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Thursday 28 April 2016


Readers of this Blog will recognize the name David Vardy as an occasional contributor. Others know him as one of the earliest critics of the Muskrat Falls project, having outlined his concerns in a Paper prepared for Action Canada, entitled Making Best Use of the Lower Churchill: The Muskrat Falls Development. But most people will know Vardy as an economist who served at the senior level of the public service for almost 30 years including as Clerk of the Executive Council (Secretary to the Cabinet), President of the Marine Institute, Deputy Minister of Fisheries, and Chair of the Public Utilities Board. In addition to several medals and awards, David Vardy is also the recipient of an Honorary Doctorate from Memorial University.

In modern parlance, Vardy is a policy wonk.

Not surprisingly, when the new Government of Premier Dwight Ball sought the public's input as to how they should tackle the deficit crisis, Vardy set to work. And, he had much advice to give. His ideas describe the need for institutional and administrative reform as well as changes in a broad spectrum of social and fiscal policy. 

Though it is a departure from this Blog's usual format, I wanted to make Mr. Vardy's Brief to the Minister of Finance available, not just to policy wonks who might wish to use his ideas as a basis to assess their own, but to all those who believe fundamental change is needed if we are to intelligently deal with the Province's worst fiscal crisis since confederation. - Des Sullivan



David A. Vardy
The scale of the current fiscal crisis is unprecedented in the post-Confederation era. Having embarked on this consultative process at the beginning of the budgetary process government should ensure continued engagement at all stages of the process including the decision-making process itself, its implementation and reporting to citizens on its success in achieving agreed economic and fiscal goals. Uppermost in our minds must be our stewardship of the province and our legacy to future generations. To allow this budget deficit to persist would be an abdication by our generation of our responsibility to future generations.

Leading by Example
Government should lead by example, starting with a pay cut for all MHAs and the elimination of the tax free allowance. Stacking of pensions and double dipping by MHAs should be terminated. MHAs should not be allowed to draw both two full pensions from the public purse. These measures should be affirmed through legislation. Government should send a strong signal of the seriousness of the problem and the urgency of taking remedial action by immediately cutting the salaries of MHAs and Ministers.
Such cuts should be made in advance of a broader set of salary cuts, beginning in the upper echelons and encompassing all public institutions and enterprises. Both wage cuts and layoffs will be necessary. Wage cuts share the burden more broadly and can be implemented quickly, while layoffs, while necessary, must be targeted and will take more time.

Advisory Panel and Consultations
Government should seek advice on a paradigm shifting approach to reinventing the way the business of the province is conducted. The change should be so transformational as to invite emulation by the province’s private sector, in their quest to compete internationally through enhanced innovation and productivity improvement. Government should draw heavily upon the expertise within the community and outside, including a panel of advisors who can propose the necessary fiscal and economic measures for these challenging times. Government should take the time to implement a sound, equitable plan for fiscal reform, so it does not have to back down in the face of public protests. Government should seek advice from citizens of the province but should also learn from the experiences of other jurisdictions who have overcome severe economic and fiscal problems, particularly Iceland, Ireland and New Zealand.

Incentives for Desired Outcomes
If you want to change the behaviour of government managers stop rewarding them based on the size of their budget and staff. The classification system rewards managers who preside over large budgets and many staff. Reform the incentive system to create incentives for other desired outcomes, including downsizing the bureaucracy. Turn the existing incentive system on its head!

Informing Citizens
Our people need to understand the seriousness of the problem and how much our economy depends on government. We need to measure the problem and provide citizens with a clear picture of where we stand. How much do we owe? How dependent are we on government? How large is the public service? How big is the deficit in relationship to our GDP and how does it compare with other provinces? We need to include both current and capital account. Muskrat Falls is being financed as a capital project, as are our investments in oil and gas and both will make large cash demands over the next three years.

Policy on Non-Renewable Revenues
Should we be budgeting on the assumption oil prices will soon rebound? Should we assume that Hebron, Bay du Nord and other offshore finds will rescue us from our current plight? Or should we establish a different fiscal framework assuming a world with low oil royalties, from $500 million to $1 billion rather than the gold rush days of $2.8 billion? On top of this we should treat royalties as the non-renewable revenues they are and use them to repay debt and to build a heritage for future generations. We should not finance our expenditures from non-renewable revenues. We should not rely on recovery of commodity prices or the largesse of the federal government, neither of which is imminent or sustainable.

