Finance Committee on Nov. 2nd, 2011

[The Chair, Conservative, James Rajotte]

I call this meeting to order.

This is the 25th meeting of the Standing Committee on Finance, pursuant to Standing Order 108(2), the study of economic and fiscal outlook.

We're very pleased to have the Parliamentary Budget Officer with us here today, Mr. Kevin Page, and officials from his office.

Mr. Page, welcome back for your at least biannual report to this committee. We look forward to your comments, and I know members are anxious to ask you questions.

If you would introduce your officials to the committee and then make your opening statement, we'd appreciate that very much.

[Kevin Page, Parliamentary Budget Officer, Library of Parliament]

Thank you, Chair.

By way of introduction, with me is Chris Matier, our senior economist, who provides us with our economic and fiscal analysis; Dr. Mostafa Askari, our assistant Parliamentary Budget Officer for economic and fiscal analysis; and Sahir Khan, our assistant Parliamentary Budget Officer for revenue and expenditure analysis.

Thank you.

Good afternoon, Mr. Chair, vice-chairs, and members of the committee.

Thank you for inviting me and my colleagues to speak to you about Canada's economic and fiscal outlook in the context of your consultation leading up to the 2012 budget.

Yesterday, as you know, PBO released a report examining the short- and medium-term outlook. On September 29, 2011, PBO released its 2011 Fiscal Sustainability Report, which examines Canada's fiscal structure from a longer-term perspective. The Parliament of Canada Act instructs the Parliamentary Budget Officer to provide independent analysis to the Senate and the House of Commons about the state of the nation's finances and trends in the national economy.

The PBO's objective is to provide you with analysis of the planning environment to support your debate about policy priorities and directions, and as members of the House of Commons, your power of the purse role in holding the government to account with respect to the prudent management of public finances.

In an effort to provide you with a rich planning environment, PBO provides you with an independent view on the economic and fiscal outlook in a fully transparent manner. In addition we provide you with analysis to support your work.

We provide you with analysis of how the economy is projected to perform relative to potential output—the size of the so-called output gap.

We provide you with analysis on the nature of our fiscal balances—what proportion of our federal deficit is cyclical and will go away when our economy returns to its potential level, and what proportion is structural.

We provide analysis on uncertainty—what does the history of private sector economic projections relative to outcomes mean for confidence intervals around projections for nominal GDP and budgetary balances.

Finally, we do not lose sight of the long term. We provide you with estimates of the fiscal gap to inform you on the sustainability of current fiscal structures and the size of actions required to stabilize debt relative to the size of the economy in light of aging demographics and other underlying long-term cost pressures.

In the budget plan tabled in June 2011, the government committed to balancing the budget by 2014-2015 through reductions in expenses that will be determined and implemented in Budget 2012. This budget must also set up the framework for negotiations with the provinces and territories to be held in 2014 on federal transfers, which represent 30% of federal program spending.

I wish to highlight three challenges in the context of your deliberations on priorities and policy directions leading up to the 2012 budget.

One, relative to the 2011 budget planning framework, the outlook is weaker. Two, the fiscal outlook over the medium term is highly uncertain. Three, the challenges of long-term fiscal sustainability stemming from aging demographics and other cost pressures are real and need to be recognized and addressed.

The outlook for the Canadian economy has weakened in the eyes of virtually all forecasters, reflecting a less optimistic external environment. The negative impacts of de-leveraging, fiscal austerity, and declining confidence underscored by financial market turbulence are largely behind the softening of growth projections.

PBO projects Canadian real GDP to grow by 2.2% and 1.5% in 2011 and 2012 respectively. The weakness in near-term growth pushes the economy further below its productive capacity--a widening of the output gap--resulting in an increase in the unemployment rate. As a result, PBO expects the Bank of Canada to maintain the overnight rate target at 1% through the third quarter of 2013 before gradually raising rates over the remainder of the projection period.

