Federal Deficits: Been There, Done That

Frontier Centre, Taxation

Governments around the world have introduced unprecedented fiscal stimulus measures in response to the current economic and financial crisis. The International Monetary Fund suggested recently that countries in a position to do so should inject fiscal stimulus of two per cent of GDP to reduce the effects of the global recession. In Canada, the January 27, 2009 federal budget proposes massive increases in infrastructure expenditures, along with tax cuts, worker training initiatives and other incentives and assistance to businesses, individuals and communities. The budget forecasts deficits totaling $85 billion over five years, including almost $40 billion for a two year stimulus program, representing approximately 2.5% of GDP. As in other countries, the policy rationale is that without additional and substantial fiscal stimulus, Canada’s economy cannot and will not recover on its own.

While there is some unease about the magnitude of the projected deficits, there appears to be general public support for the policy rationale and, at least for now, acceptance that the associated government deficits and debt are justified in the interests of saving or creating jobs, boosting income and output and thereby promoting and accelerating economic recovery.

The last quarter of the 20th-century also saw Canada and the provinces embark on fiscal stimulus programs in response to sharp recessions. Then as now, Canada initially entered a period of deficit spending from a relatively healthy fiscal position. Then as now, deficits were initially cast as ‘short term’ – unfortunate, but necessary. Then as now, the budget documents of the day generally indicated a rosy future with a return to surplus – down the road. Then as now, governments saw initial public acceptance and support for large deficits as a responsible and reasonable response to tough economic times.

But the short term stimulus deficits turned into long term ‘structural’ deficits – deficits that persisted even with economic recovery. The stimulus initiatives did not generate increased government revenues from economic growth sufficient to reverse the growth in interest expense and government debt. As deficits and borrowing requirements spiraled, government debt grew faster than GDP and interest expense consumed a growing proportion of government spending.
By the 1990s, government deficits were no longer paper abstractions. They became very concrete burdens on the everyday lives of ordinary Canadians. As credit ratings deteriorated, investors became less willing to finance ever-increasing government borrowing requirements. Canadians faced a harsh reckoning of tax increases and spending cuts as governments were forced to bring their budgets into balance. The experience left Canadians with a strong aversion to deficit budgets and left politicians with a well-founded fear of incurring them.

Because of the magnitude of the current recession, Canada would have run a deficit due to the operation of automatic fiscal stabilizers such as income tax and income support programs. No surprise – it’s supposed to work that way. In a recession, declining profits and wages cause government tax revenues to automatically fall, particularly under a progressive tax system, while expenditures for income support programs such as unemployment insurance automatically rise. With taxes taking less disposable income, and transfers providing more disposable income, automatic fiscal stabilizers help the economy from falling further into recession. Starting from an initially balanced or surplus budget position, few economists, investors or taxpayers would characterize such deficits as being either irresponsible or ineffective.

However, the recent federal budget forecasts deficits and debt that far exceed what would result from the operation of automatic fiscal stabilizers. It also sets the tone and provides the rationale for large deficit budgets at the provincial level.

During the last quarter of the 20th century, running big deficits to stimulate the economy was initially perceived as being in the short term economic interests of taxpayers and in the short term political interests of governments. But as stimulus deficits became structural deficits, they were perceived as being neither in the long term economic interests of the taxpayers who had to pay for them nor in the long term political interests of the governments that incurred them. The conclusion? You can indeed buy people with their own money, but only for a while.

And what about now? As Mark Twain said, history never repeats itself, but it rhymes.

Sheldon Schwartz worked for the Province of Saskatchewan during a career spanning 25 years, including as Assistant Deputy Minister of Finance and Chief Financial Officer and Vice President of Finance and Administration for Crown Investments Corporation. Sheldon currently lives in Victoria. Sheldon has a Masters degree in Economics from Carleton University, and holds the Chartered Financial Analyst (CFA) designation