HARPER'S AND FLAHERTY'S OBSESSION WITH "MOVING" FISCAL TARGETS
The G-20 has just completed its Summit in St. Petersburg, Russia. Not surprisingly, but quite appropriately, the focus of the meeting was on the crisis in Syria, and not solely on global economic and financial issues. A lot has changed since the last G-20 meeting. At the previous meeting, the IMF predicted that the emerging market economies would lead global economic growth and the U.S. would lag behind. However, by September 2013, the IMF had done a 360-degree turn and had the U.S leading a global recovery (albeit not very strongly) and the emerging market economies struggling with rising interest rates, capital flight and falling exchange rates, resulting from the possibility of a tapering of Federal Reserve Board monetary stimulus. The focus of most of the discussion on global economic issues at the G-20 was on returning the global economy to steady growth and the need for advanced economies to recognize policy spill-over effects and for emerging markets to implement structural reforms.
Mr. Harper and Mr. Flaherty, on the other hand, thought that the real issue for the global economy was still the need for G-20 countries to eliminate deficits and commit to significant reductions in debt burdens. They continued to urge other G-20 countries to adopt Canada’s strategy of deficit reduction and debt control. This view was not well received. According to Reuters “ideas about binding commitments to extend the Toronto debt reduction goals at a summit hosted by Canada in 2010, sought by Germany first and foremost, have been abandoned” Mr. Harper and Mr. Flaherty would appear to be still living in the Toronto Summit, while the rest of the G-20, except perhaps Germany, has moved on to confront more pressing issues, including the growing risks of global instability and the need to strengthen growth and job creation.
Mr. Harper, of course, never actually believed that the G-20 would listen to him, let alone adopt his recommendation to commit to lower debt burdens. Even though he announced another major policy commitment outside of Canada, he was playing to his domestic audience to hype his credentials as a sound manager of the government’s finances.
The Prime Minister once again re-iterated that the deficit would be eliminated in 2015-16. But he went farther and announced a new fiscal target for the federal government – reducing the federal debt to gross domestic product (GDP) ratio to 25 per cent by 2021. This government has had an obsession with targets, better still “moving targets”, since coming to office in 2006. Unfortunately, to date, none of them have been met.
In the 2006 Budget, the government promised to reduce the deficit by $3 billion per year; to reduce the federal debt-to-GDP ratio to 25 per cent by 2012-13; to eliminate the total government sector debt (which includes the federal, provincial and local governments as well as the Canada and Quebec pension plans) by 2021; and finally, to keep the growth in program expenses below the rate of growth in nominal GDP.
The deficit in 2012-13 is currently estimated at about $26 billion – in 2006-07 there was a surplus of $13.8 billion. The federal debt-to-GDP ratio in 2012-13 is estimated at 33.1 per cent – not the promised 25 per cent. Given the fiscal situation of the provinces, it is highly unlikely that the elimination of the total government sector debt will be achieved in 2021. The growth in program expenses has been running well ahead of the growth in the economy.
In the 2009 Economic and Fiscal Statement, the Harper Government announced that it would eliminate the deficit over the medium term – no date was specified. It also stated that it would restrain the growth in direct program expenses – total program expenses excluding major transfers to persons and other levels of government – but achieving this target would be dependent on economic developments. These targets provided the Government with enough wiggle room to manage any expected developments.
But, in the 2013 Budget, the Government again decided to set a target with an explicit date – elimination of the deficit in 2015-16. This was set solely for political rather than economic purposes. The final fiscal results, however, will not be known until the fall of 2016 – a full year after the federal election expected for the fall of 2015. This will not deter the government from claiming the deficit has been eliminated and from introducing the tax cuts it promised in the 2011 election.
Given the Government’s track record in meeting its fiscal targets to date, one has to wonder why Mr. Harper decided to set another one. More importantly, what does this new target mean and how important is reducing the federal debt-to GDP ratio to 25 per cent?
The date to realize this new target is 2021. It is unclear whether this relates to fiscal year 2020-21 or 2021-22. Regardless, this is at least 8 years into the future. A great deal can happen over such a long-time period – developments over which the government has little or no control. There could easily be another global recession, for example. These fiscal targets are in reality quite meaningless. The EURO area provides a good example of setting targets and failing to take the necessary policy actions to achieve them
Why should we care if our debt to GDP ratio is 33 per cent or at 25 per cent? We are far better off than we were in 1995 when the federal government had a debt-to-GDP ratio of almost 70 per cent. As the government constantly reminds us, we are better off than other G-7 countries, although certainly not better than other OECD countries. Financial markets are not concerned about the federal government’s current fiscal situation. A ratio of 25 per cent or 33 per cent is not going to determine what interest rates are going to be in Canada. This will be determined by international developments – factors beyond the government’s control.
Using the March 2013 Budget fiscal projections to 2017-18 and assuming that nominal GDP grows on average by 4 per cent per year – 2 per cent real growth and 2 per cent inflation – the target could be achieved in 2020-21, assuming no growth in federal debt post 2017-18. If the target is for 2021-22, the federal debt could increase to $650 billion from the March 2013 Budget projection of about $625 billion for 2017-18. Over the last six years federal net debt has increased by $100 billion.
A recent Department of Finance report(1) showed that the federal government’s fiscal position is sustainable and that the federal debt-to-GDP ratio would fall to about 24 per cent by 2020-21. So Harper’s commitment to a 25 per cent ratio is not overly ambitious, provided that all surpluses are directed to debt reduction and not new policy initiatives.
What happens after reaching 25 percent? Mr. Harper has said we can go lower. Does it mean we just keep on going down to 20 per cent or 10 percent or even further? Or can we simply “stabilize” our debt burden at 25 per cent? This would require the debt of the federal government to grow as fast as the economy. Assuming that nominal GDP would grow, on average, by 4 per cent annually then debt would also have to grow by 4 per cent annually. This would mean the government would have to incur ever-increasing deficits.
There is in fact no “magic number” as to the “optimal” size of a country’s debt burden. A high and rising debt burden is not desirable since it is not sustainable. But a low and falling debt burden is also not sustainable. In the final outcome, economic developments and political forces, along with unforeseen events will determine where a country’s debt burden finally “stabilizes”.
1. "Economic and Fiscal Implications of Canada's Aging Population" Department of Finance November 2013.