OTTAWA - Canada's budget watchdog is urging Ottawa to proceed with caution if it decides to transform the country's expected surplus into new program spending or permanent tax cuts.

Otherwise, the government risks plunging Canada back into deficit once economic growth slows, warns a report released Tuesday by Parliamentary Budget Officer Jean-Denis Frechette.

The message comes as the Harper government prepares to unveil tax cuts ahead of next year's election — long-promised reductions that have been contingent on Canada's return to a balanced budget.

"Policy-makers should be wary of using surpluses to implement permanent tax relief or spending initiatives if they wish to avoid returning to deficits as economic growth subsides," said the PBO's latest economic and fiscal outlook.

The report predicts the country is on track to run a $3.6-billion surplus in 2014-15, which would deliver a balanced budget a year earlier than the government's stated expectations. It would be followed by a string of five surpluses with an annual average of about $10 billion, the PBO projects.

The document, however, also points to the risks of using extra fiscal space created in an economy boosted by cyclical factors, rather than permanent, structural ones.

"Much of the projected fiscal room is a result of the economy growing faster than its potential," Frechette's outlook said.

The paper warned that policy funded with cash from a cyclical surplus could put the country at risk of another deficit as growth comes down to a normal level.

Frechette's 2014-15 surplus projection is at odds with Prime Minister Stephen Harper, who has insisted there won't be a federal surplus until 2015-16 — an election period.

The Conservative government has pledged to reduce taxes once the books are balanced with measures such as income splitting for couples with children under 18 and a doubling of the annual limits for tax-free savings accounts.

Earlier this month, Harper said last year's federal deficit — for 2013-14 — would be more than $10 billion smaller than forecast, but he's refused to predict the improving bottom line will pull Canada out of the red this fiscal year.

He announced a new $5.2-billion deficit figure for 2013-14, down from the $16.6 billion shortfall projected in February's federal budget.

Before Harper's announcement, calculations by economists and budget watchers had already projected the federal government might be headed for a surplus this fiscal year.

Last month, former senior Finance Department bureaucrats Scott Clark and Peter DeVries published a report that found Ottawa heading for a $4 billion surplus, which did not include a $3-billion "risk adjustment" cushion built into the 2014 federal budget. They based their estimates on last year's deficit falling to about $10 billion.

The budget office report said Canada's economic outlook improved faster than expected in recent months, even as it faced lower commodity prices and employment weaknesses. The document tied much of that growth to a stronger U.S. economy.

"Going forward, improved U.S. economic conditions are expected to lead to stronger demand for Canadian exports," the outlook said.

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