The recently released Budget is notable for a number of reasons. Major proposals included:
- important changes to the structure of benefits for families with children;
- a major ramp up in federal government spending, especially capital spending on ‘infrastructure’;
- a significant increase in the projected deficit.
Much of the commentary on the Budget has focussed on the projected deficit and concomitant increase in the public debt and that is what I want to discuss in this post.
The Minister justified a higher deficit in terms of a number of factors:
- spending on infrastructure is needed; it will improve productivity and, hence, future economic growth;
- government spending is also needed to increase economic activity in the near term given the prospects for weak economic growth in the near term;
- we can afford to run a deficit: interest rates on federal debt are at low levels – now is a good time to borrow. Moreover the ratio of government debt to GDP is low – the lowest among G7 countries – and the ratio of debt service costs (interest charges on the federal debt) to total federal spending is low, some 10 per cent.
The Minister committed the government to reduce the ratio of federal debt to GDP “to a lower level over a five year period ending in 2020-21”.
He stated: “In an environment of sustained economic weakness and historically low interest rates, fiscal policy is the right policy lever to use to support long term growth.” (Budget document, page 46)
If indeed the Canadian economy is in a period of “sustained economic weakness” – and most analysts think that it is – this policy stance is consistent with that advocated by most economists and by major international economic organizations such as the IMF. Referring to the need and potential for expansionary fiscal policy, Mme. Lagarde, the Managing Director of the IMF recently said: “Of course, countries with high and increasing debt, and elevated sovereign spreads need to pursue further fiscal consolidation. But others may have room for fiscal expansion—and even more so if they commit to credible, medium-term consolidation plans. With its recent budget, Canada stands out as one such country making the most of this space.”(http://www.imf.org/external/np/speeches/2016/040516.htm)
And the former Chair of the Federal Reserve Board, B. Bernanke, has called for more support from fiscal policy in the conduct of macroeconomic policy in the US. The consensus in favour of the use of fiscal policy stems, to a significant extent, from the fact that monetary policy, the other major macroeconomic policy instrument, can do little more at present to stimulate economic activity: interest rates are close to zero and, even so, there is little incentive for businesses to borrow given the weak outlook for global demand for goods and services.
Much of the political and journalistic commentary on the Budget has not focussed on – let alone mentioned such professional opinion. Rather it has criticized the government for:
- running a deficit at all and/or
- not having laid out a strategy for returning to budget balance in the future.
The first of these criticisms essentially states that debt has no place in federal government finance so that, unlike households (who, collectively in Canada currently have total debt equal to roughly 165 per cent of household income) and business firms, governments should pay for all of their activities – spending on current operations as well as that on long-lived infrastructure – out of current income (i.e. taxation).
This makes no sense; infrastructure – roads and other transport facilities, municipal infrastructure, etc. – benefits future generations and it is reasonable that they contribute to their construction and maintenance through paying for interest and principal on public debt. Moreover, when economic activity is expected to remain below its potential level for a lengthy period, it makes sense to incur deficits to generate higher GDP and employment. Not only is potentially foregone output of goods and services prevented but workers retain their skills (extended unemployment results in a deterioration of skills and productivity, not to speak of its generally debilitating effects on morale and health).
Further, with respect to the federal government, debt issued to finance deficits is owed to an overwhelming extent to Canadians by Canadians. There is no ‘burden’ on Canadian society as a whole as a consequence of the issuing of domestically held government debt. Further, the federal government, through the Bank of Canada, controls the money supply: bonds issued to finance deficits can be ‘sold’ to the Bank of Canada in exchange for deposits which are used by the government to pay for its goods and services envisaged by the Budget plan. Clearly there are limits to the extent monetary expansion can be used. If used in a time when the economy is operating at capacity the result would be increasing inflation. But, in times when the economy is operating below capacity, the resulting expansionary monetary policy would complement fiscal policy. That is the situation that confronts Canada today; I’ve not heard of any economist or institution (including the Bank of Canada and the IMF – see above) who does not think there is excess capacity in the Canadian economy now and in prospect in the near-term future.
The second criticism – lack of a plan for returning the budget to balance – has more validity and has been made by a former Deputy Minister of Finance ((http://www.theglobeandmail.com/report-on-business/rob-commentary/the-liberal-deficit-slays-one-elephant-time-for-a-second-raising-the-gst/article29382149/), by the former Parliamentary Budget Officer and by at least two academic economists (Stephen Gordon of Laval and Paul Boothe of Western).
Prof. Gordon states, for example: “The real issue is that they have not matched measures to increase spending with offsetting measures to increase tax revenues….. If you’re going to stick with Stephen Harper’s levels of revenue it’s hard to do anything else but stick with Stephen Harper’s level of spending”.!
The Minister skirted this issue; the Budget states:
- “The Government is committed to reducing the federal debt to GDP ratio to a lower level over a 5 year period, ending in 2020-21” (p. 50), and
- “The Government will set a timeline for balancing the budget when growth is forecast to remain on a sustainably higher track.” (p. 53)
One would like to have seen a longer term more coherent and explicit fiscal strategy encompassing both revenue and expenditure plans. That said one should not exaggerate the extent to which this Budget will have an impact on the longer run federal debt/GDP ratio. Prof. Kevin Milligan of UBC calculates (http://www.macleans.ca/economy/economicanalysis/we-are-not-heading-to-fiscal-crisis/), for example, that, even were the federal deficit to remain at its Budgeted level of 1.5% of GDP for the remaining years of this century, the ratio of federal debt to GDP would rise over time but, even with very low GDP growth, that ratio would still be well under its 1995 level by the end of the century. 1995 was, of course, the year then Finance Minister Paul Martin introduced drastic expenditure cuts to reduce a federal deficit that had led to a federal debt/GDP of some 65%!
All in all, I think the Budget represents a move in the right direction.Nonetheless an outline of a more detailed longer term tax and expenditure strategy would have been welcome.