19 January 2016

Updating the Alternative Spending Plan #nlpoli

In April 2013, SRBP ran a series of posts about public spending. The goal was to show how the government could have avoided its serious financial problems by having a financial policy more sophisticated than “spend it all.”

 A couple of very dramatic years have passed since then.

 Let’s update the projections and see what we get.

The essential assumption of the approach was to increase current account spending by four percent each year using 2006 as the base year.

We held capital account spending at $500 million annually. We allocated the total oil and mining royalties each year in equal allotments into four funds:
  •  The Stabilization Fund is used to cover any deficit between the annual spending, increased at four percent, and the non-renewable revenues coming to the provincial government. Just to be clear, non-renewable revenues includes any federal transfers but not the one-time cash from the January 2005 transfer deal. 
  • The Infrastructure Fund will be used to pay for the annual capital works budget of $500 million per year. In the simulation, we avoided using this fund if the Stabilization Fund could cover the annual spending. 
  •  The Debt Fund can be used to reduce debt by paying it off or by adding to the sinking funds, whichever produces the greater financial benefit. 
  • The Investment Fund is intended to generate new income from investments according to defined rules.
At the end of the simulation, we had spent roughly $7.5 billion of oil and mining royalties and we had put the same amount into debt reduction and an investment fund. Both of these would have produced new cash, the first by reducing debt servicing costs and the second by earning money from the investments. We didn’t take any of that money into account. In the update, we just continued the SIDI spending as originally planned. The result is in the image.

The black bars show actual government cash revenue. Notice that it went up and down quite dramatically. That’s the result of oil, mostly. Non-oil revenue was fairly steady each year at between $4.0 and $4.5 billion annually. The 2015 figures are estimated from current finance department figure. We just copied 2016 for the sake of simplicity.

The light blue line shows actual government spending. Note that in 2013 the Conservatives had actually cut spending quite sharply, a further decrease in 2014. In 2015, though, the Conservatives increased spending by 12%. The 2016 figure is just copied from 2015 to give a worst-case cast to the table. The Conservatives got into trouble in 2013 and 2015 for the same reason in both instances: they boosted spending dramatically, largely for partisan reasons. At the same time, oil revenues dropped as they are prone to do.

The red line is the SIDI spending, increased annually at four percent from the base year in 2005. You can see that SIDI would have only run into a problem in 2015. That’s because oil revenues dropped so dramatically. The big advantage to the SIDI approach is that the government would have an enormous cash nest egg to cover the rainy day. The government would still have to cut costs dramatically in the current year, but the nest egg would make that a lot easier. What’s more, the total spending in 2015 under SIDI would be much closer to the forecast income over the next decade - $6.5 billion – than the current government actual spending.

To get a better sense of the longer term trending, take a look at a chart showing government revenues at actual spending, on a cash basis. It’s basically the same data as used in the cart above, but without the SIDI numbers in it.

Leave aside the 2007 and 2008 spikes in revenue, which were caused chiefly by skyrocketing oil prices. The revenue in 2009 – even with the recession – was in line with 2006, allowing for an increase in oil production. Then revenue generally trends downward, which is again consistent with the long-established decline in oil production. It’s not as exact or as dramatic as oil drops but you can see a general downward trending. What's more the government folks knew about it well in advance but failed to adapt accordingly. That decline is the predictable reality the Conservatives ignored in their budget policy first in 2013 and then again in 2015.

In fact, in most of those years they actually budgeted to run large deficits on a cash basis. What happened to oil prices in 2015 is extraordinary but revenues were likely to drop anyway. As it now appears oil prices will remain low in comparison to the recent past. That makes it imperative that the government reduce spending far below current levels. We’d be looking at a total spending level somewhere around $6.0 billion .That’s the only way they can guarantee sufficient surpluses to create a long-term investment fund the Conservative should have created in 2007.