Budget watchdog questions Flaherty's deficit accounting

A new report from Canada's budget watchdog suggests the Harper government may spring a good news deficit surprise just in time for the next federal election.

Parliamentary Budget Officer Kevin Page's new analysis on the government's economic update budget projections suggests Finance Minister Jim Flaherty may be painting a bleaker picture than the current slowdown in the economy warrants.

On average, Page's analysis shows the government may be overestimating the hit to its annual revenues and impact on expenses from a weaker economy by $4.7 billion a year over five years.

That would be enough of a difference to put the government solidly in a surplus position when the finance minister of the day delivers the pre-election budget in the spring of 2015. Instead, the official update anticipates the deficit will be balanced a year later, after the October 2015 election mandated by law.

The report does not say the government is purposely cooking the books to make itself look good when it beats expectations. The report leaves the issue unanswered, aside from asking Finance officials for more information on how they arrived at their bottom line numbers.

But Page said in an email response to a media inquiry that is one interpretation.

"Finance may have made some technical adjustments to the projections, or there could be political fiscal management considerations," he wrote.

"The latter could reflect a desire to beat deficit targets, or presenting a fiscal track that encourages more restraint efforts over the medium term to get back to balance."

Since the economic update two weeks ago, both Flaherty and Prime Minister Stephen Harper have stated publicly they stillbelieve they will balance the budget one year earlierthan their release suggests. The explanation is that Ottawa has put in a $3 billion cushion for risk.

If the economy performs exactly as the five-year forecasts anticipate, Ottawa will have a $1.2 billion surplus in the critical 2015-16 year. That turns into a $1.8 billion deficit once the cushion, called "adjustment for risk," is built in.

Page's analysis suggests the government may have built in an even bigger cushion, or margin for error, than the official budget documents indicate.

Revenue model questioned

The discrepancy comes from the assumptions Finance builds into its model about how much tax revenues, and other gains and costs, Ottawa will derive from a certain level of nominal gross domestic product output roughly defined as real GDP plus inflation.

For the fall update, private sector economists advised Flaherty to reduce his expectations for nominal GDP by about $22 billion a year over the five-year budget projection period. Using the past formula, that should have amounted to an average annual loss of revenues and expense adjustments of about $2.5 billion, rather than the $7.2 billion the update calculates.

TD Bank chief economist Craig Alexander said he had the same question as Page when the update was released on Nov. 13.

"When the government released their numbers I was surprised by how much weaker the government was projecting revenues," he said.

The conclusion that can be drawn is Ottawa is building in more prudence, or it has developed a new flow-through relationship between economic growth and tax revenues, he said.

At the time, Flaherty explained the slower deficit-reduction track was made necessary by the fall-off of global commodity prices, which impact Canadian income growth.

Given that global prices for such commodities as oil, natural gas and metals are notoriously volatile, Alexander said the government may be smart to build in more margin for error on its assumptions, particularly as they extend over five years.

As former Liberal finance minister Paul Martin discovered, it is also politically advantageous to deliver more than promised, rather than less.

"I think the government will want to head into the next election saying they have balanced the books and that they are sound fiscal managers," Alexander said.

That will also allow the government to start fulfilling its 2011 campaign promises, including partial income splitting for tax purposes and doubling the tax savings accounts to $10,000, which were contingent on eliminating the deficit.