1999 Federal Budget

Paul Martin, Big Spender
By Jim Stanford, Economist, Canadian Auto Workers

There were not many surprises in Finance Minister Paul Martin’s 1999 budget. Most of its major initiatives were reported accurately in the media days before the Finance Minister even purchased his new shoes. In another era, of course, a Finance Minister would have to resign if so much of the content of his budget was revealed prior to his rising in the House of Commons. But in this age of orchestrated leaks and focus-group fine-tuning, Canadians have cynically come to expect budgets to be a purely political exercise, and it’s hard to get worked up anymore about the whole procedure.

One aspect to this year’s show that was surprising, however, was the venom with which Martin was criticized by many leading spokespersons of the financial and business communities. Until this year, of course, Martin was their man–he who finessed an unprecedented downsizing of the state while skillfully containing popular opposition with promises of a fiscal dividend always just around the corner. It would be difficult to reject the conclusion that Martin has been the most tight-fisted Finance Minister of the entire post-war period (he certainly cut spending more than any of his predecessors), and he was adored by a financial industry which saw bond yields soar as dramatically as the federal deficit was struck down.

But alas, this romance was not to be a permanent one. Perhaps Martin’s pseudo-populist rejection of the bank mergers last year was a wake-up call. And hence his refusal to implement large-scale tax cuts in the 1999 budget came as a clarion call to arms for many business and financial spokespersons. Martin was portrayed as a traitor to the cause of efficiency, prosperity, and productivity. His cautious, middle-of-the-road budget was pilloried as a return to the big spending days of yon.

These claims would be laughable if they were not being uttered by such influential people. Martin’s budget was conservative in any sense of the word: strategically, economically, and philosophically.

Martin claimed, with great fanfare, to be pumping billions of dollars back into health care and other needed programs. And his Bay Street critics seem to be taking him at face value–even though they well understand that, in the 1990s, what a federal budget actually does is likely to be quite different from what the Finance Minister says it does.

The most-quoted number of the week was "11.5 billion dollars," that being the cumulative increase in transfer payments to the provinces to pay for Medicare (added up over a five-year period). Martin could have added the money up over a fifty year period, and claimed he was spending 100 billion dollars on health care–then he’d apparently quality as a really big spender. But all his clever optics can’t hide the fact that he is increasing the baseline level of CHST funding at an average annual rate of less than 5 percent over the next four years–hardly a lightning-fast response to a health care crisis that revealed itself in dramatic fashion in the days prior to his budget. Adjust for inflation and population growth, and this so-called "health care" budget is increasing its real per capita support for provincial Medicare programs by less than 2 percent per year.

In fact, total federal program spending will actually continue to decline as a share of GDP under the latest budget plan. Even accepting all of Martin’s last-minute 1998 spending allocations as legitimate (which is highly questionable, given that much of that money will not be spent on the ground for years to come), program spending was frozen in 1998 at its lowest share of GDP since the end of World War II. And, incredibly, it is likely to fall even further in 1999 and 2000 (see chart).

Martin’s 1999 budget is considerably more conservative than the election platform on which the Liberals won the 1997 election. At that point, the party promised to allocate 50 percent of future surpluses to social programs, 25 percent to tax cuts, and 25 percent to debt reduction. In reality, Martin is allocating more than half of the latent surplus to debt reduction. If anyone should feel betrayed, it is the voters who gave this government a mandate to protect and rebuild health care and the other pillars of our collective well-being.

In addition to his $3 billion annual contingency fund, Martin has another $2-4 billion in disguised surplus hiding in his fiscal 1998 projections. His revenue forecast is especially and manipulatively well-padded: final tax revenue for 1998 will likely exceed the figure presented in the 1999 budget by at least $2 billion. And for fiscal 1999 there is even more padding: at least an extra $6-8 billion in disguised surplus monies. Martin is counting on virtually no increase at all in total tax revenues between 1998 and 1999 (not to mention that his supposed 1998 starting point will actually be significantly higher than stated in the budget). His debt service cost is forecast to increase even as the government pays off $10 billion in market debt per year and interest rates languish. His EI premiums fall even as the economy creates almost 500,000 jobs in a year–and his EI benefit costs rise, even as only a shrinking proportion of a shrinking pool of unemployed qualifies for any EI benefits whatsoever.

None of these fundamental budget building-blocks are believable. Martin is continuing his time-honoured tradition of vastly understating the true strength of federal finances, so that he bask in the glory of subsequent overperformance. This is the same strategy that used to be followed by factory managers in the planned economy of the Soviet Union: deliberately understate the true economic potential of the entity for which you are responsible, so you can collect a fat bonus when your production quotas are exceeded. As in the Soviet Union, however, the practice worked only for a while–until the stated quotas lose all their economic "bite," and the whole planning process began to crumble.

Martin’s forecasts are simply no longer credible. His former allies in the financial community used to applaud the Finance Minister’s deceptiveness: it allowed him to sell his budgets to the voting public as being gradualist, when anyone who was handy with a spreadsheet could see that they were truly radical in their restraint. But even Bay Street is now critical of the tactic, perhaps because it is being used against the financiers’ demand for tax cuts, instead of in support of their call for spending cuts.

