The federal deficit is shrinking

The last few releases of the Fiscal Monitor show that the federal deficit is finally starting to shrink appreciably.

Here is the latest version of the graph of the 12-month moving federal deficit, updated to November 2011:

After a year or so of drifting along at $35b/yr, the annualised deficit has fallen to $25.8b, well under the 2011-12 target of $32.3b set out in last June's budget. That target had always seemed very conservative to me (the deficit in 2010-11 was $33.3b), and the government should have no trouble in producing a deficit that comes in well below target.

The government's strategy is to hold the line on spending and let growing revenues close the deficit, and it has indeed managed to keep spending roughly constant for the past 18 months or so:

Comments

[Tim]

Hopefully, though the cutting of the Federal GST from 7 to 5 percent as a carrot to get Ontario to harmonize(and at this point it seems like Ontario and only Ontario) was worth it.

[Andrew F]

I'm not sure that is an accurate characterization, Tim. The federal government offered a lump sum to Ontario in exchange for harmonizing. Both GST cuts occurred before harmonization was announced.

[Greg Tkacz]

So as a % of GDP, the Canadian federal deficit is about 1.5% of GDP ($25B out of $1.7 Trillion). I was looking at the U.S. numbers for comparison, and their deficit for the fiscal year ending Sep 30, 2011, was almost $1.3 Trillion, or 8.6% of GDP. If the Canadian government were to rack-up a similar deficit as a % of GDP, it would amount to over $140 Billion(!).

With this perspective in mind, the Canadian deficit is really "not too bad", and thankfully we're on track to close the fiscal gap within a few years. The interesting story in the medium-run will be the U.S. deficit, and the policies chosen to reduce it. If spending cuts are pursued, we can expect stagnant U.S. growth, which will negatively impact Canada. However if they choose personal and corporate tax increases, this could actually be good for us, as some firms and individuals may relocate north of the border in order to save on taxes (I never thought I'd see the day that Canada could be perceived as a potential tax haven ...)

[Tim]

Greg:

Its funny you mention the Canada becoming a tax haven meme I thought only myself and few others were crazy enough to think that was possible. I don't how much of this related to deficit situation in the Canada and the US per see but I do know the Department of Finance has been getting a lot of panicky phones calls from US born Canadian citizens and some MPs I might add for the last six months nervous the US IRS is going to go after them for not filing US tax. As such Flaherty's staff has been forced to send out letters describing in some detail aspects of the collection procedure of the US Canada tax treaty. What's funny in these letters is Flaherty makes a big deal how the US has nothing to worry about as Canada is not a "tax haven" something I agree is "true" but is not as true as Flaherty might like the US to think especially in the future.

Andrew F:

I brought harmonization because it is the one and only even generous explanation for the GST cuts. I agree there was no formal link but the cuts did raise the harmonization issue again at the time and put some pressure on McGuinty to move in that direction. I remember Michael Smart at the U of Toronto soundly criticising McGuinty for not harmonizing after McGuinty criticised the Feds for the GST cuts.

[Andrew F]

I'm not really sure where McGuinty's tax reform agenda came from, especially given how much political heat he took for it. I did note that most of the measures he implemented were things Roger Martin and his team at the Ontario Institute for Competitiveness and Prosperity had been calling for. I'm sure the federal GST cuts may have made harmonizing easier for McGuinty, but those cuts were much more about federal Conservative political imperatives.

It does worry me that such a large percentage of US GDP (probably north of 10% between federal and state borrowing) is deficit financed. It's clearly unsustainable, but governments there are reticent to close the fiscal gap through tax increases or spending cuts because of the weakness of the economy and the fact that monetary policy seems to be out of rope.

[Bob Smith]

To say that this year's deficit projection was "conservative" is an understatement. Flaherty has been continuing Paul Martin's practice (which Flaherty routinely lambasted) of overstating the deficit (understating the surplus). If you looked at last year's numbers and the one-time spending that was coming off the books, it wasn't going to take much to surpass this year's deficit target.

Mind you,there's something to be said for that practice, because you wonder if the relatively high corporate and personal income tax revenue so far for the 2011/12 fiscal year (up 16 and 6% respectively) doesn't catch the apparent slow-down of the economy over the last half of 2011 (i.e., corporations and businesses generally remit their income tax instalments based on their income for prior years, not based on their current income), so might be reversed, at least to some extent, once people start filing their tax returns for 2011 claiming refunds for overpayment of their income tax instalments. I suspect the government will beat it's target, but probably not by as much as the interim numbers might suggest. And of course, it'll get a lot harder from here.

[rabbit]

The Modern Monetary Theorists would have it that federal debt doesn't mean much when the country issues its own fiat currency. I think they're barking mad.