Moving targets, routine deficits, and Canada’s short-lived federal ‘fiscal anchor’

During last fall’s federal election, the 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 moved repeatedly, as deficit projections have been steadily revised upward.

In December, Finance Minister Bill Morneau backed off of his party’s $10 billion deficit cap, replacing this “limit” with a new one, pledging to keep deficits small enough for the federal debt-to-GDP ratio to shrink every year.
    
The government repeatedly referred to its new limit as a “fiscal anchor” that would be used to prevent rapid deterioration in its fiscal position. In fact, Prime Minister Trudeau, back in December, said: “We will continue to decrease (the debt-to-GDP ratio) every single year because that’s important for the fiscal health of our country.”

Only two months later, the “fiscal anchor” has been abandoned, as the government’s latest economic outlook shows that the federal debt-to-GDP ratio will in fact increase next year. (Recent musings have also put the promised return to a balanced budget by 2019/20 in question.)

Specifically, the government now expects the federal debt-to-GDP ratio to increase from 31.0 per cent this year to 31.8 per cent in 2016/17. And this expectation is before the Liberals add their new major spending initiatives to the mix.

Once new major spending is factored in (expected to be upwards of $10 billion next year alone), the annual deficit is likely to be more than $25 billion and the federal debt-to-GDP ratio will increase even more.

The short life of the government’s latest “fiscal anchor” illustrates the dangers of constantly evolving fiscal targets, and the need for transparent, durable, and easily understood fiscal norms.

Unfortunately, recent years have seen the steady destruction (by governments across the country) of one such useful norm: the principle that governments should balance their books during “normal” economic times, and only resort to deficit spending during economic downturns. This principle took hold during the 1990s when governments across the country averted a fiscal crisis by taking decisive action to rein in government debt that had been accumulating for decades because of routine deficit spending.

In the following years, having lived with the consequences of runaway debt and having made hard choices to get it under control, Canadian governments generally avoided running deficits during periods of economic growth. This approach to fiscal policy helped create the conditions for a prolonged period when the economy boomed and the mountain of public debt accumulated over the preceding decades steadily shrank.

Unfortunately, in recent years, policymakers across Canada have abandoned the long-standing norm that deficit spending—particularly in the name of “stimulating” the economy—should be reserved for steep economic downturns.

The problem with unwritten fiscal norms (such as the one that governments generally ought to balance their budgets) is that they take a long time to develop and cement. Once the goalposts are moved, and an easily understood and long-standing fiscal principle is repudiated, it becomes much easier for governments to move them again.

And this is precisely what has happened. The $10 billion deficit cap that replaced a simple balanced budget target barely survived the election before it was replaced with the declining debt-to-GDP fiscal anchor. And this latest “limit” was even more short-lived.

Critically, all this is happening at a time when the federal government expects positive (albeit modest) economic growth next year. The recent economic outlook projects nominal GDP, the broadest measure of the government’s revenue base, to grow 2.4 per cent in 2016—this after including a conservative “forecast adjustment” that reduces the expected level of GDP by $40 billion.

The prevailing view that governments should avoid routine budget deficits has served Canada well, but it has now been largely abandoned by the federal government, and the hastily assembled fiscal anchors designed to replace it have proven mostly useless.