Who’s Afraid of Canada’s Big Bad Deficit?
There is no shortage of commentary on Canada’s first budget from the new Liberal government. The most recent polling from Abacus shows broad support for almost all of the spending measures in the budget, it also shows a distinct lack of support for the projected budget deficit. It seems the principle issue of those who are upset with the budget – and curiously, some of those who are happy with it too – is the size of the deficit. Almost everyone seems to believe that the size of the deficit is too large and is bad for Canada. Those who oppose the government from the right think the deficit should not exist; those who oppose the government from the left; in a strange twist, also think the deficit should be much smaller. Even those who support the government and its policies seem to be willing to concede the point that the deficit is bad, and attempt to shift blame onto the previous government. This odd consensus that deficits are bad brings forth what should be the most important question for the commentariat: Is a deficit a bad thing? Naturally, the answer depends on the situation.
So let’s ask the question with respect to Canada right now. There are two forms of the anti-deficit argument: That a large deficit will cause taxes to rise in the future and hurt business confidence; and that once you open the Pandora’s Box of deficit spending the government won’t be able to get it back under control and will create a debt crisis. Neither of these arguments actually holds any water.
The first form of the argument against deficits is currently favoured by the opposition Conservative Party, but it doesn’t stand up to close scrutiny. The first half of the argument claims that taxes will increase in the future to pay off the debt accumulated by running deficits now, therefore hurting consumers and taxpayers by taking away a significant chunk of future income. This is often demonstrated with the presentation of the deficit as adding $X per person to the national debt – showing what each person will have to pay back because of the government’s ‘recklessness’.
This tax argument comes from the idea of Ricardian equivalence, first presented by the 19th century economist David Ricardo who proposed that any government spending would need to be offset in the future by increased government taxes to pay for it. Of Ricardo’s many contributions to economics, this was not one that proved to be correct. Ricardian equivalence has been repeatedly shown to not operate in the way he posited and certainly not to produce the harm that its modern adherents profess. It all comes down to the nature of economic growth. If the money spent now helps the economy grow, then the total government revenue will be higher in the future without having to increase taxes. The economic pie will be larger.
The second half of the argument, that a deficit will affect business confidence, was an idea created by austerity advocates in Europe in order to justify massive cuts during a recession and it certainly hasn’t helped them. Research on business confidence shows that it is not in any appreciable way affected by deficit spending, it is more affected by the overall health of the economy – which includes overall growth and stability, something that targeted deficit spending will help.
What about the second form of criticism? Should Canadians be worried that this budget will open the flood gates and drive Canada back into a widening debt spiral that forces a future government into slashing social programs and causing pain for millions of people? I don’t think this fear is very justified at this point. The pain of the 1990s was a unique situation for Canada. Its government had run a huge structural deficit for almost two decades, no government had the political will to try to rein in spending incrementally, and the spending had lost its growth effects.
This situation is different.
The current government has indicated that they are committed to eliminating the deficit in the future; which, unless you believe politicians will tell barefaced lies routinely, should be seen as a credible commitment to not keep spending too high. Second, this deficit spending is intended to increase economic growth which should increase government revenues over time causing the deficit to shrink. This is further reinforced by the government’s commitment – which was kept by this budget – to keep the debt-to-GDP ratio constant or decrease it.
This brings up one last issue with the budget: is the spending even necessary to create growth in Canada? The opposition Conservative party says no; they argue that Canada is doing fine when compared to other countries. In this sense, they’re right. We are doing fine, relative to other countries; but that doesn’t mean we are doing well. Let’s remember what’s happening in those other countries. Europe is in the middle of an ongoing economic crisis with total growth for the Eurozone at less than 0.5% last year. The UK is still struggling along slightly better, reaching slightly higher than 0.5% growth at the end of last year. The US is doing the best at a little over 2% growth in 2015. But what about Canada? Its growth was 0.6% at the end of 2015. In fact, Canadian growth has been less than 1% since 2012. So, while Canada may not be in a recession, it is definitely stuck in a low growth period and the Bank of Canada has done everything it can to lift it out of these growth doldrums. Given these facts, fiscal policy is something that the government should definitely undertake to both boost growth and take pressure off the Bank of Canada so that it can have the breathing room to operate in a more ‘normal’ fashion.
In the face of all this evidence, deficits should be seen not as a necessary evil or something to be avoided, but rather as a policy tool that should be used responsibly by the government to help an ailing economy. Without some sort of action to promote Canadian economic growth, Canadian incomes will stagnate and job creation will stay low. The best way to help the Canadian middle class – which all politicians these days are advocating for – is to create strong economic growth; and the best way for the government to do that given the current economic reality, both internationally and in Canada, is to spend money on growth promoting projects.