Craig Alexander has served as chief economist at Deloitte Canada, the Conference Board of Canada and Toronto-Dominion Bank.
The Liberal government has presented its latest budget with fiscal projections showing continued deficits for the next five years. The government’s narrative is that despite an increase in the debt-to-GDP ratio this year, the peak of 43.5 per cent and the decline in the ratio in the next four years shows that the country can afford the additional borrowing. The government also highlights that Canadian federal government debt-to-GDP is lower than in other peer countries.
However, Canadians and businesses should be concerned about these projections for endless deficits. The accumulation of federal government debt matters. It poses economic risks and is a burden on future generations.
While the federal government likes to focus on federal debt compared with other countries, what actually matters is aggregate government debt that includes the borrowing by the federal government and all of the provinces, which is more than $2-trillion combined. On this basis Canada looks much less favourable, and the combined federal-provincial debt is the more appropriate comparison to make internationally because many of Canada’s key fiscal priorities are at the provincial level but are at the national level in other countries.
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Canadian government debt has also risen dramatically. Combined federal-provincial debt in Canada has roughly doubled since 2007 and the aggregate government debt-to-GDP ratio was likely around the 75-per-cent mark in 2022.
I choose the comparison of today with 2007 for an important reason – that appears to be when Canadians seemed to stop worrying about the state of government finances. Before the 2008 financial crisis, there was a consensus in Canada that balanced budgets were the basis of prudent fiscal policy. This consensus was the legacy of Canada’s fiscal crisis in the mid-nineties that convinced Liberals and Conservatives alike that budgets needed to be balanced outside of recessions. Canadian voters punished political parties that endorsed sustained deficits.
However, that consensus was undermined after the 2008 financial crisis. Canada ran large deficits in the wake of the 2008-09 recession, although the federal Conservative government fought hard to balance the books. It is now clear that Canadians became tired of deficit fighting. This was demonstrated by the Liberal Party’s electoral victory in 2015 on a platform that called for modest deficits despite an economy experiencing solid growth.
Those in support of government deficit spending argued that deficits didn’t matter because the cost of debt was cheap because of low interest rates. So, deficits became the norm and then came the need to provide stimulus during the pandemic, which ultimately saw governments deliver an excessive fiscal response.
The problem is that the low-forever interest rate environment is now over. In the coming years, the share of government revenues (i.e. tax dollars) going to pay interest will climb as accumulated government debt will have to be financed at a higher rate. Canada will be able to pay its fiscal bills, but every dollar of interest will be a dollar not going into education, health care or other social services.
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There is the possibility that interest rates could come down from their current levels temporarily – if there is a recession worse than what the government is projecting. If this happens, interest costs won’t rise as much for a year or two. But even a moderate recession would see government debt as a share of the economy rise sharply – because of a weaker economy, less government revenues and pressure on governments to deliver new stimulus. Deficits today limit the scope to respond to any economic downturn and the challenge of higher interest rates will return after the recession.
Another challenge is Canada’s discouraging long-term economic outlook. Because of dismal productivity, poor business investment, labour scarcity and the need to shift to a lower-carbon future, the Canadian economy is expected to deliver very weak economic growth. High inflation now is temporarily helping government revenue growth and reducing the debt burden; but as the inflation shock passes, the prospects are for the economy to have a trend rate of growth below 2 per cent per annum in the coming decades. This will make managing Canada’s government debt burden more difficult and raises the question of how governments will afford the health care and social services of an aging population.
Canada fundamentally needs to rebalance. The country has been living beyond its means for years. After massive growth in government expenditure and hiring during the pandemic, it is time to bring down deficits and return to balance by finding efficiencies and cost savings. There is a lot that could be done to boost Canadian productivity and economic growth by reducing regulatory obstacles to growth, stopping the endless cycle of new business subsidies, reforming the bloated tax system and by allowing more competition in the marketplace.
The combination of these actions would ultimately reduce the future pace of growth in government debt and lower the financial burden on future generations. It would also be highly desirable for Canadians to hold governments more accountable for their fiscal performance. Not because Canada is facing an immediate debt crisis, but rather because it will encourage future prosperity.