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Ottawa's On Track to Balance the Budget -- So What's Next?

02/13/2014 05:16 EST | Updated 04/15/2014 05:59 EDT

"Some people will say this budget is boring," finance minister Jim Flaherty remarked after unveiling Tuesday's federal budget. A careful look, however, suggests the minister might be understating the future significance of his budget.

After running six consecutive deficits totaling $156.5 billion, Flaherty has been clear that balancing the budget in 2015-16 is his top priority. Budget 2014 reaffirms that commitment.

The surprise is that the projected deficit for 2014-15 has decreased to $2.9 billion from the $5.5 billion reported in November's fiscal update. The improved bottom line includes a $3 billion contingency reserve, which means the budget could effectively be balanced a year earlier than planned.

For 2015-16 the government is now projecting a $6.4 billion surplus -- up from $3.7 billion -- which also incorporates a $3 billion cushion. If the government's plan comes to fruition, it could have a sizeable surplus in 2015-16. The outstanding question is: what will the Conservatives do with it?

But there are reasons to be cautious about the government's projections, particularly as they pertain to revenue expectations. Consider that the budget projects revenues to grow annually by 4.7 per cent and 6.2 per cent in 2014-15 and 2015-16, respectively. These projections seem ambitious even after accounting for increased tobacco taxes, tax loophole closures, and potential asset sales. For perspective, revenues grew 3.1 per cent annually, on average, over the last three years.

On the spending side, the Conservatives have exercised spending restraint in recent years but there are risks here too. Last year's budget estimated program spending will grow by 0.8 per cent in 2013-14. But a series of unforeseen events such as the Alberta floods and Quebec rail tragedy partly led to program spending growth more than doubling to 1.9 per cent.

Although Flaherty limited new spending initiatives in the budget, he did set aside $500 million over the next two years for more corporate subsidies to the auto sector and a smattering of other items like new boutique tax breaks.

If Flaherty manages to deliver a balanced budget in spite of revenue and spending risks, the story from budget 2014 will be the government's reticence about how it will use future surpluses.

Besides a couple of references to "further tax relief for small businesses" and a commitment to "examining ways to provide further tax relief for Canadians," the government was largely silent about its post-deficit priorities.

In their 2011 election platform the Conservatives made a handful of tax-related commitments conditional on eliminating the deficit. Most notable is the plan to bring in income splitting for families with children. They also pledged to introduce new or augment existing tax credits for children's fitness and other activities. Expectations have been that the government will use a portion of future surpluses to enact these measures in next year's pre-election budget assuming it remains on track to eliminate the deficit.

But Flaherty now seems to have backed away from the income splitting commitment, which -- when combined with the potential for a significant surplus in 2015-16 and beyond -- opens the door to a public debate about how best to use future surpluses.

To set the foundation for future economic growth and to attract and retain skilled workers, entrepreneurs, and investment, Flaherty should consider an ambitious personal tax reform plan. While previous tax reforms enacted by both the Liberals and the Conservatives have improved the business tax regime, Canada remains decidedly uncompetitive on personal income tax rates and the income levels at which they apply.

A bold personal tax reform package would broaden the tax base by eliminating ineffective tax credits, deductions, and other special privileges. In exchange for closing these loopholes, the government could reduce marginal tax rates for the broader population.

Here's the real upside: this type of reform would improve Canada's tax competitiveness, encourage productive activity like increased work effort, saving, investment, and entrepreneurship, and reduce the complexity of the tax system and the unproductive costs that Canadians spend on tax compliance.

Despite risks in Flaherty's plan, his budget signals that a return to surplus may soon be upon us. The next step for the federal government is to enact an ambitious personal tax reform plan.

This piece was co-written by Milagros Palacios, Senior Research Economist, Fraser Institute.

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