Balanced-budget law more political posturing than firm commitment

Federal Finance Minister Joe Oliver got an underwhelming response this week when he announced the Conservative government was finally going to table long-promised balanced-budget legislation.

Criticism quickly dismissed it as an economically unnecessary political ploy intended to burnish the Conservative Party’s claim to be a careful manager of the public purse heading into the October federal election. Which, of course, is true. Lost in the spin is whether balanced-budget laws actually are useful tools to impose fiscal discipline on governments.

Balanced budgets have become holy writ for governments in the last 30 years following decades of chronic overspending that added relentlessly to the national debt. Government expenditures consistently exceeded revenues, creating a structural deficit.

The backlash began in the United States, where a conservative political wave in the 1980s led states (49 today), but not the federal government, to pass legislation requiring that budgets be balanced. Some states embedded the requirement by amending their state constitutions, making it harder to use escape clauses to avoid spending cuts.

By the end of the 1990s, eight provinces and two territories had followed suit, but not Ottawa.

Now Oliver wants to make good on a promise made in the Conservatives’ 2013 throne speech. Details remain to be revealed, though Oliver sketched out the plan before a business audience in Toronto and his department posted a statement on its web site.

The details are important, says economist Stephen Tapp,  research director of the competitiveness, productivity and economic growth research program at the Montreal-based Institute for Research into Public Policy.

In a blog post on the institute’s web site, Tapp, a former adviser to the Parliamentary Budget Officer, said questions remain about how you calculate a budget imbalance, the effect of automatic spending freezes, the kinds of penalties ministers and senior bureaucrats would face for allowing a deficit and what “extraordinary circumstances” would permit them to run one.

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He also questioned the timing and necessity of a balanced-budget law, given Canada’s generally healthy fiscal condition.

“If the federal fiscal situation is sustainable over the long-term — as research by both Finance Canada and the PBO [Parliamentary Budget Office] suggests — then modest and persistent deficits are not a bad thing,” Tapp wrote following Oliver’s speech Wednesday. “The government could run deficits in normal times and still enjoy a declining debt-to-GDP ratio.

“In that case, what’s needed is not to shift attention to the short-term annual budget balance, but rather to shift it where it belongs: on the longer-term issue of having a sustainable debt burden as a share of the economy.”

Automatic spending cuts could make economic situation worse

In an email to Yahoo Canada News, Tapp explained that initiating automatic spending freezes when the budget heads into deficit – as Oliver apparently proposes – could worsen the economic downturn that triggered a government revenue shortfall in the first place.

“Requiring spending restraint is one option, but budgets can be balanced with corrective actions on either the spending or revenue side, and preferably both,” he said.

“In fact, my analysis finds that most successful fiscal consolidations in Canada in recent decades used both spending and revenue actions [in a roughly 2-to-1 combination], rather than relying entirely on one side of the ledger.”

A timeline for correcting a fiscal imbalance is helpful, he said.

“But providing a playbook for future governments that includes a single predefined response is probably not,” said Tapp. “And the law should be careful to include an exemption for certain essential services from automatic budget cuts.”

The PBO last September produced an analysis for MPs and senators on how to design a balanced-budget law. Among other things it recommended flexibility in how deficits are defined, when they should be allowed and what kinds of expenses (such as dealing with natural disasters) should be excluded.

“Implementing a balanced budget requirement that is designed according to these principles can enhance the law’s value and extend its longevity,” the analysis says tactfully, a point echoed in Tapp’s commentary.

That statement hints at one of the problems with balanced-budget laws: They’re often abandoned when economic times get tough.

Remember those eight provinces that adopted balanced-budget legislation in the 1990s? Most were suspended or repealed in the wake of the 2008 global financial crisis.

They’ve been largely reinstated – only P.E.I., Nova Scotia and Newfoundland and Labrador, don’t have one – but the Great Recession demonstrated the concept’s major flaw. The province’s fiscal structures weren’t robust enough to withstand a stress test like the bottom dropping out of the world economy.

“We haven’t had a recession that would be a real test until the 08-09 recession and they almost uniformly failed there,” University of Manitoba economist Wayne Simpson said in an interview.

