National Post (National Edition)
DARK SIDE TO A DEADLOCKED CONGRESS.
One word describes the outcome of the U.S. midterm elections: stalemate. The Democrats have a majority in the House and the Republicans control the Senate and presidency. And, go figure, the response of the U.S. stock markets the day after was to cheer the outcome, with increases in the Dow and S&P 500 indexes and Nasdaq.
The system of checks and balances in the U.S. constitution is perhaps one of its best features. No party can easily control the government if the voters are not willing to grant it. If the two parties want to legislate when they take the reins in 2019, bi-partisanship will be needed. Otherwise, nothing will get done. Maybe this is the thinking of the market: less government is best.
Or perhaps, investors are happy with the stalemate given that many of the Trump policies adopted so far — deregulation and tax cuts — cannot be undone since the Republicans still control the Senate. The supply-side effects of Trump policies that encourage investment and productivity therefore remain in place. So will the fiscal stimulus created by new spending and tax reductions in the 2018 budget. Further policies may still be in the offing if there is congressional agreement, for instance infrastructure spending.
But there is a dark side to a deadlocked Congress and that is its inability to address a looming fiscal crisis evolving in the near future. Deficits and debt are growing rapidly accompanied by rising interest rates. With an aging society and burgeoning spending on social security and health care, it is far from clear that the U.S. is on a fiscally sustainable path.
The fiscal position of the United States and many advanced and emerging countries is well-documented in the International Monetary Fund’s October Fiscal Monitor. Countries with large primary general government public deficits — revenues unable to cover non-interest expenditures — increase government borrowing without making any dent in accumulating deficits and interest payments. Along with household and corporate debt, a country increasingly relies on the whims of foreign lenders who fund the “current account” deficit, which indicates that domestic income is inadequate to fund consumption, investment and government deficits.
As shown in the accompanying graph, the United States is in the worst position: with a large general government primary deficit of over three per cent of GDP and a similar current account deficit. The U.S. general government gross debt (excluding unfunded government pensions) is now 106 per cent of GDP and its net debt is 78 per cent, not far from Canada’s worst days in the 1990s.
If you think that the U.S. is on an unsustainable path with high deficits, international borrowing and debt, the IMF provides another assessment that is even more disturbing. The IMF estimates that the present value of unfunded pension liabilities (2015 to 2050) is equal to 31 per cent of GDP and unfunded health care liabilities are 122 per cent of GDP. Putting it altogether, total net debt in the United States is roughly 230 per cent of GDP or US$46 trillion. Ouch!
None of this includes the expected fall in taxes as a share of GDP when the retired population grows relative to the working population. Old folks don’t pay as much income and sales taxes when they retire.
Much of the public deficit and debt problem lies at the federal level in the United States since the states tend to balance budgets as required by their constitution or legislation. So it is up to Congress and the President to address the looming debt crisis, but there is virtually no political will do so especially in a deadlocked Congress. Obviously, the market is not worried about U.S. fiscal sustainability judging from its reaction to the midterm elections, but it should be.
Before Canadians think we are all that much more fiscally prudent, the graph shows that we share the same problems as the United States, Brazil, France and Turkey, just not as extreme. Our current account deficit is roughly three per cent of GDP and the general government primary deficit indicates that revenues fall short of non-interest public spending by 0.9 per cent of GDP. We are currently living beyond our means borrowing from international markets to fund our consumption and investment at home.
Neither is our net debt position rosy for a resource-wealthy country. Gross debt of all governments in Canada total 87 per cent and net debt is 28 per cent of GDP, obviously much less than the United States on both counts. However, adding in unfunded pension (29 per cent of GDP) and healthcare liabilities (47 per cent of GDP), our total government net debt adds up to 104 per cent of GDP or about $2 trillion.
On Nov. 21, we will likely hear from the federal minister of finance how great we are doing in keeping our debt down. That is true for official federal government debt. However, it ignores pension and health care unfunded liabilities and provincial/municipal debt. The provinces particularly are facing rising health care costs that eat up almost half of their budgets.
Only one taxpayer exists to cover all these unfunded liabilities. As Canada’s retired population takes up a larger share of the population, expect pressures on the federal government to increase transfer payments to provinces with yawning deficits.
That is not the right answer since it will only shift deficits from one level of government to another. The big question is whether governments at all levels can keep the lid on spending so taxes paid by hardworking Canadians can be directed to the public services most important to them. As innocuous as it seems, funding new cars for visiting dignitaries or retired Governor-general budgets, for example, indicate inept government practices to direct funding to programs efficiently and effectively administered. We don’t have a U.s.-style checks and balances system of government that leads to stalemate, so we have no excuse for not addressing our fiscal issues.
WITH AN AGING SOCIETY AND BURGEONING SPENDING ON SOCIAL SECURITY AND HEALTH CARE, IT IS FAR FROM CLEAR THAT THE U.S. IS ON A FISCALLY SUSTAINABLE PATH.