By Philip Cross, March 23, 2017
There are two major problems with the latest federal budget, starting with the Liberals’ first budget in 2016. By immediately adopting that budget’s full array of middle-class tax cuts and more spending on everything from the Canada Child Benefit to the CBC and infrastructure, the government last year pushed the deficit as high and as fast as possible. Now the room for further increases is limited, forcing the government in the second year of its mandate to restrain spending, notably transfers to the provinces, and search for more tax revenue.
For new economic policy initiatives, the government is reduced to shibboleths supporting innovation and skills-upgrading, the staples of every government running out of money and ideas.
The government’s need to raise taxes belies the narrative that its policies are boosting economic growth. A healthy economy on its own generates the revenues to lower deficits without resorting to higher taxes. Look for taxes to rise again in the fall when tax credits could be trimmed, marking the start of taking back income from the middle class — which inevitably will end up paying for its own tax cut, because there are few other places to find large chunks of revenue.
As a result, the desultory theme for the next two budgets promises to be “austerity light,” a sombre prospect entering the next federal election. Put simply, Prime Minister Justin Trudeau’s fundamental mistake was detaching the election cycle from the budget cycle in his first budget.
Now the room for further increases is limited, forcing the government in the second year of its mandate to restrain spending, notably transfers to the provinces, and search for more tax revenue.
Usually governments want to get the bad news out of the way early in their mandate, allowing them to miraculously find room for spending increases and tax cuts close to the election. This was the tactic deployed successfully by Thatcher and Mulroney in the 1980s and Chretien and Clinton in the 1990s. (Harper’s attempt to follow suit in 2015 was undermined by the unexpected collapse of oil prices.) In its haste to distance itself from the Harper government the Trudeau government did the reverse, ignoring that a youthful Prime Minister and gender-balanced cabinet differentiated itself simply by showing up for work. Governments that increase the deficit sharply early in their term and then roll back their largesse usually don’t do well in the next election — it is surprising no one asked Bob Rae about his experience as Ontario Premier in the early 1990s. Rachel Notley’s NDP government in Alberta is treading the same politically dangerous path.
If the first Trudeau budget separated the budget cycle from the election cycle, the government’s plans for four blissful years of redistributing income, regulating the economy and taxing fossil fuels shattered with the election of Donald Trump. No wonder Finance Minister Bill Morneau refused to discuss the results on the night of the Presidential election. Since then, the Trudeau government has been reluctantly walking back its interventionist agenda to accommodate the imperative of being competitive with the U.S.
The second problem for this budget is the uncertainty surrounding Canada’s economy. There are two main sources. One is the unknown course of the Trump administration’s policies, especially for trade and taxation. The other wildcard is the sustainability of soaring home prices in Toronto and Vancouver. BMO and TD last week joining the growing crowd calling Toronto’s housing market a bubble, and the course bubbles take is notoriously hard to predict since they are based on irrational exuberance.
Without knowing Trump’s economic policies or how sustainable house prices are in Canada, it is difficult to forecast Canada’s economic growth and therefore hard to commit to spending or taxation plans — which is why there was so little news in this budget. Instead, the government appears ready to wait until the autumn to firm up its budget plans, hoping by then it will be clearer what Trump plans to do and whether house prices in Toronto and Vancouver are correcting on their own.
This government will become increasingly the prisoner of events beyond its control.
Given the heightened uncertainty surrounding its economic and budget forecasts, it is curious the government does not allow for a larger contingency in this budget than the standard $3 billion. Last fall, it removed all estimates for contingencies. Perhaps the government thinks that having budgets every six months precludes the need to build a larger contingency into its forecasts, overlooking that changing its fiscal plan twice a year generates added uncertainty for business and households. Instead, the budget offers precise estimates of the future to give the false impression of being in control. It’s more likely that, thanks to Trump’s trade and tax policies and Toronto’s housing market, this government will become increasingly the prisoner of events beyond its control.
Philip Cross is a Munk Senior Fellow with the Macdonald-Laurier Institute