Fiscal Update Today: Will Trudeau Bank or Spend Economic Dividend?

(Bloomberg) 

The Canadian government will unveil a budget update widely expected to show shrinking short-term deficits, as Finance Minister Bill Morneau looks to turn the page on questions about his own finances.

Morneau will deliver his Fall Economic Statement at about 4 p.m. Tuesday in Ottawa. The midyear update to the March budget will reflect the improving picture for government finances, driven by surprisingly strong growth. Over the past four quarters, the economy expanded by an average 3.7 percent, the best performance in a decade.

That will have an impact on the government’s bottom line. The budget forecast a shortfall of C$28.5 billion ($22.6 billion) for 2017-18. CIBC World Markets Deputy Chief Economist Benjamin Tal expects it instead to come in between C$15 billion and C$16 billion, including the so-called budgeted risk adjustment.

“That’s dramatically better than expected, mostly due to the fact the economy was way stronger,” Tal said in a telephone interview.

Annual deficits over the coming few years will hover in the same general range, with the forecast ratio of the federal debt relative to the nation’s economy also set to improve, Tal said. “The highlight will be a much lower deficit.”

Tax Backlash

Brian DePratto, senior economist at Toronto-Dominion Bank, expects a deficit of about C$16 billion for the fiscal year, also including the risk adjustment. “The fall fiscal update or Budget 2018 will provide an opportunity for the government to credibly re-commit to a fiscal anchor, such as a reduction of the debt-to-GDP ratio over a five year horizon,” DePratto wrote in an Oct. 11 research note.

The growth outlook has improved substantially since the annual budget released in March. “What a difference half a year can make,” he said.

In the midst of the better budget news, Prime Minister Justin Trudeau’s government is facing a backlash over tax proposals. The measures, introduced in July, were aimed at restricting the ability of high earners in particular to skirt the top marginal income tax rate by using corporations, converting income to capital gains or paying relatives who didn’t actually work for them. The government is backtracking on some of the proposals.

Trudeau was the only Canadian party leader to pledge deficits in the 2015 election campaign, though said they would not exceed C$10 billion annually and that he’d balance the budget by the 2019 election. His latest projections instead forecast deficits of at least C$23 billion in each of his first four full years in power, with no projected return to surplus.

Shift Focus

In addition, Morneau has been at the center of a controversy over his personal finances. He announced on Oct. 19 that he would put his family’s assets in a blind trust and sell about one million shares in Morneau Shepell Inc., the human resources and benefits firm his family founded and that he once led.

The minister has faced allegations of conflict of interest because he owned the shares. He’s also under pressure to withdraw a proposed law that opens the door to a type of pension plan he advocated for while still at Morneau Shepell. The finance minister produced a letter last week to demonstrate he followed the advice of the country’s ethics watchdog on how to handle his assets, and said he moved to sell the shares to avoid what he called further “distraction.”

The budget update gives Morneau a chance to shift focus away from the tax flap and questions over his ethics. Though challenges also loom for the country’s fiscal outlook.

Borrowing costs are rising, albeit slowly, and health transfers to provinces and direct transfers to the elderly are expected to be higher by 2021-22 than forecast just six months ago, DePratto said, leaving scant wiggle room for new spending.

“Although we expect a much better near-term fiscal outlook, the likely path for revenue and expenditures results in a fairly persistent deficit, rather than the steady, if modest, improvement envisioned in Budget 2017,” he wrote.