Troubled waters—Deficit spending and growing government debt in Canada

The new federal Liberal government will table its first budget next week, with media reports suggesting Trudeau's government will post a $30 billion deficit—triple the amount promised in the Liberals election platform. This deficit must be put into the context of the existing debt burden being passed onto the next generation. Since 2007/08, the federal debt alone has grown by $176 billion to $692 billion in 2015/16. That’s $19,302 per Canadian. Debt ultimately has to be paid back in the future through taxes and it risks endangering both our current and future prosperity.

But there is also an immediate cost to debt accumulation. This year the federal government will spend $25.9 billion on interest payments—more than spending on either EI benefits or the entire ministry of national defence. Put differently, nine cents of every tax dollar collected by Ottawa will pay for interest on debt and not to public programs that Canadians value or tax relief. And these costs are occurring within a historically low interest rate environment.

Unfortunately, there doesn’t seem to be an end in sight. The federal Liberals campaigned on a commitment to run budget deficits for its first three years while promising that the size of those deficits would be capped at $10 billion. The government also pledged to return to budget balance by 2019/20. Since then, the goalposts have been moved repeatedly, as deficit projections have been steadily revised upward and balanced budget targets abandoned.

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 ultimately consuming more than one-third of federal revenues.

There are several other risks of routine deficits incurred during periods of economic growth, which is what the federal Liberals have planned for the years ahead. For instance, it 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.
 
And for what? Some argue that deficit-financed “stimulus” spending by the federal government is necessary to help struggling provinces like Alberta, Saskatchewan, and Newfoundland & Labrador that have been hit hard by depressed energy prices.

There are three key reasons why we should be skeptical about the proposed “stimulus” spending:

1) The academic literature on stimulus spending.

A large body of evidence-based research 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.

2) Lessons from the Conservatives’ stimulus package.

Our own research that used Statistics Canada data to analyze the federal Conservatives’ two-year $47 billion stimulus package found that government stimulus spending had a negligible effect on Canada’s economic turnaround in the second half of 2009.

3) It’s a demand side response to a supply side shock.

Even if we do assume the government can deliver stimulus spending in a timely, effective manner, it is still not an effective strategy for dealing with the type of trouble energy-intensive provinces are experiencing. Stimulus spending is meant to increase consumer demand but inadequate demand is not the primary problem in Alberta, Saskatchewan, and Newfoundland & Labrador. 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 economy. But it will certainly increase the national debt and threaten to put Canada back into the trap of routine deficit spending where we were ensnared for three decades until the fiscal reforms of the 1990s.