Federal government making up fiscal rules on the fly

Last month, before the holidays, the Trudeau government released its fall economic update, which revealed—among other issues—that Canada’s federal debt-to-GDP ratio increased, meaning Canada’s debt has grown faster than the economy.

This is particularly important because the government chose the debt-to-GDP ratio to guide federal fiscal policy. In other words, the ratio is the government’s fiscal anchor, meant to impose discipline on government decisions regarding spending, taxes and borrowing.

Remember, upon entering office in 2015, the government committed to balancing the budget by 2019-20—then quickly shifted its primary fiscal goal (again, its fiscal anchor) to shrinking Canada’s debt-to-GDP ratio, a measure that indicates the country’s ability to pay back its debt. However, according to last month’s fiscal update, the federal debt-to-GDP ratio increased from 30.8 per cent in 2018 to 31.0 per cent in 2019, and is now expected to remain at that level through the end of 2021. By increasing the ratio, the government appears to have broken its own fiscal anchor so it can continue to increase spending, grow the deficit and rack up more debt. More debt means more interest costs, paid for by taxpayers. And likely higher taxes in the future.

This is not a trifle development. Fiscal anchors help guide policy on government spending, taxes, and borrowing. For example, the Chrétien government of the 1990s chose the reduction of nominal debt as its fiscal anchor, which required significantly more fiscal discipline than the current government’s goal of reducing the debt-to-GDP ratio—a goal it’s now failing to achieve.

Moreover, the fiscal update indicates that government spending will continue to grow, even above prior projections. Consequently, the federal deficit will reach a projected $26.6 billion this year, $6.8 billion higher than expected in March 2019. And of course, chronic deficits are adding to Canada’s federal debt, which is now projected to reach nearly $810 billion by 2024/25.

Looking forward, there are more reasons for concern.

First, the government has firmly established its willingness to ditch the anchor whenever convenient, essentially admitting there’s no particular fiscal discipline or rules currently governing federal spending, taxes and borrowing. Without a fiscal anchor, the government lacks a guiding mechanism to demonstrate restraint and is making up the rules on the fly. This is not a recipe for successful management of our government finances.

Second, this time the debt-to-GDP ratio increased while the economy is still growing and unemployment is comparatively low. A weakened economy going forward will spur significant increases in the deficit, debt and further increases to the ratio. There’s also reason to believe the government is being exceedingly optimistic in its economic growth projections and does not anticipate a recession in the near future.

But Canada’s major banks are preparing for an economic slowdown and recently set aside more money for loan losses. We’ve also recently seen waning business investment in Canada, rising trade tensions between key trading partners, and a softening U.S. economy. Clearly, storm clouds are forming on the horizon.

To recap, in a borderline-reckless move, the federal government has violated its fiscal anchor while the economy is growing (albeit slowly). If the economy weakens, as many predict, the debt-to-GDP ratio will increase even more. The federal government must begin to take fiscal policy—including its fiscal anchor—seriously. Otherwise, the deficit and debt burden, shouldered by Canadians, will continue to grow.