Can balanced budget legislation really work in Canada?

by Stephen Tapp

Three things to know about fiscal rules:

1.   The federal government now wants to introduce a balanced budget rule. The idea is to adopt a law that requires balanced budgets in normal economic times. Under this law, the federal government could run occasional deficits, but only when growth is very slow and a timeline to return to balance is given.

2.   Since the early 1990s, Canadian governments have increasingly relied on formal rules to guide fiscal policy. Other countries do this too. Enforcement of these rules is increasingly being delegated to independent budget offices. 

3.      My research finds a robust positive correlation between stronger fiscal rules and better fiscal outcomes on average. This result applies only to selected rules over a selected time period, namely, balanced budget and debt rules in Canadian data from 1981-2007 — i.e., before the global recession. Conversely, I find that spending or revenue rules were generally ineffective in this same period.


Three common misconceptions about fiscal rules:

Myth #1:  Fiscal rules are basically homogeneous and are readily copied from other jurisdictions.

The reality:  The details of fiscal rules matter; they differ and are jurisdiction and context specific. Canadian governments have used rules of various types and strengths. In the early-1990s there was early experimentation with debt, spending and budget balance rules, typically used on their own.  By the mid-1990s as fiscal pressures intensified, several provinces adopted more wide-reaching rules that combined various targets, with balanced budget and debt rules becoming the most common. 

The stringency of rules also varies. Some provinces have had no formal rules (Newfoundland and Labrador and Prince Edward Island), whereas Alberta and Manitoba have historically had the strongest fiscal rules in Canada.

  
Myth #2:  When fiscal rules are legislated they are set in stone, and thus act as a permanent constraint on future governments.

The reality: As used in practice, fiscal rules are better thought of as moving targets that policymakers generally aim for, but adjust at irregular intervals in response to economic and political developments (such as recessions or changes in governments).


Myth #3:  Examples where a government missed a fiscal target show that fiscal rules don’t work.

The reality:  The natural instinct is to simply compare the target (balance the budget!) and the outcome (balance the budget?). In fact, the correct comparison (the so-called counterfactual) isn’t the target, but what would have happened without it. (Of course, this can’t be observed because it didn’t happen, so it must be inferred with statistical techniques). So just because a government failed to balance its budget, doesn’t mean that it didn’t have a smaller deficit than without the rule in place.  In the same vein, seeing one driver run a red light doesn’t disprove the notion that traffic lights generally make roads safer.

Continue the IPAC Impact discussion on balanced budget legislation by reading Dr. Wayne Simpson's post, "Is federal balanced budget legislation a meaningful step?"

Stephen Tapp is a Research Director at the Institute for Research on Public Policy (IRPP). Before joining the Institute, he was a senior economist and adviser on economic, fiscal and tax issues for Canada's first Parliamentary Budget Officer. You can e-mail him here; follow him on Twitter (@stephen_tapp); and connect with him on Linkedin.  

Is federal balanced budget legislation a meaningful step?

by Wayne Simpson

Three things to know about federal balanced budget legislation (BBL):

1.  Are the feds serious about BBL?  The 2013 federal throne speech promised legislation that “will require balanced budgets during normal economic times, and concrete timelines for returning to balance in the event of an economic crisis.”

2.  When would this legislation occur?  During this session of parliament but, like the promises from the last election for income-splitting, it would not occur before the government achieves budget balance circa 2015.

3.  What do “normal economic times” and “concrete timelines for returning to balance” mean?  There was no indication in the throne speech, but these and other details of the actual legislation will be important to watch. 

Three myths about balanced budget legislation:

Myth #1: BBL will change the way governments spend.  The throne speech explicitly links BBL with “reducing the cost of government,” indicating a move toward smaller and more efficient government that is attractive to economic conservatives.

The reality: While governments may intend to “live within their means”, our study of BBL at the provincial level in Canadian Public Policy/Analyse de Politiques  found that the legislation had little discernible effect in restraining spending relative to revenues.  As a result, provinces were unable to avert deficits during the economic recession that began in 2008, and most suspended their BBL.


Myth #2: The federal government can lean on provincial experience to craft superior legislation.

The reality: The provinces have been fine-tuning their legislation since 1995, introducing fiscal stabilization funds with specific targets, defining abnormal times, tightening accounting regulations, imposing non-compliance penalties on cabinet ministers, and relaxing the budget balancing cycle (commonly achieving balance over four years rather than annually).  Yet the legislation uniformly collapsed in the face of its first real test.


Myth #3:  If budgets are balanced, all will be in order fiscally and economically.

The reality: The provinces, faced with drastic cuts to core services to balance the budget in 2008 and beyond, could not justify the spending reductions necessary to make up the revenue shortfall.  It is also difficult to justify spending cuts when public fiscal stimulus is needed to offset private belt-tightening.  The argument for fiscal stimulus, if not for maintenance of core services, will be even stronger at the federal than the provincial level.  The question is therefore whether the federal government can cut spending to accumulate a sufficient “rainy day” fund that, based on the last recession, would have to exceed $165 billion.  Superior federal taxing authority, such as restoring the GST to 7%, could help but is probably not in the cards.  Without such a fund, federal BBL would likely collapse in a recession as well, unless it is less stringent than its provincial counterparts.

Continue the IPAC Impact discussion on fiscal rules by reading Dr. Stephen Tapp's post, "Can balanced budget legislation really work in Canada?"

Wayne Simpson is a Professor in the Department of Economics at the University of Manitoba. He is a graduate of the University of Saskatchewan and the London School of Economics. He is a specialist in labour economics, urban and regional economics, applied microeconomics, quantitative methods and social policy, and has worked for the Bank of Canada and Economic Council of Canada. He is the author of Urban Structure and the Labour Market: Analysis of Worker Mobility, Commuting and Underemployment in Cities (1992) and co-author (with D. Hum) of Income Maintenance, Work Effort and the Canadian Mincome Experiment (1991) and Maintaining a Competitive Workforce (1996).  He has published more than 50 refereed articles in economics and policy journals as well as numerous technical and research reports, book chapters, and other articles. For further details on his professional activity, see  his curriculum vitae.