a decade of squandered opportunity by jm minor

7/21/2019 A DECADE OF SQUANDERED OPPORTUNITY by JM Minor

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A Decade of SquanderedOpportunity

The Budget Colloquy

Published on the Uncle Gnarley Blog

Summer 2015



At the close of the War found Newfoundland in the enjoyment of a greater measure of prosperity than she

had previously experienced. The price of codfish had risen during the War to heights hitherto undreamed

of, and fishermen and merchants alike were able to congratulate themselves on the making of large

profits. A great improvement had taken place in the standard of living; for the first time in their lives the

fishermen had more money than they required for immediate necessities and standards were set up which

in later years could not be maintained. It was forgotten that the conditions brought about by the War weretransitory and exceptional; men grew accustomed to thinking in large figures and schemes and projects

which a few years earlier would have seemed visionary and fantastic were regarded as the natural product

of the new era. Government and people alike were the victims of an over-confidence, which, in the years

following the War, was to blind them to realities, to induce a fatal disregard of the elementary canons of

public finance and finally to involve them ever more deeply in financial embarrassment. Within 12 years

the public debt was more than doubled. As a result of a long succession of unbalanced budgets, which in

turn necessitated continuous borrowing, the financial position of the country was clearly unsound even in

the seemingly prosperous years of 1929 and 1930; when the economic depression set in and the price of

fish started to fall, the Island was faced with bankruptcy.

An Excerpt from the 1933 Amulree Report



Preface

As a regular follower of provincial politics1 and current affairs, I was generally aware that

spending by the provincial government had increased, since 2006, to levels well outpacing

inflation. Yet it was not until the release of the 2015 Budget, and the province’s “5 Year Plan”2

for fiscal recovery, that I awakened to true state of the provinces finances. The $1.3 billion

projected deficit in that year was enough to garner attention.

However, it was the government’s prediction of a nearly $2 billion increase in revenue, during

the period 2015-2020, as the main driver for a return to balanced budgets, that seemed unlikely

enough to be incredulous.

I remember reading the assumption for revenue growth and realized, immediately, that it was

just too optimistic. Considering the prevailing pessimistic outlook for oil prices (even in early

2015), combined with lower economic activity, higher unemployment due to the completion of

our resource based megaprojects, and the lower royalties from Hebron, too, my reaction wasthinking that the prediction amounted to nothing less than reckless fiction. In the absence of a

miracle, I concluded, it would be virtually impossible for the province to return to a balanced

budget by 2020.

Within the 2015 Budget Highlights document, the government stated there would be nearly $5

billion of new borrowing; the amount necessary to bridge the revenue shortfall to 2020. Based

upon my own more reasonable assumption of new revenue growth, and the near certainty that

the budgeted sum for Muskrat Falls ‘equity’ would increase I also concluded, in April 2015, that

by the end of the decade new borrowing in the $8-10 billion range would be necessary.

The full extent of the Province’s structural deficit had become obvious. Without decisive change,the Province would commence a period of borrowing to a level unmatched in our history.

The Budget Highlights glossy brochure was clearly written by a government preparing for an

election. Exaggeration, even hyperbole, while unwarranted at any time, is often found to underlie

those democratic expositions. But, it should be said the P.C. Government’s slogan “Balancing

Choices for a Promising Future” was derived from neither balance nor promise. In fact, it can best

be characterized as delusional.

Having come to that conclusion, I began studying the budget documents delivered over the past

20 years. My initial goal was simply to understand how we had regressed from the position of

1 I have been a regular reader of the Sir Robert Bond Papers Blog since 2007. Although our opinions sometimes

differ (rarely) we have to duly recognize the contribution he has made in identifying the issues in real time.

Particularly on the budget, Ed has been right since 2006.2 http://www.budget.gov.nl.ca/budget2015/highlights/highlights_2015.pdf 3

http://www.budget.gov.nl.ca/budget2015/highlights/highlights_2015.pdf






having a balanced budget in 1996, to the current “Updated” one recording a deficit of nearly $2

billion; in essence, a financial debacle.

Amulree had asked a similar questions in 1929, and I wondered, too, in the current context: how

Newfoundland and Labrador, even in a period of relative economic prosperity, could have

acquired such a staggering borrowing requirement?

The research undertaken in April and May, 2015 evolved into a series of posts, published on the

Uncle Gnarley blog, entitled “A Budget Colloquy”. I do not suggest it is complete; however, I

think it is a worthwhile endeavor; possibly, one that serves as a tutorial in the experience of

downside risk found in the “unwarranted assumption”.

There were some startling statistics that resulted from this work. I want to cite just a few:

In the period of 2006 to 2010 annual inflation adjusted spending increased from $5 billion

to $6.8 billion. The 35% increase in real spending, in 4 budget cycles, is the underlying

cause of our current budget deficits. In inflation adjusted dollars, the amount spent by the government on salaries has

increased from $1.7 billion in 1997 to $3.8 billion in 2013. In real dollars (after inflation)

the government spends twice as much on salaries now than they did in 1996.

In 2013 nearly 50% of government expenditures was associated with salaries.

In the period of 2007 to 2014 (oil boom) capital works spending was $2.3 billion above

the historical norm of $300 million per year.

In the period of 2007 to 2014 (oil boom) an amount of $8.5 billion above the historical

norm was spent on salaries.

During the oil boom for every new $1 in infrastructure spending there was $3 new dollars

spent on the public service.

Reductions in income tax and HST were clearly premature.

In the period 2015-2016 the province’s combined annual income from federal sources

and offshore royalties will be less than the federal sources, alone, in 1997, in real dollars.

We are in purgatory when it comes to federal transfer payments.

Against the backdrop of the recent fiscal Update released by the newly elected Ball government,

I thought it would be beneficial to consolidate these posts, as they appeared, in a single

reference. The Colloquy contains plenty of historical data, analysis, and ideas for financial reform.

I believe it is important that the public fully understands how we got here and some of the

decisions required to reverse this sad and unfortunate circumstance. Indeed, as I see it, the fiscal

situation is dire enough that Newfoundland and Labrador may be entering Stage 2-3 of a debt

spiral3.

The general population seems to be awakening to this fiscal crisis, although it is less than clear

that the new government understands the depth of the trouble the province is in, or if it is willing

to act in a timely manner.



My greatest hope, quite simply, is that readers will conclude, as I have, that this debt and

spending crisis is real.

That realization, alone, might inspire this truly vulnerable society to step back from what the

financial precipice on which we are resting.

Hopefully, readers will profit from the opportunity to better understand the origins of the crisis,

as I have, and assess the measures proposed in the eight Posts of the Budget Colloquy. Such a

difficult issue will naturally attract different views and as many solutions. That is perfectly natural.

(The full Budget Colloquy will be published on the Uncle Gnarley Blog, next week, under the title

“A Decade of Squandered Opportunity”.)

But there is one thing on which we must find unanimity, and quickly: that is the need to act. We

must individually and collectively accept that cutbacks and belt tightening will be both

unavoidable and painful. In addition, we must be prepared to tell the new Government of Dwight

Ball we expect his Ministry to act courageously, expeditiously, and wisely.

Ever the optimist, I hope that in acknowledging the crisis and dealing with it, we will recognize its

origins in failed leadership. By acting firmly and decisively, I also hope there will emerge from this

sad and unnecessary experience, a stronger, wiser, more enduring Newfoundland and Labrador

society.

______________________________________________________________

Stages in Debt Spiral

3

1) Debt Levels increase. (This could be due to overspending, inefficient tax collection, bank

bailouts or economic slowdown)

2) Markets become concerned about debt levels leading to higher bond yields (higher rate

of interest)

3) Higher cost of servicing debt. Rising debt increases debt interest payments. But, also

Governments have to pay higher interest payments on debt because of rising bond yields.

This increases government spending even more.

4) To reduce bond yields, governments need to cut spending and increase tax.

5) Trying to reduce debt can cause a recession. The Impact of spending cuts leads to lower

aggregate demand more unemployment and lower economic growth. Lower economic

growth leads to lower tax revenues.

6) The shrinking economy means it is harder to meet debt repayments. Confidence falls.Bond yields remain high despite the spending cuts.

7) With a shrinking tax payments, the government struggles to meet interest payments. Also

markets no longer want to buy more government debt, leading to partial or total default.



1 IT S THE SPENDING STUPID

As Posted on Uncle Gnarley on May 11, 2015

My political opinions were largely formed in the 1990’s. These were turbulent economic times for both

Newfoundland, and the country as a whole. In Newfoundland the closure of the fishery represented

economic death by a thousand cuts. Our population declined by 10% and an entire generation of

Newfoundlanders were forced to migrate. In Canada, debt and growing deficits had us on the verge of

default. We were the economic basket case of the G73.

It was bleak times for both Canada and Newfoundland; yet we persevered. The Liberals came to power

in 1993 and implemented a major program of spending cuts, intended to reduce government spending

and balance the budget. In this province, Clyde Wells had to manage a pseudo economy; yet he was still

able to control spending and balance the budget in 1996. This was before the Hibernia platform was

completed, and prior to White Rose or Hebron. In the backdrop of our current $2 billion dollar deficit,

this can be considered nothing less than remarkable.

In Canada, the ratio of spending cuts to tax hikes was seven-to-one in combating the deficit. Asked why,the Prime Minister Jean Chretien replied: "There was more need on one side than the other". These cuts

were across the board, and deep. They affected every aspect of society.

The cuts in the 1990’s were difficult for everyone. Still there was an underlying agreement in the country,

even amongst the critics, that these cuts were a necessary evil. During my five years in university my

tuition increased from $1420 a year to about $3350. To put that into perspective, it would be about $5000

in today’s dollars, compared to the $2550 that Memorial students presently enjoy4.

There were a few ideologues who were immune to reality. I remember current Liberal Cabinet Minister,

Dale Kirby, as president of the Canadian Federation of Students, organizing student rallys at Confederation

Building to protest the cuts to education. I did not join those rallies because I believed in the cause of

balanced budgets. I knew my future depended on those tough decisions made by Chretien, Martin and

Wells in the 1990’s. Everyone had a stake in the required correction to government spending levels. Killing

the deficit, and restoring Canada’s economic security was a matter of both necessity and of pride.

Fortunately, my own view was shared by enough Canadians that these tough actions were implemented.

Our collective sacrifices were rewarded with 15 years of economic growth and relative stability, to a point

where we are now envied by our G7 peers.

Society of all classes, races, and creeds are better off today because of the drastic actions taken in the

1990’s.

Looking to the present, it is must be obvious to any objective pundit that Newfoundland and Labrador isagain at a crossroads. Tough political decisions need to be made and implemented. The collapse in the

oil price is the catalyst for such a review, but not the sole reason for it.

3 http://uk.reuters.com/article/2011/11/21/us-crisis-idUSTRE7AK0EP20111121 4 http://www.mun.ca/undergrad/apply/fees.php

http://uk.reuters.com/article/2011/11/21/us-crisis-idUSTRE7AK0EP20111121



http://www.mun.ca/undergrad/apply/fees.php







The recent report5 of $1.8 billion dollar deficit should be evidence enough for a call to action. It is clear

to most that the province has a structural financial problem. We are spending well beyond our means.

Yet, compared to the economy of 1996, things are still relatively buoyant. How could we balance a budget

in 1996, but cannot do it today?

This is a valid question, which requires us to review what has changed. Figure 1.1 provides a summary of

both the Total Revenue and the Current Account Spending as contained within the “Estimates” for the

past 20 years. For clarity the “current account spending” does not include capital spending on items such

as hospitals, buildings, roads and Muskrat Falls. It is purely the annual cost of running the government.

