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Pierre Trudeau famously mused about the influence of the United States on Canada, comparing it to sleeping next to an elephant. No matter how well-intentioned the pachyderm is “...one is affected by every twitch and grunt,” he said.

That is most certainly true of U.S. fiscal policy, Northwestern University economics professor Martin Eichenbaum argues in his remarks for this year’s Jack Mintz Lecture from the C.D. Howe Institute.

Dr. Eichenbaum, an international fellow at the institute, says that Canada’s fiscal policy, even if Ottawa continues with larger deficits, is likely not in any danger zone, since growth in gross domestic product would continue to outstrip the growth in debt. So long as GDP growth rates are higher than the interest rate on government debt, a country’s debt burden will shrink relative to the size of the economy. Or, in math terms, if r<g, then fiscal sustainability results; if r>g, then fiscal disaster looms.

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The Northwestern University professor warns that assurances that Canada’s relatively positive fiscal position is on the correct side of that equation miss the real danger -- that the United States is not. Canada was running primary surpluses (the budget balance excluding debt servicing costs) before the pandemic. The United States was not. Even if interest rates hit zero, the U.S. would still have a hefty deficit.

Of course, interest rates will rise, sooner or later. And as Dr. Eichenbaum points out, it won’t take much of a rise to push U.S. finances into dangerous territory. Interest rates need to be at least 3.5 percentage points lower than GDP growth to keep the U.S. debt burden from rising relative to the economy. That would be far out of step with the patterns of the past couple of decades. Without serious reductions in deficits, the U.S. could be headed for a scenario where international markets conclude that the country’s finances are unsustainable, he argues. Under that eventuality, U.S. interest rates would spike and economic growth would tumble.

That economic pain, much more than a twitch or a grunt, would rumble across the border. The likelihood of such a fiscal disaster might seem remote -- just a tail risk from the U.S. elephant -- but Canada would be well advised to buy itself some insurance, in the form of locking in long-term debt at today’s low rates, Prof. Eichenbaum said.

Taxing questions

Responding to a recent Tax and Spend on how Ottawa’s pandemic spending resulted in a windfall for the provinces, one online reader asked whether there was an uptick in sales-tax revenue in addition to the unexpected rise in individual and corporate income taxes. In its final accounting for the 2020-21 fiscal year, Ontario did disclose a relatively small increase in its sales tax revenue, at least compared to its budget projections. Sales tax revenue came in at $26.6-billion, higher than the budget forecast of $24.9-billion, but lower than the $28.6-billion garnered in 2019-20. By contrast, individual and corporate income taxes were both higher in 2020-21 than in 2019-20. Part of the reason for that much smaller effect: the hundreds of billions of dollars that have been squirreled away -- including funds from Ottawa’s pandemic supports -- have yet to be spent. So that sales-tax bump may well happen, just not quite yet.

Line Item

Hiring freeze: It’s been four months since Ottawa launched its latest payroll subsidy, the Canada Recovery Hiring Program (CRHP). But the Canada Revenue Agency has yet to fulfill its pledge to publish data on the program, which pays employers up to 50 per cent of increased payroll expenditures. The agency has been diligently publishing regular updates on the Canada Emergency Wage Subsidy program, starting shortly after its launch in May, 2020. Not so for the CRHP; so far, there’s been no visibility on how the hundreds of millions of dollars budgeted for the program are being spent. The Liberals did promise to extend the CRHP through to the end of the fiscal year, pushing the program’s total projected cost to about $1-billion -- and giving the CRA an extra five months to get around to sharing data on the program.

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