Monday, 11 May 2015

IT'S THE SPENDING STUPID

      Guest Post Written by "JM"


     My political opinions were largely formed in the 1990’s.  This was turbulent economic times for both Newfoundland, and the country as a whole.  In Newfoundland the closure of the fishery represented economic death by a thousand cuts.  Our population declined by 10%, and an entire generation of Newfoundlanders and Labradorians were forced to migrate.

    In Canada, debt and growing deficits had us on the verge of default.  We were the economic basket case of the G7.  It was bleak times for both Canada and Newfoundland, yet we persevered.  With the Federal Liberals coming to power in 1993 they implemented a major program of cuts, intended to reduce government spending and balance the budget.  In this province, Clyde Wells had to manage a pseudo economy, yet was still able to control spending and balance the budget in 1996. This was before Vale, Hibernia, White Rose, or Hebron. 

     As noted in the linked article above, in Canada the ratio of spending cuts to tax hikes was seven-to-one in combating the deficit. Asked why, the prime minister replied: "There was more need on one side than the other". 

    These cuts were across the board, and deep.  They affected every aspect of society.  During my 5 years in university my tuition increased from $1420 a year to about $3350.  To put that into perspective, it would be about $5000 in today’s dollars, compared to the $2550 that Memorial students presently enjoy .



    The cuts in the 1990’s were difficult for everyone.  Yet there was an underlying agreement in the country, even amongst the critics, that these cuts were a necessary evil.    

    There were a few ideologues who were immune to reality.  I remember Dale Kirby as president of the Canadian Federation of Students organizing student rally’s at confederation building to protest the cuts to education.  I did not join those rallies because I believed in the cause of balanced budgets.  I knew my future depended on those tough decisions made by Chretien, Martin and Wells in the 1990’s.  Everyone had a stake in the required correction to government spending levels.

    Fortunately, my own view was shared by enough Canadians that these tough actions were implemented.  Our collective sacrifices were rewarded with 15 years of economic growth and relative stability; to where we are now envied by our G7 peers.
  
     Society of all classes, races, and creeds are better off today because of the drastic actions taken in the 90’s. 

    Looking to the present it is must be obvious to any objective pundit that Newfoundland is again at a crossroads, where tough political decisions need to be made and implemented.  The collapse in the oil price is the catalyst for such a review, but not the sole reason for it.
     One just needs to review the raw budget numbers to clearly understand the predicament we are in. 



    Figure 1 provides a summary of both the Total Revenue and the Current Account Spending as contained within the “Estimates” for the past 20 years. For clarity the “current account spending” does not include capital spending on items such as hospitals, buildings, roads and Muskrat Falls.  It is purely the annual cost of running the government.  Inflation adjusted data for the past 20 years has been included to provide a fair historical comparison.








    The inflation adjusted numbers demonstrate how relatively stable the revenue and expenditures of the provincial government were from the period of 1995 to 2005.  During this time current account spending averaged around $5 billion (in 2015 dollars). 


    However, in the period from 2006 to 2010 the annual inflation adjusted spending increased from $5 Billion to $6.8 Billion annually.  Representing an increase of about 35% in 4 budget cycles.   Despite recent “austerity” budgets, real spending has held steady since 2010, with a surprising increase forecasted in the current 2015 election budget. 

    Due to our dependence upon natural resources our revenue has been much more variable.  Although the numbers from the “estimates” represent a modified cash accounting basis, and not accrual consolidated accounting, the trends are obvious.  Fuelled by overlapping oil royalties, and Atlantic Accord payments in 2007-2011 the revenues coming into the province were nothing short of spectacular.  However, they were short lived, and variable.     
  
I   It is important to note that the dramatic reduction in revenue in the period from 2011 to 2015 is not purely the result of the collapse in the oil price.  Part of the revenue reduction is due to long known reduction in oil production, and the phase out of the Federal Atlantic Accord payments.

    This brings us to the current dilemma the province faces.
  
