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tax and spend

A flag flies in front of the Peace Tower on Parliament Hill on Dec. 4, 2015.GEOFF ROBINS/AFP/Getty Images

The Liberal government’s expansive spending plans would push the federal debt burden back to the dangerous levels of the 1990s over the next decade, according to a report from one of the architects of Ottawa’s successful effort to defuse Canada’s debt crisis a quarter century ago.

Don Drummond, now a Stauffer-Dunning Fellow at Queen’s University but the assistant deputy minister of fiscal policy at the federal Finance Department in the mid-1990s, reached that conclusion in a research paper issued Tuesday by the C.D. Howe Institute. If the Liberals make good on the promises of last month’s Throne Speech, Mr. Drummond says, they will create a perpetually growing debt burden that will leave federal finances vulnerable to any rebound in interest rates.

With the government ruling out any broad-based tax increases, that will leave today’s young Canadians to deal with the fiscal fallout decades down the line, Mr. Drummond said, criticizing such an approach as irresponsible. "You really don’t have a right to pass the costs to the next generation,” he said in an interview.

Don Drummond, then-chief economist at TD Bank, speaks at an Economic Club of Canada event on Jan. 6, 2010, in Toronto.JENNIFER ROBERTS/The Globe and Mail

The C.D. Howe report is the second time in recent weeks that alarms have sounded over the direction of federal finances. In late September, the Parliamentary Budget Officer issued an economic and fiscal outlook that said federal debt levels are sustainable through the middle of this decade – but only if Ottawa does not embark on major new spending initiatives. Former Bank of Canada governor David Dodge, also a former deputy finance minister, has weighed in, contending that the government should commit to keeping its debt-servicing costs below 10 per cent of revenue.

Mr. Drummond had a seat at the table the last time Canada grappled with a debt crisis in the 1990s during the first term of Liberal prime minister Jean Chrétien, part of a career that spanned multiple Liberal and Progressive Conservative administrations. Then an assistant deputy minister at the Finance Department under Paul Martin, Mr. Drummond helped to draft the fiscal plan that dramatically curtailed federal spending.

Mr. Drummond says memories of those painful cuts were top of mind as he examined the implications of a major expansion in federal spending. “I’m very cognizant of the sacrifices it forced Canadians to make."

In his analysis, he examines four possible paths for federal spending, deficits and debt over the next decade.

Driving that analysis is a key assumption that interest rates will rise over the next decade. The Liberals have pointed to today’s low interest rates as a partial justification for continued high spending levels, but Mr. Drummond believes those rates are bound to rise eventually. His analysis projects that the effective, or average, rate of interest on the entire national debt in 2030-31 will be 3.4 per cent, nearly double the current rate of 1.8 per cent. (For the effective rate to rise to 3.4 per cent, short-term rates would rise to 3.5 per cent, from today’s 0.5 per cent, while long-term rates would be higher, between 4.5 per cent and 5.5 per cent.)

If rates do rise to that extent, the $500-billion of pandemic-related debt projected to be added through fiscal 2022 will increase the deficit by $15.3-billion.

The first scenario lays out an austerity approach that assumes a rapid reduction in federal spending to return net debt as a percentage of gross domestic product to prepandemic levels. Under that scenario, debt would fall back to 30 per cent of GDP, from a peak of 52.3 per cent two years from now, in fiscal 2023 (shown in the chart below). That would require Ottawa to run annual surpluses of $23-billion starting in that year, a significant departure from not just this year’s deficit that is above $300-billion but also from the Liberals' track record of deficits above $30-billion since taking office.

A second scenario assumes a modest dose of austerity, with the annual deficit falling to $25-billion by 2022-23, still below prepandemic levels. In that fiscal universe, debt levels would fall more slowly, to 42.8 per cent of GDP by 2030-31, as economic growth shrank the relative debt burden. In his report, Mr. Drummond notes that this level of spending “provides a nod to fiscal stability but does seem incompatible with the aspirations set out in the Speech from the Throne.”

Under a third scenario, the federal deficit remains permanently larger, on the order of $50-billion a year. That would give Ottawa $25-billion to spend on new programs such as child care, expanded income supports or green initiatives. But such a path would also lock in pandemic-related debt, with the debt-to-GDP ratio falling only marginally by 2031 from its peak in 2022. Mr. Drummond notes that interest payments would be 11.4 cents of each dollar the federal government spent in 2031, breaching the fiscal rule articulated by Mr. Dodge.

In his fourth scenario, Mr. Drummond looks at the implications of a continuing $100-billion deficit, where the growth in federal spending would consistently outstrip the rate of economic expansion. By fiscal 2031, the debt burden would grow to 62.9 per cent of GDP, and debt charges would eat up 14.5 cents of each dollar of revenue. (Even that level of spending might not fully accommodate the spending ambitions hinted at in the Throne Speech, Mr. Drummond says.)

A persistent $100-billion deficit would ensnare Canada in a debt spiral. Five years later, in fiscal 2036, debt as a percentage of GDP would hit 68 per cent – higher than even the current peak of 66.8 per cent that debt hit at the height of the fiscal crisis of 1995-96, Mr. Drummond notes.

He says he sees similarities between today’s Liberal government and that of Pierre Trudeau in the 1970s, with both administrations ignoring warning signs that economic growth is slowing and that fiscal pressures will grow as a result. And he has a simple rebuttal for those who dismiss his concerns as those akin to an old general wanting to refight old wars. “What do you want to bet that everything is different, and the conditions of the previous battleground are still not relevant?”

Tax and Spend is a regular series that examines the intricacies and oddities of taxation and government spending.

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