Budget Impact on Defence Procurement
by David Perry
May 24, 2017
The Trudeau government’s second federal budget surprised those watching the defence file. Not only was there no news for the Defence Policy Review (months overdue at this point), but there was a huge (and poorly explained) shift in the funds available to budgetarily account for Capital equipment and infrastructure purchases. In all, the defence section of the March 2017 budget sent a negative signal. Defence officials have subsequently explained though that the shifts in funding announced in the budget have laid the groundwork for the Defence Policy Review by resetting the department’s funding arrangements.
Ahead of budget day, the government had signalled that decisions related to the Defence Policy Review might not be revealed until the fall fiscal update. The actual budget document stated that the government was “considering the funding that will be required to implement the Defence Policy Review,” and that “A key objective will be to provide the military with stable and predictable budget.” While not mentioning anything specific with respect to funding, the budget concluded its defence section by indicating that “A comprehensive overview of long-term funding for the Department of National Defence will be provided when the policy is released in the coming months.” If this comes to pass, it will be an unusual arrangement. Over the last 20 years, the general thrust of the last three defence policies, in 1994, 2005 and 2008 were provided by the budgets that preceded them. If the government meant its statement that this new policy will have stable and predictable funding, and real dollars will be assigned after the fact, this will be a first for Canadian defence policy.
The bigger news in the last budget was an announcement that $8.48 billion in funding set aside for Capital procurement is being shifted out from DND’s allocations out to 2035, and moved out to a time period beyond 2035. The funds that are being shifted are part of DND’s ‘accrual space’ – the fiscal construct established by the Department of Finance for DND as part of the Canada First Defence Strategy – an allocation of Canada’s fiscal framework to account for depreciation of DND’s capital assets. Under accrual accounting practices, instead of the full amount of any annual spending counting in full against the defence budget, capital assets are amortized over their expected lifespan, and only an annual depreciation charge is counted against DND’s budget. Key to this funding arrangement is that unless DND actually spends money on something, it doesn’t need this budget room. But unlike most other departmental budgets, if the department can’t spend the money by the end of the year, it can move it to another. Unlike other parts of the defence budget, there isn’t a limit to how much unused funding can be moved to another year.
This isn’t the first time this has happened, as the budgets in 2012, 2014 and 2016 all re-profiled some of the same funding, albeit much less of it – $3.5, $3.1 and $3.7 billion respectively. In the past, the movement of funds occurred over a much shorter time period, however, the funds moved in the 2017 budget have been moved out as far as the 2070s (and no, that isn’t a typo!). Cumulatively, a very large sum of budget funds for Capital has now been moved multiple years into the future – but it’s difficult to tell how much is gone, and how far, because public documents don’t itemize money moved more than once, nor specify to which years the money was moved.
According to DND’s own analysis, between 2005 and 2035, a total of $9.3 billion dollars has been removed from the accrual space, and shifted out to future years. Of that total, it says $5 billion of this was funding never actually allocated to any specific project, and had been allocated to the department to account for unforecasted requirements or changing Capital plans; the other $4 billion worth of shifts is the result of unanticipated delays to DND’s projects. The list of project delays that contributed to this is fairly long, and the reason for this is that DND doesn’t start to depreciate an asset until it actually enters service. And almost all of DND’s major purchases in the last decade have not reached their Initial Operating Capability on schedule. So the C17, C130J, and Chinook projects contributed to this reprofiling, as did several infrastructure projects, while the largest source of unused funds was for the Canadian Surface Combatant.
It is also important to understand that, in conjunction with this shift, a significant set of changes will be made to DND’s funding arrangements and the rules that govern them. Historically, DND has actually had two separate Capital budgets, the aforementioned accrual space, and its ‘A-base’ Vote 5. Ahead of the DPR this divide will disappear, leaving DND with only the accrual space, with its existing rules. As well, unlike at present, the accrual space will only be used to deprecate Capital equipment and infrastructure. The In-Service Support costs for equipment will henceforth be funded by the additional 1 percent escalator that DND began receiving this fiscal year.
So, what to make of all of this? The lack of funding for the defence review is hard to interpret as anything but a bad signal, because the budget before a defence policy has historically set the policy’s fiscal direction. Similarly, the shifting of all of this accrual space is difficult to interpret as a good news story. Yes, DND will theoretically retain the money, and it is being moved to periods in time when DND did not have enough of it. But this is set to happening decades beyond this government’s mandate. To think back to the last defence policy, the 2008 Canada First Defence Strategy, the fiscal underpinning of that document was eroded within 20 months of its publication by an operating budget freeze in the 2010 budget. If a promise of long term, stable funding can’t last two years, it’s impossible to think it can last a half century. The money that’s being moved could have been used in the near term, but DND wasn’t able to, which is truly regrettable.
On the other hand, by making the changes to its funding arrangements, the department will gain some extra flexibility to fund its currently unfunded projects, and better assurance of funding for In-Service Support. Is it also possible that moving to a clearer and simpler funding structure, will make it easier (and hopefully faster) to make decisions about future projects?
David Perry is a defence analyst with CGAI.