The truth about slippery slopes, debt bombs and deficit hawks

The hand-wringing over the 2016 federal budget neglects the acknowledgement that ‘living in the red can be smart sometimes’

Canada's Finance Minister Bill Morneau is applauded as he delivers the federal budget in the House of Commons on Parliament Hill in Ottawa, Canada March 22, 2016. (Chris Wattie/Reuters)

Canada’s Finance Minister Bill Morneau on March 22, 2016. (Chris Wattie/Reuters)

A preponderance of columnists and pundits commenting on last week’s federal budget warned sternly against deficits and rising debt over the next four years. The papers were filled with slippery slopes, debt bombs and predictions of program cuts and rising taxes ahead: there was much disapproving clucking in the commentariat.

You might call this the Mulroney-Martin generation of journalists, who came of age when deficits and debts really mattered. They learned their lessons well and, as happens, too well for changing times.

You can judge the significance of deficits and debt only in context. Absolute numbers don’t matter, and living in the red can be smart sometimes.

In 1990-91, for every dollar Ottawa received in revenue, it spent 36 cents on debt interest payments – reflecting years of terrible fiscal management. This year, for every dollar of federal revenue, interest is just 8 cents, and this ratio will stay about the same for the next four years.

Ottawa’s debt as a proportion of GDP was 64 per cent in 1997. In 2015, it was 31 per cent, among the lowest in the world and 40 per cent less than the G7 average. It will stay in this range over the next four years as the debt and economy grow pretty much in tandem – no cause for worry.

The federal government now has reasonable debt levels in relation to national income, which Liberal budgets over the next four years will not significantly change. In fact, this year’s $29.5-billion budget is based on very low economic growth forecasts, and contains $6-billion in contingency funds as a buffer against a bad surprise – which portends a good surprise.

The wringing of journalistic hands in this context suggests habit rather than dirt under the fingernails.

The broader context offers more to ponder and less to distress.

The Holy Grail for the Harper Conservatives was a balanced budget, to the point they passed a law requiring it in most circumstances. (The Liberals are repealing that law.) But the word “balanced” is misleading here.

In 2014-15, Ottawa received $282-billion in revenue, and spent only $254-billion on programs. The rest went to interest payments on federal debt – $26.6-billion – with $1.9 billion left in surplus after that.

Any balanced budget takes in more revenue than it spent on programs. The rest goes to debt interest, and about a quarter of that debt is held abroad. Those payments leave the country. The remaining debt is held largely by Canadian banks, insurance companies and mutual funds, which are not excellent conduits in directing interest income to consumption and capital investment.

The difference between revenue and program spending is called the “primary surplus.” Last year, the primary surplus accounted for 1.4 per cent of GDP, much of which was withdrawn from the economy. A balanced budget is always contractionary. That is okay in a vibrant economy – not so good facing headwinds.

To be fiscally neutral, you need to run a deficit to offset the primary surplus. Liberal budgets will barely achieve even this over the next four years.

Interest payments in 2016-17 are $25.7-billion, compared with a deficit of $29.4-billion in offsets. Difference: a paltry $3.7-billion.

In 2017-18, interest is $26.4-billion and the offsetting deficit just $29-billion.

The forecast for 2018-19 is contractionary: Interest is $29.4-billion, the deficit just $22.8-billion.

There’s not much fiscal goose in the gander here, whatever the cant from wherever.

Let’s look at two final elements of context.

The federal budget includes new capital spending in its statement of total expenses. So if Ottawa commits to, say, $10-billion in capital spending this year, it shows up as part of operating costs and thus the deficit.

We don’t think this way at home.

If you take out a $200,000 mortgage on a house, you don’t say you ran a deficit of $200,000 in your family budget that year. Only the cost of servicing that $200,000 shows up in your annual financial accounts – principal and interest. You’re richer than you think!

It would distort understanding of your finances to lump borrowing for capital into your operating budget: Only the cost of carrying that debt is part of your annual statement. But in Ottawa and the provinces, we lump them together in the first year of our capital spending plans, overstating annual deficits along the way.

Only the cost of capital borrowing should appear in the operating budget numbers every year. As long as those costs remain within an affordable range, and the capital investments are wise, borrow on! For clarity, we should describe capital spending in a separate capital budget.

Which brings us to the last point of context: Canadians want to take care of themselves.

In Canada, we rely on governments to provide and maintain services essential to our welfare and prosperity. Most of these costs arise as part of the operating budget, from schools and universities to health care, security and income support programs. But some of them require spending on capital – transportation, housing, hospitals, utilities, equipment. And this money should be borrowed, showing up, not as a “deficit,” but as capital spending serviced in the operating budget.

In sum, we should expect to borrow every year for capital investments within a responsible range in servicing debt. It is even sensible to borrow for operating expenses sometimes in light of economic cycles.

We can afford to take care of ourselves now that our federal debt is low as proportion of GDP, and the cost of debt-service is around 1.3 per cent of GDP, where it will stay for the next four years. (In the 1980s it averaged 4 per cent.) Even most provinces are moving toward more sustainable numbers.

If there is a slippery slope in all this, it is the slope that under-invests in important public goods in the notion that we can’t afford them. That was true 20 years ago at the federal level after much excessive borrowing, but hey – it’s 2016.