Underlying the outlook is the assumption that the European sovereign debt crisis will be contained and the U.S. fiscal restructuring will take place in an orderly fashion. PBO is projecting a weaker short-term outlook than the average private sector outlook. PBO judges that the balance of risks to the private sector outlook for nominal GDP is tilted to the downside, reflecting a more sluggish near-term U.S. recovery, with real GDP growth of 1.6% versus 2% in 2012 for the average private sector forecast; a larger impact from the recent decline in commodity prices--we have GDP inflation in our forecast of 1.1% versus 2% in 2012 in the average private sector forecast; and the high level of Canadian household indebtedness that will likely restrain growth by a larger amount in the near term than appears to be factored into the average private sector forecast.

The PBO outlook for the budgetary balance on a status quo basis has the deficit declining from $37.3 billion in 2011-12, which is roughly 2.2% of GDP, to $30.5 billion in 2012-13, or 1.7% of GDP, and eventually to $7.3 billion in 2016-17, or 0.3% of GDP. These magnitudes remain significantly better than the projected outlooks of other G-7 countries and are consistent with targets set out by the G-20 in Toronto in 2010 for deficit reduction. The progress reflects reduction in both cyclical and structural balances over the medium term. The significant reduction in the structural deficit partly reflects the planned restraint in direct program spending.

Over the 2011-12 to 2016-17 period, PBO is assuming that direct program expenditure will grow modestly at 1.6% annually on average, which is significantly slower than observed over the five years preceding the downturn of 6.1%. Over the long term, PBO is projecting the structural deficit to rise on a status quo basis due to the impact of aging demographics and other underlying cost pressures.

PBO's 2011 fiscal sustainability report concluded that Canada does not have a fiscal structure at the federal and/or provincial-territorial government levels that will stabilize the debt-to-GDP ratio over the long term. We are undergoing a major demographic transition that will slow economic and government revenue growth and put upward pressure on spending. PBO estimates that restoring sustainability would require permanent policy actions to improve the operating balance amounting to 2.7% of GDP. That is 1.5% at the provincial-territorial level and 1.2% at the federal level.

While the amount of policy action is significantly less than the restraint measures implemented in the 1990s, it will need to be sustained over the longer term. These actions do not need to be taken immediately while the economy is operating below its full capacity; however, long delays in taking action would increase the amount of corrective measures significantly.

The challenges of the planning environment raise important considerations for parliamentarians regarding Canada's fiscal policy directions, targets, credibility, and sustainability.

Parliamentarians may wish to debate the policy merits of a staying the course fiscal policy reflecting the weaker outlook. Projected output losses in Canada relative to potential associated with the ongoing world financial crisis are more severe relative to the economic downturns in the mid-1990s and early 1980s. The output gap is now projected to close in 2017.

Given economic uncertainty based on accuracy of the average private sector forecast over the past 16 years, PBO analysis on balanced budget outcomes indicates the probability of fiscal balance under status quo policies is approximately 10% in 2014-15 and 25% in 2015-16.

In the context of a relatively large and persistent output gap over the medium term, uncertainty about the fiscal outlook over the medium term, and emerging fiscal pressures over the longer term, parliamentarians may wish to debate the pros and cons of further stimulus or restraint measures as well as the achievability, relative merits, and priority trade-offs associated with a fiscal target of budgetary balance in 2014-15.

While many other countries are experiencing market pressure to strengthen their medium-term fiscal plans, parliamentarians may wish to use Canada's better fiscal standing to reinforce the credibility of its medium- and longer-term fiscal plan.

A former Deputy Minister of Finance, Scott Clark, has recently written a paper highlighting four criteria for credible fiscal policy. Credible fiscal policy, he says, must be realistic, responsible, prudent, and transparent. According to Mr. Clark, credible fiscal policy should be based on a balanced view of challenges, prospects, and risks, and not be based on a rosy or unrealistic view. For example, a recent international paper by economist Jeffrey Frankel, published by the National Bureau of Economic Research, has highlighted the tendency across countries to use overly optimistic forecasts. This has facilitated complacency and contributed to tax cuts and increases in government spending.

