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Tax hikes or lower transfers Ottawa’s only deficit solutions Add to ...

The federal government’s deficit is – or should be – the focus of the upcoming budget. One theme pervading the public debate posits that the size of the federal government has grown to an all-time high, so the solution to its deficit problem lies in reducing its operating expenses. But this view is mistaken, on at least two counts.

Firstly, the trend of the last 25 years or so has been one of an ever-smaller federal government. When expressed as a share of GDP – which is the proper measure – the federal governments of Paul Martin and Stephen Harper are smaller than the one presided by John Diefenbaker. (The spike in 2009-10 is temporary and will fall as the stimulus program winds down and as GDP recovers.)

The more fundamental error is the notion that federal expenditures are driven by its operating costs. It is an understandable mistake, to be sure: isn’t Ottawa in the business of running a government? But a quick peak at the Public Accounts of Canada reveals that the business of the federal government consists largely of sending cheques to individuals (the elderly, the unemployed, etc), to other levels of government (the Canada Health Transfer, equalization payments, etc) and to federal government bondholders (debt service payments).

In 2009-10, transfers and debt service charges amounted to $195-billion, (71 per cent of total) and expenditures on non-defence operating costs was $59-billion (21 per cent of total). Put another way, if the federal government had shut down all of its activities outside of writing cheques and running the armed forces, it would have run a small surplus of about $3-billion.

There may be some room for reductions in the federal government’s operating costs, but it is extremely difficult to see how these could be enough to balance the budget. A realistic deficit-reduction strategy has to involve higher taxes and/or lower transfer payments. There’s no other way to make the arithmetic work.

Eds note: On Worthwhile Canadian Initiative, Stephen Gordon looks at 'How the federal government went from persistent surpluses to persistent deficits.'

Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative.

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