UBC Reports | Vol. 48 | No. 4 | Feb. 21, 2002

B.C.'s public spending cuts: fiscal necessity?

This week's provincial budget is based on unduly pessimistic economic forecasts, argues UBC expert

The B.C. government has launched the most sweeping cuts to spending and public services in the province's history. In their words, they "had no choice." Without major program cuts and restructuring, B.C.'s budget was headed toward "unsustainable" deficits.

The government's policy choices have been guided by the dire findings of its Fiscal Review Panel in mid-2001. The panel forecast B.C. deficits growing to $3.8 billion in 2003/04, before reflecting the personal and business tax cuts. Adding those tax impacts raises the forecast deficit above $6 billion, an unprecedented figure for any province.

The panel's forecasts relied on highly pessimistic assumptions. They assumed that revenue would grow only 1.6 per cent per year, far below the five-plus per cent rate during the NDP administration. They assumed that public spending would grow at an annual rate of 5.6 per cent, more than double the 2.3 per cent rate in the previous five years. And the panel provided a large $1.25 billion "forecast allowance" against the risk that the figures would come in even worse.

By being very conservative in its assumptions, the panel obtained fiscal forecasts that support a conservative move toward smaller government. (The panel asserted that "tax increases are clearly not an option.") Unfortunately, those who will pay most dearly for the policies resulting from a massive deficit forecast are lower-income groups most dependent on public programs and services.

If one takes more realistic assumptions about economic and revenue growth, the fiscal outlook is far less daunting. Then, a combination of moderate spending restraint and a new revenue source could resolve the structural deficit within several years.

Spurring the economy's growth rate is fundamentally more important than rapidly eliminating the province's deficit. Faster economic growth also advances fiscal sustainability, both because it raises the rate of revenue growth and reduces the relative burden of outstanding debt. Just as faster-growing businesses can comfortably handle larger debt, so can faster-growing economies.

There is a risk of confusing policies that augment economic growth with those that address fiscal balance. In some cases they are similar, while in others they may differ. For example, cutting certain taxes -- such as those on business investment and skilled workers -- may augment economic growth, but it will worsen the budgetary balance.

The B.C. Government has legislated a 2004/05 target for balancing the budget. Given its severe cuts on the spending side, more rapid revenue growth than forecast could put the province into surplus in 2004/05. How then would the government justify to disadvantaged groups their hardships from program cuts that had proven, in the end, to be avoidable?

If the economy is even weaker than forecast, that is all the more reason to maintain social benefits and protections for vulnerable members of society. Moreover, if the B.C. economy cannot grow significantly faster with new "business-friendly" policies than it did under the NDP, that would be reason to rethink the very basis of those policies.

The policy challenge is to find revenue and spending measures that augment both economic growth and fiscal sustainability while also satisfying social criteria. We need to devise a feasible alternative policy course that would better insulate low-income and vulnerable groups from impacts of the fiscal adjustments.

Adding one or two years to the official target for budgetary balance would relieve the current fiscal constraints. It would cause B.C.'s ratio of public debt to GDP to rise to a higher peak before stabilizing, but that should be bearable for public finances. B.C. is now tied for second place among provinces for the lowest debt-GDP ratio, and servicing the interest cost on public debt takes less than eight cents out of each revenue dollar.

Revenue measures also need to be considered. If the funds can be derived in a way that does not harm economic growth, or even better in a way that promotes growth, that should be an uncontested choice. Such tax increases would not undermine the growth-promoting intent of the tax cuts already undertaken.

One major untapped revenue source in B.C. is a general payroll tax, a type that is benign for economic growth. Payroll taxes are used by four other provinces; Ontario instituted a two per cent payroll-based "employer health tax" in 1990 to replace Medicare premiums. Applying that rate to the largest 10 per cent of employers in B.C. would generate $1.1 billion annually.

Alternatively, B.C.'s corporate income tax could be replaced with a business transfer tax that included labour costs in its base. It would allow full deductions for capital outlays and make B.C. the most attractive province for investment. At a rate of just four per cent -- half the eight per cent corporate rate that Alberta and Ontario are targeting and far below B.C.'s current 13.5 per cent -- this tax would generate an extra $1 billion.

With the proposed fiscal strategies, B.C. could pursue a less severely restrained spending path than the current freeze on health care and education spending and 25 per cent cuts in all other areas. Public spending could rise at 2.5 per cent annually, approaching inflation plus population growth. B.C. could avoid extreme cuts such as those impacting society's most vulnerable members -- people needing legal aid, low-income seniors, children at risk, and the chronically ill.

B.C.'s current policy course ignores another important dimension. Policies that increase inequality, heighten union militancy, rend social cohesion, and raise the spectre of future policy reversals serve to depress the attractions of B.C. for business investment. Moderated fiscal policies could avoid this risk to the province's economic future.

Rather than pursuing the imperatives of its Fiscal Review Panel's overly cautious deficit forecasts, the B.C. Government would do better to heed the panel's further advice:

"Based on recent experience in other Canadian provinces, we are concerned that cost cutting in government often comes at the expense of those groups in our society that can least afford it or by lowering standards designed to protect the environment and public health and safety. We do not believe this should be or has to be the case in British Columbia."

Economics Prof. Jonathan Kesselman is director of the UBC Centre for Research on Economic and Social Policy. He specializes in public finance and taxation policies. The full study from which this article draws is available at www.arts.ubc.ca/cresp.

UBC Reports welcomes the submission of opinion pieces from members of the campus community. E-mail the editor at janet.ansell@ubc.ca