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Flaherty's got deficit religion – but can he attain fiscal salvation?

From Wednesday's Globe and Mail

OTTAWA — Finance Minister Jim Flaherty wrapped up his fourth budget speech by urging the opposition parties to vote for it. He might have also borrowed an old line from a late prime minister: “Well, welcome to the 1980s.”

Gold has soared, the sharpest recession in at least a quarter-century is under way, and now we have another unhappy parallel with the final Trudeau years: We have deficits as far as the eye can see. This red-ink-stained plan might well win a vote of confidence in the House of Commons, but it isn't likely to do much for the confidence of Canadian business, nor lift the recessionary cloud that hangs over the corporate sector.

Mr. Flaherty's “economic action plan” doesn't portray such a grim picture, of course. It shows Ottawa busting out with a $34-billion shortfall in the coming fiscal year and $30-billion in 2010-11. But after that, the fiscal situation gets cleaned up rapidly – and by 2014, the books will be balanced again.

“Is it credible?” asks Finn Poschmann of the C.D. Howe Institute. “I think it's optimistic.” It relies on cheerful economic forecasts and some real spending restraint by Mr. Flaherty or whoever is the finance minister three years from now.

Don't bet your tax refund on it. To grapple with the severity of the downturn, Ottawa is spending money faster than it ever has before; piling the federal debt higher; and giving itself the muscle to intervene in the nation's corporate and financial affairs on a scale unimaginable when Mr. Flaherty delivered his last budget, just 11 months ago.

The Conservatives' switch to big government now has unstoppable momentum and it won't be easy to reverse in a few years.

For business, the minister turned to a bunch of old tricks and several new ones. Business owners and managers will notice a few similarities with his first three efforts. The budget contains the usual meddling with the tax code on how quickly companies can write down equipment and computers, the tinkering with the rules on small business taxes, and the sprinkling of money to help out industries in dire condition.

Forestry gets $170-million over two years to help, among other things, develop “next-generation forest products,” whatever those are. The livestock industry gets $50-million for new slaughterhouses. Shipbuilders, newspaper publishers and farmers are all given something, but probably no group will be as happy as residential contractors. “I don't understand why so much emphasis is put on home renovations,” said Sherry Cooper, Bank of Montreal's global economic strategist.

The government has also extended an old, bad idea, the regional development agency. Now there's going to be one for Southern Ontario, which has been slammed by the depression in the auto industry. This new scheme will cover the whole part of Ontario that's not already covered by the existing agency for Northern Ontario, called FedNor. The entire province, in other words, has become a federal development case. Heavens. We can't wait to hear the plans to create jobs for all those soon-to-be-unemployed bankers in greater Toronto. While they're at it, why not a new development agency for Fort McMurray?

Taken individually, no one measure in the budget is overly offensive or harmful to business. Many of them are quite good. Letting federal Crown corporations like the Business Development Bank of Canada expand their balance sheets, at a time when conventional bank loans are harder to come by for small businesses, is a sensible idea. A trickier proposition is Mr. Flaherty's idea to turn the federal government into a northern version of Morgan Stanley, buying up even more mortgage bonds and auto leases and asset-backed debt, and extending a helping hand to overextended life insurers with loan guarantees. Done carefully, these measures don't have to cost the taxpayer a cent – in fact, the government expects to make a few bucks on them.

But it's the bigger picture that has the potential to be confidence-sapping. Today's deficits are tomorrow's higher taxes. While everyone has grown accustomed to the idea of big deficits for the next couple of years, it's the path back to fiscal salvation that gives cause for concern. Just how believable is that promise of a balanced budget by 2014?

Mr. Flaherty, who lost a lot of credibility in November's economic update with his fantasyland economic forecast, learned a lesson from that political near-death experience. For 2009, he has gone from too optimistic to bearish. Finance is now assuming a 2.7-per-cent contraction this year in nominal GDP – far worse than the private sector forecast of minus 1.2 per cent – followed by a recovery in 2010 that then accelerates. By 2011, we're looking at 6.4-per-cent nominal growth, and continued prosperity beyond that. Let the good times roll, again.

(The most popular indicator of growth is real GDP, which excludes the effects of inflation. But nominal GDP is the best indicator of government revenue. Real GDP is forecast to contract 0.8 per cent this year.)

In other words, Mr. Flaherty is banking on a V-shaped recovery, a painful recession that followed by a rapid rebound. No relapse, no “double dip” recession. If that's the way it works out, great. But that still doesn't necessarily mean a balanced budget by 2014, because there's a second assumption in Mr. Flaherty's budget: an assumption that fiscal profligacy can quickly be turned into fiscal prudence.

After the budget-busting $22.3-billion increase next year, the minister thinks he can slam the brakes on program spending as a recovery takes hold. Between 2011 and 2014, this budget says, Ottawa will get by with program spending hikes that average just 2.4 per cent a year.

No government has shown such restraint since the Chrétien Liberals of the mid-1990s – and that was only because they faced a crisis. In Mr. Flaherty's first two budgets, he increased program spending by 7.5 per cent and 6 per cent in a boom economy. This year's increase is 10.8 per cent.

If fiscal prudes can take consolation from anything, it's that Mr. Flaherty's deficits are not the size of those grim, Trudeau budgets from the 1980s. But the risk of chronic deficits lasting well beyond 2014 is real, unless Red Jim rediscovers his conservative stripes.

A plan for troubled times

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