Thank you, Mr. Chair and members of the committee, for having me today as part of this distinguished panel.
I live in Vancouver, so greetings from British Columbia, where last week the provincial budget brought in the country's first carbon tax, something that I'm sure you'll be studying as time goes on.
The CCPA does not do independent macroeconomic forecasting. What we do is provide fiscal forecasts as part of our alternative federal budget process. On this front, our track record is quite good. We were the first in Canada to raise the alarm about understated revenues in federal budgets leading to lower than projected deficits and then, after 1998, larger than anticipated surpluses.
The macroeconomic framework for this year's alternative federal budget is one where economic growth projections have been lowered compared with last October, when the economic and fiscal update was tabled. Whereas the 2007 federal budget lowballed revenues, the re-estimated framework in the economic and fiscal update is much more accurate and provided the fiscal room for the government to make its multi-year tax cuts.
I won't dwell on the prospects for lower economic growth. Developments in the United States suggest that the U.S. has already entered a recession, and the nature of that downturn suggests it could be longer and deeper than recessions in the recent past.
What's at issue is to what extent the downturn for our biggest trading partner--with exports equal to a quarter of our gross domestic product--will affect Canada overall, and what sectors and regions will bear the worst of it.
My forecasts take the economic and fiscal update as a baseline and then make adjustments for changes in the rate of economic growth. The revised base case is on page 15 of the alternative federal budget, which was released today. I've brought copies for all of you. I won't review the remainder of that document, but I will leave it to you to steal our best ideas and recommend that they get put into practice.
Slower economic growth means much less fiscal room heading into budget 2008 than in budgets past. We still anticipate a surplus of $11 billion in 2007-08, as most of the tax cuts kick in during 2008-09 and years after, but based on the updated economic forecast from the Bank of Canada's January 22 monetary policy update, the available surplus drops to about $1 billion in 2008-09.
Now, I should caution that this is not accounting for the government's promise to reduce the federal debt by at least $3 billion. In order to meet that particular promise, and under this new revised framework, the government would actually have to cut spending by $4 billion next year or it would have to revisit some of its tax cuts.
Personally, I would reject the notion that paying down federal debt is a top priority for the country right now. This includes the government's promise to make a $10 billion payment on the federal debt out of the current year's surplus.
In the out years, the surplus in the base case rises to $3 billion in 2009-10 and to $6 billion in 2010-11.
I'd like to underline the fact that if there were to be a major slowdown in Canada, because there is so little fiscal room the budget would naturally move into a deficit position. This is entirely the consequence of multi-year tax cuts from the economic and fiscal update and previous budgets.
The EFU tax cuts build on tax cuts announced in the 2006 and 2007 budgets. Fully phased in, the total revenue loss from the EFU is $14.7 billion per year by 2012-13. But if those previously announced tax cuts are taken into consideration, the total revenue loss from tax cuts by 2012-13 is an alarming $40.2 billion per year. This is a number I got right out of the economic and fiscal update itself.
We therefore need to ask what the federal government would do in the event that there was a slowdown or recession that pushes the budget into deficit. The government has promised to balance the budget, so assuming that they are unwilling to revisit their tax cuts, the only choice would be to cut spending.
In a technical paper for the alternative federal budget released in January—I believe copies were distributed to committee members--I modelled four scenarios of economic downturn and recession, again relative to the EFU baseline, each increasingly more pessimistic than the previous.
Growth estimates for the non-recession years of 2007 and 2010 are essentially the same as the EFU baseline in all scenarios. Essentially what we are modelling is a slowdown or recession in 2008, with a recovery year in 2009.
One note of caution in comparing the alternative federal budget to the technical paper is that today's AFB uses a revised GDP figure for 2007, so the forecast surplus in 2007-08 falls from $11.5 billion in the technical paper to $11 billion in the alternative federal budget.
In the technical paper, scenarios one and two are slowdown scenarios but not actual recessions. They show that it wouldn't take much before the budget reverted to deficit. These scenarios can be seen graphically on page 4 of the technical paper and in more detail in the appendix.
