Fraser Forum

Canada’s federal budget: the risks of deficit spending

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Since being elected last October, Justin Trudeau’s Liberal government has seen the federal budget balance deteriorate markedly. The exact numbers won’t be unveiled until the budget is tabled, which is expected sometime in late March, but what are we to make of the return to persistent deficit spending?

On the campaign trail, the Liberals promised “modest” deficits of no more than $10 billion over the next two years, followed by a $6 billion deficit in 2018/19 and return to balance in 2019/20. After coming into power, they then backed away from this $10 billion deficit cap, switching focus to reducing the government’s debt-to-GDP ratio each year while in power, which could allow for deficits of up to $25 billion.

In the latest turn of events, Prime Minister Trudeau recently mused that not only will the $10 billion deficit ceiling be broken, but the return to a balanced budget by 2019/20 is now in question. The shifting targets have created uncertainty about what the federal government’s budget balance will look like in the years ahead.

They also raise several potential risks. For starters, it’s yet another move away from the Chretien consensus, which held that governments should typically maintain balanced budgets, resorting to deficit spending only during severe economic slowdowns or recessions.

The problem is that once governments get into the habit of running deficits, it often becomes much harder than they expect to return to balanced budgets. We saw such a scenario unfold in the 1970s, 1980s and early 1990s when the federal government ran 27 consecutive deficits. These deficits hampered Canada’s ability to enact competitive tax policies and led to a dramatic accumulation of debt, with interest payments on the debt consuming more than one-third of federal revenues, displacing important public priorities.

A closely related problem is that running large and growing deficits during non-recessionary times puts the country’s finances at risk should the economy experience a significant slowdown or recession. Unexpected slowdowns can alter the fiscal outlook, and if the government is already in a deficit position when a recession hits, the result can be much larger budget shortfalls than anticipated and a rapid run-up in debt.

These are the risks of routine deficits incurred during periods of economic growth, which is what the federal Liberals have planned for the years ahead. And for what?

Some will argue that deficit-financed “stimulus” spending is necessary to help struggling provinces like Alberta, Saskatchewan and Newfoundland that have been hit hard by depressed energy prices. Unfortunately, stimulus spending is an expensive and futile response to the economic problems facing these jurisdictions.

A large body of evidence-based research, including Canada’s recent experience, casts serious doubt on the ability of government stimulus spending to boost economic activity, whereby a dollar of government spending increases overall economic output by more than one dollar.

But even if you believe that governments are able to deliver stimulus spending in a timely, effective manner that helps boost growth during economic downturns, it still isn’t clear that stimulus spending is an effective strategy for dealing with the particular type of trouble energy-intensive provinces are going through.

Stimulus spending is meant to increase consumer demand but inadequate demand is not the primary problem in Alberta, Saskatchewan and Newfoundland. Rather, these provinces have been hit by a supply-side shock that can’t be addressed through stimulus spending, namely the precipitous decline in the price of commodities (particularly oil and gas).

So it’s not even clear that stimulus spending will do much to bolster the Canadian economy. But it will certainly cause the national debt to increase and threaten to put Canada back into the trap of routine deficit spending in which we were ensnared for three decades until the fiscal reforms of the 1990s. Ultimately, the increased government debt will need to be serviced and paid off by Canadians through taxes in future years.

Budget deficits seem to have again become routine in Ottawa. This is a troubling development given the economic problems persistent deficits cause and the dubious nature of claims that these deficits will help stimulate the economy in the years ahead. The last time that deficits became routine in Ottawa, it took more than a generation to get out of fiscal trouble. Hopefully, this time Canadian policymakers will recognize the problem much sooner and work to solve it.


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