The federal government’s actual debt repayment (in public account terms) will thus probably exceed $5 billion per year in 1998, and will come closer to $10 billion in 1999 (barring further last-minute accounting tricks like Millenium Funds and special one-time transfer payments to the provinces). In contrast, genuine new program spending for 1999 (even including a pro-rated share of the one-time $3.5 billion health care allotment which was charged against the 1998 budget, even though it will actually be spent over three years) will not exceed $4 billion, and tax cuts will equal some $2.5 billion. Instead of the 50:25:25 rule promised to Canadians in the last election, the 1999 budget suggests something like a 25:15:60 rule (25 percent of the latent surplus to spending, 15 percent to tax cuts, and the rest to debt reduction). Program spending seems to slightly beat out tax cuts (as the Liberals promised would be the case in the 1997 election), but debt repayment wins the day–by stealth.

The economic payoff to this debt reduction will be difficult to even measure, if it exist at all. The debt burden is falling rapidly as a share of GDP, and this would continue to be the case even with budgets that were only balanced. It is difficult to imagine that financial markets could even notice difference between a fast decline in the debt burden (under balanced budgets) and a slightly faster one (under annual surpluses), let alone that they would reward us somehow for our super-frugality. (With a languishing dollar, high real interest rates, and continuing fragility in financial markets, it is hard to see how we have been rewarded at all by the markets for our troubles so far–but then that is another question.)

The tax-cut lobby is now rewriting history, claiming that hard-pressed Canadian taxpayers deserve a break since they are the ones who bore the brunt of the deficit-reduction effort. For example, Nesbitt Burns Chief Economist Sherry Cooper claimed in her post-budget critique of Martin that taxpayers were tapped for 82 percent of total deficit reduction since 1995, while spending cuts accounted for just 16 percent, and lower interest rates (which most economists had figured to be quite important in explaining the surprising speed of deficit reduction) explained barely 1 percent.

In the first place, it’s rather misleading to begin a calculation like this the year after the biggest spending cuts were announced. Martin’s key spending reductions took place as part of his 1995 budget, so it’s obviously sensible to use 1994 as the starting point. A more important problem is that comparisons such as Cooper’s are constructed in nominal dollar terms, ignoring the rise in all nominal values that always accompanies economic growth and ongoing inflation. Most economists would routinely conduct a budgetary analysis of this type by measuring revenues, expenditures, and deficits as proportions of GDP, so as to better evaluate their importance in economic terms.

If you don’t take this perspective, you can come to funny conclusions: the normal rise in revenues that should accompany economic growth looks like an onerous tax increase, while the real belt-tightening that would accompany a nominal spending freeze in the context of inflation and population growth looks like no cutback at all. Given the clear policy priority of most business spokespersons (low taxes good, high taxes bad), these funny conclusions may be useful, but they are still misleading.

A better way to make the comparison is to measure the various contributions to deficit reduction as proportions of GDP (see chart). Between 1994 and 1998, the federal budget balance shifted from a deficit of just under 5 percent of GDP, to a surplus of slightly less than one-half percent of GDP. That’s a budgetary improvement equal to 5.2 points of GDP. A full 54 percent of this gain was the result of Martin’s historic spending cuts, which reduced program spending from 15.5 to 12.7 percent of GDP. Only 31 percent of the gain was due to an increase in overall tax rates (which climbed by 1.6 points of GDP during the same period). The final 15 percent was due to lower debt service charges.

To be sure, average tax rates have crept up during the 1990s–partly due to bracket creep, partly due to the procyclicality of certain revenue forms (such as corporate income taxes). Federal revenues increased from 16.1 percent of GDP in 1994 to a predicted 17.7 percent in 1998. But to claim that taxpayers have borne the brunt of deficit reduction is both to distort the facts of the matter, and to insult those Canadians whose real suffered economic and social hardship during this decade as a result of the unprecedented downsizing of government programs.

There are 800,000 unemployed Canadians who no longer qualify for EI benefits (and whose sacrifice is facilitating the continuing generation of a huge EI surplus, likely exceeding $6 billion in 1999, that subsidizes the government’s other fiscal priorities). There are university students whose tuition fees have tripled in a decade, and who now face formidable and often insurmountable financial barriers in obtaining the education that is supposedly so essential to their prosperity in the "information era." There are millions of Canadians starting to panic about the reliability of our health care system–and most of them understand well that an additional $2 billion per year, while welcome, is hardly going to solve any fundamental problems. And there are many other long-term manifestations of the profound underinvestment in Canada’s social and economic infrastructure.

Obviously, most Canadians would welcome some extra disposable income in their paycheques. But most would first like to see urgent repairs made to health care and other public services which contribute as directly to their real standard of living as surely as any extra cash in their pockets. It was program spending cutbacks that bore the greatest share of the deficit reduction burden, and it is program spending which should be the first priority of future fiscal allocations.

On this score, in contrast to the rhetoric emanating from much of Bay Street, the 1999 budget hardly even qualifies as a step in the right direction. The spending allocations are much smaller than they should have been–Martin could have allocated at least three times as much to new spending as he did, without jeopardizing his balanced budget. Martin’s budget confirms and affirms the overall downsizing of federal government programs during the 1990s, even though the fiscal crisis which supposedly motivated that retrenchment is long past. On the whole, given the generally lopsided direction of Canadian society, and the polarization of opportunity between well-off families and desperate ones, the guardians of finance should have been happy with this very conservative budget.

And secretly, perhaps, they were. For they understand as well as anyone that budgets are drama, and they are simply playing their role.