From this perspective, the projections underlying Budget 2011 are no longer realistic. Parliamentarians may wish to consider whether the recently updated average private sector forecast represents a realistic view or they may recommend that the Department of Finance provide an independent economic outlook.

Responsible fiscal policy means the government will establish a medium- and long-term fiscal plan that is sustainable, whereby debt will not grow faster than the economy. Parliamentarians may wish to request that the government provide longer-term fiscal sustainability analysis, as promised in 2007.

Prudent fiscal policy means the government may wish to provision against forecast error and missed fiscal targets due to unforeseen events. Given high levels of uncertainty, parliamentarians may wish to debate the merits of contingency reserves and prudence allowances around the establishment of medium- and long-term fiscal targets.

Finally, transparent fiscal policy means full disclosure of analysis, information, and risks. Parliamentarians may wish to ensure full disclosure of the measures covered by the strategic and operating review to be implemented in Budget 2012, as well as in the annual reports on plans and priorities, with the same level of detail afforded in the 2009 fiscal stimulus plan.

Similarly, parliamentarians may wish to request that the government provide full disclosure of departmental plans associated with Budget 2010 operational restraint measures and the adjustments to the fiscal planning framework associated with the government's crime agenda.

Thank you for the opportunity to speak to you today.

We look forward to your questions.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

We will start with Mr. Julian.

You have five minutes.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

Thank you very much, Mr. Chair.

Thank you, Mr. Page and your associates, for coming here today. You play a vital role in giving parliamentarians the straight goods on what's happening with the nation's economic outlook and finances. We appreciate your accurate and very timely projections.They are as disturbing, though, as the projections yesterday that we heard from the Governor of the Bank of Canada--that we are going into a slowdown.

I want to quote from your report yesterday:

The weakness in near-term growth pushes the economy further below its productive capacity resulting in an increase in the unemployment rate.

I see that you see a sharp spike in unemployment in 2012. I'd like to start by asking you how that translates into the number of families who will lose a breadwinner because of unemployment over the course of the next period, and whether you see measures the government could be taking, investments the government could be making, to ensure this slowdown is as least harsh as possible on Canadian families.

[Kevin Page]

Thank you, sir.

I think it's fair to say, whether it's our forecast or the average private sector forecast or the International Monetary Fund or the OECD, which recently released some numbers, that most forecasters are saying sluggish growth in the short term.

By sluggish growth in our forecast for real GDP, we're talking about 2.2% this year and something as low as 1.5% next year. If we get that type of forecast largely driven from an external outlook, that will, as you said, push us significantly below our potential. That weakness in output will translate into higher unemployment. In terms of moving annual averages from about 7.4% to 8%, we're talking a little over 100,000 additional unemployed people on average through the year to 2012.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

So another 100,000 Canadian families will lose a breadwinner. That's an important fact to mention.

I'd like to move on to the issue of forecasting. You estimate that the likelihood of realizing budgetary balance or better is approximately 10% in 2014-15. That's a significant change from what the government has been projecting.

Earlier in your paper you mention policy action that may affect budgetary revenues. You then express concern that the general corporate income tax rate will fall to 15% on January 1, 2012. Have you done projections that indicate what might happen if that additional corporate tax cut takes place? If it's stopped, would there be an increased likelihood of a budgetary balance occurring sooner, particularly if that money is diverted to investments that lead to the creation of jobs and prevent another 100,000 Canadian families from losing a breadwinner over the next few months?

[Kevin Page]

Sir, we have not done a specific scenario analysis that looks at the potential fiscal or economic impact of the corporate income tax change legislated for 2012. But roughly, a percentage point in fiscal terms for Canada at the federal level would be a 1% reduction, which would be about $1.5 billion in fiscal losses. So that would accumulate over a number of years. As to whether that would improve our chances of getting to a budgetary balance in 2014-15, we'd have to recalculate those estimates.

