FIVE-YEAR FISCAL PLANNING FRAMEWORK

Background

The slowdown in the economy in late 1997 and 1998 in the wake of the Asian downturn created a new reality which the government responded to with efforts to stimulate the economy. Recognizing the need to report on the impact current plans have on longer-term fiscal sustainability, the government set out a Five-Year Fiscal Planning Framework in Budget '99, within which revenues, expenditures and debt levels were to be managed.

The Budget Process Review ("Enns") Panel recommended the presentation of a three-year "strategic plan", to which the annual budget would be linked. The government is implementing this recommendation beginning in 2001/02. At the same time, the Panel recognized "the many technical difficulties associated with reporting on future commitments."¹ The government is including a five-year planning framework in Budget 2000 in keeping with the spirit of the Panel's recommendations on the budget process.

The focus of the Budget '99 plan was on maintaining provincial debt levels in a sustainable range relative to the size of the provincial economy. Since the ability to service debt is closely related to the size of the economy, the "taxpayer-supported debt-to-GDP ratio" is a widely accepted measure of fiscal health.

Accordingly, the Budget 2000 plan maintains the focus on the key debt-to-GDP indicator, and retains the planning range of 22 to 27 per cent.

The economy recovered in 1999, growing an estimated 1.4 per cent. Revenue growth exceeded the 1999/00 forecast by a considerable margin, owing to unexpected strength in forest product exports and energy prices, and a number of one-time revenue gains, including additional income tax payments from the federal government in respect of prior years.

Although a number of extraordinary items raised expenditures above planned levels and lowered the net income of some Crown corporations, the summary accounts deficit² was still lower than forecast. Combined with revised historical figures on the size of the provincial economy, the taxpayer-supported debt-to-GDP ratio of 21.8 per cent was lower than the forecast in Budget '99 of 23.9 per cent.

Looking ahead, the outlook for the economy has improved from a year ago. Federal and provincial tax cuts introduced this year and in previous years will reduce revenues in the short run, although this effect will be partly reversed as their positive economic effects return some of the lost revenue over the longer run. In addition, the federal government injected additional funds in each of the last two years to support health care, and has indicated a willingness to do more in this area. Any additional transfers from the federal government would be more than offset by the effect of tax cuts on revenues and upward pressures on health care expenditures (current federal transfers equal only 14 per cent of British Columbia health, education and social services spending). As a result, there will be minimal near-term improvement in the overall fiscal picture.

As in previous years, the government has consulted widely, and received advice from many groups:

• The business community continues to recommend large business and personal tax cuts, financed in part by cuts to program spending.
• Business economists have recognized that, while tax cuts will have stimulative economic effects, these effects are unlikely to replace the bulk of the foregone revenue.³
• As a result, most business groups recognize that regardless of how the economy responds to tax cuts the summary accounts deficit cannot be eliminated in the short run at the same time as taxes are being cut.
• In contrast, other groups have argued that unmet health and education needs should be funded. These organizations feel that deficits resulting from tax cuts will undermine the fiscal foundation and public support for social programs.

The Enns Panel did not provide the government with advice on fiscal policy as its role was to make recommendations on the budget process.

Consistent with the fiscal planning framework in Budget '99, Budget 2000 is based on the following principles:

• The framework must be based on reasonable assumptions, particularly in the early years when there is least room to make changes;
• The budget must be balanced within the five-year period;
• There should be continuous progress in each year of the plan;
• Health and education services to people must be protected; and
• Debt levels must remain affordable.

1) Assumptions

The Fiscal Planning Framework is based on forecasts of revenues and expenditures that are based on reasonable assumptions.

To deal with the unavoidable margin of error associated with all projections, revenue and expenditure forecasts are presented as a series of "likely forecast ranges". The revenue and expenditure forecast ranges depend on the performance of the economy, and on future fiscal policy decisions.

A summary accounts deficit target has been set for each year, corresponding to likely revenue and expenditure forecasts. This government will manage toward these targets. Different economic performance than is expected would cause revenue and expenditure to move higher or lower. As a result, there is considerable uncertainty about any projection of the summary accounts balance, aside from any fiscal policy changes that might occur.

2) Tax Reductions

The five-year framework incorporates the impact of tax reductions (measures introduced in Budget 2000 are detailed in Report C). In 2000/01, the annual revenue foregone from tax and revenue reductions since 1995 will total $1.1 billion. The annual revenue foregone rises to $1.3 billion in 2001/02 as measures in this year's budget are fully phased in.

