Why federal deficits to 2055 really matter

The federal finance December 2016 update of long-term economic and fiscal projections recently made news across the country. The projections simulate what the federal government’s long-term finances may look like under certain demographic, economic and fiscal assumptions. However, it’s arguably setting the stage for a new era of fiscal irresponsibility.

The key assumptions driving the baseline projection are an aging population, which will reduce the number of working-age Canadians and dampen economic growth. Lower economic growth will in turn translate into a lower growth rate of government revenue at the same time the projection assumes there will be upward pressure on spending for age-related programs such as elderly benefits.  

Indeed, rather than annual average real GDP growth between 1970 and 2015 of 2.8 per cent, growth from 2016 to 2055 is projected to range from 1.7 to 1.8 per cent. As with any projection, the assumptions are key.

Nevertheless, the results of the long-term fiscal projection see federal revenue growing from $355 billion in 2021-22 to $1,232.8 billion by 2055-56 with an implied annual growth rate of 3.7 per cent. Total spending (including debt charges) will rise from $369.6 billion to $1,206.3 billion for an implied annual growth rate of 3.5 per cent. Despite revenues projected to grow faster than expenditures, the government is expected to be in perpetual deficit until past the year 2051. For those with a sense of fiscal humour, the projections not so long ago were of perpetual federal surpluses.

The new persistent projected gap between revenues and spending occurs because it is not being closed fast enough early on. If revenues grow at 3.7 per cent and total spending at only 3 per cent, then the federal budget could be balanced by approximately 2027. Reduce the growth rate of spending further and the deadline for a balanced budget moves closer. In many respects, the fiscal balance of the federal government is a choice rather than only the outcome of forces beyond the control of the federal government—the most serious being the interest rate on the federal debt. In these projections, interest rates are anticipated as being in the range of 3 to 3.7 per cent.

Despite deficits for the next 30 years, the reassurance is that they are manageable. The numbers show a declining federal debt-to-GDP ratio, deficit-to-GDP ratios at a very modest 1 per cent or less, and a program spending-to-GDP ratio that at just below 14 per cent stays close to historic lows. The message really is that we can run deficits indefinitely—under these assumptions.
What’s the problem?

The seemingly modest projected deficits would be the longest consecutive string of deficits in Canadian federal fiscal history. The runner-ups? There is the 16-year string from 1930 to 1945, coinciding with the Great Depression and financing of the Second World War. Then there’s the winner to date—the 27-year string of deficits from 1970 to 1996 coinciding with the oil price shock, two recessions and stagflation that ultimately resulted in the federal fiscal crisis of the early 1990s.  

Projecting a string of modest deficits over 30 years is arguably an effort to lull the public into accepting a new era of fiscal irresponsibility. Moreover, it sends a signal to every interest group in the country as well as the provinces that the only thing standing in the way of more federal money is a louder case for spending.  

As for business investment—which is where the long-term growth of the Canadian economy really hinges—the message from Ottawa is really that there is no deadline for balancing the budget and that they are willing to risk a structural deficit. This will weaken business confidence in the economy at a time when confidence is needed more than ever if robust growth is to resume.