   Costs are relatively easy to forecast when compared to revenue predominantly pegged to commodity pricing. We know that current provincial government expenditures are at unsustainable levels in the long term.  This is an absolute conclusion that can be reached by any reasoned individual.  Cuts are required. 

    More challenging, however, is forecasting what a stable long term revenue stream is to enable long term planning, and to understand the magnitude of the required long term spending cuts.  This is very tricky business, and governments would be wise to take a conservative view in long term planning of revenue projections.  

    Within the budget highlights document produced in 2015, the government has provided a forecast target for Gross Revenue going into the future.  This Gross Revenue is a slightly different metric than shown in Figure 1, but it does demonstrate a forecasted increase in revenue of about $1.6 Billion from the period of 2016 to 2020.  



    This additional $1.6 billion in new revenue over the next 5 years, is the reason why the province is not planning to implement major cuts now.  Instead, this new revenue will allow spending to be held at nearly a constant level in real dollars.    
   
    It must be asked where is this additional revenue coming from if oil prices remain in the expect $70 per barrel range?  Is this new revenue potential realistic, or is it just an election strategy to defer the hard decisions till next year?

    It is worth investigating the potential sources of new revenue.
   
    New Revenue Source #1:  Oil Royalties

    Royalties (Mining and Oil) contributed $1.8 Billion in royalties in 2014, with a forecasted contribution of $1.3 billion in 2015.   Looking into the future, Hebron will be producing oil in 2018 but due to the spiraling project costs and lower price of oil, payout will be delayed by several years.  The royalty prior to payout is a modest 1%.  The province will, therefore, net only $200-300 million annually for the remainder of the decade from Hebron.  This must offset the declining production from the existing fields.   

    Based upon the 2008 Hebron review Wade Locke predicted that total combined royalties in the province would be $1.7 billion in the period of 2016-2020.  This figure represented a higher price for oil, and lower development costs.  I do not anticipate royalties in the 2016-2020 range being in excess of $300 million a year over the $1.3 billion collected in 2014.  Oil royalties will only be a small portion of the 1.6 billion anticipated increase in revenue unless a rapid and unexpected rebound in oil price occurs.


     New Revenue Source #2:  New Taxes

    The increases in the tax regimes, included in the 2015 budget, are necessary.  But they will not generate additional revenue to the province.  The slow-down in the province, and in Alberta (with the lower remittance payments to NL) will have an impact on the sales tax, and income tax collected.  The change in HST and personal tax rates will only be enough to offset the natural decrease due to the weakening economy.  The new tax increases will not generate new revenue; they will only serve to stabilize the existing revenue levels.  

    Considering the precarious position we are in, I agree with the PC position on the HST, and income tax changes.  History has shown that the tax reductions implemented by the Williams government in the period of 2006-2010 did not represent good long term economic policy.

  
     New Revenue Source #3:  Nalcor

    Within the 2015 Budget Highlights document  the province provided commentary concerning the future revenues which Nalcor will provide to the provincial government. 



    Just to make my position clear, this graph insults the intelligence of every Newfoundlander and Labradorian. 

    It suggests that the equity will be paid back by 2025, with the revenue stream after that being a return on investment.  This is a convenient graph which fails to recognize that the province is borrowing the $3.1 billion to provide “equity” into Nalcor.  Almost another $1 billion of deferred dividends the province have been bypassed to fund Muskrat Falls and the other oil projects. 

    The taxpayer has provided $4 billion to Nalcor over a 10 year period.  By 2025 this money will be considered “complete payback”.  However, for clarity the province will be paying nearly $200 million a year in additional interest payments to allow this false equity to be borrowed from a different bank.  By 2025 the province will have spent another $1 billion in interest payments to fund this project.  It is the unaccounted interest during construction. 

    To suggest the province will be paid back by 2025 is clear misrepresentation on the part of government. 

