The danger of returning to persistent federal deficits in Canada
The Parliamentary Budget Officer (PBO) recently released its revised economic and fiscal projections for the federal government. While it projects a balanced budget in the current fiscal year of 2015/16, the big news item is that the PBO projects deficits in every year from 2016/17 to 2020/21. It also projects a structural deficit as of 2018/19, meaning that after removing the effects of temporary fluctuations in revenues and spending, the government’s underlying position will be one where annual spending consistently exceeds revenue.
That is a much gloomier fiscal outlook that what was contained in the Conservatives’ April budget, where surpluses were projected over the fiscal plan (see chart below). The main reason is that economic growth and commodity prices are now expected to be lower than initially thought.
Importantly, however, the PBO’s projections do not account for policy commitments of the new Liberal government, which has committed to running annual deficits totalling approximately $10 billion. Indeed, the PBO’s projected deficits could end up being much larger if the Liberals follow through on their plan.
What are we to make of all this?
There are two key points. First, Canadians should be concerned about the risk of the federal government returning to persistent deficits as a normal course of fiscal policy. Deficits can make sense when the economy is hit by a severe negative shock, but we are nearly eight years removed from the great recession of 2008-09. While Canada’s economy is hardly firing on all cylinders (resource dependent provinces are indeed struggling), there’s a risk that deficits become “business as usual.” If the PBO’s projections prove correct, by 2020/21 the federal government will have run budget deficits in 11 out of the previous 13 years.
We have seen a similar script play out before in the 1970s, 1980s and early 1990s when the federal government ran 27 consecutive deficits. These deficits hampered Canada’s ability to enact competitive tax policies and led to a dramatic accumulation in debt with interest payments on the debt totalling more than one-third of federal revenues. That was until a major shift in fiscal policy beginning in the mid-1990s. The fiscal consolidation of the Chretien Liberals eliminated the federal deficit, allowed for pro-growth tax reform, and ultimately helped usher in a period of strong economic growth.
Second, Canadians should be wary of further accelerated increases in government spending, especially in the name of stimulating the economy. As a 2010 Fraser Institute study found, the federal government’s stimulus plan had virtually no impact on Canada's economic turnaround in 2009. This is not surprising given the vast body of academic literature that casts serious doubt on the ability of government stimulus spending to boost economic activity.
Budget deficits may once again become routine in Ottawa. This is a troubling development given the economic problems persistent deficits can cause, and the dubious nature of claims that these deficits will help stimulate the economy in the years ahead.
A more effective and proven course is to eliminate the deficit through spending restraint and refocus on pro-growth economic policies.
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