[Peter Julian, NDP, Burnaby—New Westminster, BC]

The current account deficit for the balance of payments is estimated by the IMF for 2012 as being one of the worst among industrialized countries—worse than Spain and France and Italy. I didn't see reference to that here. Is that something you're concerned about as well, that Canada's stalled exports or failed export policy by this government is contributing to that deficit? Is that something that you follow and analyze?

[Kevin Page]

We haven't provided you analyses on the trade balance. But the analysis we've provided to you today will imply that we will get weaker export growth. In this weaker external environment, I think this is implicit in all the downward revisions of forecasts. So we'll have less contribution growth over the short term from net exports. I think that's pretty much true. It's certainly true for Canada and it's going to be true for other countries as well. I think it's just the impact of the global slowdown.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Julian.

We'll go to Ms. McLeod.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you, Mr. Chair.

As a fairly new member to the finance committee, I have to look at the challenging situations that economists are finding right now. Revising forecasts is a fairly common experience, especially during these unprecedented times.

I notice that you say we may want to consider whether the recently updated private sector forecasts represent a realistic economic outlook. Knowing that we base our forecasts on 17 private sector economists, I would ask what you actually mean there. I note you're at 1.5% and the Bank of Canada is at 1.9%. Are you saying their forecasting is not solid?

[Kevin Page]

No.

You're absolutely right that there's significant uncertainty both economically and fiscally, and this has to be taken into account when you consider various policy options.

In respect of the forecast, it's true that we are below the average private sector forecast, which puts the average growth for next year at 2.2%. The bank is showing 1.9% real. The IMF is around that number. The OECD is 1% and we're 1.5%.

When we look at the average private sector forecasts, it's considerably higher than what we're carrying. We're thinking growth in the United States will be about 1.5%. It's our judgment call, in the context of providing realistic projections to you.

We forecast this in the context of significant declines in net worth in the U.S., significant problems in the housing sector, significant indebtedness, as well as the need to address fiscal balances. That's going to constrain growth in the U.S., and if it constrains growth in the U.S., it will have an impact in Canada.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

Thank you.

My only thought is that we have a number of different people already providing forecasts, and I'm not sure another forecast would provide additional value.

My next area of focus is really getting back to balanced budgets. Certainly, people talk about things being very different from 2008 and the situation in Europe being very much a sovereign debt crisis. I think I'd like to clarify one piece in your report. On one hand you note that the likelihood of returning to budget balance is low for the next few years, but then you say, “...fiscal actions required to achieve sustainability do not need to be taken immediately” and can be “delayed until the economy has fully recovered”.

Am I right in saying that the low probability of returning to balance in the next few years, which you predict, may in fact be appropriate?

[Kevin Page]

From my point of view, it's important to think of both the medium term and the longer term. In the medium term, I think we are heartened that if we get the kind of growth that's projected, even in the average private sector forecast of PBO, we have a declining deficit pattern in this country. So we talk about a deficit going from $37 billion this year to something like $7 billion five years out. That is a healthy projection. It's also consistent with the closing of an output gap over that period of time.

I think when we talk about delay of actions...what we provided to you at the end of September was a detailed analysis on something called fiscal sustainability. We basically look for what the impact of aging demographics is on our fiscal structure. Do we have a sustainable structure? There we're saying we will have to take measures, as we look at the long term, to deal with aging demographics in order to reduce the gap that we think is inherent in this structure right now.

So it's only in the context of dealing with the longer-term challenges. We're saying do not take these larger measures right now when the economy is weak. You can delay those actions until the economy gets back up to its potential.

[The Chair, Conservative, James Rajotte]

A brief question.

[Cathy McLeod, Conservative, Kamloops—Thompson—Cariboo, BC]

I think I would now like to focus on the plan to get back to the balance. Certainly, on the issues of deficit, you talk a lot about the numbers and timelines, but I'd like you to talk about real-world consequences for Canadians if our government does not go through with their deficit reduction action plan and get Canada back to balance.

