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
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BRIEF TO THE MINISTER OF FINANCE ON 2016 FISCAL FRAMEWORK
BY DAVID A, VARDY
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
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BRIEF TO THE MINISTER OF FINANCE ON 2016 FISCAL FRAMEWORK
BY DAVID A, VARDY
 |
| 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.
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.
Education Advisory
Council Mandate:
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.
Conclusion
In conclusion the main points from this brief are as follows:
David Vardy
