deficit ii the sequel

If you want to do a sequel to a horror film, you usually start by having someone (typically a cheerleader) wander innocently around the set in a bathrobe as the viewer slowly realizes that the bad guy - supposedly finished off at the end of the first movi

If you want to do a sequel to a horror film, you usually start by having someone (typically a cheerleader) wander innocently around the set in a bathrobe as the viewer slowly realizes that the bad guy – supposedly finished off at the end of the first movie – is about to leap out of a closet with an easy-start Husqvarna chain saw.

That’s also, more or less, how the current filming of Federal Deficit II – The Sequel is going. After a few years of congratulating ourselves about fixing the deficit in the 1990s and worrying about other things, innocent Canadian taxpayers are suddenly being chased around the house by an angry $56-billion villain.

Less than a year ago, federal Finance Minister Jim Flaherty was playing the role of the guy who reassures the cheerleader in Scene 1 that the bad guy is really dead. In October 2008 he said he expected a “modest surplus” for the 2008-09 fiscal year.

Whoops.

That year’s deficit turned out to be $6 billion and Flaherty is now expecting $56 billion this year.

We shouldn’t mock Flaherty too severely, since he wasn’t the only finance minister to be wrong by billions.

Lots of leading economists around the world, from the International Monetary Fund to the Organization for Economic Co-operation and Development, believe that many countries have done essentially the right thing to deal with a severe and unexpected economic crisis: lower interest rates and boost government spending to stimulate the economy.

There are even economists, such as Nobel-prize winner Paul Krugman, who argue that the deficits should be even bigger than they are in hard-hit countries like the United States.

The real question facing us now is how quickly to end the deficits and start repairing the damage to the national balance sheet.

There is a delicate balance to be struck here. Ending the deficits too soon could plunge the country back into recession, as some accuse Franklin Roosevelt of doing with his premature deficit-cutting in 1937. The Japanese government did something similar in the 1990s.

On the other hand, letting the deficit go too deep and too long is also a terrible idea. The debt grows, interest payments eat into spending on health and education, and public borrowing crowds out private-sector investment in future economic growth. Eventually, as the Argentineans can relate, you also face the prospect of a currency or debt crisis.

Which brings us to Flaherty’s Update of Economic and Fiscal Projections, shared with the nation last Thursday.

The update paints a soothing picture. The deficit is only 3.7 per cent of gross domestic product, far lower than in the alarming days of 1992 since our economy is now much bigger.

Our national debt will remain relatively small compared to the economy – about half the G7 average – even after a few hefty deficits. And if Flaherty’s 2015 projections of revenue growth (6.6 per cent per year) and government spending (only 1.6 per cent) come true, the deficit will be all but gone in 2015.

If this sounds too good to be true, that’s because it probably is.

The first thing to worry about is revenue growth, which is expected to grow $80 billion or almost 40 per cent between this year and 2015. The update assumes robust real economic growth of 2.3 to 3.3 per cent over the next five years. This is based on an average of private-sector economic forecasts but, as the old joke goes, economists have predicted seven of the last four economic recoveries. There is a real chance that economic growth and government revenues could fall short.

Then there’s government spending; its 1.6 per cent forecast growth rate elicits instant skepticism from anyone who has watched governments of every political stripe struggle to rein in politically popular spending programs.

There are a number of expensive programs that are forecast to end automatically, which would help, but we should remember that it is easy for politicians to promise future discipline, but tough for them to end programs like the home-renovation tax credit when the time comes.

Two important items for Yukoners emerge from the details in Flaherty’s update.

The first is his intention to protect transfer payments from cuts.

However, even if he manages to actually do this, it’s worth noting that the forecast increase is only 4.7 per cent per year. This is significantly below the increases in recent years that the Yukon government has enjoyed spending.

And if transfer payments are protected, that means other federal programs – the environment, the army, economic development and so on – are likely to face tight budgets.

The second major item that will affect every working Yukoner is Employment Insurance premiums. A complex set of reforms is under discussion and it’s not clear what the final picture will look like. But the update foresees revenues rising rapidly at almost 10 per cent per year. Some of this will come from (hopefully) reduced unemployment, but some will most likely come out of your paycheque.

While Flaherty will call this an “insurance premium,” in effect it is a tax on jobs. And it hits the lower paid disproportionately hard.

So will the movie end as soothingly as Flaherty suggests? Perhaps.

But if anything goes wrong with his revenue or expense forecasts, get ready for more screaming. And hope that the chain saw never sinks its teeth into our transfer payments.

Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels. His latest book Game On Yukon! was just launched.