In 1966, Canada’s finances were in remarkably strong shape. Twenty years of fiscal discipline after World War II had brought the debt-to-GDP ratio to less than 30 per cent. Interest costs absorbed less than 2% of GDP, or about 12 cents of every tax dollar. The budget was in slight surplus.
As it happens, that’s more or less exactly where we stood a couple of years ago, again after a prolonged period of fiscal discipline: 30% debt-to-GDP ratio, interest costs of about 2% of GDP, small surplus.
In 2008, our fiscal position seemed rock-solid, as it must have seemed in 1966. And indeed, there are those, including in government, who assure us that even today, with a deficit of more than $50-billion, we have nothing to worry about. Though the debt-to-GDP ratio has climbed to 35%, that’s still the lowest in the G7. Five years from now, according to the budget, it will be back down to 32%. What’s to worry?
But then, what was there to worry about in 1966? We were then at the height of the 1960s boom — from 1963 through 1967, real growth averaged an astonishing 6.4% per year, a performance never since equalled or even approached. It was a time to dream big dreams: the following decade saw the implementation of all of the main components of the modern welfare state — medicare, old age pensions, the Canada Assistance Plan. It was expensive — real federal spending per capita grew by 78% between 1966 and 1975 — but revenues grew very nearly as fast: though the economy had by now cooled off somewhat, rising taxes more than made up the difference. Federal tax collectors took in fully two-and-a-half percentage points more of GDP by the mid-1970s than they had a decade before.
And so although we started consistently running deficits in 1971, no one much cared. They weren’t very large, after all, just 1 or 2% of GDP. Indeed, the debt-to-GDP ratio continued to fall throughout this period. By 1975 it was down to less than 19%. To be sure, inflation was rising, and interest rates along with it, but nominal GDP growth was still more than fast enough to keep abreast of the rising tide of debt.
But then came the recession of 1975, and the puzzling new phenomenon of stagflation: high and rising inflation even as growth was nosediving. And suddenly our fiscal position did not seem quite so rock-solid. Over the next few years inflation tore huge holes in the federal tax code. But while revenues fell sharply, spending was not similarly curtailed. The deficit leapt to 3.6% of GDP in 1976 (about what it is now), then to 5% in 1978 and 5.4% in 1979. By 1980, the debt-to-GDP ratio was back to 28%, roughly where it had been in 1966. But where before the debt was stable or falling, now it was growing by more than 20% per annum.
Too late, an attempt was made to rein in spending. In 1980, real per capita spending, which had been growing by 8 and 9% per year earlier in the decade, actually fell by 5%. By 1982, program spending had been brought very nearly in line with revenues. But by now this was no longer the issue: the rising cost of servicing the debt was. The deficit that year, at 4.4% of GDP, was almost entirely accounted for by debt charges, that is by the cost of paying interest on past deficits. At $15-billion, debt charges were now five times what they were in 1975. The momentum of spending had been broken. But the momentum of compound interest it had set off would not be so easily stopped.
Then came a second recession, much worse than the last — and with federal finances in a much more exposed position than before. By 1983 the deficit was cresting 8% of GDP. Soon, debt charges were consuming more than 35 cents of every tax dollar — three times as much as they had been in 1966. It would take another twenty years to get them back to where they were.
Yet it had only taken a few years to get ourselves into this mess. What had seemed quite manageable at the time carried the seeds of later chaos. Each stage of the crisis had set in motion the next: The rapid spending increases of the late 1960s leading to the first descent into deficit spending in the early 1970s, before the headlong plunge into debt of the later part of the decade that set off the near-exponential compounding of interest. Yet as late as 1975, the debt had seemed well under control.
Moral: Maybe today’s deficits don’t seem like much to get worked up about. They never do.