The Parliamentary Budget Officer and What Lies Ahead for Canada - November 2011 Edition

Canada's Parliamentary Budget Officer and Stephen Harper's nemesis and a man he wishes that he had never hired for the job, Kevin Page, has released his prognostication for Canada's economy in his most recent PBO Economic and Fiscal Outlook (EFO).  Here are some of the highlights of his independent and non-partisan analysis.

The PBO opens by noting that the global economic outlook has soured since their June EFO due, in large part, to the ongoing concerns about unsustainable levels of Eurozone debt.  Also playing into the equation is the slowdown in the United States economy and the downward revisions to previous quarterly growth figures which show that the 2008 Great Contraction was longer and the rebound has been weaker than originally thought.  Here's a graph showing what really happened to American economic growth once revisions were considered:

All of this has led to downward pressure on global commodity prices; this is of particular concern to Canada's economy which hinges on the production of commodities.  Here is a graph showing how commodity prices have retraced their steps to just above last year's lows:

When the PBO takes all of these factors into consideration, they conclude that the level of nominal GDP will likely be $20 billion lower this year and $48 billion lower in 2012 what was expected in their May 2011 projection.  Here is a chart showing the growth downgrade:

The PBO anticipates that real GDP will grow by 2.2 percent in 2011, 1.5 percent in 2012 and 2.1 percent in 2013.  The growth in 2011 is 2.5 percent below the economy's productive capacity and this gap will ultimately lead to higher unemployment.  As well, the PBO is concerned that the high level of Canadian household debt will restrain growth by a significant amount and will result in less spending on residential investments.  With Canada's real estate market becoming increasingly frothy-looking, I suspect that a correction in the housing market could retard Canada's economic growth even further than the PBO projects.

Mr. Page goes on to discuss the impact of slower growth on the Federal government's (pardon me, the Harper government's) fiscal situation.  Let's look at the revenue side of the ledger first.  As the economy grows, budget revenues are expected to outpace growth in nominal GDP for two reasons; first, the increase in tax revenue based on growth in the economy and second, the increase in EI premiums from $1.78 per $100 of insurable earnings to $2.28 in 2016.  Unfortunately, this is offset by the reduction in corporate income tax to 16.5 percent in 2011 and 15 percent at the beginning of 2012.

On the expense side of the ledger, government program expenses are projected to growth at 2.8 percent annually on average over the next 5 years with direct program expenditures expected to growth at 1.6 percent annually, well below growth levels seen in the mid-2000s but higher than what was seen in the second half of the 1990s as shown on this graph:

Unfortunately for all of us, public debt charges (interest on the debt) is projected to increase from $30.9 billion in 2010 - 2011 to $40.7 billion in 2016 - 2017 as deficit spending adds to the debt and interest rates rise to normal levels.  The only thing saving our bacon right now is the prolonged period of ultra-low interest rates.

Mr. Page does note that revenues are anticipated to increase faster than total expenses including debt charges with deficits falling from $33.4 billion in 2010 - 2011 (2.1 percent of GDP) to $7.3 billion in 2016 - 2017 (0.3 percent of GDP).  Here is a graph showing how he assesses the likelihood of Ottawa actually balancing its budget over the next 5 years showing that he feels that there is only a 10 percent chance of achieving balance by 2014 - 2015:

The fly in the ointment for whether or not Ottawa can achieve fiscal balance over the long term is Canada's aging population.  As the coming decades pass, increasing numbers of Canadian's join the ranks of those who collect both their public pension and make use of their health care entitlements as shown on the red bars.  The dashed and solid black line shows that there is a massive decline in the number of Canadians paying into the system at the same time as more and more Canadians are availing themselves of the nation's pension plan and health care:

It is this demographic transition that, over the long term, will make it increasingly difficult for Canada's federal government to achieve fiscal balance, in fact, here is a graph showing how Canada's net combined Provincial and Federal debt will climb exponentially over the next 60 years as a percentage of GDP:

The preceding graph brings to mind this particular graph from the United States Congressional Budget Office which shows the impact of aging on growth in America's federal spending as a percentage of GDP over just the next 25 years:

The aging issue will be faced by most of the world's developed and developing economies, some sooner rather than later, because of a worldwide decline in birthrates over the past 4 decades.  In the case of Canada, the PBO estimates that permanent policy actions that include tax increases, reduced spending or a combination of the two amounting to 2.7 percent of GDP (1.5 percent of GDP at the provincial level and 1.2 percent of GDP at the federal level) would be required to stabilize Canada's net debt-to-GDP ratio at 58 percent of GDP.  Delaying this action by 10 years will increase the amount of corrective action to 3.4 percent of GDP and waiting for 30 years will require an increase in corrective action to 5.8 percent of GDP.

