The federal government is on track to eliminate the deficit by 2015-16. The last time the federal government recorded a surplus was in 2007-08, with a surplus of $9.6 billion, following a string of surpluses that began in 1997-98. Over the previous three decades a surplus has been recorded in only one year.

 

The conventional wisdom these days is that deficits are bad. Any government, federal or provincial, with a deficit is in serious political difficulty. If they want to get re-elected, they had better commit not only to getting rid of their deficits, but also to doing it without raising taxes.

This has been Conservative government’s sole objective since 2010, and their success, in eliminating a deficit they in fact created, will be a critical part of their 2015 election campaign. To their political advantage, it is likely that the government will post a surplus, (refer to previous article this month) one year ahead of their political commitment.

 

Premier Wynne is committed to eliminating Ontario’s deficit by 2017-18. Quebec is also committed to eliminating its deficit within the next two years. British Columbia is committed to maintaining balanced budgets. The federal government is committed to balanced budget legislation. All governments are petrified of the U.S. rating agencies, notwithstanding the dismal record of these rating agencies prior to the financial meltdown that led to the 2008-09 recession.

 

Any political party advocating deficits and borrowing to spend on investments that Canadians (current and future) need would face an uphill battle in trying to get elected.  Financing a deficit through the creation of debt is regarded as a “fiscal sin”.

 

Why are deficits so “demonized” by politicians, the media, and the pundits and most importantly by just about everyone?  Why do Canadians believe that if we don’t eliminate our deficits (federal and provincial), we will end up like Greece? Why do Canadians believe that it is always wrong to create deficits, because that would leave our “grandchildren” with higher debt?

 

This demonization of deficits and debt, and the scare mongering that goes with it, may simply be a legacy of the growing debt burden in the 1970s and 1980s, and the tough fiscal actions needed in the mid 1990s to fix the problem. It may also be related to the deficit crisis in the EURO area and the actions these countries are taking to address the issue. More importantly, it may simply be part of the narrative in support of a small government agenda.

 

Unfortunately, this demonization of deficits and debt represents a fundamental misunderstanding of what sound fiscal management really means. To most Canadians, getting rid of deficits is the only thing that matters. If a government has a deficit then it is not a prudent fiscal manager. But this is not true and this failure of understanding is unfortunate, because it can lead to bad policy outcomes for both current and future generations. Without debt, both public and private, economies simply could not function.

 

Most economists accept that governments should adopt fiscal policies that will lead to a “sustainable fiscal structure”. Defining a “sustainable fiscal structure” (link to Parliamentary budget office fiscal sustainability report September 26, 2013) is not easy and not without controversy in the economics literature.  

 

In our view a “sustainable fiscal structure” is one in which the expenditure framework and revenue structure, as a share of GDP, result in a “stable” debt-to-GDP ratio over the medium to longer term. In the 1970s and 1980s, the federal government clearly did not have a sustainable fiscal structure.  The debt to GDP ratio doubled over that period. This is not the case today.

 

This “sustainability” and “stability” condition is essential no matter the size of government.

 

For example, Sweden has a sustainable fiscal structure built around a relatively large public sector and relatively high but stable debt-to-GDP ratio.

In Canada, the federal government currently has a sustainable fiscal structure, but one built around a relatively small federal government, and a stable debt-to-GDP ratio, that averaged around 33 per cent between 2009-10 and 2012-13, and 29.6 per cent in the three previous years, before the 2008-09 recession

 

In contrast, according to the Parliamentary Budget Officer, the provincial, territorial and local government sector does not have a sustainable fiscal structure, even though their aggregate debt-to-GDP ratio is currently under 30 per cent, but expected to rise significantly due to the impact of an ageing population on their finances. The situation varies among individual provinces.

 

In other words, the size of government doesn’t matter when it comes to sound fiscal management. Both small and large governments should commit to sustainable fiscal structures. This is what the rating agencies want. They don’t care about the size of government, only that their fiscal structure is sustainable.

 

In Canada, the federal government currently has a debt-to-GDP ratio of about 33 per cent and under current policies this ratio will continue falling. The Harper government has set a “target of stabilizing” the debt-to-GDP ratio at 25 per cent by 2021-22. According to the 2014 Budget, the debt-to-GDP is expected to fall to 25.5% in 2018-19.  As a result, the federal government will likely be under 25% by 2019-20; two years ahead of schedule. This is a fiscal record that all G-7 countries envy.

 

The federal government has never said what it would do once it has achieved its debt target of 25 per cent. How would it actually stabilize the ratio so that it wouldn’t go up or go down? At this point, politics becomes irrelevant and the rules of mathematics take over.

 

If the Conservative government wants to stabilize the debt-to-GDP ratio at 25 per cent, then at that ratio, the government must run a permanent and growing structural deficit that will result in the government’s debt increasing at the same rate of growth as the economy. This is not ideology, this is high school mathematics.

 

This is something Mr. Oliver and Prime Minister Harper probably didn’t see coming or simply don’t understand. Or maybe they do and they were always planning to let the debt ratio just keep falling. Perhaps we will see what they mean when they finally come out with the specifics of their “Balanced Budget Legislation”, which they announced in their 2011 election campaign. Balanced budget legislation does not mean a stable debt to GDP ratio.