Inflation, adjusted data for the past 20 years, has been included to provide a fair historical comparison.

Figure 1.1: Current Account Spending and Revenue – Inflation Adjusted (2015 Dollars)

The inflation adjusted numbers demonstrate how relatively stable the revenue and expenditures of the

provincial government were from the period of 1995 to 2005. During this time current account spending

averaged around $5 billion (in 2015 dollars).

However, in the period from 2006 to 2010, the annual inflation adjusted spending increased from $5

billion to $6.8 billion annually, representing an increase of about 35% in 4 budget cycles. Despite recent

“austerity” budgets, real spending has held steady since 2010, with a surprising increase forecasted in the

current 2015 election budget.

5 http://www.cbc.ca/news/canada/newfoundland-labrador/deficit-projection-1.3345756



Due to our dependence upon natural resources our revenue has been much more variable. Although the

numbers from the “estimates” represent a modified cash accounting basis, and not accrual consolidated

accounting, the trends are obvious. Fueled by overlapping oil royalties and Atlantic Accord payments, in

2007-2011, the revenues to the province were nothing short of spectacular.

However, these spectacular revenues were both short lived and variable. But the reduction in revenue,

starting in 2013, was also very predictable.

It is important to note that the dramatic reduction in revenue in the period from 2011 to 2015 is not

purely the result of the collapse in the oil price. Part of the revenue reduction is due to long known

reduction in oil production, and the phase out of the Federal Atlantic Accord payments. Which brings us

to the current dilemma the province faces.

Costs are relatively easy to forecast when compared to revenue predominantly pegged to commodity

pricing. We know that current provincial government expenditures are at unsustainable levels in the long

term. This is an absolute conclusion that can be reached by any reasoned individual. Cuts are required.

More challenging, however, is forecasting a stable long term revenue stream to enable long term

planning, and to understand the magnitude of the required long term spending cuts. This is very a tricky

business, and governments would be wise to take a conservative view in the long term planning of

revenue projections.

Within the budget highlights document, produced in 20156, the government provided a forecast target

for Gross Revenue going into the future. This Gross Revenue is a slightly different metric than shown in

Figure 1.1, but it does demonstrate a forecasted increase in revenue of about $1.6 billion from the period

2016 to 2020.

Table 1.1: Consolidated Surplus (Deficit) in Millions $

This additional $1.6 billion in new revenue, over the next 5 years, is the reason the PC Government did

not plan to implement major cuts during the 2015 budget process. Instead, this new revenue will allow

spending to be held at nearly a constant level in real dollars.

It must be asked: where is this additional revenue coming from if oil prices remain in the expect $70 dollar

per barrel range? It is worth investigating the potential sources of new revenue.

6 http://www.budget.gov.nl.ca/budget2015/highlights/highlights_2015.pdf







New Revenue Source #1: Oil Royalties

Royalties (Mining and Oil) contributed $1.8 billion in royalties in 2014, with a forecasted contribution of

$1.3 billion in 2015. Looking into the future, Hebron will be producing oil in 2018 but due to the spiraling

project costs and lower price of oil, payout will be delayed by several years. The royalty, prior to payout,

is a modest 1%. The province will therefore only net $200-300 million annually from Hebron for the

remainder of the decade. This must offset the declining production from the existing fields.

From the 2008 Hebron review Wade Lock predicted that total combined royalties in the province would

be $1.7 billion in the period of 2016-2020. This was with a higher price of oil, and lower development

cost. I do not anticipate royalties in the 2016-2020 range being more than $300 million more a year than

the $1.3 billion collected in 2014. Oil royalties will only be a small portion of the $1.6 billion anticipated

increase in revenue unless there is a rapid and unexpected rebound in the oil price.

New Revenue Source #2: New Taxes

The increases in the tax regimes included in the 2015 budget are necessary. But they will not generate

additional revenue to the province. The slow-down in the province, and in Alberta’s (with the lower

remittance payments to NL) will have an impact on the sales and income taxes collected. The change in

HST and personal tax rates will only be enough to offset the natural decrease due to the weakening

economy. The new tax increases will not generate new revenue; they will only serve to stabilize the

existing revenue levels.

Considering the precarious position we are in I agree with the PC position on the HST, and income tax

changes. History has shown that the tax reductions implemented by the Williams government in the

period of 2006-2010 was not good long term economic policy.



New Revenue Source #3: Nalcor

Within the 2015 Budget Highlights document the province provided commentary concerning the future

revenues which Nalcor will provide to the provincial government.

Just so my position is clear, this graph insults the intelligence of every Newfoundlander and Labradorian.

It suggests that the equity will be paid back by 2025, with the revenue stream after that being a return on

investment. This is a convenient graph which fails to recognize that the province is borrowing the $3.1

billion to provide “equity” for Nalcor. There is nearly another $1 billion dollars of deferred dividends the

province has bypassed to fund Muskrat Falls and the other oil projects.

The taxpayer has provided $4 billion to Nalcor over a 10 year period. In addition, the province will be

paying nearly $200 million a year in additional interest payments to allow this false equity to be borrowed

from a different bank. By 2025, the province will have spent another $1 billion in interest payments to

fund this project. It is the unaccounted interest during construction.

To suggest the province will be paid back by 2025 is clear misrepresentation on the part of government.

It is time to stop pretending that Muskrat Falls or Nalcor will generate significant amounts of new wealth

to Newfoundland and Labrador. The jig is up. It will be late 2019 before they get full production from

the plant. Even then, at market value this will contribute about $100 million a year in true revenue.

Anything else reported by Nalcor will come from the taxpayers of Newfoundland and Labrador in the form



of a tax on electricity. This will have to be used to pay off the $5 billion dollar direct debt, and the $4

billion dollar equity investment the province will have made to fund this project.

Nalcor will not be a significant generator of revenue for the province, until well into the future, when the

Upper Churchill agreement expires. It is time for Nalcor to be transparent on any claim suggesting

otherwise.

Uncertain Revenue

I can’t see any valid basis for this rather optimistic forecast of future revenues to the provincial

government. Dwight Ball, Cathy Bennett and the remainder of the opposition would be wise to question

government on the source of these forecasts. They should dissect and challenge the numbers.

They do not make sense, and in my opinion are overstated by about $500 million to 1 billion a year with

a realistic assumption of oil being in the 70-80 $barrel range, for the remainder of the decade.

A realistic but conservative view on revenue projects will highlight the extent of our spending problem.

If I am shown to be correct, our $5 billion in new borrowing could easily be $7 to $8 billion by 2020.

Combined with Muskrat Falls the people of the province will have a public debt in the $20 billion range.

This is $40,000 dollars of debt for every person in the province.

The time is now to act.

As Chretien said in 1994, the problem is not taxes, the problem is spending. Few people, 20 years later,

would argue with his actions. Likewise, few people can argue that we do not need significant cuts in

public spending in the Newfoundland and Labrador of 2015.

In my opinion, we need to cut at least 15% from our annual budget in real dollars to be sustainable on a

long term basis. These cuts will not be easy, but they are required.

The economic house of cards that was built by the Williams government is about to fall. It is time for real

leadership to deal with the structural issues we have in government financing. To modify a great 90’s

political slogan – “It’s the Spending – Stupid”



2 PUT HIM IN THE LONG BOAT TILL HE S SOBER

As Posted on Uncle Gnarley on June 1, 2015

The 2015 budget documents contained a piece entitled “Budget Highlights – Balancing Choices for a

Promising Future”7. This is a glossy flyer which provides a summary of the current fiscal position of the

province, and a look 6 years into the future. It predicts that in 5 years the province will return to balanced

budgets. It contains sufficient colored graphs, and statistics to seem believable.

I encourage all Newfoundlanders and Labradorian’s to read this document.

In a recent Uncle Gnarley post, entitled “It’s the Spending Stupid”, I gave some initial thoughts regarding

the 2015 Budget. Since then, I have been practically consumed with trying to better understand the

province's fiscal position; both current and projected. The work has included a financial review of the past

twenty years. I hope it will result in additional perspective as I dissect the data.

At the outset, I can say my conclusions are certainly similar. I would add, we can’t delay further the massive

changes that are required to correct the structural issues that affect the province’s finances.

People should not be influenced by the glossy brochures produced by the Department of Finance. Nor

should they suffer the unsubstantiated optimism that an inevitable rebound in oil prices will take care of all

our problems; a view held by the Government's advisor, Wade Locke8.

Uncle Gnarley has been gracious enough to provide me the space for a three part series to present some

of the data from the past 20 years of budget documents (both the estimates, and the public

accounts). Furthermore, I will offer my opinions on the province’s present fiscal situation, a recommended

plan to control spending, and suggestions to restore a reasonable balance to spending.

This first Part will review the government spending over past years, with a view to educate the reader as to

where the oil money has been allocated. Embedded within “It's the Spending Stupid" is a graph containing

the inflation adjusted spending for the past 20 years by the government. The data was taken from “theEstimates” and adjusted for inflation in accordance with the Bank of Canada's online calculator.

The data demonstrated that, in the period from 2006 to 2010, the annual inflation-adjusted

spending increased 35% in four budget cycles. Despite recent “austerity” budgets, real spending has held

steady since 2010, though a surprising increase is forecast in the current 2015 election budget.

This is an alarming increase in public spending.

Even more alarming is the fact that, based upon the 2015 Budget Highlights document, we are about to

embark on a borrowing program of nearly $5 billion (new debt) over the next 5 years. Moreover, this new

borrowing is not required solely for capital works projects, infrastructure, or Nalcor investments.

7 http://www.budget.gov.nl.ca/budget2015/highlights/highlights_2015.pdf8 http://www.mun.ca/care/Locke_Presentation_Mills.pdf

http://www.mun.ca/care/Locke_Presentation_Mills.pdf



http://unclegnarley.blogspot.ca/2015/05/its-spending-stupid.html








Figure 2.1: Forecast Borrowing next 5 Years (Source 2015 Budget Highlights)

Of the $2 billion being borrowed in 2015, nearly 350 million is required for the day to day running of

government. It is very reasonable to ask that despite the collapse in oil prices: how can we be in an

operating deficit position, even with a relatively strong economy powered with 3 simultaneous Mega

Projects (Hebron, Vale, and Muskrat Falls? Either one of these projects would have been an economic

messiah in the pre-oil economy of Newfoundland and Labrador.

The answer lies in the spending trends over the past 7 years when compared to the historical norms. The

author has drawn on 20 years of data from the public accounts9 to try to determine the trends in spending.

The data is from the annual report of Program Expenditures and Revenues contained on the department

of Finance website. Unlike the “estimates” this data is based on the accrual accounting methods, and

presents the expenses in the year they were accrued.

Figure 2.2 presents a revised Gross Revenue and Gross Expenditures made by the province from 1997 to

2013, with a forecast to 2020. The actual data comes from the “Consolidated Statement of Operations”

within the annual public account documents. The forecasted data comes from the 2015 Budget Highlights

document. This data is in real 2015 dollars. The historical data has been adjusted for inflation as

determined by the Bank of Canada inflation calculator, the future data has been discounted by a 2%

annual inflation rate.

9 http://www.fin.gov.nl.ca/fin/public_accounts/index.html

http://www.fin.gov.nl.ca/fin/public_accounts/index.html

http://www.fin.gov.nl.ca/fin/public_accounts/index.html



Figure 2.2: Inflation Adjusted Revenue Versus Expenses (Consolidated)

On a real dollar basis, expenses were relatively consistent in the $6 billion dollar range from the period

from 1997 to 2006. From 2006 to 2010 the annual expenses increased to $8 billion, where it has remained

relatively constant in real terms. Despite a small uptick in 2016, spending will slightly decrease by 2020.

