FINA Committee Report

CHAPTER THREE — THE PRIORITY OF PROSPERITY AND GROWTH

It is the view of the [Canadian Professional Sales Association] that the federal budget for fiscal year 2002-03 will be the most important such document in recent years. In fact, it should probably be accorded the same degree of significance as the budgets that introduced measures to return Canada to a position of fiscal integrity. Maintaining that integrity in the fiscal years ahead should be the central objective of the coming budget. (Canadian Professional Sales Association, 9 September 2002)

As identified in the Introduction, economic prosperity, with the benefits widely shared by all Canadians, is an issue upon which Canadians were asked to comment during the Committee’s pre-budget discussions and consultations. Certain conditions must exist if Canada is to continue to enjoy economic prosperity, and many of these were identified by the Committee’s witnesses: ensuring that the budget, at a minimum, is not in a deficit position; continued efforts to reduce our debt; an adequate contingency reserve along with a measure of economic prudence; tax reductions as a stimulus to growth and prosperity; and the reallocation of existing expenditures to meet new spending needs.

Staying the Course

We have placed a mortgage on future generations and unless we adopt and implement responsible measures in the short and medium term, our action from the past will reduce the quality of life of our children and grandchildren. It will also impact on our ability to prosper as a nation. (Canadian Printing Industries Association, 31 August 2002)

In his October 2002 presentation to the Committee, Minister of Finance John Manley informed us that Canada continues to enjoy strong economic growth, and that we will lead the G-7 countries in economic growth in the future. This is a notable achievement in light of global uncertainty, weaker-than-expected growth in some countries — notably the United States — and uncertainty related to corporate governance failures and a potential war with Iraq.

Strong economic growth has resulted in benefits, not only in terms of employment gains and rising incomes for Canadians, but also in terms of the federal government’s financial situation. Since 1995-96, Canada’s net-debt-to-GDP ratio has fallen from almost 71% to 49.1%. On a National Accounts basis, an accounting system that allows for cross-country comparisons, Canada’s net-debt-to-GDP ratio in 2001 was below the G-7 average for the first time since 1985. While almost all of the reduction in the net-debt-to-GDP ratio was the result of economic growth, budget surpluses totalling $46.7 billion since 1997-98 also contributed to the decline. Data from the federal government’s Economic and Fiscal Update 2002 suggest that the trend toward a lower net-debt-to-GDP ratio is likely to continue — and fall below the G-7 average of 40% — even if the government only just balances its budget (i.e., makes full use of the economic prudence and contingency reserves), as shown in Figure 11. The Committee supports efforts that would contribute to further declines in the net-debt-to-GDP ratio to 30% by 2011 to address partially the demographic pressures that will result from the retirement of the baby-boom generation. The resulting savings in interest payments could be used to finance those programs and services desired by Canadians.

The Committee notes, however, that reducing the net debt is not equivalent to paying down the debt. These are two separate concepts, as the Auditor General recently noted in her review of the federal government’s financial statements: “The surplus for the year does NOT automatically pay down the debt. There is neither any law nor accounting rule that requires this. This year’s surplus was applied to several areas, only one of which was the reduction of debt. Part of the surplus was used, for example, to support increases in financial assets such as loans, investments and advances.”³⁰ That being said, a portion of the surpluses has gone to paying down the government’s market debt, which more closely corresponds to a mortgage or loan and has saved the government a certain amount in interest costs. Figure 12 shows the evolution of these two debt concepts.

Many witnesses, including the Canadian Federation for Promoting Family Values and the Canadian Institute of Chartered Accountants, told the Committee of the need for prudent action in order to avoid moving back into a deficit position. As well, Dr. David Laidler indicated to us that the credibility of Canada’s monetary policy regime “has been considerably enhanced since 1995 by fiscal policies that have reduced both the public debt, particularly at the federal level, and Canada’s overseas indebtedness.” A balanced budget, if not a surplus, remains a priority of Canadians.

Budget Planning, the Contingency Reserve, Economic Prudence and What to Do with the Surplus

Identifying areas in need of an injection of public funding, ensuring that there will be positive spin-offs attaining multiple policy objectives, and partnering with other organizations from the public, private or not-for-profit sectors; these are characteristics of a wise strategy for spending hard-earned tax dollars. (Canadian Library Association, 9 September 2002)

Government efforts designed to ensure that the federal government avoids budget deficits and generates surpluses were welcomed by witnesses, although some commented on the frequency with which the government underestimates the size of the budget surplus. The government has been able to consistently surpass its surplus forecasts, as shown in Figure 13.

There are a number of reasons underlying these smaller-than-anticipated deficits and larger-than-anticipated surpluses:

There has been some erosion in all of these conditions except, perhaps, for the budget process itself. That being said, recent employment growth suggests that last year’s slowdown in revenue growth stemming from the U.S. recession could be short-lived. Moreover, program spending has increased by an annual average rate of about 3.8% since the federal government began balancing its budget in 1997-98. According to projections in the Economic and Fiscal Update 2002, federal program spending will rise from $126.7 billion in 2001-02 to $163.6 billion by 2007-08.

Minister of Finance John Manley has made it clear that he will not risk a budget deficit. Federal government program spending as a percent of GDP is currently 11.6%, its lowest level in the post-war period; it is projected to fall to 11.1% by 2007-08, indicating that program spending is expected to grow slightly more slowly than the economy as a whole.

In terms of interest rates, while the Bank of Canada’s benchmark interest rate has risen by 75 basis points since spring 2002, reaching 2.75%, it — and interest rates in general — remains near historic lows. With the continuing uncertainty in the U.S. economy, it is unlikely that interest rates will rise significantly in the short- to medium-term.