It will be interesting to see whether Mr. Flaherty shows the intestinal fortitude required to keep Canada's spending and revenue picture in balance through tax increases and staff reductions among other things.  As shown here, his prognostications have been far from accurate in the past.  With the Federal Reserve revising down their projections showing that growth for 2011 has dropped from 2.7 to 2.9 percent to 1.6 to 1.7 percent in just three short months, I'd suggest that the growth projections of both Mr. Page and Mr. Flaherty may both be well on the optimistic side.  This will make it increasingly unlikely that the Conservatives will reach their budgetary targets.

Canada's PBO Kevin Page - Canada's Stubborn Deficit and Growing Fiscal Gap

On February 15^th, 2011, Kevin Page, Canada’s Parliamentary Budget Officer appeared before the House of Commons Standing Committee on Finance to discuss the Parliamentary Budget Office’s (PBO) updated fiscal projections and issues associated with the upcoming 2011 Budget.  I’ll focus on the highlights from his speech.

The PBO’s fiscal projections are based on Finance Canada’s December 2010 survey of private sector forecasters.  While the PBO bases its projections on these forecasts, the Office produces their own projections and uses the private sector forecasts as guidance only.

From these forecasts, the PBO projects the following:

1.)   The federal deficit will fall from $56 billion or 3.6 percent of GDP in 2009 – 2010 to $10 billion or 0.5 percent of GDP in 2015 – 2016.

2.)   The federal debt is projected to rise from $519 billion or 34 percent of GDP in 2009 – 2010 to $652 billion or 31.9 percent of GDP in 2015 – 2016.

Note that although the total dollar amount of the debt is higher by $133 billion in 2015 – 2016, it drops as a percentage of GDP because of growth in the economy.  Risks to the growth in GDP include weaker than anticipated growth in both the United States and the remainder of the world’s economy, changes in the value of currencies, the high level of household debt which could suppress consumer spending (and put negative pressure on GDP growth) and a rise in global interest rates which would impact the interest payments on the debt.  These factors could have a dramatic affect on the debt-to-GDP ratio.

Here is a summary of the fiscal projections used by the PBO:

The PBO also assesses the probability of returning to balanced budgets over the period from 2010 to 2016.  As shown in this chart, the chance of achieving budgetary balance by 2013 – 2014 is zero and the chance of achieving balance by 2015 – 2016 is only 16 percent, in other words, slim to nil.  As an aside, it is in the 2015- 2016 fiscal year that Mr. Flaherty’s 2010 budget projected a return to balance:

Here are Mr. Flaherty’s budget deficit projections for the next 5 fiscal years from his 2010 Budget document:

Here are the PBO’s projected deficits for each fiscal year for comparison:

For fiscal 2015 - 2016, there's a gap of $7.9 billion between the Harper government's projections and those of the PBO.  Now, who are we going to believe – a politician standing for re-election or an independent Budget Officer?  As well, with global economic slowdowns occurring every 5 to 7 years, it is most likely that during the 2011 to 2016 time frame, another global recession will take place.  This will make it even more unlikely that the Canadian government will be able to balance its budget.

On top of the normal economic issues of debt and deficit, the PBO asserts that Canada is facing a long term fiscal challenge.  Here’s a quote from Mr. Page’s speech:

“Canada’s serious fiscal challenge is underscored by ageing demographics and weak productivity growth.

Our population is getting older. In 1971 there were 7.8 people at working age for every person over 65; which fell to 5.1 in 2008 and is projected to be 3.8 in 2019 and 2.5 in 2033. Growth in labour supply will fall dramatically due to slower population growth and the retirement of the baby boom generation.

Productivity growth is trending down: 2.6% average growth from 1962 to 1976; 1.2% since 1976; about 0.8% since 2000.

The bottom line is that Canada does not have a fiscally sustainable structure. There is a fiscal gap. This means that sustained fiscal actions are required to avoid excessive debt-to-GDP accumulation. Based on PBO’s 2010 report, assuming that the Canada Health Transfer grows in line with projected provincial-territorial health spending beyond 2013-14 – which is projected to be approximately 4.2% per year on average – the fiscal gap is about 1% of GDP, or $20 billion in 2016. Alternatively, if the Canada Health Transfer continues to grow at 6% per year as currently assumed by Finance Canada, the fiscal gap increases to 1.9% of GDP, or about $40 billion in 2016. Moreover, a significant delay in taking fiscal action substantially increases the required amount of corrective measures.”

