National Post (Latest Edition)
No fiscal anchors holding back the Liberals
Monday’s federal budget, the first in more than two years, is about pre-election spending financed by heavy deficits. The minister of finance, Chrystia Freeland, is rolling the dice that never-ending deficits will be manageable. There is no plan to balance the budget or to bring the federal debt back to pre-pandemic levels. If inflation and interest rates are subdued in the medium term, then there’s no need to worry — at least in Freeland’s eyes.
You have to dig pretty deep to find any reference to a fiscal anchor in this eye-straining 724-page federal budget. Only one reference, on page 53, can be found: “the government is committed to unwinding Covid-related deficits and reducing the federal debt as a share of the economy over the medium-term.”
This is a pretty weak fiscal anchor. It perpetuates deficit financing forever. It is also easily violated every time the economy slips into a recession, such as our recent one. As debt ratchets up as a share of the economy, the rule permits bigger and bigger federal deficits over time.
The recent pandemic-induced recession makes this point clear. Just before the pandemic, in 2019–20, federal debt was $721 billion, which is seemingly minuscule compared to today. The economy grew by 3.5 per cent that year, so the deficit could be high as $25 billion while still keeping debt from rising as share of the economy.
With the pandemic, the federal deficit ballooned by $354 billion — federal debt rose to $1.079 trillion for the fiscal year 2020–21. If economic growth were the same now as 2019–20 (3.5 per cent), a deficit of $38 billion would keep debt stable as a share of the economy.
Actually, the government assumes in its projection that the economy will grow by 9.3 per cent in 2021. That would mean the federal government could run a deficit as big as $110 billion to satisfy its fiscal anchor. In this vote-seeking budget, Freeland actually projects a $155 billion deficit in the current fiscal year. As a result, federal debt rises from 49 to 51 per cent of GDP in the fiscal year 2021–22.
None of this is surprising with a profligate government. Back in the 1980s, when inflation and interest rates were higher than today, the federal fiscal anchor was similar. Debt would be kept to reach a maximum share of the economy and the ratio would fall thereafter. That did not happen. Downturns in the economy and overspending resulted in the projected debt share ratcheting up year by year, eventually leading to a fiscal crisis.
The federal budget argues that deficit financing is tolerable since interest and inflation rates are low. Freeland forecasts inflation to pop up to three per cent in 2021 and fall back to two per cent in the next four years. Even in this scenario, interest costs almost double from $20 billion in 2021–22 to $39 billion in 2025–26. Freeland claims this will keep debt charges as a share of GDP “near the lowest level in a century”.
Canadians should take note, though, that they will be paying $40 billion in taxes just to cover interest expenses by 2025–26. That concern is ameliorated if the government prints money to fund the deficit, including interest charges. In the belief that the printed money won’t cause inflation to increase, we can happily spend money without raising taxes — just the sort of happy thinking behind the new-age Modern Monetary Theory.
That is the optimistic scenario. But if we are to learn anything from this pandemic, it’s that events beyond our control can happen. It is well possible that supply shortages in the face of pumped-up public spending could lead to higher and sustained levels of inflation. If this happens, a buildup of inflationary expectations could result in higher interest rates, pushing up debt charges more than expected. There is some evidence that is happening already, with shortages in semiconductor supplies, elevated shipping costs and higher commodity prices.
When interest rates rise, debt issued by the federal government becomes more expensive. In 2021–22, for example, the federal deficit and the rollover of federal debt will require the Canadian government to seek over a half-trillion dollars in new financing. Just a onepoint increase in interest rates would then increase the annual deficit by close to $5 billion.
Alternatively, we could see another recession in this decade, resulting in a ratcheting up of federal debt once again. When governments look like they no longer have the fiscal capacity to finance their debt obligations, international lenders get nervous and negotiate higher interest rates to offset credit risks.
Thus, we should be considering the possibility that things might not unfold exactly as we expect. It is one thing to help the economy overcome the pandemic, but it is another to let debt rise as a share of the economy in the coming years. Eventually, someone has to pay the forthcoming bill.
The federal budget had little in the way of tax increases except higher employment insurance premiums after three years — hardly surprising if the Liberals are planning to trigger an election soon. There will be about $12 billion more in taxes from some large companies over the next five years with the new digital service tax, limits on interest expense and other measures to limit international tax avoidance. Meanwhile, tax reductions are provided to the working poor and for small business investment. Economic growth will be boosted little by these tax measures. Instead, Freeland believes that public spending on climate change, business subsidies and child care will boost growth and productivity, which is, at best, debatable.
In this budget, encouraging business investment is takes a back seat to spending. And the absence of a strong fiscal anchor will mean perpetual deficit financing, at least until it can’t go on any longer and the chickens come home to roost.