The provinces spending profile dramatically changed in the period of 2006 to 2010.

Where did this money go?

Figure 2.3 provides a summary of expenses by object, as documented within Schedule 12 of the public

accounts. Again this data has been adjusted for inflation. The reader must be reminded that this is theconsolidated expenses, and not from the “estimates”. As such the “capital works” spending is not

recognized in the year the money is actually paid out to the parties doing the work. Rather the

depreciation, only is recognized in the “amortization” line item within the annual ex penses.

To explain this concept in practical terms, the $20 million spent on Humber Valley Paving in 2013 would

be amortized over 20 years. In the “estimates” the full $20 million would be recorded in the expenses for

2013 on a cash basis. However in the consolidated account only $1 million in depreciation is expensed

($20 million depreciated over 20 years is $1 million per year in a linear depreciation model). Although

$20 million was spent in 2013, only $1 million of that expense was included in the net debt, or deficit

calculations.



Figure 2.3: Expenses by Object 1997-2013

Salaries and Employee Benefits

It is no surprise to anyone who lives in St. John’s that there has been a rapid expansion of the public service

in this province. There is now literally a government office in almost every strip mall in the city. Afterreviewing the “estimates” it was no surprise that Salaries has increased at rate far outpacing inflation.

Figure 2.4 provides a summary of salary only data from the period 1997 to 2013, again adjusted for

inflation. Also included in this graph is the percentage (%) of salary compared to the total expenses of the

government.



Figure 2.4: Salary and Employee Benefits

In real dollars the amount spent on salaries and employee benefits has increased from $1.7 billion in 1997,

to $3.8 billion in 2013. These are inflation adjusted numbers! In real dollars the provincial government

spend over twice as much on salaries in 2013 as they did in 1997.

This growth should make even the leaders of the provinces unions blush with shame.

However, it is not until you calculate the percentage of government spending when you realize the breath

of the issue. In 1997 salaries and employee benefits represented 30% of the total government expenses.

In 2013 it represented 47% of government expenses. This is a startling statistic.

Professional Services

What was most alarming in reviewing the provinces books was the growth in professional services.

Professional services are outside consultants who supplement the government staff on special projects,

or even day to day works. Every time the government refers to “bringing in a consultant” the cost of that

work gets allocated to “professional services”.

Figure 2.5 provides a summary of the amount spent on “Professional Services” from 1997 to 2013, again

in real inflation adjusted dollars. From the period of 1997 to 2002 about $280 million spent annually for

this purpose. Since the 2003-2004 budget year this amount has steadily increased. The figure now

exceeds $500 million in the 2012-2013 budget year!



Figure 2.5: Professional Services Expenditures from 1997-2013

The taxpayers of this province must ask why, despite the historical increase in the size of the public service,

and given the salaries which we pay public servants, why we have had to effectively double the budget for

external consulting?

I believe that the Opposition should be asking many questions concerning the nearly half billion dollars in

public expenditures in this category. How much of this is tendered competitively? What is the process for

awarding consulting services contracts? How many contracts does this represent? What services are these

consulting doing? How much of this $500 million is essential?

Most importantly, we need to ask how much of the work completed by consultants should actually be

performed by the Public Service? Why is the government doing less, with more?

To give this issue further perspective, the sum is equal to 4% of the 15% HST collected from every NL

taxpayer; almost 1/3rd of all the HST revenues collected is used exclusively to pay for consultants. Figure

2.5 should be met with outrage from the taxpayers of the province.

Capital Works

As explained above, the annual public accounts summarized in Figure 2.3 contains only the depreciationon the new capital assets. Figure 2.6 provides a summary of the capital spending for the past 20 years,

as contained within the “Estimates”. This is the amount of cash the government has actually spent each

year on capital works projects. Again, these numbers are adjusted for inflation and the spending on the

resource projects (ie: Nalcor) has been removed to provide a true comparison.



Figure 2.6: Inflation Adjusted Capital Spending (Cash Outlay) Per Year

In the period from 1995 to 2006 the province spent about $313 million annually on capital works projects.

Since 2007 that number has increased, but has now returned to a more historical reference point.

In the period of 2007 to 2014, the government spent a cumulative $2.4 billion on capital works projects inexcess of the historical reference, or $300 million more a year on average.

Due to the method of recognizing the depreciated value as an expense line in the net debt calculations, the

spike in spending from 2007 to 2013 will eventually lead to an increase i n the provinces “net debt”, unless

our annual operational spending can be funded by revenues and not new borrowing. When it comes to

the consolidated accrual accounting, and net debt calculations, the province has only robbed Peter to pay

Paul.

Where Have We Spent the Oil Money?

The provincial government will promote that the oil wealth has been invested in such things as capitalspending. Adopting the methodology of Figure 2.6 to compare the spending of salaries to capital spending

it is clear that the majority of the oil wealth has been spent enlarging the public service, and increases in

employee benefits. This is shown in Figure 2.7.



Figure 2.7: Growth In Salaries Versus Growth in Capital Spending

Since 2005, government has spent $8.5 billion of the new oil wealth in salaries for public servants. It has

spent $2.3 billion on items such as new schools, roads, and infrastructure. The math suggests for

every one new dollar spent on infrastructure, three dollars has been spent on salaries. Capital works

projects can be reduced with the stroke of a pen. Public service salaries are not so easy to cut.

It is important to note that these huge public sector cost increases were enabled by a strong economy,

large and short-term oil royalties, and low interest rates. But the huge increases were truly enabled by

successive governments who were content to spend like sailors on shore leave.

But now, at least two of those three enabling conditions are no longer present. Furthermore, as recently

documented within the Globe and Mail article entitled "Canada's Governments Brace for Looming Debt

Crunch"10, how long will these low interest rates remain?

It raises the question: where will Newfoundland and Labrador be in 15 years, when the cost of borrowing

money is back to historical levels?

By any definition, this is a province that needs to start planning and preparing, now, for 15 years into the

future. The problem is, successive recent budgets, all of which have been characterized by an

unsustainable level of spending, only demonstrate that we are incapable of planning for even 15 months.

Can we start over?

10 http://www.theglobeandmail.com/report-on-business/national-debt/article24397940/

http://www.theglobeandmail.com/report-on-business/national-debt/article24397940/







Perhaps. But, first, the political leadership has to change. Decisions are made based on the greatness of

things yet to happen, whether the recovery in the price of oil, revenues from Muskrat Falls, or the

potential of deepwater oil fields. Unbridled optimism is the fuel our recent class of politicians uses to

formulate public policy.

With the 2015 budget the PC’s have decided to essentially hold the course on spending. They are banking

on a rebounding economy to grow new revenues with which to balance the budget into the future. If

they are wrong, then get ready for even bigger deficits ahead.

There is only one way to tackle a spending problem. It is time for the sailor to sober up.



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The Government of Newfoundland and Labrador has a spending problem. This problem can be masked

by the temporary windfall revenues which occurred in 2008-2012. However, a responsible government

plans its long term spending based upon a sustainable, realistic revenue stream.

As part of the 2015 budget documents the government attempted to do just that. In the document

entitled “Budget Highlights – Balancing Choices for a Promising Future”11 there was a forecast of both

spending and revenue for the next 5 years. It predicts that in 5 years the province will return to balanced

budgets. It contains sufficient colored graphs, and statistics to seem believable.

The following is a summary as presented by the government in this “highlights” document.

Table 3.1: Consolidated Surplus / Deficit from the 2015 Budget Highlights

The province is predicting that for the 2014/2015 and 2015/2016 fiscal years revenue will be just less than

$7 billion. However, by 2020/2021 there will be a $2.6 billion (37%) increase in revenue in nominal dollars.

It is this increase in revenue, rather than a decrease in spending, which will provide the means for theprovince to return to a balanced budget.

Is the government’s projections for future revenue grounded in reality, or is it merely wishful thinking?

This post will attempt to answer this question.

Historical Context on Provincial Revenue

Figure 3.1 presents a revised Gross Revenue and Gross Expenditures made by the province from 1997 to

2013, with a forecast to 2020/2021. The actual data comes from the “Consolidated Statement of

Operations” within the annual public account documents. The forecasted data comes from the 2015

budget highlights information provided in Table 3.1. This data has been adjusted to real 2015 dollars.

Historical data has been adjusted for inflation as determined by the Bank of Canada inflation calculator,and the future data has been discounted by a 2% annual inflation rate.

11 http://www.budget.gov.nl.ca/budget2015/highlights/highlights_2015.pdf





Figure 3.1: Inflation Adjusted Revenue Versus Expenses (Consolidated)

Figure 3.2 provides a summary of the sources of revenue to the provincial government. In 2008 the

province received $9.68 billion in revenues (2015 dollars). This was underpinned by $2.5 billion in oil

royalties, $2 billion in Atlantic Accord payments, and $0.5 billion in equalization payments from the

Government of Canada. By 2014 the total annual revenue had reduced to $7 billion. The figure

represents nearly a 30% reduction from the peak. However, it was still nearly $1.7 billion more in annual

revenue (2015 Real Dollars) compared with the amount that sustained governments from 1997 to 2006.

Figure 3.2: Revenue By Source – Inflation Adjusted

0

2000

4000

6000

8000

10000

12000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Misc.

Enterprise

Fees/Fines

Investment

Other

Mining

Gas Tax

Corporate Tax

Sales Tax

Income Tax

Offshore RoyaltiesFederal

Provincial Revenue by Source

1997-2013

Inflation adjusted



Figure 3.1 clearly demonstrates that our return to balance budgets will be achieved only by the forecasted

increases in revenue, and not by any real reduction in public spending. The province has decided to tackle

the deficit by holding spending, and raising taxes. This is not a balanced approach.

By any economic measure, Newfoundland is in a recession. Major projects are winding down, productionprofiles from existing offshore platforms are decreasing, oil prices appear to have returned to a historical

supply/demand balance, and new offshore projects are getting delayed.

Is the 10% growth in revenue (in inflation adjusted real dollars) reasonable? Or are the provincial

government simply sticking their head in the sand?

From Federal Dependence to Oil Addiction

There is no better graph to demonstrate the changing economy of Newfoundand and Labrador

than the one represented in Figure 3.3. Inflation adjusted revenue is shown from both oil and

gas, and federal sources over the past 16 years. Also included is the % of total revenue coming

from the combined sources.

Figure 3.3: Federal and Offshore Contributions to the Revenue of Newfoundland

In 1997 the Province of Newfoundland and Labrador received nearly $3 billion (in 2015 dollars) from the

Government of Canada. This was in the form of equalization, cost shared projects, and health transfers.

This equaled almost 50% of the revenue from the province. These were tough times.



In 2013 the combined income between the 2 sources was about $3 billion. It is expected that when the

2014 consolidated public accounts are released this will be several hundred million less than the $3 billion

number.

In the period of 2015-2016 the province’s combined annual income from Federal and Offshore royalties

will be less than the federal sources alone, in 1997 in real dollars! This is a startling statistic, and one

which should send cold shivers through the spines of anyone who is concerned about the province ’s

finances.

As long as our economy is strong enough that we will remain a “have” province, and not qualifying for

equalization, we will be in a difficult position. That is until Hebron royalties come online post “simple

payout”, or the price of oil returns to nearer to 90 or 100$ per barrel.

