Monday, October 20, 2008

Harper and deficits

I tried to warn readers a long time ago about a Tory government and the return of deficits.

First of all, I was wrong about some things in that post. I speculated that the return of deficits could spell the end of PM Harper. Clearly, that wasn't the case and while the possible return of deficits was discussed in the campaign, it was not a big factor in this election. Instead, a related issue, the financial turmoil, was a big factor and the Liberals were not able to capitalize. The financial turmoil will lead to deficits but that is an issue for the next election, not this past one.

Second of all, it appears that a deficit is not in the cards for 2008/09, at least based on Harper's recent statement. There is a likely a lag on revenues from the recession and it appears that there were enough buffers and one-time gains to keep us in surplus for 2008/09.

However, barring major changes to spending, it appears that Canada is headed for a deficit in 2009/10. While the financial turmoil and recession are partly to blame, the Liberals and Tories are also partly to blame.

A little history

The Liberals, especially in the later Chretien years and under PM Martin, ramped up spending like crazy. Some of the spending was due to needs neglected in the belt-tightening 90s. The Martin PM years were mostly runaway spending years with relatively small income and corporate tax cuts. Then, along came PM Harper with big GST cuts, more corporate tax cuts, targeted income tax credits and more runaway spending.

I believe that the income tax and corporate tax cuts were smart but that the GST cuts were a huge mistake. I also think that both Martin and Harper overspent. The GST cuts totalled $12B and were the wrong type of stimulus (encouraging spending when the consumer was already overspending) at the wrong time (the economy was already hot). If Harper had avoided the GST cuts and held spending down, we may have had a $20 billion buffer.

2000 Buffer
In 2000, Canada had a huge buffer ($20 billion plus). Finance Minister Martin's massive (and well timed as luck would have it) 2000 tax cuts helped keep Canada out of a recession. Martin was probably lucky because he cut them in a special election budget that was called just as the economy was starting to sink, and in response to an aggressive tax cut proposed by the Canadian Alliance platform. Super shrewd PM Chretien probably saw tougher economic times coming in calling for an election in October 2000, but few saw a recession back in October 2000.

2009 No buffer
Instead, Harper now has to either cut spending (a sound long term decision) or raise taxes (unlikely) at precisely the wrong time as it may further hurt the economy in the short term. If Harper had a buffer, he could have cut income taxes to stimulate the economy. Harper also has to do this in a minority government.


Conclusion
At this point, big deficits are coming due to the fact that we are entering a severe recession. In such a recession, given our current budgetary situation, I would choose to run a deficit as cutting spending severely would likely make things worse. I would wait until the recovery (as the Liberals did in 1995- again lucky as they only got elected in 1993) to make huge spending cuts.

Notice how the Big Bank economists only starting talking about issues like recessions and deficits this past month, when this blog has been talking about this since last winter!

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