents for every dollar of revenue, are roughly half what they were at their peak. And with the costs of looking after the aging baby-boom generation projected to rise exponentially, it only makes sense to carve out as much fiscal room as we can, while we can: paying down debt now gives us more freedom to go into debt later on, if we need to.

The answer to unbudgeted surpluses is not deficits: it’s to build the surplus into the budget. Line item one in each annual budget should be a modest payment against the national debt. Expressed as a fixed percentage of the remaining debt -- 1 or 2% -- this would decline over time, both absolutely and relative to the economy, in line with the debt. The amount of surplus available for spending increases or tax cuts would then be a function of debt reduction, rather than the other way around. And without making a liar out of the Finance minister.