Spendthrift Liberals risk nasty shock ahead
Maybe I’ve had this all wrong.
I grew up with the federal deficit and I still have the fiscal scars to prove it. Twenty-seven straight years the federal government ran deficits, 21 of them in excess of three per cent of GDP. At its peak, in fiscal 1985, it hit a nightmarish 8.3 per cent.
Taxes were raised, spending was cut, but too late: the fiscal momentum from running such large deficits for so long was unstoppable. From less than 20 per cent of GDP in 1976, the federal debt grew to 68 per cent two decades later. Just to pay interest on that mountain of debt eventually consumed as much as 38 cents of every tax dollar: almost as much as the federal government spent directly on all other programs combined. It is hard now to recall how crazy that period was: like those scenes of people carting around wheelbarrows of money in old German newsreels.
Maybe we shouldn’t try. Like elderly Germans still living in terror of hyperinflation decades afterward, maybe I and others of my generation are living in the past, caught in the grip of an irrational deficit-phobia born of our youth. Maybe, as some economists gently suggest, we need to let it go. We are not still living in the 1990s, after all. The federal deficit today, at $19 billion, is less than one per cent of GDP; the debt, just 31 per cent. Interest costs are an incredible seven per cent of revenues, the lowest in at least a century, maybe ever.
So when it is revealed, as in last week’s annual financial report, that the Liberals, handed a $20-billion revenue windfall in the last fiscal year, spent it all — leaving the deficit unchanged from the previous year — maybe we should all chill out. The federal government could run $19-billion deficits forever, and the debt-to-gdp ratio would continue to fall. Maybe federal deficits are yesterday’s issue.
Or maybe not. If it’s too easy to compare today’s deficits with those of the past, it’s also too easy to forget how quickly those past deficits spiralled out of control. It took just four years in the late 1970s for the deficit to go from 1.4 per cent of GDP to more than five per cent, even with economic growth averaging 3.6 per cent per year. The recession of the early 1980s may have been the torpedo that sank federal finances. But the ship was already low in the water.
Unfair, an economic historian might object. Inflation was near double digits in those years, and interest rates higher still. Of the nearly $80 billion added to the debt between 1976 and 1982, just $24 billion was the result of operating deficits, i.e., program spending that exceeded revenues. The rest, more than two-thirds of the total, was interest costs. The current period of low inflation and interest rates is not remotely comparable.
All true. But just because interest costs are low now doesn’t mean they will be forever. More to the point, governments can always find ways to run into fiscal trouble even without the help of high inflation. What would it take for today’s apparently tamed debt to turn on its masters? Not a lot, it turns out.
Comparisons can be deceiving. Federal spending growth was actually relatively restrained in the late 1970s: per capita, after inflation, program spending was about the same in 1980 as it was in 1975. By contrast, spending today is nowhere near being under control. Over the last three years, spending has grown by more than 20 per cent, or about 6.3 per cent per annum.
Result: a decade after the last recession, with unemployment at a 40-year low, we are still running deficits — not because growth is slow or revenues are low, but because spending is at an alltime record high. (Yes, these figures incorporate the accounting changes unveiled in the financial report: at $8,358 per capita in 2018 dollars, program spending last year pulled roughly level with its previous peak, postfinancial crisis. It is almost sure to pass it this year.)
Suppose spending continues to grow at this pace. And suppose a recession were to hit next year — not a monster, like that of the early 1980s, but a medium-sized one, such as Canada experienced in 2009 (it was much worse elsewhere): enough, say, to cause a 10-per-cent decline in real revenues over two years.
The impact on federal finances is immediate and dramatic. The deficit jumps from its current 1 per cent of GDP to 2.5 per cent in the first year, more than 4 per cent the next, and higher still beyond. That’s even with a couple of years of above average growth in revenues factored in, post-recession.
As Ottawa’s fiscal position deteriorates, we might further assume the interest rates on federal bonds start to rise from their historic lows: from about 3.4 per cent of federal debt at present, interest charges might climb back to four per cent or more — about where they were five years ago.
Anyone with a spreadsheet can reproduce these results for themselves. By fiscal 2024, just four years later, the deficit would be well over 5 per cent of GDP; the debt-to-gdp ratio, closing in on 50 per cent. We’d be back on the treadmill we were on in the 1980s. Only now the growth in debt would not be driven by interest costs, but by mammoth operating deficits. The kind that are even harder to reverse.
Is this scenario realistic? I don’t know. You might think even the current government would rein in spending as its deficits continued to grow. But then again, the same government might decide it should raise spending even faster, in response to the recession. If spending should increase at six per cent-plus per year in good times, as is its apparent credo, who knows how fast it should increase in bad?