The federal deficit is shrinking quickly

During the recession and recovery, I got into the habit of writing graph-laden posts every time there was an important data release. I've gotten out of that habit, but I still keep track. One of the things I track is the federal Department of Finance's Fiscal Monitor, which is a brief monthly summary of federal government expenditures and revenues. There's an important seasonal pattern, so I've been taking 12-month moving sums. The March observations of these moving sums correspond pretty closely to the those of the fiscal year, but the annual numbers can include adjustments for items booked for the entire year although not for any month in particular.

The 2005 budget was the one where the federal surplus was so embarassingly large that Paul Martin decided to play with the accounting rules - which would otherwise have sent that surplus to pay down the debt - and transfer it to the provinces. I'm not sure what happened in 2010, but if I had to guess, it had something to do with the cost of some stimulus infrastructure programs being booked to 2009-10 at the last minute. [Update: In the comments, Bob Smith suggests that the likely explanation is that the federal government was required to book all of the costs of the Ontario/BC HST harmonisation in 2009-10, and not spread them over a couple of years as had been originally planned.]

The monthly series bottomed out in early 2010 and bounced up pretty quickly for a few months, but then it leveled off at a rate consistent with an annual deficit of about $35b or so. But since the middle of last year, the 12-month deficit has narrowed sharply, from $34b in July to $21b as of February.

Here is how revenues and expenditures have evolved:

Revenues recovered their pre-recession peak in January, but what I find more striking is the fact that expenditures have stayed at the same level - and these are nominal data, not corrected for inflation or population growth - for two years now. Yes, this was after a sharp, stimulus-driven increase, but still: two years of constant nominal spending is not something you see very often.

Here is how spending breaks down:

 

 

The plan in this year's budget is to let transfers grow with nominal GDP while holding program spending constant, but it looks like this strategy has been in place for two years. And if they can continue to hold total spending constant and if revenues continue growing at the rate they have been, the deficit will close before the end of 2013.

 

Comments

[Determinant]

And that's a good thing? At the cost of austerity and 19,000 jobs lost, everything from Indian Health Branch workers at Health Canada to canal workers on the Trent-Severn Waterway, with reduced hours for the canal. They are cutting a month of operation. That will cost money and tertiary jobs, the multiplier is right there for everyone to see.

Paul Krugman has a book I intend to buy which directly addresses (and rebuts) the implied arguments made in this post.

Revenues recovered their pre-recession peak in January, but what I find more striking is the fact that expenditures have stayed at the same level - and these are nominal data, not corrected for inflation or population growth - for two years now. Yes, this was after a sharp, stimulus-driven increase, but still: two years of constant nominal spending is not something you see very often.

We should have been increasing spending. Just like the US should have refrained from public-sector austerity.

[Billiam Smith]

Without being catty, I'd like to point out that not too long ago, quite a lot of people who had reason to be listened to were adamant that the deficit was structural, that no amount of tinkering with program spending was going to fix it, and that the only solution was to increase revenues through taxation. This is a good opportunity to repudiate that position (which I guess you've just done).

[Nick Rowe]

A deficit of $21b is roughly, IIRC, what is needed to keep the debt/GDP ratio constant over time. In other words, it's a roughly balanced budget, once you adjust for real growth+ inflation.

I wonder why there was that little dip in the red line in the second graph in 2009? Lower interest charges on very short term debt?

Paul Krugman would have been very happy to have swapped the US graphs for the Canadian graphs. Man, those Harper Conservatives are just so Keynesian!

[richard]

If the Conservatives want to remain in power, program spending increases will resume within 2-3 years (Those caps may be based on a philospohical or ideological approaches to governance, but will run into short-term political considerations). The deficit will then start to increase again.

[Stephen Gordon]

Billiam Smith: That's not what we mean by a structural deficit. A structural deficit is one that will not go away on its own when the economy returns to capacity. Fixing a structural deficit requires a combination of tax increases and spending cuts. For a given level of services, spending increases at the rate of nominal GDP; holding nominal spending constant means cuts. What we're seeing is a structural deficit that is being reduced by reductions in spending.

[Bob Smith]

I think the dip in 2010 related to the payments from the feds to Ontario and BC relating to the implementation of the HST. They had originally proposed to book it over a couple of years, but were told they had to book it all at once - so there was a $5-6 billion bump in the deficit for that year.

[Stephen Gordon]

Ah - thanks. That makes sense; I'll add an update.

[Billiam Smith]

Stephen - Understood, but if I recall correctly (and forgive me if I'm misattributing this to you), you were skeptical that spending reductions and economic recovery alone could eliminate the deficit. However, it appears that that's exactly what's happening - or do you believe that the economic performance of the last year/next year are atypical or artificially inflated in some way?