Forging a Credible Plan
Government has to demonstrate to the rating agencies that it has a plan, with measurable fiscal targets. More importantly, government has to convince the public that strong fiscal measures are inevitable and that they will be taken in an equitable and efficient manner, protecting the most vulnerable people in our community. The fact is we have created a dependency on government which is unhealthy and non-sustainable. There is no silver bullet! This is hard work and the actions will be painful. Our object should be to ensure that the burden is fairly distributed, so that those who suffer illness or disability are not made to suffer.

Spending for Job Creation
We cannot spend our province into prosperity. A national government can stimulate the economy because most of the stimulus remains within the country. In a small province like NL the leakages are enormous. We cannot rationalize Muskrat Falls as a make work project. The cost per job is $500,000 because labour is a small component and so much of the equipment and construction materials come from outside the province. Continuing this project to avoid job reduction makes no sense. When the project is completed the jobs will disappear!

Taxation and User Fees
What are the options on the revenue side? We have to maintain an environment which is attractive for capital investment by local business and by outside investors, including immigrants. If taxes go too high the impact on both revenues and the economy will be negative. Government needs to pay special attention to the cost of doing business here and our ability to compete with other jurisdictions.  

Megaprojects such as Long Harbour, Hebron and Muskrat Falls have made it more expensive to do business, leading to the loss of small manufacturing operations. Megaprojects have driven wages, reduced productivity and have not fostered development of competitiveness and comparative advantage. We need a transformative economic development strategy based on the reality of our cost structures and our competitive position globally. This must become the focus of the business, labour and public sector.

The easiest option is to increase consumption taxes. Increase the HST by 2% and generate up to $200 million in a full year. There is also room for small increases in income tax, both personal and corporate. Increase gasoline taxes, which is easier to do with today’s lower gas prices.

Government may have to consider new taxes as well. An option would be to introduce a health premium which is related to personal income along the lines of the Ontario Health Premium, which is capped at $900 and paid only by people with a taxable income of $20,000 or higher.

Another tax option, recently proposed by Dr. James Feehan of Memorial University, is a Muskrat Falls Tax, which would contribute to the provincial advances of “equity” for building the project. This tax would be temporary, remaining in place up to the point in time when full power comes on stream.  It would contribute to the required provincial equity financing for Muskrat Falls, which has gone from $700 million in 2010 to $3.55 billion today, based on the $9.05 billion cost estimate announced by Nalcor on September 29, 2015. This fivefold increase in the cash demands placed on the province is an important component of the fiscal challenge faced by government.

Increase user fees gradually, up to their full cost. The fiscal crisis is of such a magnitude as to demand a paradigm shift, a fundamental realignment of expectations. The fiscal gap cannot be closed without both major revenue and expenditure initiatives. Tax measures can be introduced quickly. They can help but they cannot solve the problem on their own, without major spending cuts. Some of the expenditure options will take longer to plan and implement but must be relied upon to make the largest contribution to balancing the budget.

Health and Education
Health and education are the two largest objects of expenditure and the deficit cannot be remedied without action in these two sectors. We should be seeking less costly ways to deliver medical services such as through the greater use of midwifery and other paramedical services whereby clinical services can be provided safely and more economically. We should be making better use of hospital beds and avoiding the use of acute care beds for long term care.

Most of the services provided in health and education are supplied with no user fee or co-payment. In the longer terms some form of co-payment for health services appears to be inevitable, particularly when it comes to medical and hospital services but this may require amendment to the Canada Health Act.

Similarly user fees should also play a more significant role in the education sector, perhaps through higher tuition fees for post-secondary education and perhaps even the introduction of such fees in primary and secondary school. We benefit enormously from foreign and out of province students but can we afford to subsidize them as we are doing? Why is our university’s enrolment growing when our student population is shrinking? Can we afford to have the largest University east of Montreal?

Public Sector Energy Investments
Can we afford to complete the Muskrat Falls project? The project started in 2010 at $6.2 billion and now it has grown to $9.05 billion. Costs are escalating without limit. Could this project go to $15 billion? How much will it cost to stop the project? How much will it cost to finish it?

Why have we invested $930 million in oil and gas equity to obtain participation in offshore developments rather than drawing our income exclusively from royalties?

Public Policy Research
Some measures, such as tax increases and wage rollbacks, can be implemented quickly while other measures require time to review the effectiveness of existing programs and to find better mechanisms for service delivery, in a province which continues to have a highly dispersed population. We need to understand better whether amalgamation of regional authorities in health and education has achieved the touted savings and whether quality of service has been affected. We must learn from our past experiences.

Rural Newfoundland and Labrador is undergoing a painful and protracted transition and better solutions should be sought through focused public policy research. The economic base of rural areas is declining while our rural population is growing smaller and older. Rather than responding with palliative care should we not be energetically developing public policy solutions which will revitalize regional economies while delivering high quality public services equitably and effectively?

