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Parliament Hill in Ottawa. (Fred Lum/The Globe and Mail)
Parliament Hill in Ottawa. (Fred Lum/The Globe and Mail)

Canada’s long-term debt target: An oldie but a goodie Add to ...

The federal government used the opportunity of the recent G20 meetings in Russia to announce a new policy target: To reduce federal debt to 25 per cent of gross domestic product by 2021. The announcement was aimed at two audiences. For the international crowd, it highlighted Canada’s relatively strong fiscal position and nudged other countries to announce clear timetables of their own to reduce public debt levels. For the Canadian audience, this target was a missing piece of the puzzle of the federal government’s fiscal plan.

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While one can contest the means and the ends, the government has now articulated a clear and likely achievable fiscal strategy: It wants to shrink the federal government’s size over the long term by reducing spending today, balancing the budget tomorrow and offering tax cuts in their next election platform.

Setting this new target has two redeeming qualities. First, it’s good politics, as the Conservatives will use it to support their narrative of being prudent fiscal managers. Second, it’s good policy – provided a few more pieces are added to the fiscal puzzle.

Having a medium-term fiscal target gives the government a sense of direction and helps anchor public expectations of future policy choices. A well-articulated plan, even if it’s imperfect, beats having no plan. When people want to achieve goals, explicit targets help them resist temptation and keep their eyes on the prize.

Recent evidence also suggests that fiscal targets can work in practice. For instance, in a recent article published in Canadian Public Policy, I find that Canadian provinces with legislated debt targets generally had lower public debt levels (analyzing all provinces over 1981-2007 and controlling for factors including economic performance and the decision to adopt a target). I estimate that debt targets lowered debt-to-GDP ratios by 1.5 percentage points, on average, in the sample period. While not huge, this is nothing to sneeze at in the context of a future fiscal squeeze from an aging population.

Those with good recall may feel a sense of déjà vu with this announcement. After all, in 2004, the Liberal government also had a 25-per-cent debt-to-GDP target, which the Conservatives appropriated in 2006. Both would essentially have been met by now, had they been respected. The global recession and fiscal stimulus package intervened, raising the federal debt-to-GDP ratio from its earlier downward path to where it now stands at about 34 per cent. So much for past promises.

Critics say this latest pledge just recycles the old target but with a delayed timeline, and that it simply reflects the status quo fiscal path (i.e., it assumes no major new policy initiatives or economic disruptions). As such, it merely rationalizes fiscal policy in the years ahead, but does not fundamentally alter it. And if we couldn’t achieve this target last time, why would we achieve it now? As the government highlighted in its announcement, achieving the 25-per-cent target depends on the economy meeting performance expectations (as it should; if you win the lottery, you’ll pay off your mortgage faster, but if you lose your job, you may need to borrow more).

Detractors will also question the arbitrary choice of the target and timeline. Why choose a 25-per-cent debt level rather than, say, 20 per cent, or even 50 per cent? There’s little evidence to suggest that public debt matters much for advanced economies, provided it remains within a reasonable range. And while lower debt is generally better, since it reduces the government’s borrowing costs and frees up resources for other uses, not all government debt is bad. Some debt funds long-term investments that provide broader social returns, such as infrastructure spending.

Astute taxpayers will also complain that while they care about the federal government’s debt burden, they also care about those of other levels of government, and of public pension plans. If federal tax rates fell in the future while provincial rates rose, this wouldn’t leave the after-tax incomes of households any further ahead.

And while this “new” debt target should be welcomed, some unfinished business remains. Transparent long-term budget targets require transparent long-term budget projections. Finance Canada should release these in the upcoming fall update, to buttress this target’s credibility in the eyes of the public and financial markets.

Transparency also involves educating the public to the fact that indefinite surpluses are not the only route to reducing the debt-to-GDP ratio. It could also occur with modest deficits, provided these deficits grow more slowly than the economy.

Monitoring and enforcement are other big concerns. In eight years, few of today’s politicians will still be in office. Therefore, the government should create supporting legislation that includes a clause that commits it to regularly release the government’s long-term budget forecasts. Independent monitoring of compliance with this new target should be assigned to Parliament, with analysis provided from the Parliamentary Budget Office, which already releases such reports annually.

So this “new” debt target is not new. Yes, similar targets were missed earlier, and the target is not overly ambitious given the current fiscal outlook. But even if it was only adopted for political reasons, setting this target is good public policy. And doing so should help reduce our federal debt.

Stephen Tapp is a research director at the Institute for Research on Public Policy (stapp@irpp.org or @stephen_tapp on Twitter).

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