What the PBO report means for the Trudeau government's spending plans

Just one week after taking over the ship of state, the new Liberal government has had its first peek in the engine room and there are signs of smoke.

To judge by a report released Tuesday by the Parliamentary Budget Officer, the outgoing Harper government was unduly optimistic in its forecasts and estimates.

• Liberals face bigger deficits, weaker economy, PBO says
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• Oil prices expected to stay below $80 until 2020
• Canada's housing market faces bubble

The Canadian economy continues to face strong headwinds, from both sluggish global demand and stubbornly low oil prices.

The PBO is now predicting the price of a barrel of West Texas Intermediate crude will increase slowly to about $59 by 2020. In the last estimates, produced in April, the same barrel of oil was forecast to be worth about 10 per cent more over that period.

The low price of oil and other external factors have combined to slash the PBO's economic growth forecast for this year to 1.1 per cent from 2.1 per cent.

The Canadian economy is now forecast to produce $32 billion less income next year than had been anticipated in the last forecast, published in April. National income for 2017 will be $43 billion less than expected.

Surplus a mirage

All of that suggests that the Conservatives' heralded return to a budgetary surplus was in fact a mirage that could not have been achieved without the one-time sale of government-held shares in General Motors early in the first quarter.

For each of the next five years, the PBO projects fiscal deficits averaging $4.3 billion a year.

However, those deficits don't include the Trudeau government's spending plans. They are the deficits that would have occurred under the budgeting of former prime minister Stephen Harper, if his government had remained in office.

A crimp in Trudeau's plans?

The Liberal government has committed to a major infrastructure spending program, designed in part to stimulate the economy.

In its campaign platform, the party announced that "with the Liberal plan, the federal government will have a modest short-term deficit of less than $10 billion in each of the next two fiscal years."

That plan was built on earlier estimates that saw the federal Conservative government returning to surplus in 2015 and staying in the black over the next few years. Under that scenario, the whole of the deficit the Liberals planned to run would have been available for new stimulus spending or other priorities.

Under the new forecasts, it now seems that nearly half of that deficit is already spoken for, even before counting any new spending.

For Liberal Finance Minister Bill Morneau, it suggests that if he wants to keep the deficit within the $10-billion bounds promised in the Liberal Party platform, the amount of money available for infrastructure spending has been cut almost in half.

One reason for the government's worsening fiscal situation is that the PBO based its forecast on the Conservative government's commitment to cut Employment Insurance premiums starting next year from $1.88 per $100 earned to $1.44.

The Liberal government also plans to cut EI premiums, but by only about half as much. That means the loss of revenues will not be as great as it would have been under the Harper plan.

Still, there will be less money available than the incoming government believed based on previous estimates.

Options include bigger deficits

What to do about that reality now becomes a political question on which the Liberals have two options.

One is to shrink their spending plans, in order to keep the deficit under $10 billion. That will mean fewer new bridges, fewer new green jobs and fewer dollars for transit and housing projects.

The other option is to declare that the economy and budget they inherited from the Harper government are in worse shape than they thought and that their deficits will therefore need to be bigger.

Conservative MP Tony Clement, who served as Treasury Board president in the previous government, said in a statement Tuesday that the Liberals need to tell Canadians how they will respond to the downturn.

"We want to know how the Liberals will avoid falling deeper into the fiscal hole," Clement said in the release. "Our concern as Official Opposition remains that the shortfall will be made up through the pocketbooks of hard-working Canadians using tax hikes on their paycheques, removal of benefits they rely on and cutting services they need."

Morneau acknowledged the PBO report Tuesday, but said he couldn't say much more until he's more fully briefed, noting he has been in the job for just six days.

However, he did say that the more pessimistic numbers in the PBO report reinforced the government's view that the spending outlined in the party's election platform is needed.

"Our platform talked about significant investments and infrastructure, investments that we believe will help us to enhance growth, investments that we see will have the possibility of creating jobs, and investments that will enable us to improve the lives of Canadians across the country," Morneau told reporters.

"So, this really does reinforce for us the need for our platform, one that we think will make an enormous difference."

Morneau said he expects to deliver a fiscal update before the end of the year.