As was outlined within the post “It’s the spending stupid” the province must be transparent in their

calculations of oil royalties going forward. Without this information placed in the public domain, and

with key inputs such as oil price and production profiles clearly visible, it is impossible to have meaningful

public debate on the provinces finances, or spending priorities.

However, there are several obvious facts which should be stated for the reader:

The first is that the existing fields are declining fast, and even if we return to historical oil prices, their

royalty payments to the provincial government would be decreasing. This is perhaps best documented in

the Wade Locke submission to the Hebron Public Review panel12. In his submission, Locke clearly

demonstrated how the oil royalties would be decreasing without Hebron. This is summarized within Table

3.2:

Table 3.2: Royalty Payments [Ref. Wade Locke – Hebron Review Panel]

Secondly, Hebron is late and more expensive than was the case when Wade Locke presented to thereview panel. This has delayed the year of simple payout from 2019 to 2022, a fact reported by Tom

Baird , (a mathematics professor at MUN) on his twitter account following an access to information

request. The excerpt from the request is provided below:

12 http://hebronpublicreview.ca/wp-content/uploads/2011/07/Hebron-Public-Review-Commissioners-Report-

February-20121.pdf

http://hebronpublicreview.ca/wp-content/uploads/2011/07/Hebron-Public-Review-Commissioners-Report-February-20121.pdf






The reader should be reminded that the royalty prior to pay out is a modest 1%. Table 3.2 shows that

Wade Locke anticipated royalties of $88 million per year from Hebron in the period of 2016-2020. If

payout is not achieved until 2022, then Hebron will likely be contributing less than $100 million a year in

Royalties for the next 5 years.

The reader is also reminded that within the current “Estimates” the department of Finance has predicted

oil royalties of $ 1.3 billion in the 2015-2016 fiscal year. If the price of oil does not rebound significantly,

considering the reduction in production profiles, then oil royalties will be less than $1.5 billion per yearfor the remainder of the decade.

If federal government contributions to the province hold in the $1 billion range, then the province should

be planning for a combined contribution of the range of $2.5 billion, in total. When adjusted for inflation,

this is less that the province received from the Federal Government in 1997.

Brian Peckford was right in forecasting that “Someday the sun will shine...” and it did shine, but it did not

last long; a fact hastened by fundamental mismanagement of all too temporary wealth.

Personal Income and Sales Tax

Within the 2015 budget the province is planning a program of new taxes13 to assist with returning to a

balanced budget. This includes modest increases to income taxes, and the increase to the HST. Figure

3.4 provides a summary of the provincial revenue from both income taxes and sales taxes since 1997.

Again this is inflation adjusted data, coming from the public accounts.

13 http://www.budget.gov.nl.ca/budget2015/factsheets/Tax_Adjustments.pdf

http://www.budget.gov.nl.ca/budget2015/factsheets/Tax_Adjustments.pdf

http://www.budget.gov.nl.ca/budget2015/factsheets/Tax_Adjustments.pdf



Figure 3.4: Sales and Income Tax Revenues –

Inflation Adjusted

This increase in revenue from both sales tax and income tax over the past decade occurred with

simultaneous reductions in the levied rate. This dramatic increase was due not only due to the strong

local economy, but also the strong economy of Western Canada and the associated remittance payments.

However the increase, undoubtedly, was due to the robustness in world commodity prices (oil and

minerals).

With the collapse of the mining industry in Newfoundland and Labrador, and the ongoing weakening of

the oil industry, we are in a multi-year recession. Within the 2015 budget highlights document the

province predicts 5 years of negative growth, and reductions in employment. This is summarized within

Table 3.3 below:

Table 3.3: Key Economic Assumptions – 2015 Highlights Document

Over the next 3 years the weakening in the long term oil price will have a pronounced effect on the local

economy. Unemployment will increase, and wages will decrease in real dollars. Bonus’s linked tocompany’s profitability, and generous living allowances will disappear. This is on the local scene; the

collapse in the Alberta economy will also have a great impact, particularly in the rural areas of the

province. The impact is only now starting to unfold.

It is, therefore, not clear to the author how the revenues from both income and sales tax will hold steady

in the face of 4 years of negative growth. I do not believe that the increases in the tax rate will even be

sufficient to hold the current levels, let alone increase revenue.



The department of Finance should be pressured to explain the economic models used to project revenue

based on key economic inputs.

In the opinion of the Author, the provincial government should be planning for a 5% reduction in sales

and income tax revenue from 2014/2015 levels until the end of the decade. I am fearful with the

completion of the mega projects, and the long term outlook for commodity prices, even this small

reduction is overly optimistic. However, $2 billion in revenue (real 2015 dollars) is a reasonable forecast

for the remainder of the decade. Unfortunately, it would be not be surprising if the fundamental long

term weakness in the global commodities market will result in a 10-15% reduction in real sales and income

tax revenue by 2020.

Corporate Income Tax

With the increases in GDP fueled by oil and minerals exports, there has been an increase in corporate

income taxes collected by the province. This growth in real dollars is shown in Figure 3.5.

Figure 3.5: Corporate Income Tax

From the 2015 estimates document the province collected $470 million in corporate income tax in 2014-

2015 and are forecasting an equivalent number for the 2015-2016 calendar year.

It is unclear to the author how the value of corporate income taxes will remain consistent.

The Minister of Finance should be pressured to provide clarity on this forecast. As Figure 3.5 so effectivelydemonstrates, the corporate income tax in this province is pegged to oil prices and production levels.

Corporate Income taxes should therefore follow a similar trend to royalties?

In the Author’s opinion $500 million seems to be a realistic upper bound on corporate income tax for the

remainder of the decade.



Other Sources of Revenue

There are additional sources of revenue for the provincial government which make up about 25% of the

annual total. This is summarized within Figure 3.6 in inflation adjusted figure. As Figure 3.6 shows these

revenues are relatively stable, and contributed on average about $1.8 billion to the province from 2006

to 2013. This should be a fairly reasonable assumption in real dollars for the remainder of the decade.

Figure 3.6 – Other Sources of Provincial Revenue

What is the Source of the Additional Revenue?

In the above discussion the author has completed a very coarse “Top Down” assessment of the provincial

revenue for the next 5 years by each major category. This is an estimate which incorporates the general

weakening of the economy, and the likely long term softness in oil prices. The results of the above

discussion are summarized within Table 3.4.

Table 3.4: Authors Recommendation for Revenue Projections



In the opinion of the Author the province should be forecasting revenue of $6.8 billion per year, in 2015

real dollars. There should be no substantial increases in revenue until “Simple Payout” is achieved on the

Hebron field. In the current oil price environment this does not occur until 2022.

As shown in Table 3.1 the provincial government is much more optimistic in its revenue forecast for the

period from 2016 to 2021.

The province is forecasting a revenue in 2015-2016 which is nearly the same as is 2014-2015. This does

not make sense.

The figures do not even match those contained in the formal estimates document released by the

government as part of the 2015 budget. Statement II of the 2015-2016 estimates forecasts a $500 million

dollar reduction in revenue, year over year. Why does the budget highlights document, the glossy flyer,

not show a similar reduction in revenue? This is surely a question for the Premier.

However, the Premier should also explain to the people of the province the methodology used to forecast

the total revenue over the next 5 years. The projections contained in Table 3.1 are not reconcilable with

reality.

A more reasonable revenue would be $6.8 billion in real number for the balance of the decade. Figure

3.7 graphically illustrates the difference in the government’s forecast and my own.

Figure 3.7 – Authors Forecasted Revenue Versus Provincial Government

In the opinion of the Author the provincial government is overly optimistic in its revenue projections for

the remainder of the decade. The numbers seem inconsistent with the economic reality the province is

facing.

This is a very serious subject. Lofty projections of a return to a balanced budget surely have a disarming

influence on the battle for public opinion. However, the public should not be fooled.



Don Mills, CEO of Corporate Research Associates who recently spoke to the St. John's Board of Trade, is

correct when he states that we have a serious fiscal imbalance in this province. In fact, the imbalance is

so disturbing that drastic action is needed now. The glossy flyers, and the professional ads, merely serve

to provide the public an unfounded sense of security in the government’s ability to manage.

I do not possess faith in our leadership that, given these considerable fiscal challenges, it will manage the

public purse properly.

Since 2008 public policy in this province has been based on oil prices above 120 $/barrel. The government

continues to manage for the long term as if it still shares this expectation. The view is maintained despite

the massive evidence which suggests oil will be in the 70 $/barrel range for a long, long time.

Premier Davis would be wise to listen to the 2011 version of his economic advisor, Wade Locke. In

2011 Wade Locke14 could have been writing the speaking notes used by Don Mills in 2015.

In short, the party is over. The problem is, simply, this government is oblivious to that reality. Premier

Davis is just one more in the recent string of Premiers content to keep buying new party dresses.

14 https://www.mun.ca/harriscentre/policy/memorialpresents/2011c/Wade_Locke_presentation.pdf

https://www.mun.ca/harriscentre/policy/memorialpresents/2011c/Wade_Locke_presentation.pdf





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“Cheaper oil is here to stay, and energy companies need to adjust to that reality. I do think the industry

needs to prepare for lower for longer" Bob Dudley, CEO, British Petroleum, April 21, 2015

“Investors should brace themselves for more volatility in the oil market, with prices staying around

current levels for a while” Rex Tillerson, CEO, Exxon Mobil, March 2015

“Oil prices should reach a long-term equilibrium of $90 per barrel, but it is impossible to predict when

prices would return to those levels… Oil prices were poised to remain volatile in the mid -term”

Ben van Beurden, CEO, Shell

“This is my fifth rodeo. We’re going into a world that’s going to be characterized by lower, gradually

rising prices and a lot of volatility.” The shift for ConocoPhillips away from billion-dollar projects that

take years or decades to complete is rooted in a belief that crude prices could gyrate wildly for years to

come. Any price recovery in the near term will be modest, as slowing U.S. production helps push up

prices to between $70 and $80 a barrel within three years” Ryan Lance, CEO ConocoPhillips

“I’m planning for five years of low oil prices, in the low $60s per barrel” - Scott Sheffield, CEO, Pioneer

Natural Resources

"We're planning for $60 oil. I think there's still a lot of 'whistling in the graveyard' mentality.… One could

hope for $75 oil but you've got to plan for lower." Stephen Chazen, CEO, Occidental Petroleum

“We currently expect oil prices (Brent) to average around $75 per barrel for this year, below the global

marginal cost of production due to the current oversupply scenario, and increase gradually towards the

$85 per barrel mark over the next two years, as the supply becomes tighter due to the recent cutbacksin capital spending by almost all major oil companies and the growth in demand picks up to more

normalized levels” R.A, Walker – CEO Anadarko

We've assumed prices for 2017 of around $80 per barrel and then a careful rise after that” Eldar Saete,

CEO Statoil

Historians will view 2014 as the year in which the historical supply – demand relationship was

reestablished for oil. The shift was driven by a number of factors though the chief reason is technological

advance. On the supply side, proven technologies in horizontal drilling and fracking are unleashing vast

reserves of shale oil and gas. On the demand side, machines that require oil are becoming much morefuel efficient; curbing consumption in the developed economies. In the new economies of Asia, demand

for oil is slowing in those regions, too.

