December 12, 2006

 

Blurb: For years successive Canadian governments’ budgetary performances were always worse than expected. Lately, the opposite’s been true. When will finance officials get grip?

 

The challenges of government budgeting

 

By Peter Diekmeyer • Bankrate.com

 

As the final days of the year gradually tick away, Canadians are beginning to plan for 2007. For many, that means preparing a detailed budget of household revenues and expenses, coupled with a forecast on how much will be left over at yearend.

 

Yet while thousands of individuals do fairly accurate household budgeting, the Canadian government appears to have more trouble. For example according to the Finance Department’s Fiscal Monitor, the federal government recorded a surplus of $5.3 billion during the first six months of 2006-2007. Yet as recently as this spring, Finance Minister Jim Flaherty forecast a total surplus of only $3.6 billion for the entire year.

 

Year after year, government forecasts have missed the mark by wide margins. Yet the question remains: if individual Canadians can do reasonably accurate budgeting for their own households, why can’t the government do so for the entire country?

 

A wide variety of risk and variables

One element of the wide gap between estimated and actual surpluses is plain old politics. The Conservatives have long accused Liberal governments of understating forecasts, then producing large surpluses. This time around it looks like the Conservatives have repeated the trick.

 

That said, there’s more to budgeting on a national level than meets the eye. Furthermore, many of the widely publicized complaints are in regards to legitimate disagreements on estimates. Others are in fact symptoms of improving budget discipline. In fact further changes are on the way that could make overall budgeting process even better.

 

Federal government forecasters deal with challenges that households only dream of. A typical couple needs to simply add their combined salaries to estimate next year’s annual income.

However the federal government’s revenues are dependent on a plethora of factors, a swing in any one of which could cause revenues or expenses to fluctuate by hundreds of millions if not billions of dollars.

 

Future values of variables ranging from the employment picture, corporate profits, natural resource prices and interest rates, to name a few, are anyone’s guess. Worse, some or all of these elements are strongly affected by developments in the global economy, over which the federal government has almost no control.

 

Surpluses and deficits: the trouble with forecasts

Ironically governments’ recent positive budgetary upside surprises are actually an improvement on what we had in the past. In fact during the 1980s and early 1990s, the problem went in the other direction. Back then, governments used to justify excess spending by making rosy projections on how well the economy would perform and about the lavish revenues that would come in. Then, months later, they would quietly announce that oops, they had made a mistake and in fact the picture was far worse.

 

This was particularly true around election time, when governments (not just the feds, but provincial governments too) would announce lavish programs. Then, after the election, they would release updated budgets with the “surprisingly high,” costs included.

 

However due in part to pressures from the International Monetary Fund, starting in the mid-1990s, the Canadian government was forced to institute measures that would restore sanity to the system. “There was a serious credibility problem and we had to act,” said a senior finance department official.

 

For one, the federal government began using private sector economic forecasts to justify its revenue and expense estimates. In addition, it included a $3 billion contingency reserve into forecasts, which, if not required for unexpected events, was to be used to pay down the national debt. “Economic prudence,” --which worked out to about $1 billion worth of extra cautious safeguards, -- was also built in.

 

Of course it didn’t take long for things to swing in the opposite direction. Soon after the measures were announced, the federal government began announcing a string of “better than expected” financial results, a situation that persists until this day.

 

Too much of a good thing?

The good news is that the federal government is in the process of changing its budgeting processes, in part in order to improve its forecasting performance.  For example the $3 billion contingency reserve is now explicitly listed in the budget as a pay-down in debt and the “economic prudence,” measures are being wiped out.

 

In fact finance department officials say that the “excess surplus,” reported in its Fiscal Monitor is unlikely to persist to the same degree, because the effects of recently announced measures such as the GST cut and other expenditures will kick in. Of course politicians will no doubt then find new ways to spin the numbers. It will be thus up to Canadians to figure out their new tricks.

 

 

Peter Diekmeyer (www.peterdiekmeyer.com) a freelance business and economics writer.

 

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