I wish to express my gratitude to Kam Hon Chu and Policy Options for giving me permission to republish this much needed Paper dealing with NL’s existential fiscal crisis.
– Des Sullivan
Newfoundland and Labrador needs more than an economic recovery plan
Now that the dust has settled after the election in Newfoundland and Labrador, attention shifts to the Premier’s Economic Recovery Team (PERT), with the release of its final report just around the corner. The mandate of PERT is to come up a comprehensive plan to address the province’s ballooning debt, deficit and expenditures.
The economic recovery plan is important not only to Newfoundlanders and Labradorians but also to all Canadians because its policy recommendations will certainly affect the welfare of N.L., and a failure to avert a debt crisis there would have adverse spillover effects on the rest of Canada.
The current discourse on the province’s fiscal problems – including recommendations of the coalition People’s Recovery NL as an alternative to PERT and a recent report by the C.D. Howe Institute – has put more emphasis on the province’s economic outlook and ways to balance the budget by manipulating government program expenses and revenues. While an economic recovery plan to revitalize the NL economy and to deal with its soaring public debt by various fiscal measures is certainly needed, such a plan alone may not be sufficient to resolve the province’s fiscal problems.
Therefore, some fiscal rules in addition to an economic recovery plan are needed to keep the fiscal house in order and to resolve the current debt crisis.
Three other options should be seriously considered:
- expenditure limits or program cuts;
- tax limits or even tax cuts, to spur investment;
- balanced-budget legislation.
Notwithstanding the province’s long-term economic growth since joining Confederation in 1949, the N.L. government’s budget has been in the red most of the time and its persistent fiscal deficits have led to massive public debt.
N.L. has the highest government program spending per-capita in Canada. For the 2010s, it was 32 per cent higher than the national average, up from 21 per cent a decade earlier. Some expenditure limitations are thus needed to constrain the growth in program spending and also to force the government to streamline its programs.
Needless to say, economic austerity measures are unpopular. One may argue that such expenditure limitations or drastic cuts to government programs are unnecessary because any government has the power to tax its citizens to finance its expenses.
But raising taxes is highly unlikely to be a solution because N.L. has one of the lowest fiscal capacities in Canada, whereas its tax burden and marginal tax rates are already among the highest. Further increases in taxes will induce more people and corporations to vote with their feet and leave the province, thus aggravating the chronic demographic problem of a shrinking population. Higher tax rates could reduce the tax base and fail to generate sufficient tax revenues to finance total government expenses.
The government may instead contemplate using supply-side economics – advocated by economists like Arthur Laffer and Canadian Nobel laureate Robert Mundell – by lowering personal and corporate income taxes. Such a policy could possibly increase N.L.’s competitiveness, thus reversing the outmigration and also encouraging new business startups and investment, both locally and from abroad. The resulting larger tax base would generate more tax revenues than the government could otherwise obtain. Admittedly, the applicability of supply-side economics in practice needs further investigation.
Nonetheless, official statistics reveal that increases in government revenues over the years have more or less been matched or even exceeded by increases in both program expenses and total expenses, without making any improvement in the government’s overall fiscal position.
What this scenario means is that N.L. needs limitations on not only government expenditures but also taxes – say, to prohibit an increase in an existing tax or the creation of a new tax unless approved by referendum.
On top of tax and expenditure limitations, N.L. also needs balanced-budget legislation.
The recent discourse on how to fix the problems seems to have overlooked tax and expenditure limitations and balanced-budget legislation as required measures to resolve the province’s current fiscal problems.
A royal commission in 2003 recommended the N.L. government introduce balanced-budget legislation. But this recommendation was rejected.
Perhaps the lack of compelling empirical evidence of the effectiveness of balanced-budget legislation at that time was a good excuse.
Back then, balanced-budget legislation was relatively new to Canada. In 1991, British Columbia was the first province to introduce it, but it was quickly abandoned a year later. Other provinces introduced balanced-budget laws in the 1990s and British Columbia also reintroduced it in 1999. N.L. and P.E.I. are the only provinces without balanced-budget legislation or similar fiscal rules.
The experience of Canadian provinces with fiscal rules up to 2013 was examined by Michael M. Atkinson, Haizhen Mou and Peter Bruce. They found that while the experience was far from a complete success, it was not an abject failure, either.
I have carried out a simple statistical analysis based on more updated data for the years 1981-2020. The number of fiscal deficits or surpluses for each province before and after the introduction of balanced-budget legislation are shown in Table 1.
As can be seen from the second-last row in Table 1, the total number of balanced budgets (or surpluses) for all 10 provinces is about the same as that of fiscal deficits in the years after the introduction of balanced-budget legislation. This seeming ineffectiveness of balanced-budget legislation was partly due to the Great Recession of 2008, which led to decreases in taxes on the one hand and governments’ use of fiscal deficits as countercyclical policy on the other.
But by sharp contrast, fiscal deficits greatly outnumbered balanced budgets before the introduction of balanced-budget legislation. This can be clearly seen from the experience of each individual province and the 10 provinces as a whole.
So, we can confidently assert the following:
- Balanced-budget legislation does not necessarily eliminate fiscal deficits because there are other factors beyond government control;
- The odds of fiscal deficits, however, are very high in the absence of balanced-budget legislation.
Against these findings, are there still reasons for N.L. not to introduce balanced-budget legislation like it did back in 2003?
It is an illegitimate reason, for example, to reject balanced-budget legislation on the grounds that it is unrealistic for a government to balance its budget every fiscal year. Instead, legislation can require a balanced budget over a certain time frame – say, every five years – to allow some flexibility in fiscal policy.
The exact forms of fiscal rules appropriate for N.L. have yet to be determined. But they need not be introduced cold turkey. Instead, they can be introduced gradually after careful study.
Indeed, N.L. has a lot to learn and gain from other provinces’ experience. But whatever fiscal rules are adopted, it is high time that NL took its first step to strengthen fiscal governance.
A patient needs medical treatment to cure her disease, but she also needs self-discipline to support healthy living.
Likewise, N.L. needs an economic recovery plan to revitalize her economy, but she also needs fiscal rules to maintain fiscal discipline to sustain long-term economic growth and stability.