3) Economic and Revenue Framework

Over the 2000-to-2004 period, British Columbia's economy is forecast to grow at an average annual rate of 2.6 per cent. This is in line with the Conference Board of Canada forecast of 2.7 per cent. Growth in nominal GDP, which is a rough proxy for growth in the provincial tax base, averages 3.9 per cent annually in the Ministry of Finance and Corporate Relations forecast, reflecting modest assumptions about growth in domestic inflation and prices of British Columbia exports and imports. The Conference Board's forecast is more optimistic, projecting 4.9 per cent growth in nominal GDP. (Details on the Ministry's five-year economic forecast can be found at: www.fin.gov.bc.ca).

Underlying revenue (revenue before policy factors such as tax cuts are incorporated) would be expected to grow 3.5 to 4 per cent annually over the five-year planning horizon (see Chart 1). When the two-year tax cuts in Budget 2000 are incorporated, actual annual revenue growth is expected to be about half a per cent lower. Given the measures in the last two federal budgets, some enhancement of federal support for health care is considered likely.

4) Expenditure Framework

The planning framework assumes that government expenditures will be managed to grow at an average annual rate of 2.2 per cent over the next four years (see Chart 1). This is the same rate that expenditure is expected to have grown over the five years from 1996/97 to 2000/01. Nevertheless, this rate of expenditure growth will present a considerable challenge, as health care needs continue to rise rapidly and collective agreements negotiated recently will absorb much of the available room for expenditure growth. Chart 1 shows likely revenue and expenditure ranges.

5) Capital Plan Framework

Capital plan expenditures of the provincial government's funded agencies will peak at about $2 billion in 2000/01. This reflects the completion of infrastructure projects started during the recent economic slowdown. Over the next four years, capital plan expenditures will decline to $1.2 billion as major projects such as the SkyTrain expansion are completed.

6) Crown Corporation Framework

Crown corporations and agencies collectively are expected to run a $100 million annual net loss after 2000/01.

7) Deficit/Surplus Framework

In 1999/00, the summary accounts deficit was lower than forecast. In 2000/01, the summary accounts deficit is forecast at $1.28 billion. (Note that these figures cover the operations of the provincial government and all Crown corporations and agencies, whereas the consolidated revenue fund target in the five-year planning framework in Budget '99 covered direct provincial government operations only.)

With revenue growth averaging 3.3 per cent and expenditure growth of 2.2 per cent annually, the summary accounts deficit would be eliminated in 2004/05 (see Chart 2).

Faster revenue growth or smaller spending increases could advance this timetable for eliminating the summary accounts deficit. However, in the event of sustained revenue gains in excess of planned levels, the government's view is that tax cuts are a higher priority than advancing the timetable for deficit reduction.

As Chart 2 illustrates, tax and resource revenue cuts already in place are a major factor delaying the elimination of the summary accounts deficit.

8) Taxpayer-Supported Debt

Taxpayer-supported debt represents the accumulated summary accounts deficits of the provincial government, plus debts incurred to finance capital spending by Crown corporations and government-funded agencies.

The debt-to-GDP ratio in 1999/00 was 21.8 per cent, significantly below the 23.9 per cent forecast. Even accounting for Statistics Canada's upward revisions to historical GDP figures, the debt-to-GDP ratio was below the Budget '99 forecast.

Taxpayer-supported debt as a per cent of GDP was the third lowest among provinces. Estimates by the Toronto-Dominion Bank show the average debt-to-GDP ratio in the other nine provinces at 29 per cent in 1999/00. With about 8 cents of each revenue dollar going to debt service, British Columbia's debt places a smaller burden on taxpayers here than in other provinces.

As stated in the 1999 fiscal planning framework, "The (taxpayer-supported debt-to-GDP) target range will be reviewed annually to ensure that the limits remain appropriate . . ." From 2000/01 through 2004/05, the debt-to-GDP ratio is projected to remain well within the 22 to 27 per cent range set in Budget '99.

Conclusion

The province's debt-to-GDP ratio is expected to remain in the 22 to 27 per cent range set in Budget '99 (see Chart 3). However, it will be a considerable challenge for the government to eliminate the summary accounts deficit, given the ongoing expenditure pressures from the public in priority areas such as health and education, as well as demands for more tax cuts.