In so many ways the collapse in oil price is a technology story. The result is that price growth from 2007

to 2014, a period in which oil averaged over 100 USD/barrel, can be viewed as an anomaly. We are now

in for a prolonged period of volatility in which the lower prices echo the 20 year period following the oil

http://data.cnbc.com/quotes/XOM

http://data.cnbc.com/quotes/PXD


http://data.cnbc.com/quotes/OXY





http://data.cnbc.com/quotes/XOM



crisis of the 1970’s. Figure 4.1 clearly communicates that the oil price spike from 2006 to 2013 may well

be considered just a spike15.

Figure 4.1: Inflation Adjusted View on Oil Price

A geopolitical crisis can always change the price equilibrium. But, as is evident from the quotes that

prefaced this post, oil companies are adjusting for a fundamental shift in the present oil economy. They

are cutting staff and reducing costs to an extent which documents their belief the slowdown is not a short

term phenomenon.

Due to our exposure to the oil and gas sector, Newfoundland and Labrador will be particularly hard hit by

the downturn. The province has been caught flat-footed. The collapse in current oil revenues (i.e.

royalties) have had a dramatic impact which is being mitigated only by massive governmentborrowing. However, as the price remains depressed for longer periods, the reductions in other revenue

sources (Income tax, sales tax) will only exacerbate the revenue shortfalls. Alas, the long term solution is

not sustained borrowing.

15 http://www.zerohedge.com/news/2014-07-23/annotated-history-world-oil-price-shocks



The oil price collapse has necessitated the requirement to have a serious conversation and an action plan

for our future. A dose of fiscal reality, perhaps, is just what this province needs.

A Record of Stimulated Unsustainability

The Progressive Conservative Government started out with good intentions to manage this new energyfueled wealth. Their tenure began in 2004 with a reduction in government spending. In 2007 the

government generated a long term plan to shape our energy strategy16. Contained within the Energy Plan

was a projection for long term oil prices, as shown in Figure 4.2.

Figure 4.2: Long Term Oil Projections – 2007 Energy Plan

By 2008, the government had forgotten about those long term projections. They began to make long

term decisions based on short term oil prices. Taxes were cut, government spending was increased by

35%, and infrastructure projects were initiated. The fiscal policy changes were enabled by peak

production and record oil prices, which occurred simultaneously.

In consequence of all this stimulus, the provincial government took a fundamentally strong economy and

made it “white hot”. Salaries were raised at a pace far outpacing inflation. It fueled a real estate boom,

and caused an increase in the cost of doing business in Newfoundland and Labrador. It impacted our long

term competitiveness on the global market.

The government’s economic advisor, Wade Locke, said that stimulus was a good thing17.

In 2013, it was difficult to argue otherwise. People were making small fortunes from real estate

valuations; new graduates in skill trades and professions could look forward to six figure salaries after a

couple years of getting their ‘ticket’. But, the boom was unsustainable.

Now, in 2015, it is clear that the government did exactly what it should not have done. Fundamentally,

they initiated stimulus during the boom. They made long term policy changes, such as increasing the size

of the public service, based on a short term spike in oil prices. They implemented major public works

projects at the exact time that we were executing mega projects. The measures contributed to cost

16 http://www.nr.gov.nl.ca/nr/energy/plan/pdf/energy_report.pdf17 http://www.mun.ca/care/Locke_Presentation_Mills.pdf

http://www.nr.gov.nl.ca/nr/energy/plan/pdf/energy_report.pdf



http://www.nr.gov.nl.ca/nr/energy/plan/pdf/energy_report.pdf



overruns on Hebron, and on other offshore developments. The inflationary impacts will be the cause of

lower royalties when those facilities come on line.

Oil and government policy, from 2006 to 2010, initiated an unprecedented boom. However, it was the

stimulated expansion that fundamentally destabilized the long term economic stability of the

province. Now, as we commence a predicted contraction of the economy (i.e. a recession) following thecompletion of several mega projects, the collapse in the oil price will only serve to magnify all those

negative impacts.

We need to ask: what should the government be doing in terms of fiscal policy?

Continued Stimulus or Expenditure Cuts?

The prevailing economic thought is to take advantage of low interest rates, and fuel stimulus to “ride out”

the economic downturn. Despite the claim of an “austerity budget” the government is actually increasing

spending in 2015. They are borrowing heavily to fund both infrastructure and current account (program

expenditures). The 2015 Budget is, in fact, a stimulus budget; it just happens that the stimulus is less thanin the previous five budgets!

Let's ask: is continued stimulus the correct action to take? Or, should the government of Newfoundland

and Labrador make long term adjustments to reflect the new oil reality, and to correct the fiscal

imbalance?

Based upon the analysis provided in Chapter 3, it is clear to the Author that the government should be

basing their mid-term policy on annual revenues in the $6.8 billion range. The Finance Minister is

projecting long term spending in the $7.5 billion range. As shown in Figure 3.7, in the absence of any real

reduction in government spending, or a major increase in oil prices, we will be running $700 million

deficits for the next five years.

This is the fiscal imbalance to which CRA pollster, Don Mills, recently referred!

To correct it, we must first recognize that we have one.

The government refuses any such acknowledgement.

They are happily whistling past the graveyard.



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When it comes to recognizing the fiscal imbalance, the political leadership of the province are whistling

pass the graveyard. But government inaction is not limited purely to the deficit. They are failing to make

concrete actions on many of the larger issues facing the province today.

In a nutshell, they default to the “politics of optimism”. Whether revenues from Muskrat Falls or the vast

untapped wealth of the Newfoundland offshore, government policy and communications are entrenched

in hyperbole. This excerpt from the 2015 ‘Speech From The Throne’ is an example:

Our government is buoyed with optimism as our people begin to come into their own, enjoying

the highest levels of income ever in our history, employment levels that are higher than a

decade ago, and a vast array of initiatives that enhance the lives of the oldest to the youngest

among us. Our government is managing the affairs of the province responsibly, progressively

and sustainably to ensure the incredible gains we have already achieved are eclipsed only by

the phenomenal gains that we are about to bring to fruition. Newfoundland and Labrador is

stronger today than it has ever been, and we are on course to achieve goals that will benefit

our people for generations to come. Our government is filled with confidence and optimism

that the prospects for Newfoundland and Labrador, both in the short term and over the long

term, are incredibly bright. Ours is a future that knows no bounds, and we shall ever remain

resolute in defence of this province we so dearly love – Newfoundland and Labrador, proud

and strong.

This is a speech, and a theme, we have heard many times over the past 5 years. Of course, the politics of

optimism is an easy road for any politician. Difficult issues require tough and politically unpalatable

decisions. It is much easier to talk about future greatness; validating, by default, present day largesse.

Although we now experience a fiscal imbalance, nurtured since 2006, it can be corrected with common

sense, discipline and the ordinary application of restraint.

However, this government have had their heads in the sand with even the bigger issues. They have not,

for example, used the fiscal liberty afforded by offshore wealth to address the single largest issue they

have inherited; the province’s aging demographic. It is an issue even more daunting than the fiscal

imbalance.

The problem requires a plan that will span more than one or two election cycles; it will require a plan that

must bridge partisan politics. Most importantly, it should be concrete and achievable.

Like the provincial plan to return to balance budgets, the recently released "Population Strategy"18 does

a tremendous disservice to the issue. As Figure 5.1 so effectively demonstrates, the rural Newfoundland

and Labrador we picture in our memories is no more. Instead of young children playing on the shore, or

young families building a livelihood on the sea, rural areas will be, by 2040, almost 50% populated by

18 http://www.thetelegram.com/News/Local/2015-06-25/article-4194367/Province%26rsquo%3Bs-new-

population-growth-strategy-short-on-specifics/1

http://www.thetelegram.com/News/Local/2015-06-25/article-4194367/Province%26rsquo%3Bs-new-population-growth-strategy-short-on-specifics/1





seniors. When you study the projection of youth (0-19) and see how, in 2035, it is nearly the same as in

2016, you can’t help but think that even this projection is optimistic.

Figure 5.1: Population of Rural Economic Zones

The servicing of rural Newfoundland, and the fiscal imbalance we currently have are undeniably linked.

Both are unsustainable in the long term. But the issue of our aging outports will inevitably be a crisis

within the next 20 years. No extent of government spending will avert this outcome in the majority ofrural communities.

Instead of facing the clear reality of the future of rural Newfoundland and Labrador, our politicians and

many leaders default to the rhetoric of blind optimism as demonstrated in the throne speech. They do

have their heads firmly in the sand!

The crown prince of the charlatans is none other than Nalcor’s CEO Ed Martin.

The Nalcor head does the province no favours when he refers to Newfoundland and Labrador as the next

North Sea19. Whether it is his claim to the “new North Sea” or to the amount of revenue that Nalcor will

one day provide to the government of Newfoundland and Labrador, Ed Martin has a level of optimism

which is not shared by his peers in the industry.

The problem is that the politicians seem to believe him because his proclamations are made without

challenge.

19 https://theogm.com/2014/10/20/newfoundland-future-outlooks-from-ed-martin-president-and-ceo-of-nalcor-

energy/

https://theogm.com/2014/10/20/newfoundland-future-outlooks-from-ed-martin-president-and-ceo-of-nalcor-energy/







Although I fully support Nalcor’s work in deepwater exploration, we should not be making long term policy

on 2D seismic, and on exploration wells yet to be drilled. We need a more cautious approach. One ought

to look to Greenland to understand how a world class oil play can be put on ice after a couple of

unsuccessful wells.

When it comes to fiscal planning in the current global oil environment, we need to err on the side of

caution. I suggest we should plan only for the new Bay du Nord discovery and the Hebron oilfield,

currently under construction. Those two new offshore assets might result in oil royalties of the magnitude

earned during the period 2008 to 2012.

If oil returns above 100$/barrel, we could have an additional $2 billion in annual revenue in the period

from 2025 to 2035. Beyond this expectation, we should not be counting on any new oil developments. If

they happen: great!

But they should not be the basis of our long term economic policy. The issue is central to the question I

raised in Chapter 3: should we continue to borrow, and inject economic stimulus from 2016 to 2023, the

likely start date of significant royalties from Hebron?

The answer to the “stimulus” question is clearly, NO!

We need to correct the fiscal imbalance now so that if and when a second “oil boom” occurs, we will have

the ability to build a true “generational’ fund for when the oil runs out. We must learn from the mistakes

we made in the period 2006 to 2010. In that way we can properly plan in the event another boom occurs

in the period 2025 to 2035.

We must correct the current fiscal imbalance within the next 5 years. That is the only way we can ensure

that the royalties from a second oil boom are not used to simply maintain wage growth in the inflated

public service, and to service our ever increasing debt. If we get this second chance, we should use it for

the "generational fund"20 that the current group of politicians love to dream about.

That said, when you examine the aging demographic profile of the province, it is clear any “ generationfund” sourced from the second oil royalty boom (2025-2035) will not be a fund in the conventional sense

of the Norwegian endowment21. Rather, it will have to be used to implement a major resettlement

program for the hundreds of rural towns in this province. Any future generational fund will be simply

applied to correcting the impending demographic crisis in rural Newfoundland.

By 2030, the issue can’t be ignored any longer. We will need the massive oil royalties from Bay du Nord

and Hebron to deal with the humanitarian “crisis” which outport Newfoundland will become. ‘Crisis’ is

not too strong a word. I suggest the government and the public are naive to think otherwise.

We need to plan for that crisis now. We need to start trading in reality. The issues at stake are far bigger

than partisan politics.

