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BC Election Series: Fiscal Planning and the Economic Cycle

Over the next ten days or so, Business Council policy staff will be blogging on the election platforms released by the three main parties contesting the BC election: the BC Liberals, the NDP, and the Greens.

Today, we comment on the overall fiscal context and constraints facing the government that will take office following the election, drawing on the 2017 BC budget and our assessment of the economic cycle.  Later this week, we take a closer look at the key spending and taxation promises in the party platforms.  Next week, we intend to turn to the parties’ promises in the areas of education and human capital; innovation and productivity; housing and transportation; and policies concerning the environment, land use, and First Nations. 

For a cross-platform comparison of the three parties' election commitments, check out our summary document.

Blog 1: Fiscal Planning and the Economic Cycle

By Jock Finlayson and Ken Peacock

All three parties take as a starting point the fiscal projections and underlying assumptions found in Budget 2017.  The Budget posited small annual operating surpluses in the range of $200-300 million during fiscal years 2017-18, 2018-19, and 2019-20.[1]  It also announced a number of new commitments by the Liberal government, including a 50% drop in Medical Services Plan premiums in 2018,[2] increased spending across most Ministries and provincial agencies, the phasing-out of the provincial sales tax on business purchases of electricity, a reduction in the small business income tax rate, a higher threshold for the homeowners’ grant, and the extension of a handful of existing tax incentives/credits.  Finally, the budget predicted that, while BC’s taxpayer-supported debt would continue to climb due to ongoing borrowing to fund capital projects, the key net debt/GDP ratio would remain stable at around 16% over the balance of the decade.

Against that backdrop, we observe that all of the parties are proposing higher government spending – beyond the amounts planned in Budget 2017 – in various areas.  Both the NDP and the Greens envisage bigger aggregate spending hikes – and make more new spending commitments – than the Liberals. 

New priorities outlined in the Liberal platform amount to a slim $50 million beyond what was delineated in the Budget for the 2017-18 fiscal year, with the amount of new spending rising by $130 million and $156 million in the following two years.  In comparison, the NDP platform proposes to spend a further $717 million this year, followed by $1.26 billion more in 2018-19 and another $1.53 billion in 2019-20 (over and above the spending levels in the Budget).  The Green Party platform proposes the heftiest expenditure increases, with new spending rising from $1.17 billion this year to $4.1 billion by 2019-20. 

The Liberals' additional spending is modest enough to be covered by existing revenue streams, while also maintaining Budget 2017’s contingency and forecast allowance as fiscal cushions. The NDP are proposing moderate tax increases to cover their new expenditures.  They also foresee reallocating money from the Prosperity Fund and from unspecified savings in other areas, and expect some additional revenue to flow from their planned expansion of infrastructure projects.  The Green Party’s platform calls for tax increases in a number of areas, amounting to several billion dollars over time, to cover most of their new expenditures.  For the Greens, the biggest planned revenue boosts come from broadening and increasing the carbon tax and from “revenue to replace MSP premiums” (although in the latter case, this new revenue presumably would be offset by revenue lost when MSP premiums are eliminated).    

The Liberals promise to keep the operating budget balanced or in surplus over the next four years, in keeping with the targets set in Budget 2017.  The other two parties also support balanced budgets in principle, but are less categorical than the Liberals on this point.  The Greens say they will likely run operating deficits in some years, but will try to balance the budget “over the course of our four-year mandate.”  The NDP adopts a similar approach, which will provide some fiscal flexibility in the event that they form government.   

In our view, the party platforms don’t account for the very real possibility of an economic downturn within the next few years.  Consider that the current US economic expansion has been under way since mid-2009,[3] which is significantly longer than the average post-war expansion cycle (58 months).  This raises the odds of a US recession before 2020, a development that would quickly dampen economic activity in Canada and also in BC.  Consider, too, that BC’s economy grew briskly over the 2014-16 period.  In fact, in our judgement, BC’s economy is operating very close to “full capacity” after three years of real GDP growth averaging over 3% coupled with sizable job gains.  If we are right about this, an argument can be made that BC should be striving to realize budget surpluses while macro-economic times are (relatively) good.  This is partly to ensure that government has the fiscal capacity to navigate the next economic slump or sharp slowdown, but also to permit further retirement of the remaining direct provincial operating debt.[4] 

As the figure below shows, provincial revenue growth is indeed quite cyclical, with strong increases tending to last four or five years, followed by shorter periods of weaker revenue growth or outright declines.  The figure also indicates that provincial revenue increases are well correlated with nominal GDP growth, suggesting that any looming downturn in the US/Canadian economies would soon be reflected in provincial revenue collections.

  

Note that if the BC economy slows slightly such that one percentage point is shaved off the growth of household income, consumer spending, and business investment, while housing starts fall by 5%, the government’s budget would take a hit of $200-250 million.[5] And this scenario assumes only a minor softening in economic activity – well short of an actual downturn.  A more meaningful economic slowdown would quickly push the provincial government into multi-billion dollar operating deficits.  That’s why it makes sense to aim for operating surpluses when macroeconomic conditions are favourable.

There is one final point: we live in an increasingly competitive and uncertain world. Economic downturns and lost growth -- as evidenced by the experience of 2008-09 -- can plunge governments and the economy into significant deficits and declines. Adding spending and new long-term social entitlements without addressing fundamental competiveness issues creates risks for business and future investment.  It also raises questions about the robustness of the revenue streams that government relies on to pay for the services that citizens expect.

To conclude, the Liberals’ platform, with smaller-scale spending commitments than the other parties and a pledge to remain in surplus while the economy posts decent growth, embodies more caution about the economic and fiscal outlook. In that sense, the Liberals’ overall fiscal strategy can be described as more prudent than what the other parties are proposing – and that is before we address the issue of costing the platform promises.

In our next blog, we will review the major spending and taxation elements of the three party platforms.



[1] The budget includes extra fiscal cushions that would give the government room to meet its targets in the event of adverse developments, namely, small annual “forecast allowances” as well as several hundred million dollars that have been set aside as contingency funds.

[2] For those with annual household incomes below $120,000.

[3] The recovery from the 2007-09 recession started in Q3 of 2009, and the US has recorded positive economic growth without interruption since then.

[4] Direct operating debt is the sum of all past operating deficits incurred by the government; it does not include borrowing for capital projects and investments.  As of March 31, 2017, the direct operating debt stood at $5.2 billion, with total taxpayer-supported debt reaching $42 billion.

[5] Based on estimates in table A.5 in the 2017 BC budget.