Here’s the PBO chart used to show the growth in the dependency ratio (the number of Canadians 65 years of age and older divided by the number of Canadians aged 15 to 64 as a percentage) and the shrinking rate of population growth.  Note that in the next 50 years, nearly 1 in 2 Canadians will be over 65, up from 1 in 5 at the turn of the millennium:

Thank you Mr. Page.  At least someone in Ottawa is thinking well beyond the 4 year election cycle. As the baby boomer cohort ages, they will be using more government services (health care etcetera) and contributing less in revenue to the federal government in the form of both consumption and income taxes.  This makes the current scenario unsustainable.

In closing, Mr. Page chastises the Harper government for its unwillingness to supply the PBO (whose mandate from the Parliament is to provide independent analysis of Canada's finances to both the House of Commons and the Senate as stated in the Harper Government's Federal Accountability Act of 2006) with the necessary information which would allow for an open and  transparent assessment of expenditures.  I’ll quote from Mr. Page’s speech once again:

“There is genuine concern that Parliament is losing control of its fiduciary responsibilities of approving financial authorities of public monies as afforded in the Constitution. In the recent past, Parliament was asked to approve changes to crime legislation without financial information or knowledge of monies set aside in the fiscal framework. Parliament was asked to approve authorities related to operational restraint without access to a government plan.

New policy measures (e.g., Afghan mission extension) and existing measures (e.g., corporate income tax reductions) must be debated in an open and transparent manner with the information required for parliamentarians to assess their financial costs and risks.

Budget 2011 should provide a frank picture of the short- and medium-term planning environment and budgetary constraints. Parliamentarians could benefit from having access to the Government’s estimates of the output gap, structural budget balances, and the quantification of risk and uncertainty.

PBO believes that the Government should provide the strategy to achieve estimated operating savings in the 2011 budget and departments and agencies should outline their plans to achieve their respective three-year savings contributions in their 2011-12 Reports on Plans and Priorities.

It is our view that this would be similar to the approach the Government took in its Economic Action Plan where the two-year stimulus strategy was outlined in the 2009 budget including additional planned resources for government programs before Parliament was asked to provide financial authorities. The degree of transparency demanded by parliamentarians for stimulus spending should parallel those required for spending restraint measures.

The PBO also wishes to note this Government provided Parliament details on spending restraint by

department and agency in 2006 prior to parliamentary approval of financial authorities as did the previous government in 2005 on its expenditure review exercise. This raises the question as to why the application of Cabinet confidence with respect to restraint measures appears to have changed in such a short period of time.

Further, the application of Cabinet confidence has been used to withhold information regarding the assumptions used to translate the private sector economic forecasts into Finance Canada’s fiscal projections.

New policy measures (e.g., Afghan mission extension) and existing measures (e.g., corporate income tax reductions) must be debated in an open and transparent manner with the information required for parliamentarians to assess their financial costs and risks.” (my bold)

Apparently, the Harper government seems to have lost touch with the fact that the money that they spend belongs to Canadian taxpayers and that as suppliers of that money we deserve to know how it is being spent and how they plan to dig us out of the fiscal mess they have created over the past 3 years. 

But then again, we’ve learned that Mr. Harper loves to operate in secret.

Kevin Page and the Cost of the One-For-One Deal

This week, Parliamentary Budget Officer Kevin Page released his analysis of the cost of the new jails that would be required under the "tough on crime" Conservative Party agenda in a report entitled "The Funding Requirement and Impact of the "Truth in Sentencing Act" on the Correctional System of Canada. Mr. Page analyzed the cost of a single piece of legislation at the request of the Opposition Liberals.

Mr. Page does admit that the figures used in his report are best estimates only since the federal government would not release the data he requested. Join the club Mr. Page. Here's a screen cap from that page in the report:

The federal government's "Truth in Sentencing Act" (Bill C-25), which came into effect on February 22, 2010, would eliminate the two-for-one credits that prisoners now get for pre-remand time spent in jail once they are sentenced. Some Canadians charged with crimes wait for lengthy periods between the time of their arrest and the time of their sentencing because of delays in the court system. Originally the credit was in place because it was deemed that time spent in lock-up before sentencing was "harder time" than the time spent in real prison because of crowded conditions. Mr. Page's report deals only with the costs associated with this single change in legislation.