20 http://www.cbc.ca/news/canada/newfoundland-labrador/paul-davis-announces-generations-fund-at-election-

style-kickoff-1.304521521 http://www.huffingtonpost.ca/2014/01/11/oil-fund-norway-millionaires_n_4576887.html

http://www.cbc.ca/news/canada/newfoundland-labrador/paul-davis-announces-generations-fund-at-election-style-kickoff-1.3045215


http://www.huffingtonpost.ca/2014/01/11/oil-fund-norway-millionaires_n_4576887.html






6 G

ETTING

B

ACK TO

B

ASICS

As Posted on Uncle Gnarley on July 6, 2015

Oil has done many great things for Newfoundland and Labrador. It has diversified our economy,

generated wealth, provided tremendous opportunities for our young people, and given us a glimpse into

a truly global industry. Oil has fundamentally changed this province, the people, and our culture. We can

attribute to it a collective confidence on a level never conceived in the pre-oil Newfoundland and

Labrador.

But it can be argued that it has also incubated an undertone of both arrogance and invincibility, a condition

which has particularly plagued our political leadership. It has led to us to think, dream, and spend, as if

we had made the economic big leagues. From the mammoth Muskrat Falls public works project to the

35% increase in government spending, not once did we consider our exposure should oil prices return to

their historical (and far lower) valuations.

History has repeated. The oil price collapse has demonstrated just how weak our economy really is.

As we move into a Fall election, voters should seek a strong fiscally conservative government; one willing

to correct the fiscal imbalance which exists in the province. The problem needs to be corrected now in

order to ensure that if the second “oil boom” occurs in this province (2025-2035) we will have the ability

to make long term investments from the excess oil royalties; we should plan not to be left with even

higher debt, debt service costs and salary obligations to a bloated public service that the government

created during the past few years.

Within the next two posts, on Uncle Gnarley Blog, I will focus on the issue of short to medium term budget

planning.

I suggest it is vitally important, over the next five years, that we encourage our government to get back to

basics in the day to day business of providing strong management to government. We must correct thefiscal imbalance and get back to balanced long term budgeting. Only by implementing tough measures

now, will we be able to truly benefit from the second anticipated royalty boom in the province and, in the

process, provide much needed long term sustainability.

This 5 year plan will involve ideas for both raising revenues and cutting taxes. But the plan must be

gradual. For that reason, the remainder of this post will consider the first step in reducing the fiscal

imbalance: raising new revenue.

Increasing Revenue – A Modest Proposal

By nature I am a fiscal conservative. I believe that raising taxes hurts the economy. However, history in

this country, and in the province, clearly documents that premature tax cuts are more dangerous to ourlong term economic stability than raising taxes.

The tax cuts of the 2006-2010 period were premature. Although Dwight Ball is correct when he states an

HST increase is a “job killer”, I believe the changes implemented in the 2015 budget were necessary.

Fundamentally, the current government has only corrected their previous mistake of lowering the HST

and cutting income taxes, in the first place.



As identified in Chapter 3, due to our heavy reliance on oil royalties, the small changes in taxation in the

2015 budget will have a minor impact on revenue growth. The small increases implemented in 2015 will

only serve to stabilize revenue in the face of a weakening economy.

The author will suggest some other modest, but important, actions the government can take to increase

revenue:

1. Implement a tax on junk food:

The spiraling cost of health care is unsustainable. The problem is due, in part, to the relatively poor health

of Newfoundlanders and Labradorians, as documented in a recent report identifying 30% of residents as

obese. The problem is due in no small part to the lack of affordable fresh foods, and a culture that

promotes unhealthy eating.

By taxing junk food and fast food you are rightly penalizing the industries which contribute to an unhealthy

culture. By taxing junk food, you are following the government’s practice of taxing ‘vices’ such as tobacco,

and alcohol. Hence, it is very reasonable to consider a tax on ‘junk food’, which includes fast food. A

sample calculation on how much revenue the measure would generate is provided below:

Consumers 400,000

$/week $10 per week

Suggested Tax 15% (Double the provincial portion of the HST)

Revenue $30 Million annually

The increase may seem high, but this is a token tax! I suggest the revenue should be used to promote

healthy eating habits, and to subsidize local agriculture. In addition, I suggest one of the greatest legacies

of Muskrat Falls (possibly the only one) might be that ‘surplus’ power is used to power large greenhouses

on the West Coast of the island.

But do not sigh if you are thinking a comparison with Sprung!

Greenhouses, located on the West Coast, would have a longer natural growing season. The initiative

would lead to rural diversification. It would stabilize the security of our food supply. Greenhouses which

grow tomatoes, peppers, greens, and other produce would serve to lower costs, and provide more

nutrition to citizens of the province.

This is not 1988. The province is now better ready for the development of a large greenhouse complex.

The real financial benefit: eventual savings in health care. The larger issue of health care is beyond the

scope of is paper, but there is considerable literature which establishes the link between healthier living

and lower health care costs.

The eating habits of Newfoundlanders and Labradorians are some of the worst in the world. The problem

very directly relates to our record of relatively high spending on health care services. I suggest it is time

to tax the culprits who produce these products and encourage local, healthy and sustainable nutrition.



2. Corporate Income Tax

The Provincial Government should prepare and release benchmarking which compares corporate tax

rates in NL (combined with the federal tax) with other provinces in Canada, and against other jurisdictions

in the world. For reference, NL has the 4th highest corporate tax rate in Canada. Accordingly, we should

not forget that our corporate tax rate should remain competitive, internationally. Due to the federalreductions offered by the Government of Canada, there may be an opportunity to increase provincial

rates. We need to, at least, be at the OECD average and better than the rates applied in other oil centers.

As shown in Figure 6.1, there may be an opportunity to increase corporate income tax by 1-2% and remain

competitive. As with income tax, the provincial government may be able to take the recent reductions

offered by the federal government.

Figure 6.1: Comparison of Tax Rates

For various reasons, the idea of raising corporate income tax is not one to which I subscribe. But the

necessity to increase revenue is influencing this recommendation. Presently, corporate taxes provide

about $400 million annually to the province. I recommend targeting a 10% increase. The measure has

the potential to yield $40 million per year in new revenue.

Corporate Income Tax $40 Million per year

3. Targeted Returns From Nalcor

Within the 2015 Budget Highlights document, the government alludes to the large revenues which Nalcor

will generate. They failed to mention two very relevant facts regarding how this revenue stream is

produced: (i) the province has been borrowing equity to provide Nalcor the “complete payback” it



promises by 2025 (the amount excludes the interest paid by the province) and (ii) any such revenue is

largely coming from the pockets of Newfoundlanders; essentially it is a tax on electricity rates.

The reader might wish to consider that the annual interest payment, alone, on the Muskrat Falls project

will be about $320 million (composed of interest on the $5 billion Federal Loan Guarantee and interest on

$3.2 billion borrowed provincial equity). If all the energy were sold on the open market, assigning no feefor transmission, the sale will yield only about $195 million (3900 GWhr at 50$/MWH). Any revenues

coming from Muskrat Falls, therefore, are from our very own pockets.

A more balanced view of the revenue stream from Muskrat Falls can be found in the following reference

in an article posted on The Sir Robert Bond Papers Blog entitled "Muskrat Falls: delayed dividends, more

equity needed22.

That said, I suggest the province should mandate Nalcor to provide dividends to the province in an amount

sufficient, at least, to pay the interest on the equity the province is borrowing to pay for these projects.

The amount would be in the range of $120 million per year.

In the period of 2016-2020 an anticipated $120 million dollar dividend from Nalcor is a high expectation

anyway. Nalcor might achieve this target but only if it cuts costs, and reduces employees, and employee

benefits, like every other energy business in the world. Therefore, we might ask: why has Nalcor CEO Ed

Martin not implemented those market intervention strategies already?

Nalcor Targeted Revenue $120 million per year (the figure is higher post 2020)

4. Hibernia Holding Corporation

Most readers are aware that the Hibernia Holding Corporation (HHC)23 is a federal holding company which

owns the 8.5% federal stake in Hibernia. The company is listed in Calgary, not Newfoundland andLabrador. It is a very profitable investment for the federal government.

The province has tried many times to get the federal government to transfer this 8.5% ownership. The

federal government has retorted with the entirely reasonable position that the stake should only be sold

at fair market value. (As an aside, I would like to know if this Alberta registered holding company pays

provincial corporate tax to the NL government.)

Although not a direct source of revenue, I suggest the province of NL should argue, given that the federal

government has already made their investment back on the Hibernia development, the revenues from

the HHC should now be re-invested in deep-water exploration in Canada. Federal government revenues

from the HHC should be reinvested in a Petroleum Incentives Program or “PIP” grant type of program forCanadian deep-water exploration (all Provinces). This approach would certainly be a more palatable

position to the rest of Canada.

Uncle Gnarley might be mortified at the thought Nova Scotia might benefit from Hibernia revenues.

Likely, he remembers how Nova Scotia betrayed Newfoundland during negotiations for the original 1985

22 http://bondpapers.blogspot.ca/2013/02/muskrat-falls-delayed-dividends-more.html23 http://www.albertaoilmagazine.com/2013/05/murray-todd-hibernia-holding-corp/



Atlantic Accord. However, I am hoping the industry has matured. Newfoundland and Labrador companies

would gain tremendous benefit from deep-water developments in Nova Scotia as well as in Newfoundland

and Labrador. Indeed, I suggest we should encourage more such corporations, not fewer. Two deep-

water plays would, in fact, de-risk the long term outlook for Canadian offshore companies who, by and

large, are situated in St. John’s.

A joint lobby, by the coastal provinces, to use HHC revenue for deep-water exploration would perhaps

increase the likelihood of a positive result. The increased revenue from the deep-water exploration could

help the provincial coffers of NL, NS, and the federal government.

5. Income Tax

The province has increased taxes on the highest earners. The author is in agreement with this tax

increase. However, I am not an advocate of additional increases in income tax.

Authors Note:

Since writing this initial post I have revised my opinion on the subject of income tax. A review

of the provincial income tax levels24 suggest that perhaps we have room to increase income taxwithout having significant impact on our competiveness. I would argue that the current financial

challenge would necessitate a 15% increase in the total income tax. This would contribute an

additional 150 million to the provinces revenue. This would keep us competitive to the Atlantic

Canada benchmark.

6. Raising Minimum Wage

The debate regarding minimum wage has existed since Eisenhower implemented the concept in the

1930’s depression era. I will not go into the debate either way, as there are many excellent papers

reflecting arguments, for and against, easily available upon a quick Google search.

Newfoundland and Labrador has some unique challenges which, in the opinion of the author, justify an

increased minimum wage.

I would recommend an increase to 15 $/hr.

Other fiscal conservatives might decry this position. They would argue over the loss of competiveness

and its impact on job growth. A higher minimum wage likely will have an impact on job creation. A massive

increase in minimum wage might even result in the disappearance of some minimum wage jobs. But, in

future, this province will be challenged to find sufficient people to fill those low paying jobs. Presently,

we struggle to get people on social assistance into the work force. We find it hard to attract and retain

immigrants.

Such a drastic increase in minimum wage would help overcome both these challenges. Naturally, themeasure would substantially improve the purchasing power for those people whose career depends on

the minimum wage. In turn, it will help the economy and increase tax revenue to the province. In addition,

precisely because an increase in minimum wage will help attract immigrants, it should be a key part of the

province’s population growth strategy.

24 http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html



There are those who will argue that minimum wage will hurt business. They forget that, in the global

sense, Newfoundland and Labrador is not a cheap labor jurisdiction. We will never be able to compete

with China, Vietnam, Malaysia, or the southern United States, when it comes to wages. This is not 1996;

cheap labour should not be a cornerstone of our economic diversification efforts.

