Sudden spike in federal deficit projections blamed on accounting change, not big spending or economic issues

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Parliament’s spending watchdog is questioning why the federal government’s deficit projections have suddenly spiked and is blaming an accounting change last year related to public-sector pensions as a key reason driving the volatility in Ottawa’s bottom line.

Parliamentary Budget Officer Yves Giroux said in an interview that it appears the primary cause of the sudden and dramatic swing in the size of federal deficit projections is a little-discussed accounting change the government adopted in 2018 related to how to estimate the cost of the government’s future pension and benefit liabilities to public servants.

Mr. Giroux said his office is asking officials for more information behind the surprise swing, which was revealed in Finance Minister Bill Morneau’s Dec. 16 fall economic update. Just nine months after the release of the March budget, the update reported that deficits are now projected to be much larger – by about $7-billion a year – than forecast in March.

Yet most of the change had nothing to do with big spending or economic changes. The largest factor was a $27.8-billion swing over five years owing to adjustments to cover the costs of pension and benefit programs for public-sector employees.

Economists and other budget watchers are still trying to decipher why Ottawa’s pension obligations changed so dramatically in just a few months. But much of their attention is focused on the accounting change announced by the Finance Department in the fall of 2018 after years of pressure from the Auditor-General and others.

Mr. Giroux said Ottawa should consider adjusting its approach so that year-to-year changes are not so dramatic.

“Having swings on an annual basis is probably not the wisest move," he said. “Having something that’s more stable over time and that reacts as a response to changes in demographics or long-term changes to economic conditions and rates of returns is a better reflection of the true liabilities.”

Mr. Giroux said having large year-to-year swings in the bottom line due to pension and benefits evaluations "is not very helpful to portray an accurate picture of the government’s finances.”

The 2018 change relates to how Ottawa should plan for the massive, unfunded debt it owes to federal public servants for work up till the year 2000. Since that year, Ottawa has been putting money aside in pension funds to cover the cost of future benefit payments. But before that, federal pension obligations were largely a bookkeeping exercise that has produced an unfunded obligation worth more than $200-billion.

Estimating the size of that debt to public-service pensioners requires complex actuarial assumptions in areas such as life expectancy and interest rates.

Former auditor-general Michael Ferguson had warned the government that the interest rate it was using – based on a 20-year average of long-term Government of Canada bonds – was too high, especially in light of the prolonged period of ultralow interest rates in recent years.

The new approach is to use the current Government of Canada bond yields, essentially replacing a backward-looking guide with a forward-looking one. The benefit of the change is that it uses more current data to reflect the view that interest rates are now much lower and are expected to stay near historical lows for a while.

The downside is that the approach could be more volatile, which the PBO flagged as a concern in 2018 after the change was announced.

University of British Columbia economist Kevin Milligan said that, regardless of whether the accounting change was the right thing to do, Canadians should be aware that Ottawa’s bottom line will swing more dramatically as a result.

“People want to know, is the government increasing the deficit or not? Well, if it bounces around $10-billion here and there based on small changes in interest rates, it gets really hard to understand what the government is doing," he said. "So while there perhaps is a good case for making this change, a consequence of it is an increase in volatility and, I would argue, a decrease in transparency.”

The changes revealed in the update occurred during a period of relatively stable interest rates. Dr. Milligan says that, in a period of frequent rate cuts or hikes, the fiscal impact would be even more dramatic.

Essentially, he said interest-rate cuts during a recession will make deficits even larger, while a period of interest-rate hikes could dramatically shrink the deficit or even swing the Liberal government back into surplus.

Finance Department spokesperson Anna Arneson played down the role of the 2018 accounting change in the latest deficit figures.

“While we do not have a precise estimate, we expect that only a small portion of this fluctuation is attributable to the accounting change,” she wrote in a statement.

Bill Robson, president and chief executive of the C.D. Howe Institute, has advocated for an accounting change for years, and said the volatility is an asset because it reminds taxpayers that they are on the hook for backstopping these pensions.

“There’s a big transfer of wealth going on through these plans and we haven’t been seeing it," he said. “We never realized just how generous we were compensating them, and now it’s coming to light. … If we don’t want more of this sort of thing, what we need to do is not mess with the accounting, it’s change the pension plans.”

Chris Aylward, president of the Public Service Alliance of Canada, the largest union of federal public servants, strongly objects to the accounting change and said it was “rushed through” without consultation.

“This change artificially shows the plan to be costlier than it truly is," he said in a statement. “Pension plan obligations are long-term in nature. Pegging this [interest] rate to a snapshot at only one point in time inaccurately assumes that all liabilities must be discharged in that year.”

Mr. Morneau’s update promised consultations on whether the government should change the way it reports on its costs related to public-sector pensions and benefits by including a new “operating balance.” However, the Finance Department confirmed those consultations are not related to the accounting change.

“We are not proposing to reduce any information," Mr. Morneau said on the day of the update. "We’re actually proposing to improve the transparency of the numbers by adding a line that takes out the variability that comes through interest-rate changes on pension liabilities.”