Government should address the “rural dilemma” through a consultative process which mobilizes all of the expertise available, both locally and internationally.  Such a process should examine the role which could be played by a well-managed fishery, which has remained as an economic driver in Iceland and Norway. It should also examine public policy measures to support a globally competitive manufacturing industry as well as the growing ocean science and marine technology sector.

Government should establish a Blue Ribbon Panel to assess both the cost of stopping Muskrat Falls and the cost to complete it, as well to conduct a benefit cost analysis of the options available to government. The services of Ernst and Young should be made available to the panel along with any other resources which the Panel may deem necessary, which would likely include engineering expertise. The scope of the work of Ernst and Young would need to be expanded in order to facilitate a full benefit cost analysis of the options, including full and partial suspension.

Options to consider:

Budget Principles
1.      Create a panel of advisors with strong representation from business, labour, university and community organizations, along the lines of the section below entitled “Governance Structure for Fiscal Reform.”

2.      Establish deficit reduction targets, including both revenue and expenditure measures, but relying more on spending cuts than revenue increases.

3.      Develop an accountability framework whereby government reports back to the public on its success in meeting these targets on a quarterly basis.

4.      Establish the principle of earmarking non-renewable revenues to repay debt and build a heritage fund.

5.      The cash deficit which must be financed includes capital account as well as current expenditures. As with current account spending the amount allocated to capital should be scaled back and not exempted from restraint.

6.      Both wage reductions and layoffs may be necessary and the two largest objects of expenditure, health and education, cannot be exempted.

Expenditure measures
7.      Leading by example, MHA salaries should be cut immediately, followed by wage cuts throughout all public agencies, boards, enterprises and commissions, in order to share the burden equitably.
8.      Terminate the practice of stacking public service pensions by MHAs.

9.      Reverse the incentive for bureaucrats to build larger organizations and expand the public service.
10.   Terminate equity participation in oil and gas.

11.   Reduce the number of governmental enterprises and agencies but only when savings and efficiencies can be demonstrated, drawing upon lessons learned in recent years when school and hospital boards were consolidated.

12.   Reduce the size of the public service, broadly defined, to bring it in line with standards in other provinces.

13.   Consider the suspension of all or part of the Muskrat Falls project, examining all options after determining the cost of stopping the project, compared with the final cost of completion.
14.   Reduce costs at Memorial University.

15.   Undertake a review of the effectiveness and relevance of all government programs, with no discrimination among programs provided by core government compared with public enterprises and agencies.

16.   Reduce dependency on professional services, which has doubled over the past ten years.

Revenue measures
17.   Increase HST, PIT and CIT in line with other Atlantic provinces and raise gasoline taxes.

18.   Increase user fees such as student tuition, ferry transportation, and other services which are highly subsidized.

19.   Consider a health premium tax.

20.   Consider a temporary tax on power consumption to recover the province’s equity advances to Nalcor Energy for Muskrat Falls. Such a tax would continue to make sense if the project is suspended, in whole or in part, in light of the large advances that have been made by the province.

Economic and systemic change
21.   Review our competitive position and how we can encourage growth and expansion through innovation and productivity improvement, along with training better aligned to the needs of industry.

22.   Encourage population growth by promoting the province as a fiscally attractive, safe and stable destination for immigrants.

23.   Prepare a Green Paper on the future of rural Newfoundland and Labrador, how its economic base can be strengthened and public services delivered equitably and cost effectively.

24.   Dismantle Nalcor and transfer its hydroelectric assets to NLH.

25.   Privatize the Newfoundland and Labrador Liquor Corporation (NLLC) and other government agencies and enterprises which can be more effective in the private sector.

26.   Strengthen and expand the public tendering process to remove partisanship and reduce costs.

27.   Expedite reform of municipal government by taking a leadership role in consolidating services on a regional basis and amalgamating town councils.

Governance structure for Fiscal Reform
One of the biggest challenges will be to create a consensus on the implementation of the necessary fiscal measures as part of a multi-year plan. This will require a special governance structure.

Three advisory councils are proposed, one for each of health, education and the economy. Each would be given a broad mandate. Each would be assigned multi-year fiscal targets to be achieved. These targets would take the form of a fiscal envelope for each sector: health, education and other sectors covered by an advisory council on the economy. The latter would include municipal reform, infrastructure and competitiveness, in the private and public sector as well as the allocation of funding to the resource departments. The structure could be used to prepare the 2016 budget.