Furthermore, the budget process remains essentially unchanged: the federal government still adopts a conservative approach to its forecasts by using the average of private sector forecasts and then adding a measure of economic prudence for unforeseen economic circumstances and a contingency fund for emergency spending needs.

Following the terrorist attacks of 11 September 2001, the federal government, in its 2001 budget, abandoned the economic prudence amount altogether and reduced the contingency reserve to $1.5 billion. In the post-September 11 environment, these conservative assumptions made sense, as the government noted in its 2001 budget: “The size of the Contingency Reserve and economic prudence included in this budget is smaller than in previous budgets. Previously, the contingency reserve was set at $3 billion per year, with an additional amount for economic prudence. These amounts were included to cover risks arising from unforeseen circumstances, like those being experienced now.”³²

While appearing before the Committee in October 2002, the Minister of Finance announced that the contingency reserve would be restored to $3 billion, and that economic prudence would be re-introduced in order to ensure no return to budget deficits. He also reaffirmed the federal government’s commitment to devote any surpluses not utilized — including the economic prudence amount and the contingency reserve — to reducing the debt. In that event, the Committee believes the government should ensure that these funds are used to reduce actual market debt.

The Minister of Finance’s announcement about the re-introduction of a larger contingency reserve and a return to economic prudence received the support of witnesses. They also shared with the Committee a wide range of views on what to do with any budget surplus. Some witnesses advocated spending the excess funds on social programs — notably health care — while others supported tax cuts of various kinds. Still others suggested that the full amount should be used to pay down the federal government’s market debt.

The Bottom Line

The government must determine priority areas and exercise restraint. We recognize that certain incremental growth in spending based on population growth and inflation is inevitable. Our position is focused on new initiatives — if the government believes that money would be better spent in one area, they need to reallocate that money from another area which is no longer a priority concern. Real, consistent and aggressive spending control strategies are required for fiscal flexibility. (Metropolitan Halifax Chamber of Commerce, 30 October 2002)

The Committee endorses the federal government’s prudent approach to budget making and believes that surpluses should be used to pay down the market debt as much as possible. This has benefits for all Canadians. In addition to taking action in order not to burden our children, grandchildren and all future generations, reducing our debt means that the federal treasury saves on debt-interest costs. These savings can then be used to focus on the priorities of Canadians, whatever they may be.

Tax competitiveness is a key component of the federal government’s strategy to become a magnet for investment and skilled labour, two of the basic drivers of economic growth. Tax cuts, whether personal or corporate, are a priority for the Committee, as they too can generate economic growth. Economic growth, in turn, enables spending on other priorities. As pointed out by the federal government in 2001, and by several witnesses presenting to the Committee, the five-year tax reduction plan announced in the 2000 budget was perfectly timed to help Canadians and the Canadian economy during the 2001 economic slowdown. In our view, a further reduction in tax rates in the next budget could have a similarly positive effect in the event that the sluggish U.S. economy begins to affect seriously the Canadian economy. We believe that, at a minimum, the measures outlined in the five-year tax reduction plan must continue to be implemented. From this perspective, the Committee recommends that:

RECOMMENDATION 1

The federal government continue to implement the five-year tax reduction plan announced in the February 2000 budget and the October 2000 Economic Statement and Budget Update.

A healthy corporate governance culture is another important element of competitiveness and economic prosperity. The scandals at large U.S. firms such as Enron and WorldCom have not only undermined confidence in corporate balance sheets and corporate culture, they have also had a deleterious effect on capital markets and the economy as a whole. As the Canadian Pensioners Concerned Incorporated noted in its appearance, “assurance of the highest quality of life for all can only be brought about if the economy is governed by the highest principles of honesty, fairness and justice as well as efficiency and effectiveness.” While Canada has not experienced any corporate scandals similar to those arising in the U.S., the Committee feels that a review of corporate governance and related issues should be a federal government priority, and we note a number of initiatives currently under way.³³

The Committee also understands the need for limited spending increases to meet the normal needs of existing programs. We believe, however, that the federal government should limit average annual program spending increases to 3% or less, which is equal to the sum of population growth (approximately 1% annually) and inflation (about 2% annually). We also note that the average of private-sector projections for program spending in the Economic and Fiscal Update 2002 are reasonably close to this target: between 2002-03 and 2007-08, government spending is projected to grow at an average annual rate of about 3.9%.

Spending targets are essentially “disciplinary” tools that force the government to scrutinize closely any new spending proposal. In the Committee’s view, any new spending that threatens the objective of a balanced budget should either be abandoned or delayed. If the government still finds it necessary to pursue these new policies, it should undertake program review and reallocate existing expenditures to other purposes. We believe that this is the proper approach, and that the monies in the contingency reserve should only be spent in extraordinary circumstances.

Budget making is about prioritizing. This prioritizing must be done in the context of a continued focus on the avoidance of a budget deficit, a plan of action to reduce our debt, a contingency fund and economic prudence of an appropriate size, personal and corporate tax reductions as an economic stimulus, and a review of existing expenditures in order to identify areas for the reallocation of spending from lower- to higher-priority areas consistent with the views of Canadians, whether they be further debt reduction, tax reductions or increased spending. Discipline in all of these areas is required in order to ensure the future economic prosperity of our nation and the quality of life of its citizens. For these reasons, the Committee recommends that:

RECOMMENDATION 2

The federal government continue to focus on a balanced budget, with any surplus used to pay down its market debt. The government should consider the extent to which savings realized as a consequence of lower debt-interest costs should be spent on existing or new programs that have been identified as priorities for Canadians. Moreover, the government should undertake an ongoing review of federal expenditures with a view to monitoring continuously the activities that are priorities for Canadians in order that appropriate reallocation of spending occurs. Finally, spending increases should be limited to the rate of inflation and population growth.