Throne speech brings bigger government, more fiscal challenges

In today’s throne speech, the Trudeau government announced substantial new spending commitments, marking a new vision for Canada, which includes increasing the size and role of government. Unfortunately, more spending and bigger government will only add to our debt and deepen our fiscal challenges, without necessarily helping our economy.

Indeed, according to the speech, the government plans to create a national childcare system, extend the Canada Emergency Wage Subsidy (CEWS), introduce substantial “green” spending and offer additional support to specific industries hard-hit by the pandemic.

These additional spending commitments will increase the size of government relative to the economy. Put differently, the government—not entrepreneurs, businesses and investors—will play a larger role in allocating society’s resources.

Why is this a problem?

For starters, the appropriate size of government is critical, as it shares a close relationship with economic growth and social progress. Indeed, a large body of research finds that total government spending (federal, provincial and local) that comprises between 26 per cent and 30 per cent (as a share of the economy) maximizes economic and social outcomes. Beyond that, additional government spending can fail to meaningfully improve outcomes and in fact actually hinder economic growth.

Now, consider that in Canada in 2018 total government spending (as a share of the economy) was 40.3 per cent. Clearly, even before COVID and the recession, the size of government was beyond the level associated with the strongest economic growth and social progress. More federal spending announced in the throne speech will move Canada further away from this optimal level.

At the same time, the throne speech failed to meaningfully address the state of federal finances, including the budget deficit and growing debt levels tied to additional government spending (among other factors).

Prior to the speech, the federal deficit already stood at an historic $343 billion and the debt-to-GDP ratio—a measure of the level of debt relative to the size of the economy—was on pace to surpass 49 per cent by the end of March.

A recent report also suggested Canada’s aging population will place upward pressure on spending over the long-term and limit growth in revenues. Consequently, the federal budget, absent a shift in policy, will unlikely be balanced before 2050.

This will likely hold true even if the Liberals implement new and economically-damaging wealth taxes as indicated in the Throne Speech, so much for the Prime Minister’s promise of no new taxes. The new plans announced Wednesday will add to the debt and could extend the timeline for budget balance even further down the road.

But there are serious risks with this approach. Higher and more persistent budget deficits risk a downgrading of Canada’s debt by rating agencies, which increases the risk premiums (i.e. interest costs) attached to our debt. Rising interest rates in future years would lead to higher debt-servicing costs that consume more and more government revenue, which could otherwise fund health care, social services and tax relief.

The long-term combination of persistent deficits, debt and potential rising interest rates means we risk repeating the near debt and currency crisis of the mid-1990s when federal debt-servicing costs consumed more than one-third (35.2 per cent) of federal government revenues.

Simply put, this throne speech puts Canada on track for bigger government, more spending and more debt accumulation in the years ahead.