Why permanent deficits are a bad idea

Temptation great to leave problem for future generations

Do deficits matter? To read the Liberal election platform, you’d have to say no. The party proposes $57-billion in new spending over the next four years, most of it borrowed; the deficit would hit $27-billion next year, and remain in excess of $20-billion throughout — and, presumably, beyond.

This, mind, is from the party that in its 2015 platform promised deficits would remain below $10-billion; by now they were supposed to have fallen to zero. Significant parts of the Liberal platform, such as the new pharmacare plan it sort-of promises, are left out of the overall spending figures, while its projected revenue increases are the subject of some doubt among economists. Throw in a recession — a rising possibility, more than 10 years after the last — and the deficit could be three or four times as large as forecast.

But what’s significant about the Liberal platform isn’t the size of the deficits. It’s their permanence. Unlike in 2015, the party does not even pretend to commit to balancing the budget — not after four years, not ever. The new standard, rather, is a steadily declining debtto-gdp ratio, from 30.9 per cent of GDP today to a projected 30.2 per cent four years out.

By that criterion, the budget need never be balanced. So long as the debt grows more slowly than the economy the ratio of the two will continue to fall. Given nominal GDP growth averaging 3.7 per cent, and remembering that the debt is only 30 per cent as large as the GDP, a deficit of less than 1.1 per cent of GDP — about $27-billion, as it happens — would suffice.

This rather looser standard of fiscal probity has an obvious appeal to practising politicians. Rather than confine their spending to what they can raise each year in taxes, they get another one per cent or so of GDP to play with. But it also has some intellectual respectability.

Obviously there is no critical importance to a single annual deficit: we don’t, as I’ve written before, turn into pumpkins if spending exceeds revenues in a given fiscal year. And even the debt, the sum of all previous deficits, only has meaning in proportion to our national income.

Back in the 1990s, when the federal debt was 68 per cent of GDP and interest on the debt consumed as much as 38 cents of every tax dollar, we were in a genuine fiscal crisis. Today, not so much: not only is the debt less than half as large, relative to GDP, but interest costs are just seven per cent of revenues. As the economist Kevin Milligan writes in The Walrus, “we should just accept that the debt battle has been won and move on.”

All right. Suppose we accept that the debt-to-gdp ratio, rather than the annual deficit, is the right measure. Who’s to say, however, that there’s anything special about its current level? Or even the trend?

If it is barbaric superstition to restrain spending, with all of society’s pressing needs, in pursuit of an arbitrary target like a zero deficit, how is it any less barbaric to do so in pursuit of an equally arbitrary target for the debt-togdp ratio? And having freed ourselves from the one, are we not just as likely to cast off the other? Today the conventional wisdom is a declining debt-to-gdp ratio. But perhaps some future skeptic will suggest it is sufficient that it should not rise.

Or even that it should, provided it does not rise too quickly. Would anyone really notice if the debt were to rise from 30 per cent to 32 per cent of GDP? Or from 32 per cent to 33? Or 34? Or 35?

On the other hand, if there’s no special significance to any particular debt-to-gdp target, what’s to prevent a skinflint like me from arguing it should fall further, faster? The Liberals are content that it should exceed 30 per cent of GDP four years from now. But why not set a target of, say, 25 per cent — a level that would require us, not just to balance the budget, but run surpluses?

Just switching from deficit to debt targets, in other words, doesn’t really answer the question. Or maybe it’s not the right question. Maybe the question we should be asking is not how much governments should borrow, but why they should do so at all.

There’s a pretty broad consensus, for starters, that governments should not go into deficit to finance current consumption — borrowing to pay the groceries — but rather should limit such funding to investments that yield a stream of future returns, sufficient to offset the costs of borrowing.

Fine: but how do we measure those returns? It’s not enough just to label it “investment.” One reliable way to measure the value of a good or service, at least as a first approximation, is to see how much people will pay for it at the margin. Hence the growing interest in public infrastructure projects that recoup their costs from charges on users, such as road tolls.

But if you can charge users for it, the case for public finance disappears — private investors are just as capable of funding it. The definition of a public good, the kind that has to be financed from taxes (and tax-supported borrowing), is precisely that you can’t charge for it. On closer examination, then, there is little reason to think deficits should finance investment, any more than consumption.

And there’s another argument for matching spending against taxes. It’s not just that, without a budget constraint, governments have no incentive to be choosy about spending. It’s that neither do taxpayers. So long as the deficit option is available, the temptation will always be to chalk up spending to future generations — who if you’ve noticed don’t get a vote. Which is how you get such relatively low-priority spending programs as universal federal camping subsidies (Liberal platform, p. 35).

Moral: no, even permanent deficits wouldn’t kill us. That doesn’t make them a good idea.

THE PARTY DOES NOT EVEN PRETEND TO COMMIT TO BALANCING THE BUDGET.