Trudeau government poised to embrace much more federal debt

Starting in the mid-1980s, Canada’s federal fiscal policy focused heavily on trying to limit the accumulation of debt and push down (or at least prevent) growth in Ottawa’s debt-to-GDP ratio. To achieve this objective, successive governments have either reduced or restrained spending.

For example, the Chretien government’s 1995 budget is rightly seen as a historic turning point in our federal government’s approach to spending (although it’s worth noting that the Mulroney government had already begun to reduce spending and the deficit).

More specifically, as the chart below shows, federal program spending fell from 20 per cent of GDP in 1985 to 16.6 per cent in 1995. This was sufficient to eliminate the primary budget deficit, which is to say revenues were aligned with program spending. The remaining deficit was entirely the result of interest payments the federal government was paying on existing debt.

After the ’95 budget, the Chretien government further reduced spending to achieve its goal of a balanced budget. Since then, federal government spending has crept up to 14.9 per cent of GDP in 2019, which remains far below the mid-’80s peak.

This spending reduction and restraint produced important benefits for Canadians. For starters, the country’s debt-to-GDP ratio fell from a high of 67 per cent in the mid-’90s, reaching the low 30s in the 2010s, where it’s remained until this year. Due to this debt reduction and low interest rates, federal debt interest payments plummeted from approximately one-third of all revenue in the 1990s to less than 10 per cent in the 2010s.

And yet, despite the benefits of Canada’s longstanding low-debt approach to government at the federal level, this era of policymaking may be coming to an end.

The Trudeau governments has replaced it with the looser objective of preventing growth in the debt-to-GDP ratio. As a result, this government’s recent pre-pandemic budgets did not include a path back to a budget balance, which have been a staple of federal budgets for decades.

In fact, the Trudeau government used the extra room afforded by its looser fiscal target to increase spending relative to GDP. This growth in federal government program spending (as a share of GDP) in a period of, albeit slow, economic growth represented another break from the approach of successive governments over the past 35 years.

Recent developments suggest that a greater shift, even more embracing of debt, may be underway.

This year, Ottawa plans to run a historic $381 billion budget deficit. Given the current economic and public health crises, it would be a mistake to read too much into the 2020 deficit. But announcements about the future are more telling. For instance, the last federal fiscal update forecasted a budget deficit in the $120 billion range for next year. Subsequent announcements of additional expenditures have pushed the government’s own deficit projections higher still.

Furthermore, Trudeau’s government has announced several big ticket spending items such as pharmacare, childcare and ambitious green initiatives. These commitments suggest an even greater acceptance of new debt than has prevailed in the past.

If a shift in the federal government’s posture toward federal debt is indeed underway, it will bring risks and costs to Canadians. First, particularly if interest rates rise, a high ongoing rate of debt accumulation could produce increased debt interest costs. (Remember, Canada’s relatively low federal debt-to-GDP ratio is part of the reason the government was able to respond quickly and aggressively to COVID and its effects.)

Whether or not you agree with the Trudeau government’s choices and policies over the past 12 months, a strong balance sheet gave Canada a wider range of choices to respond to the COVID crisis than we would have had if Canada’s debt burden had been higher.

Although the strength of the commitment has not been identical from government-to-government, Ottawa’s long-term concern about debt accumulation had been remarkable. This 35-year era, however, seems to be coming to an end. We’ll know much more when Finance Minister Chrystia Freeland soon tables the next federal budget, and this government’s approach to debt accumulation comes into sharper focus.