CANADA'S DISAPPEARING BUDGET SURPLUS

UNCLAS SECTION 01 OF 03 OTTAWA 002931 SIPDIS SENSITIVE DEPARTMENT FOR EB/IFD, EB/OMA, WHA/EPSC, AND WHA/CAN TREASURY FOR STEPHEN GOOCH STATE PASS FEDERAL RESERVE BANK FOR CHUGH STATE PASS SEC FOR JACOBS PARIS ALSO FOR USOECD E.O. 12958: N/A TAGS: EFIN EAID ETRD KTFN ECON PREL CA SUBJECT: CANADA'S DISAPPEARING BUDGET SURPLUS REF: A. OTTAWA 1960 (BUDGET BILLS PASS PARLIAMENT) ¶B. OTTAWA 640 (2005-06 BUDGET) ¶C. 04 OTTAWA 2779 (2003-04 SURPLUS) ¶1. (U) Introduction and summary: Canada's 2004-05 budget surplus came in at C$1.6 billion (about US$ 1.36 billion), almost C$8 billion lower than conventional wisdom had expected. The GOC attributes the discrepancy to an unanticipated change in accounting procedures for one-time expenditures and to the uncertainties of full accrual accounting. In May, 2005 a Finance Canada publication projected a surplus of C$9.8 billion, and without the one-time expenditures the 2004-05 surplus would have topped C$10 billion. According to the Conference Board of Canada, the 15.1% increase in program spending is the highest since 1974-75. (That was also the last time Canada had a Liberal majority government supported by the NDP.) The Department of Finance counters that, as a percent of GDP, spending is in line with previous years. Strong revenue growth this year and the pre-payment of pending one-time charges bode well for the fiscal situation in 2005-06 -- and for the Liberal Party's ability to spend generously in the run-up to an election in which they hope to win a majority and a freer hand to govern. Note: The GOC's Annual Financial Report and Fiscal Reference Tables are available on the Finance Canada web site at www.finance.gc.ca. End Note; end Introduction and Summary. Revenues strong; expenditures stronger -------------- ¶2. (U) Revenues were up 6.6% last year while program expenditures increased 15.1%. Excluding one-time expenses, 80% of which comprised transfers to provinces and territories, program spending was up 7.6%. (Note: Which is still well above inflation of around 2%. End note.) Compared to estimates for 2004-05 in the February 2005 budget, actual revenues were C$2.6 billion higher, public debt charges were C$0.6 billion lower, and program expenses were up C$4.5 billion than forecast. The unanticipated 2004-05 spending since February included the following items (in C$ billions): -- 2.7 to finance the offshore revenue agreement signed February 2005 with Newfoundland and Labrador, and with Nova Scotia, in in one year instead of over the life of the agreement as initially anticipated; -- 1.0 announced March 29, 2005, just before the end of the fiscal year, to cover immediate assistance to cattle producers and other farmers; -- 0.8 to cover additional environmental liabilities for the GOC-owned Atomic Energy Canada Ltd., bringing the total to C$2.3 billion. The charge for environmental liability had been anticipated, but its scope was unknown until near the end of the period. The increased spending was mitigated by one-time revenue: -- 2.6 sale of the last of the GOC's shares in the integrated energy firm Petro-Canada. Big, but not unprecedented -------------- ¶3. (SBU) An expert at the Department of Finance tells us that this scope of adjustment is not unprecedented and notes that revenues in 2004-05 were about half the C$5 billion received at the end of the previous year. The adjustment was exacerbated by a decision in mid-summer to change accounting for the offshore revenue sharing agreement, taking the full charge last fiscal year rather than spreading it over several years as originally anticipated. According to Finance, the Auditor General first questioned the accounting for offshore revenue in June, but discussions did not conclude until late July or early August. In response to a query, we were told that had the Department known of the change in booking the offshore revenue expenditures, they would have notified Parliament (implying that since the decision occurred after Parliament recessed, there was no way to convey the word to the opposition parties). Debt reduction -------------- ¶4. (U) Net federal debt, at C$499.9 billion, was 38.7% of GDP (down from C$529.9 billion or 68.4% of GDP in 1996-97).In 2004-05, debt servicing costs were 17 cents per dollar of revenue, down from a high of 39 cents in 1990. Finance estimates that the reduction in debt service has freed up over C$3 billion a year in interest savings. Collectively, the provinces and territories enjoy a fiscal surplus (boosted by Alberta and British Columbia),and their combined net debt as a share of GDP continued to decline, reaching 22.2% from 23.8% in 2003-04. Political impact -------------- ¶5. (SBU) The Conservative Party finance critic blasted the lower-than-expected surplus as an example of "junk accounting" and accused the Liberal Party of cooking the books. Private-sector forecasters are left scratching their heads at the swings and feeling somewhat exposed. According to Finance, this reveals their lack of understanding of the "risks of accrual accounting." ¶6. (SBU) Last year's surplus of C$9 billion, which was automatically allocated to debt repayment, exceeded forecasts by over C$7 billion. Expectations (Ref C) that this year's surplus would be even higher amplified calls by opposition parties for a more transparent forecasting and greater flexibility in using the surplus for tax cuts or program spending, rather than only for debt reduction. ¶7. (SBU) The sharp discrepancy between actual and estimated surpluses in the past two years is likely to increase calls from opposition parliamentarians for greater forecasting transparency. Finance will respond by agreeing to more frequent appearances by the minister and top officials before the parliamentary committees and by providing more detail in the monthly Fiscal Monitor. (Comment: However, cooperation does not seem to extend to sending word to opposition leaders when a major change in accounting policy has been adopted. End Comment.) Looking forward -------------- ¶8. (SBU) The 2005-06 budget tabled in March (Ref B),had an estimated fiscal impact of C$7.4 billion (about US$6 billion). The NDP deal for C$4.6 billion in supplemental spending over 2 years (Ref A) does not take effect until this fiscal year and it is not yet clear whether it will be split over two years or front-loaded this year. Finance also flagged for us a GOC agreement with aboriginal communities that will lead to supplementary spending this fiscal year. The Finance Canada monthly Fiscal Monitor for July, 2005 shows continued revenue growth this fiscal year and estimates a fiscal surplus in 2005-06 of C$7.1 billion (C$2.8 billion ahead of the level at this time last year). Program expenses have been increasing more slowly than revenues, even with the additional transfers to the provinces and territories for health care and other payments, and public debt charges were lower than last year. This should bode well for the ruling Liberal Party's ability to spend generously in the run-up to a campaign, but this year's results show the folly of second-guessing the budget maestros. Comment -------------- ¶9. (SBU) This budget maneuvering screams "upcoming election." As Parliament resumes this week, the minority Liberal Party government (which currently holds 133 of 308 seats in the lower house) will be conducting a virtual campaign while trying to avoid an accidental no-confidence vote. That caution has led Finance Minister Ralph Goodale to announce that plans to reinstate corporate tax cuts deleted from last year's budget as part of the bargain with the NDP will not proceed and has slowed anticipated movement on announcing a policy on bank mergers. Visit Canada's Classified Web Site at http://www.state.sgov.gov/p/wha/ottawa WILKINS