A problem of far greater concern is that Newfoundland and Labrador suffers from a massive problem of

competitiveness. The issue is not related to our minimum wage level. Indeed, there are many other deep

rooted reasons for our loss of global competitiveness. I would recommend the reader study the excellent

report recently generated by the Conference Board of Canada25 report on the subject.

One of the most intractable problems, exhibited by graphs contained in the Conference Board of Canada

report, is the alarmingly low amount of business expenditures on R and D in the province. Despite

numerous government programs to stimulate R and D spending over the years, the business community’s

record remains deplorable. This problem cannot be blamed on minimum wage workers. Lack of R and D

uptake sits squarely with the managers and owners of business.

Plenty of reasons abound to consider raising the minimum wage a progressive move. I suggest a $5 an

hour increase can be implemented over the next 5 years.

Figure 6.2: Rankings of R&D Expenditures

I submit, in the most polite terms, the ideas presented here are modest. Worryingly, there are limited

opportunities for new revenue generation in the province. Readers are encouraged to submit their ideas

in the comments section.

Finally, I would add it should be clear to all that the fiscal imbalance will not be corrected by increasing

revenue. That problem will require a fundamental change in how the province spends public money. The

next Chapter will examine some areas where spending controls might be implemented.

25 http://www.conferenceboard.ca/e-library/abstract.aspx?did=6956

http://www.conferenceboard.ca/e-library/abstract.aspx?did=6956





7 R

IGHTSIZING

E

XPENDITURES

-W

HERE THE

R

EAL

W

ORK IS

N

EEDED

As Posted on Uncle Gnarley on August 3 and 6, 2015

John Maynard Keynes is perhaps one of history’s most influential economists. His theories regarding the

requirement for state intervention to moderate the natural “boom-bust” cycle of an economy has been

especially en vogue since the financial crisis of 2008. The basic premise of the theory is that government

should borrow in periods of slow economic growth (or during a period of retraction), invest in

infrastructure, and then manage the economy until it is stronger.

In Newfoundland and Labrador, since 2006, the government has perhaps done the opposite of what

would be advocated by Keynes. Despite a strong economy fueled by mining and offshore developments,

the Provincial government commenced, in 2006, a series of programs to further stimulate the economy.

They were represented by a general increase in spending of some 35% in real dollars, tax cuts, and a series

of large infrastructure developments. The latter included the massive Muskrat Falls public works project.

The result was that in 2012 the political leadership proudly proclaimed our economy to be “white hot”

The white hot economy was fueled by government stimulus, which, in turn, inflated salaries, drove up

project costs, and allowed housing prices to increase at a pace far outside of inflation. It was simply not

sustainable and I am deeply afraid it will have a long term negative impact on the economy.

The result is that with an economic downturn driven by low commodity prices the province does not have

the financial strength to be able to implement additional stimulus. (I say “additional” as we are presently

running a $2 billion cash deficit).

Newfoundland and Labrador is an economic nomad. We must get back to basics.

As shown in Figure 3.7, a more realistic estimate of government revenue would suggest that governmentspending has to be reduced by about 10% to be sustainable over the next 5-10 year period. In the opinion

of the author, the government should implement a 5 year plan to remove at least $700 million annually

from the spending side of the budget, representing 10% in real dollars.

Cutting 10%, in real dollars, is a daunting task. However, it is a required action for a responsible

government to make. After studying the estimates, I have attempted to identify where cuts might be

make. The following is a list of the modest ideas of the author. Comments and suggestions are welcome

in the comments section of the blog.

1. Public Service

In 2013 the province spent $3.8 billion on salaries. Based on a long term revenue of $6.8 billion, the

provincial government will be spending 55% of their revenue on salaries. Next to commodity pricing, the

size of the public service is the biggest threat to economy of the province. The salary commitments will

preclude the province from making key infrastructure investments, lowering taxes or other key initiatives

to help diversify the economy. As our population ages, and the requirements for health care increases,

the ability to serve these needs will be limited by the number of people the province has on staff.



The salary growth of the public service employees will also limited by the size of the public service. The

top employees in the provincial government should, therefore, be just as concerned about the size of the

public service, as I am!

There should be no doubt that any reduction in public spending needs to start right here. The author

recommends that the government implement the following actions:

10% head count reduction in all departments other than health. This includes Nalcor,

MUN, CONA, and other government agencies.

5% head count reduction in health.

However, in the public interest, union agreements will have to be ignored. The reductions should be

across all levels of government, and all positions (management and front line workers). But it should not

be based on seniority. It should be based on performance! The province should get rid of the dead wood!

As most people in business will tell you, a 5%-10% cut in head count will actually lead to better output.

The reason is that if you reduce head count based on performance, as opposed to seniority, you maintainyour best employees. The “lowest common denominator” is increased, and the improved output is

increased. Managers will tell you that the bottom 10% of staff take 30% of their time to manage.

I am sure people will laugh when they read this recommendation. My mother, who is a long time NAPE

organizer, certainly did! She told me that the union would never agree. The union management would

never agree, but what about the membership?

Most people are not oblivious to the government's predicament. They know that their future raises, and

pensions are all threatened by this fiscal reality. Most union members also know that the ability to remove

under-performers, will actually make life better for the average worker. People don’t like working

alongside dead wood. It makes their job harder, and their workplace less pleasant.

The province needs to tackle the size of the public service, first by cutting poor performers, but remaining

staff ought to have the opportunity for better compensation. I suggest they should be offered an annual

bonus mechanism linked to oil prices. If the price of oil increases, and there is an increase in revenue,

then part of that upside can be shared with them. This type of bonus mechanism would represent a better

compensation model than long term increases to salaries.

Of course, the unions would have to agree. On this account, I am not optimistic!

However, I would mandate that NAPE (and other unions) put the proposal to their membership. The

membership should have an opportunity to give input into the direction of the required austerity. Giventhe choice of a 5 year wage freeze, and a strong likelihood of a cut based on seniority, or a 10% cut based

on performance, I am pretty certain that human nature would prevail.

After explaining this to my shop steward mother, she lamented: “in a secret vote, I would probably vote

yes to that proposition”.



A cut based on performance based on seniority is the only way to maintain quality of service while facing

our current economic realities. This should result in savings of ~250 million per year. The cuts should be

implemented over a 3 year period.

But I am fearful that even this magnitude of a cut will not be sufficient.

2. Professional Services26

As documented in Chapter 3, government spending on professional services has gone from $280 million

per year (1997-2003) to almost $500 million a year in real dollars. As recently documented in the AG’s

Report, many issues remain unanswered regarding how this work is identified, and how the contracts are

awarded. I am not sure if people in government truly recognize how out of step the province is with OECD

best practices for awarding such work. By comparison, the system in this province is in great disrepair.

In the face of the current reality, I would cut $75 million from professional services over the next 3 years.

This is a coarse analysis. But departments should be tasked with doing the work in-house. Any work that

has to be subcontracted, should be done in a manner that utilizes the public tendering system. No longershould consultants be selected by the Minister, with budgets based on a proposal, as opposed to a

competitive tender. In addition, distribution of work among consultants should be based on performance,

rather than on political connections.

I believe a good part of this targeted savings proposed could be achieved with true public tendering, using

professional services only for “real” requirements; those that truly cannot be provided in -house. One

example of an unnecessary consultancy is the engagement of a consultant in to review how consultants

are engaged. This is work that can easily be conducted in-house; the skill-set available at Confederation

Building is simply not that deficient.

But the first step in cutting cost is to understand what comprises the $500 million spent each year inprofessional services. It is a staggering number; one that is completely disproportionate to virtually any

metric for a province of its size and budget.

3. Executive Council

The amount spent on executive council has grown from $19 million in 1995 (in 2015 dollars) to $60 million

in 2015. There are several actions which should be immediately implemented:

Women’s Policy Office: The province spends $4.3 million per year on this Office. I would take this

outside government, and give 50% of the budget to the Status of Women Council to undertake

the mandate.

Office of Climate Change and Energy Efficiency: This is an office with a budget of $1.13 million. I

would eliminate it, and transfer the responsibilities to the existing staff within the Works Services

and Transportation.

26 Please note that following this post the Author realized that a portion of “Professional Services” is allocated to

Medical Doctors, and not all truly consulting services.



Office of Public Engagement: The Office has an annual budget of $5 million. I would remove it.

It should be completed by the existing communications people in each government department.

Alternatively, the government should remove the communications staff from each department.

There are simply too many communications staff in government.

Human Resources Secretariat: Consolidation of the several of its departments including “openingdoors”, “strategic staffing”, “strategic management” - too many managers.

Office of Chief Information Officer – hold all enhancements to IT programs.

Labrador and Aboriginal Affairs Office – annual budget $4.2 million. With 4 MHA’s I am sure the

budget of this department could be cut 50% if not eliminated entirely.

Muskrat Falls Oversight Committee: This committee is duplicating work that Nalcor completes

internally; it provides little, if any, real oversight of the project. Mandating Nalcor to post all

internal monthly reports on the internet would negate the need for this entire oversight exercise.

With the information in the public domain, the media would complete the role of the oversightcommittee, in its current form.

Communications: Again, we are a province of only 500,000 people. I suggest a review of the

entire government communications with the goal of benchmarking the staffing complement to

private industries of similar size.

4. Legislature

The Legislature division of government has a $30 million budget in 2015. In 1995, its budget was $10

million, in 2015 inflation adjusted dollars. There has been considerable growth in the cost of the services

this allocation is intended to fund. They include: the office of the Auditor General, Chief Electoral Offices,

Citizens Representative, Child and Youth Advocate, and Information and Privacy commissioner.

I would reconcile the Child and Youth Advocate, Information and Privacy Commissioner, and the Citizen

Representative into a single Ombudsmen office. Some may argue that this would weaken the service to

the weakest members of society. However, history has shown the greatest weakness of these separate

offices is the public actually knowing they exist. A single agency for which those in need could contact,

would be a much stronger in this regard.

Could a single agency perform any worse than the current incantation27?

5. Advanced Education and Skills

This is a broad ranging department with an annual budget of $870 million representing a considerable

expenditure on grants as well as programs. I would recommend a full review of this department,

particularly in the area of rural presence. As part of this discussion we need to challenge the requirement

27 http://www.ctvnews.ca/canada/n-l-s-child-advocate-not-aware-of-most-deaths-since-2009-1.2022498



that this department should have representation in so many nooks and crannies of the province.

However, some immediate actions might include:

Atlantic Veterinary College: Eliminate the $1.2 million grant for “seats”. Let students apply

competitively.

MUN: An additional cut of $20-30 million. Memorial University is getting fatter to server fewer

local students. A reality check is needed. The first of those “reality checks” is that a province of

500,000 people can’t have a world class university, across all faculties. It is irresponsible to even

suggest it. The university should review whether we should even continue with some of the more

expensive faculties. Perhaps the med school, for example, should be reviewed. Although the

budget comes via the Department of Health, the MUN medical school has an annual budget of

$60 million per year. It accepts about 80 students per year; only about 60 are local. Is it not more

cost efficient to pay other universities to train our medical students in more of the disciplines?

Medical schools are controversial topics. So too is tuition. Newfoundlander’s tuition is too low,

and has to be increased. Tuition fees should be increased by 25%.

College of the North Atlantic: The College has 17 campuses located in Newfoundland and

Labrador. This model was acceptable 25 years ago, when students from Fogo had perhaps never

been further than Gander. Things have changed. Students from rural areas of the province are

decreasing in numbers, but they are becoming worldlier. CONA has to reconcile their campuses.

