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Recently announced tax cuts could end a decade-long streak of federal surpluses if even a slight economic downturn materializes in 2008, a new report suggests.

A study released by the left-leaning Canadian Centre for Policy Alternatives on Monday says the government's October economic update does not take into account the possibility that Canada's economy will slow down.

The recent cut to the GST, in addition to reductions previously announced by the Conservative government, will cost $40.2 billion annually by the end of the 2012-2013 fiscal year, the report said.

Those reductions have "greatly eroded the fiscal capacity of the federal government," the report said.

"It turns out a mild recession -- not even a recession -- just a mild economic downturn would actually lead to the first budget deficit in over a decade," Marc Lee, the economist who authored the paper, told Â鶹ӰÊÓnet on Monday.

In his economic statement, Finance Minister Jim Flaherty compared the Canadian economy to the bright "North Star" and announced the GST reduction to five per cent.

"Since those tax cuts were tabled back in October, we're starting to see some signs of deterioration, particularly in the United States economy," Lee said, adding that there was a greater than 50 per cent chance the U.S. would go into recession in 2008.

While the Canadian economy has remained buoyant despite the faltering U.S., many see a downturn as inevitable.

How far Canada's economy declines could depend on how the United States' slump changes the demand for lumber, machinery and petrochemicals imported from Canada.

Economic slowdown

Lee's paper "stress tests" government numbers by using four scenarios of future slowdown, from moderate slowdown to strong recession.

Most surprisingly, it found it would take much less than a recession -- two consecutive quarters of economic reduction -- to result in a budgetary deficit.

Lee said despite the conventional wisdom held by Ottawa, the government should not slash spending in an attempt to avoid a deficit.

He said the government can and should run a deficit if the economy turns down.

"The biggest danger is that the feds will respond by cutting spending in order to maintain the budget balance, a move that would only worsen the downturn," Lee said in a press release.

He told Newsnet that tax cuts wouldn't deliver "the bang for the buck" that other options could.

"You might want to divert some of the tax cuts into things like bolstering unemployment insurance, targeting transfers to low- and middle-income people -- basically transferring money to people who are going to spend all of that money," he said.

Prime Minister Stephen Harper and Flaherty have suggested there will not be any new tax cuts or spending programs announced in future budgets because of the expected slowdown in the Canadian economy.

Recent federal estimates suggest Canada's gross domestic product (GDP) will grow just over two per cent this year, down from original estimates of 2.4 per cent.

However, some economists think even a two per cent estimate is optimistic and suggest closer to 1.4 per cent, or less.

In the 2006-2007 fiscal year, Canada generated a surplus of nearly $14 billion, based on strongly rising corporate and personal tax revenues.

The Finance Ministry has projected this fiscal year will result in a small surplus of $3.3 billion.

A deficit could be embarrassing for the Conservative government, which has sought to appear more economically mindful that the Jean Chretien-Paul Martin Liberal leadership before them. That government ended decades of massive budget deficits in the mid-1990s.

Lee, however, says the government's fiscal position would remain strong compared to the past. He said Canada's debt to gross domestic product ratio has plummeted from 68 per cent a decade ago to 32 per cent.

"With an election potentially on the horizon, all federal parties should be clear to the public about what their plans would be with regard to taxation, spending and deficits," said Lee.