 

In a recent report for the C. D Howe Institute, Professor Scarthe of McMaster University concludes that a ”debt ratio target of 25 per cent – along with an ongoing nominal GDP growth rate of 4 percent, requires a permanent deficit ratio of 1 percent, not zero.” This is roughly equivalent to $13 billion a year today and growing by 4 per cent a year. In fact, if Professor Scarthe is right, which he is, the federal government never really had to eliminate the current deficit to have a sustainable fiscal structure.

 

He also concludes that “raising its (the government’s) deficit target back up to 1 per cent (from zero) makes more sense when there are other short-term-pain-for-long-term-gain initiatives that are needed to address more pressing objectives than lowering a debt ratio that is already the envy of the world.”

 

The conclusion of his analysis is that completely eliminating the deficit, which has been the government’s objective since 2010, was never really necessary, at least not on economic grounds.

 

Professor Scarthe also recommends that, once the deficit is eliminated in 2015-16, any future government should gradually start creating a deficit by, for example, spending on infrastructure and this could be done while at the same time maintaining a stable debt to GDP ratio of around 25 per cent over the medium to longer term. We have made this same case for deficit financing of infrastructure spending in previous commentaries (March 12, 2014).

 

That should be an interesting communication problem for a Conservative government, or for that matter any of the opposition political parties as well.

 

The point of all this is that a “deficit is not always bad”. Sooner or later political parties, and Canadians will have to confront this reality.

 

The statement that a deficit must always be eliminated is a political statement, not an economic statement. In fact, it is hard to find any OECD country that actually has a commitment to eliminate the deficit. The deficit target for the EURO countries is 3 per cent of GDP and the debt-to-GDP target is 60 per cent of GDP.

 

Unless the federal government believes that it is more important to steadily reduce the debt ratio (to 20, 15, 10, or zero per cent), rather than dealing with other critical policy issues, then the federal government will soon have to start running deficits.

 

Indeed, as part of the 2015 election, all political parties should be asked how they view the role of the federal government in the economy; what size of government (i.e. debt ratio) are they looking for; and how would they achieve it? Based on the past eight years and current rhetoric the answers for the Conservative government would appear to be: minimal; zero or lower; and, balanced budget legislation. For the two opposition parties we don’t know the answers.

 

These questions may sound technical and arcane and not very politically relevant. But the opposite is true. They are very politically relevant. The answers to these questions will fundamentally determine the kind of government we want and the kind of country we will live in in the coming decades.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The federal government is on track to eliminate the deficit by 2015-16. The last time the federal government recorded a surplus was in 2007-08, with a surplus of $9.6 billion, following a string of surpluses that began in 1997-98. Over the previous three decades a surplus has been recorded in only one year.

 

The conventional wisdom these days is that deficits are bad. Any government, federal or provincial, with a deficit is in serious political difficulty. If they want to get re-elected, they had better commit not only to getting rid of their deficits, but also to doing it without raising taxes.

 

This has been Conservative government’s sole objective since 2010, and their success, in eliminating a deficit they in fact created, will be a critical part of their 2015 election campaign. To their political advantage, it is likely that the government will post a surplus, (refer to previous article this month) one year ahead of their political commitment.

 

Premier Wynne is committed to eliminating Ontario’s deficit by 2017-18. Quebec is also committed to eliminating its deficit within the next two years. British Columbia is committed to maintaining balanced budgets. The federal government is committed to balanced budget legislation. All governments are petrified of the U.S. rating agencies, notwithstanding the dismal record of these rating agencies prior to the financial meltdown that led to the 2008-09 recession.

 

Any political party advocating deficits and borrowing to spend on investments that Canadians (current and future) need would face an uphill battle in trying to get elected.  Financing a deficit through the creation of debt is regarded as a “fiscal sin”.

 

Why are deficits so “demonized” by politicians, the media, and the pundits and most importantly by just about everyone?  Why do Canadians believe that if we don’t eliminate our deficits (federal and provincial), we will end up like Greece? Why do Canadians believe that it is always wrong to create deficits, because that would leave our “grandchildren” with higher debt?

 

This demonization of deficits and debt, and the scare mongering that goes with it, may simply be a legacy of the growing debt burden in the 1970s and 1980s, and the tough fiscal actions needed in the mid 1990s to fix the problem. It may also be related to the deficit crisis in the EURO area and the actions these countries are taking to address the issue. More importantly, it may simply be part of the narrative in support of a small government agenda.

 

Unfortunately, this demonization of deficits and debt represents a fundamental misunderstanding of what sound fiscal management really means. To most Canadians, getting rid of deficits is the only thing that matters. If a government has a deficit then it is not a prudent fiscal manager. But this is not true and this failure of understanding is unfortunate, because it can lead to bad policy outcomes for both current and future generations. Without debt, both public and private, economies simply could not function.

 

Most economists accept that governments should adopt fiscal policies that will lead to a “sustainable fiscal structure”. Defining a “sustainable fiscal structure” (link to Parliamentary budget office fiscal sustainability report September 26, 2013) is not easy and not without controversy in the economics literature.  

