In the spring of this year, the federal Liberals released their first budget, which centred on big increases in government spending, persistent deficits, growing debt and higher taxes. At the time, we warned that a fundamental problem with the government’s approach of running significant budget deficits outside of a recession is that it exposes Canada’s finances to serious risk.

If the expected growth doesn’t materialize, this could trigger a greater run-up in debt.
 
Yesterday’s economic and fiscal update confirmed this is happening. Federal finances are now in worse shape than they were just seven months ago.

Recall the spring budget proposed marked increases in federal spending—a whopping 20 per cent increase over just three years. The Liberals acknowledged this would produce a string of deficits much larger than they campaigned on and with no plan to balance the budget within their current mandate.

The update now pegs the five-year cumulative deficit at $32 billion higher than initially planned just seven months ago (and still no plan to return to balance).

Not only is the five-year cumulative deficit total larger, the government has decided to remove its annual safety cushion of $6 billion per year. Prudent budgeting, as was done by previous Liberal and Conservative governments, included a contingency in case of unforeseen events that would cause spending to be higher than planned and/or revenues to be lower than expected. By removing this contingency, the federal government has exposed its finances to even more risk. This is hardly a “fiscally responsible” way to budget, as Finance Minister Bill Morneau claims.

Any further unexpected economic shocks to either revenues or expenditures will lead to even bigger budget deficits and even more debt. There are specific risks on spending. By the early 1990s, a third of all federal government revenue was being used simply to pay interest on the debt is real.

Why else should Canadians care about persistent deficits and a run-up in debt? For one thing, economic research shows it will result in slower economic growth as growing public debt increases uncertainty for households and investors and requires future taxpayers to foot the bill. Put differently, more government debt will harm the economy and likely raise the tax burden.

Canadians have seen the unfortunate consequences of routine budget deficits and increased debt play out before. For example, the federal government ran a generation worth of consecutive budget deficits starting in the 1970s, which resulted in a serious debt problem. By the early 1990s, a third of all federal government revenue was being used simply to pay interest on the debt.

It wasn’t until a Liberal government led by Jean Chretien made the tough decisions to slay the deficit, rein in debt, and put federal finances on better footing. That experience helped shape the unwritten norm that deficit spending must be temporary, avoided during non-recessionary times, and accompanied by a plan to return to balance. Without this “fiscal anchor,” governments can easily get stuck in the quicksand of deficits, making it very difficult to dig their way out.