    It is time to stop pretending that Muskrat Falls or Nalcor will generate significant amounts of new wealth to Newfoundland and Labrador.  The jig is up.   It will be late 2019 before they get full production from the plant.  Even then, at market value this will contribute about $100 million a year in true revenue.  Anything else reported by Nalcor will come from the taxpayers of Newfoundland and Labrador in the form of a tax on electricity.  This will have to be used to pay off the $5 billion dollar direct debt, and the $4 billion dollar equity investment the province will have made to fund this project. 

    Nalcor will not be a significant generator of revenue for the province, until well into the future, when the Upper Churchill agreement expires.  It is time for Nalcor to be transparent on their claims suggesting otherwise. 


    Uncertain Revenue

    I can’t see any valid basis for this rather optimistic forecast of future revenues to the provincial government.  Dwight Ball, Cathy Bennett and the remainder of the Opposition would be wise to question government on the source of these forecasts.  They should dissect and challenge the numbers. 

    They do not make sense and, in my opinion, are overstated by about $500 million to $1 billion a year with a realistic assumption of oil being in the $70-80 barrel range for the remainder of the decade.
   
    A realistic but conservative view on revenue projects will highlight the extent of our spending problem. 

    If I am shown to be correct, our $5 billion in new borrowing could easily be $7 to $8 billion of new borrowing by 2020.  Combined with Muskrat Falls the people of the province will have a public debt in the $20 billion range.  This is $40,000 dollars of debt for every person in the province.    


     The time is now to act. 
   
   As Chretien said, in 1994, the problem was not in taxes, the problem was in spending.  Few people, 20 years later, would argue with his actions.   Likewise, few people can argue that we do not need significant cuts in public spending in Newfoundland in 2015. 

    In my opinion, we need to cut at least 15% from our annual budget in real dollars to be sustainable on a long term basis.   These cuts will not be easy to endure, but they are required. 
  
    The economic house of cards that was built by the Williams government is about to fall.  It is time for real leadership to deal with the structural issues we have in government financing. 
  
     To modify a great 90’s political slogan – “It’s the Spending – Stupid”

      _________________________________ 
"   JM" is a researcher and writer.  While retaining his anonimity, he is a frequent contributor analysing, in particularm aspects of the Muskrat Falls project. JM's most recent essays include: IN NALCOR WE TRUSTDelusion and Deception (Part III), and The Snow Job (Part I).

3 comments:

  1. JM, I wonder if, going forward,if carbon pricing will add to the present poor economics of Muskrat Falls

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  2. Good morning Mr. Sullivan and other readers alike. To add further fuel to this conversation, how come our Province/Country hasn't put in place the capacity to take royalty payments in the form of actual Oil, as opposed to reduced royalty payments, whenever the price of oil goes below a certain threshold? That is what the Oil Producing Nations/Companies do. Why are we not doing this? There are many appropriate deep water, ice free ports in this Province that could already handle such an undertaking. We simply need to assemble the storage facilities. Far safer to have the oil on, already "brown," land in large holding tanks, with the appropriate safety measures in place, than to have third parties anchored out in our various Bays, waiting for the rumours of a price increase. Why the hesitation, all these years to be able to implement such a prudent policy? It is in the terms of our agreements to do this. Who loses and who gains by not exercising this right of the People?

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  3. The current administration are the offspring of a brutally flawed and failed economic approach based on the cult of the personality. They boosted their popularity with our heritage and spent like drunken sailors. Their callous disregard for the needs of tomorrow led to the current malaise but we can only cast some of the blame on them….after all, the people of the province gave them carte blanche by supporting a fool's dream!
    This was never more apparent than when the wonder boy rode off into the sunset, leaving his wonderful legacy in the flowing waters of the Churchill River. Despite the facts quickly dispelling the hype, the general populace was still spellbound by the PC fairy tale and chose to blissfully ignore the looming crisis from that one decision. This one undertaking,,,more than any other…will make this province an economic basket case, struggling and losing the battle with economic stupidity caused by a massive blunder the elected representatives wilfully turned a blind eye to. For that, they will be judged as having shown cowardice in the face of adversity…..for not one among them had the courage to stand up and be counted.

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