Scenarios three and four model actual recessions rather than slowdowns. In my worst case scenario, the deficit hits $6.2 billion in 2008-09, rising to $12.7 billion in 2009-10 before falling back to just over $10 billion in 2010-11. In terms of tipping the fiscal balance, a nominal GDP growth rate under 2.65% will lead to a deficit for the 2008-09 fiscal year.
The policy question, of course, is what should be done in response to a recession. The prospect of a downturn puts the recent tax cuts into sharp relief. Should the government hold the line on its tax cuts as its primary policy response? And to what extent would things such as the tax back guarantee, which I would argue is a gimmick that converts savings on debt interest payments arising from surpluses into tax cuts.... What would happen to that should surpluses turn into deficits? Does it in fact become a tax increase guarantee?
In response to a downturn, I believe the government should be prepared to run a deficit. Personal and corporate income tax revenues and GST revenues will minimally slow and possibly decline. Automatic stabilizers such as the employment insurance program have been greatly weakened since the mid-1990s, but in the face of a downturn they will push the budget towards deficit.
Surpluses on the EI account have already shrunk a great deal because of rate cuts, from an excess of $4 billion of premiums over benefits paid in 2001-02 to an estimated $2 billion in 2007-08. If unemployment were to rise, the EI account would turn to deficit rather quickly.
The conventional wisdom in Ottawa is a deep antipathy towards deficits under any circumstances. But I would argue that having saved for a rainy day, the federal government should be prepared to use the umbrella of deficit spending if need be. Canada's debt-to-GDP ratio fell from 68% in 1996-97 to 32% in 2006-07. The government has substantial room to run a deficit if it so chooses. Compared with those of other G7 countries, Canada's net liabilities are the lowest by a fair margin, with other countries running deficits in recent years, in contrast with Canada's surpluses.
In the United States, the Bush-Bernanke stimulus package, which has been criticized as not being stimulative enough, comes in a context of a previous year's deficit above 2% of GDP. In Canada, an equivalent deficit would be above $30 billion. That's not what I'm recommending; it's just to put it in perspective for Canadian audiences.
I believe there is much work to be done on climate change, poverty, transportation, and so forth, which make a compelling case for public spending as the vehicle for action. Federal expenditures have recovered somewhat, to about 13% of GDP from a low of 12% in 2000--01, but even this amount is three to five percentage points of GDP lower than levels that prevailed up to the early 1990s.
To put this in dollar terms, four percentage points of GDP amounts to about $60 billion, a fairly considerable sum.
There are detractors, of course, who would prefer to rely solely on monetary policy and who view fiscal policy as ineffective and ill-timed. I disagree. While we need to lower interest rates, this is increasingly an ineffective policy, because there is little ripple effect from the changes in overnight rates from the Bank of Canada to the rest of the interest rate structure. We are seeing, if anything, higher rates from banks for commercial and household lending due to the credit crunch, while the flight to quality in financial markets is driving down interest rates on medium-term government bonds.
We need to put fiscal policy options on the table. The critique that fiscal policy comes too late has some merit, to the extent that recessions are short-lived and fiscal measures involve a lot of long-term planning—for example, building a new bridge or a highway.
But other fiscal measures can be brought to bear. The key is to get money quickly into the hands of people who will spend it. I already mentioned EI. The government should consider measures that would enhance eligibility for EI, so that more unemployed workers would benefit, as currently only about one-third of the unemployed are eligible for EI.
Another measure would be to enhance the GST credit, which would quickly put more money in the hands of low-income Canadians. Other targeted measures could be considered for specific regions and industries that are hard hit.
As for infrastructure, we should be prepared with some big ticket items that we need anyway. The labour market is currently strong, but the fallout for construction could be large over the next year or two.
The fact that the U.S. recession is being driven by a dramatic fall in asset prices--in the past such an event would be called a depression, not a recession--suggests that this will not be your garden variety post-war recession with a quick drop and return to business as usual. This could take a couple of years to play out, and any resulting slack in the employment market could be absorbed by needed capital investments in things like social housing, public transit, and early learning.
That's my presentation. I'd be happy to entertain any questions after the next presentation.
Thank you.
