Deficit spending not a free lunch—it’s a bill to future taxpayers

It’s official. According to the federal government’s fiscal monitor, Ottawa ran a $19.4 billion budget deficit for 2017/18. And this government’s appetite for deficit spending shows no signs of relenting. In fact, there’s no plan to balance the federal budget for the next three decades.

With deficits becoming common place again, it’s easy to grow complacent. After all, deficit spending can seem like a free lunch—by running deficits, the government spends money without the immediate cost of raising taxes to pay for it.

In reality, however, when the government spends more than its tax revenue allows, it must finance the additional spending through debt (i.e. by borrowing). One cost of borrowing is the annual interest paid on the debt—currently $26.3 billion for the federal government alone. Of course, the debt’s principal eventually must be repaid, too—a cost that will be borne by future taxpayers.

To get a better sense of the magnitude of the current federal deficit, consider what it would take for Ottawa to finance all its current spending with higher taxes today rather than kicking the tax bill down the road. In other words, what would tax rates have to be to cover the Trudeau government’s expected $18.1 billion deficit for 2018/19?

Let’s start with personal income taxes, the largest single source of revenue for the federal government. According to the Parliamentary Budget Office’s (PBO) tool for calculating the revenue impact of tax changes, to cover the current federal deficit, the government would need to raise all five personal income tax rates by two percentage points—at a cost to taxpayers of $18.3 billion. In this scenario, the bottom personal income tax rate would increase from 15 per cent to 17 per cent, and the top rate from 33 per cent to 35 per cent. These tax hikes would discourage Canadians from working, saving, investing and being entrepreneurial—all activities that help spur economic growth. And they would push our already high combined federal and provincial top rates to even higher levels, weakening our already weak competitive position internationally.

Corporate income taxes comprise the second largest revenue source for the federal government. Corporate taxes also happen to be one of the most damaging types of tax, in terms of their effect on the economy since it affects mobile investment, a key driver of productivity.

The current federal general corporate tax rate is 15 per cent, but closing the federal deficit exclusively with this revenue source would require a substantial increase. According to the PBO, a 10.5 percentage point increase—for a total tax rate of 25.5 per cent—would net $17.9 billion for Ottawa, just shy of the current $18.1 billion deficit. This tax hike would nearly erase the bipartisan (Liberal and Conservative) effort that cut the federal corporate tax rate almost in half and gave Canada its decade-plus business tax advantage over the U.S.

And finally, a GST rate of 7.25 per cent, rather than the current rate of 5 per cent, would also come close to covering the current $18.1 billion deficit—raising $17.7 billion in revenue for the feds.

To be clear, we’re not suggesting Ottawa raise tax rates to eliminate the deficit. These scenarios simply illustrate the size of the federal deficit and the tax bill being left to future taxpayers. Raising personal and corporate income taxes especially would be economically damaging and further undermine Canada’s attractiveness for investment and entrepreneurs—particularly in light of the recent sweeping tax reforms in the U.S. that improved American competitiveness on both taxes.

Moreover, evidence-based research shows that reducing spending—not raising taxes—is the best way to eliminate budget deficits because spending reductions minimize the adverse effects on the economy and are most likely to achieve budget balance.

Deficit spending today is taxation deferred until tomorrow. Rather than kicking the can down the road, the federal government should avoid discretionary spending choices that exceed its revenue when the economy is expanding.