The 2016 budget delivers on the Liberal election platform, but it comes with fiscal risks.
The first budget of a new government is particularly important. It not only spells out the financial commitments of the coming fiscal year, but also provides strong guidance on the government’s priorities. The 2016 budget delivers on the Liberal election platform, but it comes with fiscal risks.
The budget provides near-term support to economic growth, aims to boost future competitiveness through investment in infrastructure and other priorities, and helps those who are disadvantaged – particularly low- and middle-income Canadians; aboriginals and First Nations people; and youths. These are all worthy goals.
The main criticism of the budget delivered Tuesday is that it is “overreaching.” It paints a bleak picture of the outcomes of Canadians – except the top 1 per cent of earners. It implicitly promises that this picture will change under the new government, but Canadians should keep expectations realistic. For example, while the budget shows fiscal stimulus raising the level of economic activity by half a percentage point in 2016 and another half point in 2017, private-sector forecasters are unlikely to raise their projections by that much.
There is much to like in the budget. In the short term, it aims to help regions suffering from low commodity prices, with measures such as expanding and improving access to employment insurance, and investment in skills and training for displaced workers. Even modest fiscal stimulus might reduce the need for the Bank of Canada to cut rates further.
Canada’s infrastructure is aging and in need of refurbishment. Infrastructure projects that get under way quickly can provide a modest boost to growth.
There are many economic and social initiatives that should provide gains in the long run: an expanded and new child-care benefit, investments in aboriginal education, support for young people. Many of the priorities make sense, but there are exceptions, such as rolling Old Age Security eligibility back to age 65, which should be seen as a move to deliver on election promises.
The problem is that there isn’t money to pay for the government’s commitments. The last time the Liberals were in power, there was a consensus that sound fiscal policy constituted running balanced books. The 2016 budget has taken the view that responsible fiscal policy means keeping the ratio of federal debt-to-GDP stable or declining until growth accelerates in the indefinite future.
This has allowed the government to say that running deficits each year – while the economy is growing – out to 2020 is reasonable. The deficit surges to $29.4-billion in 2016 and then it declines slowly to $14.3-billion in 2020. There is a strong bias toward spending, with a number of references that if money is not spent as expected, it will go to other initiatives rather than to lowering the deficit.
Many Canadians will not fret about this. After all, the deficit is still a small share of the overall economy and debt servicing costs are limited by low interest rates. There is a sense that deficits don’t matter – but they do. They tend to expand over time. Once committed to running them, it’s harder to say “no” to new initiatives.
The debt-to-GDP ratio also fluctuates with the business cycle. When (not if) our economy sees its next recession, any federal deficit relative to the size of the economy will jump, reducing Ottawa’s capacity to respond.
Debt is also a burden. The new budget increases federal debt to $732.5-billion in 2020 from $619.3-billion in 2015 . The more than $100-billion of additional debt will have to be financed through interest payments .
The government is like a consumer charging through the mall with a no-limit credit card. The debt-financed spending will put more money into the tills of retailers, adding to economic growth. However, the bill always arrives, and many Canadians have had the experience of scratching their heads and asking “How did it get so big so fast?”
If the deficit does increase, taxes will likely be raised. GST hikes become more likely, but businesses will worry about rising corporate income-tax rates. All things that will ultimately drain private savings, which in turn will dampen investment and economic growth.
The accumulated deficits shown in this budget are not so large as to pose a material economic threat. However, there is a real risk that the economy does not grow as fast as predicted, that tax revenues disappoint, that interest rates rise more than anticipated or that more spending is called for in future budgets. Sustained deficits can add up quickly and dramatically, which is why they are not sound fiscal policy.
Craig Alexander is vice-president of economic analysis at the C.D. Howe Institute.
Published in the Globe and Mail
