Published in the Toronto Start April 11, 2017
In 2015, hot on the campaign trail and seeking a way to differentiate themselves from their political opponents, the Trudeau Liberals made a political calculation: rather than raise taxes to finance their spending commitments, they would resort to deficit financing. The initial promise was to run two consecutive $10 billion dollar deficits before returning to budgetary balance in 2019, though once in office that commitment was promptly jettisoned.
In Budget 2017 we learned that last year’s deficit was $23 billion, this year’s deficit will rise to $29 billion and, by 2019, the shortfall will still be $23 billion. And while a recent Nanos survey indicates that a majority of Canadians support deficit spending, some researchers and pundits have issued ominous warnings (‘Greece!’) that deficit spending will impose a fiscal straightjacket on younger Canadians.
Now, to most Canadians a $29 billion dollar budgetary shortfall sounds unimaginably large, but by historical standards it is rather modest. $29 billion amounts to just 1.4 percent of GDP, which is well below the half-century average deficit of 2.4 percent. Canada’s debt load, which is the lowest among the G7, is projected to hold steady at roughly 31 percent over the next four years. And the federal government’s debt servicing ratio (interest plus principal), which is the most significant metric when assessing debt sustainability, is at a 50 year low.
Just as striking is the fact that federal budgetary revenue as a share of GDP has declined. With the onset of tax reform in the late 1980s, the relative size of the federal government began to contract. By the time the Trudeau Liberals came to power in 2015, the budgetary revenue share of GDP had fallen under 15 percent, which is roughly the level it was in 1940 (before universal health care and the Canada Pension Plan). Back-of-the envelope calculations indicate that, had budgetary revenue held steady at mid-1970s levels, the federal government would have an additional $92 billion in annual revenue today.
Given these facts it seems imprudent to conclude that projected Liberal deficits represent a fiscal threat or excessive spending. Instead, these deficits signal the need for Canadian legislators to revisit their commitment to lower taxes and less government spending.
The theoretical argument for budgetary reform hinged on the hypothesis that because deficit spending involves government competing for funds with private enterprise in the debt market, interest rates would be driven upward. This would ‘crowd out’ business investment and undermine economic growth, or so the theory went. One of the core arguments for corporate income tax reform was even simpler: by increasing the share of after-tax profit that business retains, a greater quantity of capital would be injected into the economy, thus increasing the rate of economic growth.
In the decades since these reforms were undertaken, Canada experienced a significant deterioration in its macroeconomic performance: business investment has worsened and the rate of job creation and GDP growth have both decelerated. If there is no solid economic evidence to suggest that budgetary and tax reform succeeded in elevating investment levels or increasing the rate of economic growth, how are we to understand the commitment to balanced budgets and shrinking government?
The answer is, unsurprisingly, political. The Canadian welfare State grew out of the wreckage of the Great Depression. In the early postwar decades many of the federal programs that Canadians enjoy were created. As a share of GDP, budgetary revenue grew from 10 percent in 1939 to 20 percent by 1974—an effective doubling of the size of the federal government during a period of exceptionally strong economic growth.
Today, after decades of proportional reductions in revenue and spending, the federal aspects of the welfare State have been significantly diminished. The political program of undoing the New Deal model of governance has largely succeeded in Canada, at least at the federal level.
But here’s the problem: cutting taxes or reducing spending will not facilitate Reconciliation with Canada’s Indigenous Peoples, who experience a vast funding shortfall when it comes to infrastructure, education and health care. It will do nothing to make housing more affordable in Vancouver, nor will it expedite the transition to a low-carbon economy in Alberta. A balanced budget will not ease gridlock in the GTA, nor will it provide the health care resources Atlantic Canadians require to cope with an aging population.
Perhaps that’s why, after decades of the ‘smaller government is better’ mantra, Canadians have opened themselves up to the utility of deficit financing. The next step would be to extend the conversation into the domain of taxation, to determine what level is required to solve some of Canada’s most pressing policy challenges.
Jordan Brennan (@JordanPWBrennan) is an economist with Unifor and a visiting research fellow at Harvard Law School. Kaylie Tiessen (@KaylieTiessen) is an economist with Unifor and a research associate of the Canadian Centre for Policy Alternatives.