Tories face $10B deficit, report suggests

Canada risks running a $10 billion deficit in the 2009-2010 fiscal year if the re-elected Conservative government fails to stitch a “looming fiscal hole” that is already raising the spectre of higher taxes and possible spending cuts, a report suggests. That stark prediction was made yesterday by Merrill Lynch economist David Wolf.

That stark prediction was made yesterday by Merrill Lynch economist David Wolf, hours before Prime Minister Stephen Harper unveiled a six-point economic plan and vowed to keep government spending “focused and under control.”

Merrill Lynch’s report suggests Ottawa may succeed in eking out a small surplus this year, but it is on track to recording its first deficit since the 1990s – a political anathema for Canadians.

Wolf is known for his pessimistic views. His analysis in this case assumes no change in fiscal policy. Nonetheless, some of his contemporaries agree the growing likelihood of a deficit will force the Harper government to make some difficult spending decisions if it intends to live up to its no-deficit pledge.

At least one other economist is taking Wolf’s argument to the next level. Don Drummond, TD Bank’s chief economist, said a multi-billion dollar deficit is not only possible, it is unlikely to be “a one-year wonder.”

For his part, Wolf argues that Canada’s real economy is stagnating amid the global financial crisis. Sharp declines in commodity prices will weigh heavily on exports, while corporate profits are set to fade.

“This fiscal year still looks on track for a small surplus given the better results in the first half of the year, but next year looks awful – we estimate that nominal GDP (gross domestic product), the best proxy for the tax base, will contract outright in 2009 for the first time since 1933,” he wrote. “The effects on government revenues are likely to be profound.”

The last federal budget projected a $2.3 billion surplus for 2008-2009. When asked about that estimate last week, Finance Minister Jim Flaherty told reporters: “No, actually we’re on track – a little bit ahead of the track – on the surplus.”

Still, some private-sector economists say posting a surplus this year will be tricky. The idea of a deficit, however, is politically taboo. The last time Canada recorded one was in the mid-1990s. At the time, legislators worked tirelessly to slay it and subsequent governments vowed to never to repeat it.

“Given the circumstances that we’re in, a budget deficit is more of a political issue than an economic issue,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“If it is caused by the fact that the global economy is struggling mightily (rather than by overspending), then a deficit is something we probably have to accept.”

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