Here are the guts of Bill C-25:

"The bill amends the Criminal Code (the Code) to limit the credit a judge may allow for any time spent in pre-sentencing custody in order to reduce the punishment to be imposed at sentencing, commonly called “credit for time served.”(1) There are three scenarios:

• In general, a judge may allow a maximum credit of one day for each day spent in pre-sentencing custody (“custody” in the bill) (clause 3 of the bill, new section 719(3) of the Code). On 8 October 2009, the Standing Senate Committee on Legal and Constitutional Affairs proposed to amend the bill to allow a maximum credit of one and one-half days for each day spent in pre-sentencing custody. However, the Senate defeated the amendment on 20 October 2009.
• However, if, and only if, the circumstances justify it, a judge may allow a maximum credit of one and one-half days for each day spent in pre-sentencing custody (clause 3 of the bill, new section 719(3.1) of the Code). On 8 October 2009, the Standing Senate Committee on Legal and Constitutional Affairs proposed to amend the bill to allow a maximum credit of two days for each day spent in pre-sentencing custody. However, the Senate defeated the amendment on 20 October 2009.
• If the person’s criminal record or breach of conditions of release on bail was the reason for the pre-sentencing custody,(2) a judge may not allow more than one day’s credit for each day spent in pre-sentencing custody (clause 3 of the bill, new section 719(3.1) of the Code).On 8 October 2009, the Standing Senate Committee on Legal and Constitutional Affairs proposed to amend the bill to allow a maximum credit of one and one-half days for each day spent in pre-sentencing custody. However, the Senate defeated the amendment on 20 October 2009."

In his report, Mr. Page predicts that the additional 13 federal prisons required to house the 4000 additional offenders would cost federal and provincial taxpayers an additional $5 billion over the next 5 years as shown in this diagram from the report.

Mr. Page's analysis estimates that the total cost of federal and provincial corrections will increase to $9.5 billion by fiscal 2015 - 2016, up from the current level of $4.4 billion just for the implementation of Bill C-25 alone.

Some provinces had been in discussions with the federal government to abolish the two-for-one pre-sentencing credit; as such, the federal government claims that any additional costs incurred by the provinces will not be covered by the government because the changes were requested by the provinces.

Provincial facilities are used for inmates serving sentences of less than two years and federal facilities are used to house inmates that have been sentenced to terms greater than two years. The report estimates that the provinces would be responsible for 56% of the total new costs.

Public Safety Minister Vic Toews, quite naturally, disagrees with Mr. Page's analysis. He states that the Correctional Service of Canada estimated the increased cost to the federal government at $2 billion over five years. Minister Toews feels that no new facilities will be required because the government will rely on more double-bunking (housing two inmates in a cell designed for one) and that, at most, some new units will be built but only in existing facilities. He also claims that the provinces will be net beneficiaries of the new legislation because more inmates will be recipients of sentences longer than two years in duration meaning that the federal government will be responsible for their room and board.

It is interesting to note that the Liberal government voted for the passage of the Bill C-25 when it came to the house back in 2009. Now, their spokesperson Mark Holland claims that they were mislead about the costs involved. It surprises me that the Liberals went so far as to actually trust the government's estimates in the first place! They have no one to blame but themselves.

To put the new legislation into a broader perspective, the United States has the highest documented prison and jail population in the world with nearly 2.3 million inmates in local, state and federal prisons at the end of 2009. In fact, by some estimates, they have 25% of the world's prisoners. One in every 133 United States citizens is now in prison of some sort and at year end 2008, an additional 5.1 million citizens were under "correctional supervision" putting the total ratio of inmates and parolees at one in every 41 United States citizens. That is a rather shocking number, especially when you consider that the number of prisoners is up nearly 500% since the early 1980s as shown in this chart from the Justice Policy Institute Report "The Punishing Decade":

One would think that there has been a marked drop in crime considering the huge increase in the number of incarcerations; that is not necessarily the case. Here's a chart of statistics taken from the United States Bureau of Justice website:

While the violent crime rate has dropped since it peaked in 1991, it is still at the same level that it was at back in 1974 when the rate of incarceration per capita was lower by half. The rate of non-violent crime is similar; it is now at the same level that it was at back in 1966. Something just doesn't quite seem to be working.

I have no solutions to the problem of crime and punishment but it is apparent that throwing more people in jail and tossing away the key for a longer period of time is not necessarily the solution as seen int he example of the United States. Expediting the passage of the accused through the Canadian justice system would have eliminated at least some of the need for this specific legislation. Perhaps increasing the resources available to the judiciary and court system would have solved the two-for-one time credit issue for once and for all.

Sometimes, I think that it would be a good thing if government put a little more thought into solving society's problems before popping out another piece of legislation. Occasionally the best solutions are the simplest ones. But I guess pumping a few hundred million dollars into the court system to allow for speedier trials just isn't as appealing in the context of a "tough on crime" agenda as Bill C-25 is.