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analysis

Noted macroeconomist Wilkins Micawber has best captured the risk inherent in Canada’s bet that economic growth will continue to outpace interest rates for years to come.

“Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness,” he says. “Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

Okay, that’s actually a quote from Charles Dickens’s David Copperfield, and Mr. Micawber is a character in that book, not an economic deep thinker.

Still, his observations illustrate a central point about Ottawa’s strategy to lean on economic growth to ever so gradually reduce the debt burden resulting from pandemic deficits. So long as the rate of economic growth outpaces interest rates, the result will be happiness for the federal budget, with the ratio of debt to gross domestic product declining even with persistent (if relatively modest) deficits. But if that relationship reverses, and interest rates are higher than economic growth, then the result is much less happy.

The Micawber principle is illustrated nicely in a new report from the Parliamentary Budget Officer that examines the sustainability of federal debt through to fiscal 2026-27. The PBO emphasized that its calculations should be viewed as a “stress test” of assumptions in the federal budget, rather than as projections.

With that caveat noted, the conclusions in the report make for sobering reading. On balance, there is a risk that debt-to-GDP ratio will be higher than forecast in the budget, the PBO writes.

One of the main reasons is that the parliamentary watchdog is using much less favourable assumptions on the relative balance of economic growth and interest rates. The federal budget forecasts that economic growth will outstrip interest rates by 1.29 percentage points in 2026-27, for a differential of -1.29 percentage points. The PBO’s results, based on simulations using historical data, contemplate a flip in that differential. In 2026-27, for instance, the PBO arrives at an average differential of 1.36 percentage points – in other words, a world in which interest rates are significantly higher than economic growth, and send the debt ratio on an upward spiral.

Or, as the Micawber principle would put it: result misery.

Taxing questions

Responding to last week’s Tax and Spend on the NDP’s accusation of price-gouging in the grocery industry, one online reader wondered about the soaring price of butter, and questioned whether that increase really resulted from farmers getting more for the milk they produce.

The short answer is: Yes, for the most part. From March, 2020 to April, 2022, the price of butter jumped 19 per cent, according to Statistics Canada (using data that are not seasonally adjusted). But more than half of that increase has come just in the past three months, with the price of butter rising 9.9 per cent in that time span.

The mystery isn’t hard to figure out. The prices set by the Canadian Dairy Commission for milk and butter storage both rose sharply on Feb. 1, kicking off the spike in butter prices. So, there is a lack of competition driving up butter prices, but it is the officially sanctioned dairy cartel that is responsible, not the supposed – and as yet unproven – collusion of grocery chains.

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Science friction: The scientific method is indeed a criterion to claim tax credits for scientific research and experimental development, the Federal Court of Appeal has ruled, denying an appeal from National R&D Inc. The company had contended that a Tax Court of Canada ruling denying its claim for credits was in error, in part because adherence to the scientific method is merely a suggestion, not a prerequisite for receiving such credits. The appeal court disagreed, saying there is still a requirement for adherence to the scientific method, established in an earlier case, despite the use of less specific language in more recent guidance from the Canada Revenue Agency.

Follow me on Twitter, @PatrickBrethour or ask your Taxing Question here.

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