Simpson and colleague Jared Wesley, now a director of intergovernmental relations for the Alberta government, produced a 2011 study analyzing how western provinces’ balanced-budget laws fared during the crisis in 2008-09. In general, not well.

Only Saskatchewan didn’t suspend balanced-budget law in 2008 crisis

Only Saskatchewan was able to avoid suspending its law despite going into deficit, said Simpson. Its rainy-day contingency fund covered the shortfall, plus the province enjoyed rising revenues from energy and potash production.

Manitoba also had an $800-million budget-stabilization fund but still was forced to suspend its legislation to avoid statutory cutbacks that would have exacerbated the downturn.

The supposed objective of balanced-budget laws is to encourage fiscal prudence by government. That, too, didn’t appear to happen, said Simpson.

“What we found was that the behaviour in terms of their expenditure patterns relative to revenues didn’t change before and after the legislation,” he said.

“So in that sense the legislation is a failure because the legislation eventually says you’ve got to be able to meet your deficit obligations when they occur out of a savings fund and therefore you’ve got to save money in the good years to tide you over in the bad years. In general government didn’t do that.”

The law doesn’t have to mandate a rainy-day fund explicitly, Tapp said in his email, as long as Ottawa builds up a buffer to draw on during bad economic times. Governments in recent years have set aside about $3 billion a year for contingencies, essentially a surplus.

“If you wanted to be really sure that you could avoid a deficit in most cases, then this amount would probably need to be increased,” said Tapp.

Perhaps Oliver has taken a lesson from the province’s experience in that regard.

Attacking a deficit through statutory spending cuts alone, coupled sometimes with fire sales of public assets, ends up being counterproductive during a recession, said Simpson.

“It accelerates the downturn in demand by cutting public demand as well as private demand,” he said.

Another common feature of balanced-budget laws is the penalties imposed on ministers for not avoiding a deficit, usually a slice off their ministerial salaries. The proposed federal law is no different, stinging ministers for five per cent of their pay. But it apparently goes further by extending the pain down to deputy ministers, the senior professional public servants.

Senior bureaucrats would also face financial pain

Tapp said it’s the first time that he’s aware of that unelected officials in Canada are included. It might indeed strengthen their resolve to keep a lid on their department’s spending, he said, but is it fair?.

“But if you’re the deputy minister of a small line department or agency that hits its spending target and the government runs a deficit for reasons entirely out of your control, then docking the pay of all deputy ministers seems to me to be excessive,” said Tapp.

Simpson also points out the entire concept, while it might appeal to voters, seems ineffective anyway. The Manitoba law dinged ministers 20 per cent but didn’t stop the province’s plunge into the red and the government’s suspension of the law.

So if balanced-budget laws don’t appear to actually work, what’s the point of Joe Oliver’s proposed legislation? Is it simply political window-dressing, as opposition critics and many analysts claim?

“It sounds like ineffective legislation prepared to make them sound like better fiscal managers than the opposition,” said Simpson.

But it still begs the question why the law is necessary. If voters don’t already see the Conservatives as good fiscal managers – and some don’t, given the string of deficits they’ve racked up – then how will the law change perceptions?

Simpson said there’s a pretty wide consensus that prudent fiscal management and keeping debt-to-GDP at reasonable levels is something all governments now are expected to do.

“So in the sense it [the law] conveys that sense that they’re going to do that, I think most people would expect a Conservative government to do that anyway, he said.

Simpson doubts the law will make much of a splash with voters; they’ve already had experience with it on a provincial level.

If the Conservatives lose the Oct. 19 election, a balanced-budget law would leave the incoming government a political poison pill. It likely would have to accept the law. Amending it to soften its terms or abolishing it altogether would leave the new regime open to accusations it’s not interested in sound fiscal management.

History suggests that’s not true. For the most part, federal governments of all stripes have kept public finances in long-term balance. Deficit spending went out of control in the ‘70s and ‘80s but the Liberal government, led by then-finance minister Paul Martin did not need a balanced-budget law to take drastic measures to keep the country from heading over a fiscal cliff.

But the Conservatives seem determined to have a law, despite the disconnect between the idea and its execution. Whether Oliver can tweak his legislation to avoid its historic pitfalls remains to be seen.