I would target a reduction to 5.

6. Transportation and Communications

Within the annual “Estimates” document which is produced with each annual budget, there is an

informative graph which presents “Where the Money Goes”. The following is the excerpt from the 2015

budget Estimates28

Figure 7.1: Where the Money Goes - 2015

28 http://www.budget.gov.nl.ca/budget2015/estimates/estimates_2015_16.pdf

http://www.budget.gov.nl.ca/budget2015/estimates/estimates_2015_16.pdf

http://www.budget.gov.nl.ca/budget2015/estimates/estimates_2015_16.pdf



In 2015 the province spent $324 Million in transportation and communications. As shown in Figure 7.2

this value has increase by about 120% in real dollars since 1995.

Figure 7.2: Transportation and Communications Costs – Inflation Adjusted (In Millions)

One can’t review the budget allocation for “Transportation and Communications” without having a much

larger discussion about services to rural Newfoundland. Those costs need to be reduced, allowing an

historical reference point to guide future expenditures.

One controversial topic is the cost of providing coastal boat services. I suggest that, within the next five

years, we must cut all coastal boat services to any area having a population of less than 500. Taxpayers

can no longer support communities where the cost of a single service is completely disproportionate to

its economic contribution. We pay $80M annually on coastal services for less than 15,000 people. That is$5,000 per person per year! As the rural population declines the per capita number will just increase. As

politically unpalatable as all governments regard the subject, I suggest we need a discussion now, to

properly plan for specific community relocations.

A similar discussion can be had regarding road and bridge upkeep. The province’s infrastructure is in very

poor condition. Like the coastal boats, this infrastructure cannot be maintained in the smaller areas for a

diminishing population, regardless of what politicians say.

Notwithstanding the need for a 10% cut across all government expenditures, transportation and

communications cannot be neglected. I would target a reduction of $30 million from current annual

expenditures.

7. Health

Like transportation, there can be no discussion about downsizing government in the absence of a real

debate on the future of health care. I suggest the discussion needs to be focused on three key points.

They are:



I. finding efficiencies in system delivery

II. public – private components of the system - we need to deliver more services with the use of

private companies.

III. rural services

Given our aging population, it is not reasonable to decrease the total health budget (other than through

the reduction of staff as mentioned in item 1 in the previous post). The province should hold the line on

current expenditures as it seeks ways of providing more efficient services.

The health care field contains many places where efficiencies can be found and abuses eliminated. We

need to begin identifying the most egregious and start correcting them. But real change should begin at

the top and not just with administrators. Physicians should not be the oligarchs of Newfoundland society.

They are public servants, too.

8. Pensions

Although the province has recently made some much needed change to the public service pension plan 29

government’s claims to long term sustainability seems suspect, considering how minor the changes.Additional data should be released to substantiate the claims, especially the assertion of an 84%

probability the plan will be self-funded in 30 years.

I suggest the government needs to implement the following changes immediately:

1) New employees should have a defined contribution plan rather than a defined benefit.

2) The minimum retirement age should be 65 or 35 years of service.

3) There should be no double dipping on pensions permitted.

4) Pensions should not be based on the best 5 or 7 years earnings of an employee. The pension should

be indexed exactly to the average annual salary over the full duration of the employee’s period of

employment.

Anyone in the private sector who has directed that their financial advisor determine their annual RRSP

contribution, to ensure 70% of their best 7 work years, indexed, and with medical benefits, will truly

understand how difficult it is to retire at age 60.

Each of the eight ideas for cutting 10% from the annual budget could justify a lengthy and detailed post.

So, these comments constitute a mere beginning. Hopefully, readers will weigh in with their own views.

However, one thing is certain: as I studied the estimates in order to address the question “where would

I cut?”, I quickly concluded it is impossible to arrive at real cuts unless a fundamental shift in the way

services are delivered to the rural areas of the province is contemplated.

In addition, whether it is the College of North Atlantic which operates 17 separate campuses, or the

unrealistic demands for a plethora of health care services in areas with small populations, we can’t have

a real discussion on reducing the budget without addressing the two other major issues.

29 http://www.exec.gov.nl.ca/exec/hrs/pensions/PSPP_presentation.pdf



The first of those is the aging demographic, which is a crisis unfolding in front of our eyes - in both the

rural and urban centers.

The second is the reality that the small outport way of life can’t be resuscitated, in spite of the amount of

government money devoted to the attempt.

My personal story reflects that reality.

The town in which I spent my formative years has a population of about 250 people; the average age is

65. I will never live permanently in that community again. This is a choice made irrespective of economic

opportunity or job prospects. Like many of my generation, I simply do not want to live in a town of 250

people. In 20 years, this small town will be reduced to 200 people; the average age will be 75.

The inevitability is that unforced resettlement will continue to occur.

High oil prices have enabled a decade of inaction by government on the problems represented by

demography. I suggest that convenience is at an end. The economic realities represented by 50$ oil,declining production, and limited federal transfers, will impose on us the necessity to make tough

decisions, and they will need to be made within the next 5 years. The catalyst will simply be financial

disparity. The first of the baby boomer cohort will start reaching age 70 in 2016; the cost of sustaining

small rural towns will be exacerbated, even if the province’s financial situation improves.

The impending provincial election campaign is a time when those issues, and the ideas to deal with them,

should be discussed in earnest; though that is not likely. Our politicians seem inured to fiscal reality.

Whether it is the promise of student grants, the refusal to reign in the size of the public service, except

through attrition, or the willingness to ignore the possibility tax hikes may be required, they are content

merely to keep borrowing.

With a total NL public debt nearing $12 billion (Muskrat Falls included) we are nearing a very

uncomfortable place for a population of 0.5 million. Puerto Rico, the Caribbean archipelago that is an

American territory, has just defaulted on its public sector debt. It has reached $72 billion. Puerto Rico’s

population is 3.5 million; seven times our own. The math is as compelling as it is disturbing. We should

think about that.

Finally, in the future posts, I will conclude this Budget Colloquy by presenting an alternative 10 year fiscal

plan.



8 O

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ES

I

T IS A

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RISIS

As Posted on Uncle Gnarley on January 13, 2016

The final post intended to conclude the Budget Colloquy on the Uncle Gnarley Blog did not appear during

the Summer, as intended. It was just as well. The pre-Christmas budget “Update” has provided a more

current, but no less grim, appraisal of our worsening problem. The budget “Update” has shown that the

government has experienced both a collapse in revenues, and, unbelievably, an increase in program

spending30 during 2015.

Table 8.1: Fall 2015 Update

Based on a more realistic assessment of future revenues there is now a $2 billion deficit forecast for each

of the next 5 years. In the opinion of the Author, even these revised estimates for future revenue remain

grounded in optimism. Without real cuts in spending the deficits will only worsen from those predicted

by the government.

Table 8.2: 5 Year Forecast Provided in Fall 2015 Update

On a cash basis, the province is now predicting $15.4 billion in new borrowing over the next 6 years! The

figure assumes there will be no further increases in the ‘equity’ required for the Muskrat Falls project .

Again I believe this is an overly optimistic assumption, and it would be wise to assume that at least another

30 http://www.fin.gov.nl.ca/fin/publications/2015_mid_year_update.pdf



$1 billion of new borrowing will be required before that boondoggle is completed. A figure of $16.4 Billion

is a staggering amount of new debt for province of our size. It is not something that should even be

contemplated.

I started this budget colloquy with a quote from the 1933 Amulree Report31, which reviewed the status of

the Dominion of Newfoundland, and which ultimately lead to the abandonment of democracy. The

parallels with the period 1920 to 1930 and the past 10 years are eerily similar. For those who doubt the

severity of our current situation, Table 8.3 will provide cold comfort.

Table 8.3 was completed by Ed Hollett of the Sir Robert Bond Papers Blog32. It compares the current

program of borrowing with what happened to Newfoundland leading up to the end of responsible

government.

Table 8.3: Summary of Borrowing as a Share of Expenses

If we have learned anything from voluntarily giving up our democratic franchise, is the massive burden of

debt servicing and the impact it has on government’s ability to function. In the period from 2015 to 2020,

debt servicing costs will increase from $820 million to $1.4 billion annually. Without a return to a balanced

budget, this will only continue to increase.

We are in the debt spiral. Urgent action is required. It cannot be delayed.

In my opinion, we are in a period of prolonged oil price collapse; similar to that which occurred in the early

1980’s (refer to figure 4.1). If this comparison holds, and we have 10 -15 years during which oil pricesremain below 80 $/barrel (real price) we can expect that our deepwater development will be stalled, and

payout on Hebron will be delayed. New revenue growth will be very difficult to achieve in a low oil

environment. Government can not wishfully hope for a return of 100$ oil. We cannot plan to annually

borrow $2 billion in perpetuity either.

31 http://www.heritage.nf.ca/articles/politics/amulree-report-introduction.php32 http://bondpapers.blogspot.ca/2016/01/metrics-nlpoli.html



Every year we borrow $2 Billion will generate nearly $80 million in new debt servicing costs. Every year

we delay cuts, requires that we cut another $80 million in program spending to return to a balanced

budget. Any eventual reduction in our bond rating will add another $50-75 million annually in debt

servicing costs.

I repeat Newfoundland and Labrador are in the debt spiral. Urgent action is required. It cannot be

delayed.

Although I appreciate the Ball government does not want to accelerate the softening of the local economy,

cuts will have to be made. They are inevitable. What the Liberal government must realize is that we still

have a relatively strong economy. It is much better to start the cuts now, as opposed to waiting until

March 2017 as suggested by their consultation road map.

The work has been done by the government departments to understand where the cuts are required, and

where are potential sources of new revenue.

To repeat the essential theme contained in the Budget Colloquy posted during the summer of 2015: we

must raise revenue and cut spending. These measures have to be implemented over the next 3 years.

Time truly is of the essence.

The new revenue sources, noted in Chapter 6 “Getting Back to Basics”, are summarized below:

New Sugar Tax 30 Million

Corporate Income Tax 40 Million

Nalcor 100 Million (They need to tighten their belts as well)

Income Tax 150 Million

Restate HST increase 150 Million

Total New Revenue 470 Million



The spending cuts identified in Chapter 7 “Rightsizing Expenditures” are summarized as:

Public Sector Layoffs 250 Million

Professional Services 75 Million

Executive Council 10 MillionAdvanced Education 50 Million

Transportation and Coms 30 Million

Total Spending Cuts 415 Million

These measures may have been originally interpreted as extreme, they would not reduce the current

deficit by even 50%!!! The spending cuts are not even equivalent to the new debt servicing charges

between 2015-2020!

That is why the suggestion, “we are in a debt spiral”, is neither ill-defined nor unwarranted. Indeed,

without substantive action we threaten every aspect of our society from health care and education to

existing pension obligations.

More borrowing will only exasperate the situation. Delay cannot be entertained. It is a crisis.

To conclude, we need to immediately start raise taxes to the tune of $500 million annually. We need to

cut spending by $700-800 million. Every year of delay increases the required cuts by $80 Million.

We are undeniably in a crisis. I am deeply afraid that a delay of another 1 year in consultations will be the

final death nail. Substantive action is required today.

But it is also important that we collectively recognize the long term damage which horribly unwise

government decisions, made in the period 2006 to 2010, have inflicted. These mistakes were incubated

in prosperity, and recent governments did not take adequate measures to correct them.

The period of 2006 to 2015 will be referred to as the decade of squandered opportunity for Newfoundland

and Labrador. Urgent action is required for us to survive.

a decade of squandered opportunity by jm minor

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