 

In our view a “sustainable fiscal structure” is one in which the expenditure framework and revenue structure, as a share of GDP, result in a “stable” debt-to-GDP ratio over the medium to longer term. In the 1970s and 1980s, the federal government clearly did not have a sustainable fiscal structure.  The debt to GDP ratio doubled over that period. This is not the case today.

 

This “sustainability” and “stability” condition is essential no matter the size of government.

 

For example, Sweden has a sustainable fiscal structure built around a relatively large public sector and relatively high but stable debt-to-GDP ratio.

In Canada, the federal government currently has a sustainable fiscal structure, but one built around a relatively small federal government, and a stable debt-to-GDP ratio, that averaged around 33 per cent between 2009-10 and 2012-13, and 29.6 per cent in the three previous years, before the 2008-09 recession

 

In contrast, according to the Parliamentary Budget Officer, the provincial, territorial and local government sector does not have a sustainable fiscal structure, even though their aggregate debt-to-GDP ratio is currently under 30 per cent, but expected to rise significantly due to the impact of an ageing population on their finances. The situation varies among individual provinces.

 

In other words, the size of government doesn’t matter when it comes to sound fiscal management. Both small and large governments should commit to sustainable fiscal structures. This is what the rating agencies want. They don’t care about the size of government, only that their fiscal structure is sustainable.

 

In Canada, the federal government currently has a debt-to-GDP ratio of about 33 per cent and under current policies this ratio will continue falling. The Harper government has set a “target of stabilizing” the debt-to-GDP ratio at 25 per cent by 2021-22. According to the 2014 Budget, the debt-to-GDP is expected to fall to 25.5% in 2018-19.  As a result, the federal government will likely be under 25% by 2019-20; two years ahead of schedule. This is a fiscal record that all G-7 countries envy.

 

The federal government has never said what it would do once it has achieved its debt target of 25 per cent. How would it actually stabilize the ratio so that it wouldn’t go up or go down? At this point, politics becomes irrelevant and the rules of mathematics take over.

 

If the Conservative government wants to stabilize the debt-to-GDP ratio at 25 per cent, then at that ratio, the government must run a permanent and growing structural deficit that will result in the government’s debt increasing at the same rate of growth as the economy. This is not ideology, this is high school mathematics.

 

This is something Mr. Oliver and Prime Minister Harper probably didn’t see coming or simply don’t understand. Or maybe they do and they were always planning to let the debt ratio just keep falling. Perhaps we will see what they mean when they finally come out with the specifics of their “Balanced Budget Legislation”, which they announced in their 2011 election campaign. Balanced budget legislation does not mean a stable debt to GDP ratio.

 

In a recent report for the C. D Howe Institute, Professor Scarthe of McMaster University concludes that a ”debt ratio target of 25 per cent – along with an ongoing nominal GDP growth rate of 4 percent, requires a permanent deficit ratio of 1 percent, not zero.” This is roughly equivalent to $13 billion a year today and growing by 4 per cent a year. In fact, if Professor Scarthe is right, which he is, the federal government never really had to eliminate the current deficit to have a sustainable fiscal structure.

 

He also concludes that “raising its (the government’s) deficit target back up to 1 per cent (from zero) makes more sense when there are other short-term-pain-for-long-term-gain initiatives that are needed to address more pressing objectives than lowering a debt ratio that is already the envy of the world.”

 

The conclusion of his analysis is that completely eliminating the deficit, which has been the government’s objective since 2010, was never really necessary, at least not on economic grounds.

 

Professor Scarthe also recommends that, once the deficit is eliminated in 2015-16, any future government should gradually start creating a deficit by, for example, spending on infrastructure and this could be done while at the same time maintaining a stable debt to GDP ratio of around 25 per cent over the medium to longer term. We have made this same case for deficit financing of infrastructure spending in previous commentaries (March 12, 2014).

 

That should be an interesting communication problem for a Conservative government, or for that matter any of the opposition political parties as well.

 

The point of all this is that a “deficit is not always bad”. Sooner or later political parties, and Canadians will have to confront this reality.

 

The statement that a deficit must always be eliminated is a political statement, not an economic statement. In fact, it is hard to find any OECD country that actually has a commitment to eliminate the deficit. The deficit target for the EURO countries is 3 per cent of GDP and the debt-to-GDP target is 60 per cent of GDP.

 

Unless the federal government believes that it is more important to steadily reduce the debt ratio (to 20, 15, 10, or zero per cent), rather than dealing with other critical policy issues, then the federal government will soon have to start running deficits.

 

Indeed, as part of the 2015 election, all political parties should be asked how they view the role of the federal government in the economy; what size of government (i.e. debt ratio) are they looking for; and how would they achieve it? Based on the past eight years and current rhetoric the answers for the Conservative government would appear to be: minimal; zero or lower; and, balanced budget legislation. For the two opposition parties we don’t know the answers.

 

These questions may sound technical and arcane and not very politically relevant. But the opposite is true. They are very politically relevant. The answers to these questions will fundamentally determine the kind of government we want and the kind of country we will live in in the coming decades.