Gateway Gazette

Alberta has no reason to panic . . . yet

 

Its lack of fiscal discipline on both the spending and saving side is the real culprit behind its current financial bind

Prof LivioBy Livio Di Matteo, Professor of Economics, Lakehead University

THUNDER BAY, ON/ Troy Media/ – A dramatic fall in oil prices, predicted to reduce provincial government resource revenues by $7 billion – a drop of at least 16 per cent – has generated intense speculation regarding public expenditure cuts, tax changes and, of course, the introduction of a general sales tax.

While it has been estimated that a 5 per cent general sales tax harmonized with the GST could raise approximately $5 billion, Albertans should be wary of making haste when it comes time to fixing their public finances.

There is no reason to panic. Quickly raising taxes, opening up public sector contracts or slashing spending is a recipe for chaos and disruption both of the public finances and of public services. The current drop in oil prices is the result of market intervention by the Saudi’s and is likely a short-term phenomenon that will run six months to a year. Indeed, lower prices will likely fuel new demand for oil. Once the Saudi’s have stabilized their market share and additional higher cost supplies come off the market, prices will begin to rise again.

Moreover, this type of precipitous price drop has happened before. And as before, the calls inevitably arise that more resource revenues should be saved in the Heritage Fund and used to stabilize government revenues during these negative commodity price shocks. But the real culprit is the Alberta government’s tendency to use an upturn in resource prices to enrich spending rather than build up a sovereign wealth fund. It is this lack of fiscal discipline, on both the spending and saving side, that is the real problem when it comes to Alberta’s public finances – not the reliance on resource revenues.

The volatility of public revenues from resource revenue fluctuations is a long-standing issue and best fixed over time rather than in a hurry. The Alberta government should approach this policy issue as follows:

First, it should accept that a substantial deficit will occur for the remainder of the 2014-15 fiscal year and likely into the 2015-16 fiscal year. It should aim to balance the budget for the 2016-17 fiscal year. Running a deficit during bad times is what a deficit should be for and, in Alberta’s case, can be tolerated given that it still has a negative net debt position.

Second, the room to manoeuver that is obtained by running a deficit should be taken as an opportunity for the government to exercise firm fiscal leadership by appointing a commission to design a consumption tax reform that brings in a general harmonized sales tax in two years – after the current deficit crisis has subsided.

A consumption tax provides greater incentive for individual saving and therefore investment and capital formation. However, quickly introducing a consumption tax now is problematic. Introducing a sales tax would be gentler on the economy and voters after a downturn rather than during one. Moreover, a new general sales tax needs to be designed as revenue neutral – that is accompanied by reductions in corporate and income tax rates so as to keep Alberta’s tax system competitive.

Third, the Alberta government must takes steps to firmly legislate a contribution of at least 30 per cent of natural resource revenues to its Heritage Fund. Alberta has barely contributed 5 per cent of its resource revenues to its sovereign wealth fund, whereas Alaska contributed 25 per cent and Norway – admittedly an extreme case – 100 per cent. A contribution rate of 30 per cent can be phased in over several years beginning the year that the general sales tax is introduced. Moreover, explicit provisions must be set that only the income generated by the fund can ever be used to stabilize government revenues and then only during a recession – that is two consecutive quarters of negative GDP growth.

Alberta’s government needs to exercise leadership in dealing with the current fiscal crisis and must not allow short-term panic to drive the policy agenda. Alberta is a province with great natural economic advantages but must exercise fiscal discipline over the long-term to best take advantage of its opportunities.

Livio Di Matteo is Professor of Economics at Lakehead University.

Source: www.troymedia.com

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