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The truth about slippery slopes, debt bombs and deficit hawks

  1. Thorsell is ignoring subnational government debt…i.e. the debts and deficits of the provinces and cities, which are significantly larger than they were a generation ago, and essentially double the size of the national debt to around 60% of GDP.

    Several provinces are bordering on runaway debt levels. Certainly most of Atlantic Canada, and Ontario.

    Japan has been running deficits and accumulating debt and building infrastructure for a generation, and it has gotten them nowhere.

    The United States can force their worthless paper on the world at the point of a nuclear missile, and buy goods for IOU’s. Canada cannot.

  2. It should be noted that through they liked to talk about the importance of being debt free the Conservatives rolled up major deficits during their tenure adding 150 billion to the national debt overall.

    In fact Andre Coyne has said that “of the Of the 10 biggest spending years in Canadian history, adjusting for inflation and population growth, nine occurred under the Conservatives. The cuts in their last years, while real, were only from the all-time record high to which they pushed spending in 2009-10.”

    So all this promotion of the Conservatives as frugal spenders is baloney.

    By cutting 2 points off the GST and their tangle of boutique tax cuts,they left themselves cash poor and unable to take measures to stimulate the economy without borrowing heavily.. Of course borrowing heavily was their modus operandi before, during and years after the recession.

    More importantly they ran yearly trade deficits , They pinned all their hopes on sky high oil prices and an inflated housing market.They failed to support the
    manufacturing sector so that the inevitable oil bust left the economy exposed.

    The Harperites spent, but on a very expensive crime bill, pandering to certain interests, wasteful no hope court cases and advertising . They were ideologically opposed to social spending however.

  3. Hi Kelper,

    There are some inaccuracies in your post that I would like to correct. First, if we were to adjust for inflation, the Harper government added $127 billion to the national debt, not $150 billion. To put this into perspective, Chretien increased the national debt by $82 billion, Mulroney increased it by $523 billion, and Pierre Trudeau increased it by $384 billion (all numbers adjusted for inflation).

    I am not sure where Coyne got his numbers from, but he is slightly off as of the 10 largest deficits, 7 belong to the Conservatives and 3 belong to the Liberals. Stephen Harper posted the 5th largest deficit in Canadian history (not the first), to the tune of $61.27 billion (again, adjusted for inflation). It should be noted that this deficit was from the 2009 budget, in which the opposition parties threatened to overthrow the Conservatives if they did not amend the budget to include massive stimulus spending. Naturally, it was the Liberals that voted in favour of the new budget, so it would be disingenuous to lay it solely at the feet of the Conservatives.

    As for the remaining top 10 Conservative deficits, they all belong to Mulroney, not Harper. As you can see above, Mulroney posted massive debt, but part of the issue was having to deal with the enormous debt service costs that were the result of Pierre Trudeau’s substantial debt and double digit interest during his tenure as PM. (All of my deficit figures can be found here: http://www.cbc.ca/news/multimedia/canada-s-deficits-and-surpluses-1963-to-2015-1.3042571 )

    The Conservatives actually posted consecutive surpluses, so it wasn’t the GST cut, nor the boutique tax cuts that left them strapped for cash. It was actually something else. Perhaps you have heard of it? Infamously it was called the 2008 Financial Crisis. I challenge you to find a single developed nation that did not engage in massive stimulus spending, or one that fared better than Canada while it was at its peak (to be fair, this last point is something that Paul Martin deserves some credit for as well).

    Rightly or wrongly, the Conservatives bailed out the automotive sector, so I find it quite perplexing that you would argue that they failed to support the manufacturing sector. Now that that has been sorted out, please carry on…

  4. You might call Thorsell part of the “Bedrooms of the Nation” generation of journalists, paying homage to the themes of the era of their social emancipator.

    Justin Elliot-Deficit IS good at delivering a well-written line, but the fisc is not his forte.

  5. Relax, everyone, Canada is in great shape compared to much of the world. To those very determined commenters who post comments here and elsewhere who insist that provincial debt is being ignored when we look at Canada’s debt load – yes, it is true that net provincial debt has been climbing steadily and in 2015 climbed above net federal debt for the first time ever. The combined Canadian federal-provincial net debt is now somewhere around 66 per cent of GDP.

    However, this is still well below the net debt of the UK, the U.S., etc. Looking into the future, the spending pressure is mostly on provincial healthcare and education costs, so it makes sense for the federal government to gradually take on a greater share of these costs as the federal government’s borrowing costs are less than the provinces and municipalities. It is certainly time to start having this national conversation.

    It is also true that taxes that Canadians pay are going to have to rise in the future if the things that Canadians value – healthcare and education – are going to be kept intact and revitalized. This is as much a need to rebalance taxes way from income taxes to consumption taxes, so a higher GST in return for lower marginal tax rates is probably a smart way to go.

    Looking at both issues, there is no crisis at present, so we can all relax. But we should start talking about where we are going as a nation and civil society and where we want to go. This recent budget focuses on economic stimulus, the favourite word is ‘investment” and this is a good start since there is so much slack in the economy and has been for the past 8 years, otherwise we would not have had interest rates at such a low level. But the longer-term issues are important and need to be recognized.

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