The budget could announce a number of tax measures and public sector wage rollbacks with major expenditure reductions to follow later. Each advisory committee could be asked to report back in 30 days, with a combination of new fees, fee increases, program reductions and structural reforms to achieve efficiencies. Each advisory council would be comprised of ten to twelve members who would be expected to work continuously over the 30 days period, supported by a secretariat made up of public servants. Each council would appoint its own facilitator/chair, subject to the approval of the Minister of Finance.

Such an approach was used in the health care sector in the early 1990s by the Wells administration. The committee was called a “resource committee” and comprised key decision makers, including at least one representative from the hospital boards. My understanding from discussion with former Deputy Ministers is that this approach was successful in finding savings. The fiscal challenge at that time was far smaller than that facing government today but the notion of allocating a fiscal target and asking the key organizations in the health care sector to recommend a package of measures to achieve the target remains a viable approach and could be applied to education, other social sectors as well as to the resource departments and agencies. Documentation of the experience of the early 1990s should still be available within government.

Government could allocate envelopes or fiscal target allocations to each sector, including health, education, justice, other social sectors and departments mandated with economic development. Allocations of funds to health and education should reflect the differential impact of demographic change, the decline in the number of population in the primary, secondary and post-secondary age groups as contrasted with the growing number of older people who will make increasing demands on the health care system. Therefore the proportionate reduction in the allocation to health services should be less than the corresponding allocation to education, including primary, secondary and post-secondary.

While wage rollbacks and tax measures can be decided and announced in the 2016 budget the layoffs could be decided later, on the basis of the recommendations forthcoming from the sector councils. The layoffs could be combined with a number of systemic reforms in the way government does business and these changes must indeed be transformational, in order to achieve the massive cuts in current and capital spending required and to achieve higher cost recovery through a wide range of user fees.
There has to be some light at the end of the tunnel. Restoration of the wage cuts could be linked with recovery of the provincial economy. As GDP recovers there should be a formula which provides for wage increases linked with GDP growth beyond some threshold value. An example of such a formula would be one where nominal wages are increased by one percent for each two percent growth in GDP beyond its 2013 level ($35 billion). This should be subject to the proviso that non-renewable revenues should be used only for debt repayment or creation of a heritage fund.

The three proposed Advisory Councils could report to a special committee of Cabinet, committee on government renewal, chaired by the Minister of Finance.

The proposed mandates of the Advisory Councils could be as follows:

Health Advisory Council Mandate:
Propose measures to reform hospital, medical and long term care to reduce net costs to government in order to achieve the assigned fiscal targets, focusing on enhanced productivity and operational savings, user fees and other measures.

    Report back within 30 days with recommendations on new revenue sources and expenditure savings.
  Government reserves the right to reject recommendations and to request alternative measures, to achieve the fiscal target.

Education Advisory Council Mandate:
    Propose measure to reform primary, secondary and post-secondary education to reduce net costs to government in order to achieve the assigned fiscal targets, focusing on enhanced productivity and operational savings, user fees and other measures.
    Report back within 30 days with recommendations.
    Government reserves the right to reject recommendations and to request alternative measures to achieve the fiscal target.

Economic Advisory Council Mandate:
This Council could have both a public and private sector mandate and might have representation from government, industry and labour. It should report back on its public sector mandate within 30 days and on its private sector mandate within 90 days.
     The mandate of the Council should be to forge a social compact among all sectors of the province with the object of sharing the burden of fiscal reform and growing the private sector through a rebalancing that will enable job losses in government to be offset at least in part by job creation in the private economy.
    Recommend reforms in the provision of infrastructure so as to reduce the net cost to the province, possibly including an enhanced role for the private sector.
    Recommend measures relating to government departments responsible for economic development and regulation, to reduce net costs to achieve the assigned fiscal targets, focusing on enhanced productivity and operational savings, user fees and other measures.
    Recommend measures relating to local government as well as services to rural communities and propose measures to reduce net costs to achieve the assigned targets, focusing on enhanced productivity and operational savings, user fees and other measures.
    Review measures to improve productivity in the private sector and to improve the competitive position of the province.

In conclusion the main points from this brief are as follows:
    Lead by example, with Ministers and Members of the House of Assembly making concessions on their own salaries, pensions and other benefits.
    Seek advice from a broad range of people, particularly the people involved in delivering and managing public services.
    Include health and education in the fiscal restraint program as well as all public agencies, enterprises, commissions and board, including Nalcor Energy and Memorial University.
    Apply restraint to both current and capital account expenditures and rely mainly on expenditure reductions rather than revenue increases.
    Reserve non-renewable revenues for debt repayment and the creation of a heritage fund.

David Vardy