Richard - I expect you're right that program spending will begin increasing again in 3 years or so - at which time the deficit will have been completely eliminated.

My point is that it's not often that you see a government fiscally-manage its way out of deficit without increasing taxes, to the point that many people simply ceased to believe that it was possible. It seems like it may well be that this government is proving that they can do just that.

[Stephen Gordon]

Of course it's possible to reduce a deficit by cutting spending. That's one of the ways to get rid of a structural deficit. If there were no structural deficit, austerity and layoffs wouldn't be necessary to balance the budget.

[ianlee]

Stephen – can you interpret the data provide to illuminate the hypothesis that the various GoC restructuring policies over the past several years ranging from new FTAs, to transformation of PST to GST and then GST harmonization, reduction of corporate income taxes etc, have contributed to a more resilient economy that is growing more quickly that otherwise would be the case - because of these economic restructuring policies to mnake the economy more efficient (?), competitive (?) or whatever word you prefer.

To clarify what I am getting at, it appears to me there are two understandings of "growth" in the current political debate in Europe. The Hollande-Krugman (if I may concatenate) view of growth seems to support more and increased classical pump priming, fiscal stimulus to get the economy growing again i..e more deficit financing.

By contrast, the "fiscal conservatives" for want of a better phrase (e.g. IMF, Germany), are advocating policies that will generate growth via very different means - economic restructuring of the economy including opening closed occupations, protected sectors, deregulation, privatization, reduction of trade barriers to encourage more competitive, dynamic economies that will grow organically without the need for fiscal stimulus.

Thus my question is asking if you can estimate the relative contribution to deficit reduction of fiscal austerity policies of expenditure reduction of govt program spending versus the cumulative impact on economic growth of restructuring policies undertaken under three successive administrations: Mulroney-Wilson (NAFTA, GST), Chretien-Martin (deficit elimination)and Harper-Flaherty (GST harmonization across Canada, FTAs).

Stated even more simplistically: is it revenue growth or expenditure reduction that is doing the heavy lifting of deficit reduction in Canada today?

I understand both are good (like broccoli). But which is “better”?

[oblivious]

Billiam: I believe what people expressed doubt about was that the structural deficit could be eliminated without breaking any CPC promises (especially the promise to keep health transfers at 6% beyond 2014). Remember that at the time the government adamantly refuted that there even was a structural deficit.

I expect low interest rates have had something to do with the constrained spending. This has been accomplished partly by pushing the cost of new legislation onto provinces. We still don't know how military procurements fit into the spending projections (ie if future governments are paying for current spending commitments). I imagine municipalities will be making more and more noise for reliable transfers for infrastructure, which may throw a wrench in the fed's plans; a lot of mayors are a lot more popular than the federal Conservatives.

[richard]

"It seems like it may well be that this government is proving that they can do just that."

I think that they are proving the opposite. Spending will be ramped up in a few years and the deficit will re-appear. The defict reduction is more of a stunt than a long-term fact.

[Bob Smith]

Richard,

First, I think the political reality of Canada since the 1990s is that running a deficit for any extended period of time is politically dangerous. If you've got a plausible excuse (a recession, where the opposition parties are calling for more spending) you can get away with it for a short-period, but only so long as take credible steps to bring the budget into balanvce in the medium-term. The Tories (or the NDP or Liberals if they were in power) will move heaven and earth to avoid a deficit past 2015.

Second, we know how the Tories are going to start blowing any surplus that arises in 2015 (or earlier), because they've already told us, and it ain't spending. They promised to double the TFSA contribution limit and introduce income splitting in the last election. We can debate the wisdom of those policies, but there is no denying the popularity of those policies with the Tory base, so expect to see them introduced.

I'm actually surprised the NDP hasn't caught on to this yet. That the Tories are trying to cut spending in Ottawa now in order to finance their tax cut commitments down the road. It's actually kind of clever, if you do them at the same time, the link is obvious and the NDP goes nuts about gutting the civil service to fund tax cuts. If you cut spending now and cut taxes in 3 years time, the link isn't so obvious (and, in any event, the civil servants have already been laid off). Maybe the NDP never bothered to read the Tory campaign platform, or maybe they've made the mistaking those commitments for promises that the Tories never intended to keep (in which case, they're sadly mistaken).

[rabbit]

If you divided these graphs into the Liberal government era and the Conservative government era, and then asked an American which was which, they would probably guess wrong.

[Bob Smith]

Scott Clark asks the right questions, but just misses the obvious answer...

http://www.3dpolicy.ca/content/why-government-cutting-52-billion