I could give a number of quotes, but because of the time constraints I'd really like you to speak to Canadians and tell them what it would mean to our day-to-day lives if the government doesn't get moving on plans to get back to balance.

[Kevin Page]

I think we do have a fiscal consolidation plan in this country that gets us toward balance in the medium term. Again, with all this uncertainty, we don't know, plus or minus $5 billion, $10 billion, $15 billion, whether or not we'll actually achieve that. Again, we're talking about an economy of roughly $2.1 trillion in 2016-17, so we have a healthy plan. I think we're in good shape. As highlighted by Minister Flaherty, with the stimulus now being off and with modest spending constraints as we move out to the medium term, if we get the growth that's built in these projections we'll be very close to balance. In fact, we will have fiscal balance.

Then the bigger question becomes, are we setting ourselves up for the longer term? Then you're dealing with the issue of aging demographics and other cost pressures on Canada's economic growth, revenue growth, and spending growth, and that's an important issue.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. McLeod.

We'll go to Mr. Brison, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you, Mr. Chair, and thank you very much, Mr. Page, and to your colleagues for appearing before us today.

Your projections are, I think you said, assuming that the sovereign debt crisis in Europe and the U.S. will be contained. There are a lot of moving parts in that equation, and even this week we've seen the situation in Greece in terms of the decision to have a referendum. Would you agree that if the wheels come off this and the sovereign debt crisis is not contained, that will have a material impact on Canada's capacity to meet your projections?

[Kevin Page]

If the sovereign debt crisis unwinds unfavourably and we get risk of financial contagion, I think most people would see...we assume we would see, basically, a significant recession in Europe, likely to be followed probably by a recession in the United States. If that large amount of the world economy goes into recession, as we experienced in 2008-09, it would mean a recession in Canada as well. I see that would pretty much eliminate chances--simply because of the pressure it would put on government and revenues, and actually upward pressure on spending as well--of getting back to balance in the medium term. But it would be a cyclical issue.

[Scott Brison, Liberal, Kings—Hants, NS]

Minister Flaherty sometimes discusses the $10 billion adjustment for risk built into Budget 2011. In your report, you downgraded your projections for the Canadian economy quite significantly, as has the Bank of Canada and the IMF. What is left of Minister Flaherty's $10 billion risk adjustment from the June budget?

[Kevin Page]

In our numbers, sir, and if you look at nominal GDP, which has affected the way we look at the tax base, over the medium term we've basically downgraded nominal GDP again, which is about $1.7 trillion in the Canadian economy today, by roughly about $50 billion. Again, in that context, the prudence provision that was put in the 2011 budget, roughly of $10 billion...we now are talking about a downgrade, in our forecast anyway, as a result of real GDP and lower GDP inflation certainly next year of $50 billion. It is a significant movement down.

[Scott Brison, Liberal, Kings—Hants, NS]

Should we include in budgeting practice the type of rainy day fund reserve that Liberal governments previously incorporated into budgeting as a practice?

[Kevin Page]

We think it's a good thing that the government has established a fiscal target, and of course when one establishes these targets—a budgetary balance in 2014-15, and we know it's impossible for economists to nail down precisely what the economy is going to look like in 2014 and in the time between then and now, particularly in a world of great uncertainty. I think you can make a strong case that if you're going to establish a target, you build prudence around it.

But again, it's a policy choice the government has to make. It is setting aside contingency reserves, or economic prudence. It may mean less public spending to deal with other issues. For us, it's a political choice.

[Scott Brison, Liberal, Kings—Hants, NS]

The government's crime bills not only will have significant costs for the federal government but also will impose significant costs on provincial governments, and we've heard the Government of Ontario and the Government of Quebec opine on these costs this week.

Have members of Parliament, your office, and the provinces been provided with the full and detailed costing of these crime bills?