What Do Harper and Flaherty Mean By “Sustainable”?

In his  “Speech to the World” in Davos on January 26, 2012, Prime Minister Harper proclaimed that steps would be taken to ensure the “sustainability of our social programs and fiscal position over the next generation”. What does this mean?

 Since coming into office in 2006, the Prime Minister and his Minister of Finance have denied the emergence of a structural deficit due to the aging of the population.  Reports issued by the Parliamentary Budget Officer and others were dismissed out of hand.  Now with a majority government, the aging of the population and its long-term impact on federal government programs and the resulting fiscal position have become the number one budget priority. 

 The first indication of this was the Government’s unilateral decision, in December 2011, to restrain the growth in the Canada Health Transfer (CHT) to a three-year moving average in nominal Gross Domestic Product (GDP), beginning in 2017-18.  Funding is to be guaranteed to increase by at least 3 per cent per year. Up to 2016-17, the CHT will grow by 6 per cent per year.  Thereafter, however, the annual rate of growth will be in the 3.5 to 4 per cent range.

 Is this what the Prime Minister and Minister of Finance mean by “sustainable”? Do they mean that any federal program that grows by more than the rate of growth in GDP is not sustainable and must be cut? If they do, then they are wrong.

 What government programs are growing faster than GDP?

Excluding automatic stabilizer and self-financing programs, only one major program is currently expected to grow faster than GDP and that is elderly benefits (OAS). In previous budgets, steps were taken to ensure that other federal programs were not increasing by more than the growth in GDP. In the March 2010 Budget, the rate of growth in international assistance was reduced from 8 per cent per year to zero.  Between 2005-06 and 2010-11, defence spending averaged 7.2 per cent.  However, in the March 2010 Budget, defence spending was reduced by $525 million in 2012-13 and $1 billion annually beginning in 2013-14.  The chart contained in the 2010 Budget shows defence spending growing less than GDP in the future. Transfers under the Equalization program are capped at the growth of nominal GDP. With the ending of most of the stimulus measures in 2011-12 and the restraint measures put in place in the March 2010 Budget, coupled with the upcoming savings under the Targeted Strategic and Operating Reviews, only OAS benefits will be increasing faster than the rate of growth in nominal GDP over the long term.

 This is the program that the Prime Minister targeted in his Davos speech.  According to the Chief Actuary, Office of Superintendent of Financial Institutions Canada, OAS benefits are expected to increase from $36.5 billion in 2010 to $107.9 billion in 2030 and to $200.1 billion in 2055.  Apparently, the government considers these “large” increases to be unsustainable.

 But are they?

 As a percentage of the economy, they increase from 2.25% in 2010 to 3.14% in 2030 before falling back to 2.6% in 2050.  These ratios are much lower than in other advanced countries. Therefore, as a percentage of GDP, the increases are not large at all. Between 2010 and 2030 the increase amounts to only 0.89% of GDP.

 As noted above, all other components of program expenses are expected to grow at the same rate as GDP growth or well below it.  On balance, excluding OAS, total program expenses, as a percentage of GDP, will likely decline continuously over the next twenty years.  In addition, with a progressive tax system, budgetary revenues as a percentage of GDP will likely increase over time.  These two factors alone would more than fund the projected small increase in OAS benefits as a share of GDP over the next twenty years.

 Public debt charges and interest rates remain the wild card. The sensitivity on the budgetary balance of changes in interest rates has increased significantly since 2008 due to the accumulation in the stock of federal debt ($183 billion from 2007-08 to 2015-16) due to the recession and the impact of the stimulus measures introduced as part of the Economic Action Plan. 

 From a fiscal or budget perspective, a sustainable fiscal structure is one in which the government debt is not growing  faster than the economy. In other words, the government’s debt burden (the ratio of debt to GDP is either stable or falling.  

 Following the Second World War, the federal debt-to-GDP ratio fell to about 18.5% in 1973-74.  Thereafter, it rose steadily – to about 30% by 1980-81, to just over 50% by 1990-91, before peaking at 68.4% in 1995-96.  Clearly, during most of this period, the federal fiscal position was “unsustainable”.

However, over the 1995-96 to 2008-09 period, the federal debt-to-GDP ratio declined dramatically from a peak of 68.4% in 1995-96, to 28.9% in 2008-09.  The recession and the impact of the stimulus measures have resulted in an only a slight increase in the debt-to-GDP ratio.  According to the June 2011 Budget, it is expected to reach 35% in 2012-13, before resuming its downward path reaching 30.3% in 2016-17.

 Based on these projections, the federal position is still sustainable.  In fact, the Prime Minister and his Minister of Finance take great pleasure in announcing to the world that Canada’s debt-to-GDP ratio is the lowest among the G-7.

 If the Prime Minister and the Minister of Finance are worried about fiscal sustainability, they must have in their possession research that shows that over the next twenty years, that the federal debt to GDP ratio is rising steadily, and therefore the government’s fiscal position is not sustainable. If this is case, this analysis should be released in the budget..

 The Minister of Finance has up until now rejected studies by the Parliamentary Budget Office (PBO) and others (www.3dpolicy.ca) that the federal government has a long-term structural deficit.  Originally, the PBO concluded that the federal fiscal position was not sustainable over the long term. However, by restraining the growth in federal transfers to the provinces under the CHT, PBO recently concluded that the federal fiscal position is now sustainable.  However, the PBO also concluded that the federal government had just transferred its structural deficit  to the provinces and that fiscal position of Canada “Incorporated” is not sustainable.

 As stated by the PBO[1], “responsible fiscal planning needs to take account of challenges, not only the next few years, but also those anticipated over the long term”. Most OECD countries produce long-term fiscal sustainability reports.  According to the OECD, such reports “offer invaluable signposts to help current governments to respond to known fiscal pressures and risks in a gradual manner, earlier rather than later, and help future governments avoid being forced to adopt sudden policy changes”.[2]      

 It is time that the Prime Minister be clear on what he means by “sustainability” and why he now believes it is should be of great concern to Canadians. The public is sorely in need of credible information and analyzes, which can be studied by others and debated. This would involve

[1] “Fiscal Sustainability Report 2011”page I; Office of the Parliamentary Budget Officer September 2011.

[2] OECD (2009) “The Benefits of Long-term Fiscal Projections” OECD Policy Brief.

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