Feds’ Spilling More Red Ink Raises Risks, Moral Hazard

Finance Minister Morneau maintains now is the time to ‘invest’ despite calls to the contrary
December 18, 2019 Updated: December 18, 2019

News Analysis

OTTAWA—Running deficits as far as the eye can see, Finance Minister Bill Morneau’s focus when he released his economic update this week seemed to be on the advantageous situation Canada is in. But this approach comes with risks, including creating a moral hazard—what a C.D. Howe report termed as a temptation to “massage the numbers”—while unnerving the business community.

Morneau made it a point to refer to government spending as “investing” in his press conference on Dec. 16. The Liberals aim to cut taxes for the middle class and spend to keep the economy rolling.

“Our view is the appropriate response right now to our economic situation is to continue investing,” he said.

The fiscal update’s deficit projection for 2019–20 is $26.6 billion—up from $19.8 billion at the time the 2019 federal budget was released on March 19.

Not delivering on budget commitments results in greater spending per person and higher taxes, said the C.D. Howe Institute’s CEO Bill Robson in a press release for the think tank’s July 11 report, “Big Spenders: Canada’s Senior Governments Have a Bad Budget Habit.”

The report found that since 2000–01, governments have routinely spent and taxed more than projected in their budgets—thus raising the size and cost of government over time.

The institute makes several recommendations to improve fiscal accountability and also warns that deficits can open the way to not being entirely transparent with the numbers.

“Governments should stay fiscally healthy: Deficit and debt concerns create temptations to massage the numbers to achieve a bottom-line target,” it said.

Awash in Red, Future Burden

The enlarged deficit is expected to decline to $11.6 billion by 2024–25. 

The federal debt-to-GDP ratio is also expected to decline from 31.0 percent in 2019–20 to 29.1 percent by 2024–25. The deficit as a percentage of GDP is projected as 1.2 percent in 2019–20 and declining to 0.4 percent in 2024–25.

In contrast, the United Conservatives in Alberta, in their first budget delivered Oct. 24, promised to balance the provincial budget in four years even while facing a deficit that’s 2.5 percent of GDP and a weaker economy.

“The longer you wait to make a fiscal adjustment, the bigger the necessary adjustment will be in the future,” said Trevor Tombe, associate professor of economics at the University of Calgary. He added that the United Conservatives’ plan to get the budget in order now is prudent.

Low interest rates have been both a blessing and a curse for the Liberals. Interest rates have fallen slightly since Budget 2019, allowing the government to finance spending more cheaply and making the current interest expense lower than that at the time of Budget 2019’s release. 

Nevertheless, the feds are still projected to spend $24.4 billion on interest payments in 2019–20, climbing to $31.5 billion in 2024–25. This represents 1.1 percent of GDP.

The main reason the deficit jumped since Budget 2019 is higher costs from revaluing pensions and other benefits like veterans benefits and RCMP disability benefits. As interest rates fall, the value of benefits to be paid in the future (liabilities) rises.

‘Debt-to-GDP Ratio Should Be Falling Further’

Tombe believes that governments shouldn’t run deficits during good economic times and that the Liberals should instead run surpluses to bring the debt-to-GDP ratio down faster than they are currently doing.

“For me, the debt-to-GDP ratio should be falling further, because the federal government should be spending less on business subsidies and superclusters,” he said.

Morneau’s fiscal spending has been encouraged by large multinational organizations like the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) to boost economies when central banks have already cut rates below 0 percent in many jurisdictions.

“The advice not only nationally—from the IMF, the World Bank, the OECD—is that making fiscal investments in prosperity today that grow and enable people to be successful and create future growth is the right economic approach in this particular time,” Morneau said.

Morneau also reiterated that maintaining Canada’s triple-A credit rating is crucial, as it would ensure that the government can borrow at the lowest cost.

Conservative shadow minister of finance Pierre Poilievre said the Liberals need to reassure investors with a reasonable plan to phase out the deficit. Ultimately, if investors are uncomfortable with Canada’s debt dynamics, they could demand higher interest rates as compensation. Investors can make a judgment on a country’s creditworthiness long before rating agencies react.

Business Groups Disappointed

The Canadian Federation of Independent Business (CFIB) was disappointed by another increase in the deficit. 

“Small businesses are looking to the government for certainty and stability. They know that today’s deficits are often tomorrow’s taxes,” said Jasmin Guénette, CFIB vice-president of national affairs, in a press release on Dec. 16.

The government’s most recent policy action came on Dec. 9, when it proposed to raise the basic personal amount to $15,000 by 2023—a move that would allow single individuals to save close to $300 in taxes a year when fully implemented.

The CFIB says that while the basic personal exemption for taxes is good news for Canadians facing cost-of-living increases, the money will likely be offset by rising Canada Pension Plan premiums over the next six years.

The Canadian Chamber of Commerce lamented deficits being an enduring fixture of Canada’s fiscal plan, as it limits the government’s options in a real economic downturn.

“Should a foul economic wind blow at any time in the next four years, this fiscal house of cards will inevitably fall,” Trevin Stratton, the organization’s chief economist and vice-president of policy and advocacy, said in a Dec. 16 press release.

Stratton said the debt levels are untenable and will impact future generations of Canadians.

‘Anxiety Among Canadians’

However, Morneau gave a glowing review of the Canadian economy and rubbished talk of a near-term recession. He also touted the fact that Canada has the most pristine balance sheet among the G7. The Department of Finance uses economic forecasts from 14 private-sector economists to come up with its projections.

“The Canadian economic situation is very strong,” he said.

The government expects economic growth of 1.7 percent this year and 1.6 percent in 2020. Employment growth had been robust for most of 2019 until a loss of 71,000 jobs in November resulted in a spike in the unemployment rate to 5.9 percent.

For now, it appears that the Liberals are seeing the ill effects of deficit spending as being less relevant and are leaving it up to a subsequent government to rein in the deficit—if it so chooses.

But as many have noted, greater deficits comes with great risks, and the need for more borrowing—with the accompanying moral hazard—can be exacerbated.

Morneau himself said that “we still see a level of anxiety among Canadians.” 

The media’s repeated questioning of the finance minister regarding never-ending deficits may even partially reflect the public’s anxiety about the government’s balance sheet. Canadians themselves understand what it’s like to be deep in debt.

Follow Rahul on Twitter: @RV_ETBiz