How Canada Can Tame the National Debt

First, stop the bleeding; second, liberate the economy
July 27, 2020 Updated: July 27, 2020

Commentary

At best, governmental debt is deferred taxation plus interest. At worst, it signals regime uncertainty and corrodes investment and economic competitiveness. Canada’s unprecedented deficits are more than toying with the latter.

Budget deficits are ballooning while measures to mitigate the COVID-19 pandemic remain largely in place. As noted in a recent memo from the C.D. Howe Institute, combined provincial and federal debts are on track to soon exceed 100 percent of GDP.

That is a well-established threshold that dissuades capital formation, particularly foreign-direct investment, which has already plummeted since 2017. Without an about-face and economic restart, Canadians can expect stagnant incomes and higher taxes to boot.

To compound the problem, governments are enjoying near-zero interest rates. Although rates will remain low during the pandemic—the Bank of Canada is monetizing deficits—they will inevitably rise to offset inflation and weakened credit worthiness. A glaring portion of tax revenues will then service debt and be unavailable for principal functions such as infrastructure, national defence, and medical care.

Brace Yourself for the Numbers

In early July, the federal government estimated tax revenues would decline by $43.5 billion and the national deficit would reach $343.2 billion for the 2020–2021 fiscal year. The Bank of Canada projected a 7.8 percent drop in GDP.

More than 6 million Canadians have lost their jobs, and the government forecasts a 10 percent unemployment rate for 2020. The shutdowns have most severely hurt small businesses, crucial for taxes and employment. Research from the University of Chicago suggests 32–42 percent of shutdown-induced employment losses will be permanent.

The total contraction in federal revenues, $72.2 billion, more than doubles that of the 2008–2009 global financial crisis. The sea of red has led Fitch Ratings to downgrade Canada’s AAA debt assessment for the first time in 25 years.

Rather than austerity, cash relief and loans have rained from above. The Canada Emergency Wage Subsidy has covered up to 75 percent of 7.5 million employees’ wages and will last until December 2020. For the first time ever, the national debt could surpass $1 trillion.

Perrin Beaty, CEO at the Canadian Chamber of Commerce, says the debt will “undermine Canada’s fiscal capacity for decades.” He has urged officials “to transition from a subsidy-based crisis response toward restoring economic growth and getting Canadians safely back to work.”

A Bitter Pill to Swallow?

To close deficits, lawmakers must reduce spending, increase taxes, or both. At some point, though, higher rates erode the base and provide little more than short-term revenues. “Reducing government spending is significantly less costly from an economic perspective than raising taxes,” write C. D. Howe senior fellows Glen Hodgson and Peter van Dijk.

Given the sticker price and compliance costs, there is little room for higher taxes, and they would be unpopular with voters. We are at our limit, and Canadians across all income levels pay higher income taxes than Americans. The proof is in the pudding with bankruptcies spiking prior to the pandemic.

Austerity has to be on the table for a bloated Ottawa. That especially applies to the wrongheaded Employment Insurance formula and the $71.3 billion Canada Emergency Response Benefit. This haphazard program has bankrolled wealthy families and paid people to remain unemployed rather than return to work.

The good news is that there is an additional way to lessen the pain of closing deficits: economic growth. There is low-hanging fruit, and this is an opportunity to liberalize and modernize.

Kick-Start the Economy Now

This pandemic has been a diabolical lesson in tradeoffs. Putting the focus exclusively on eliminating the virus has failed to consider the consequences. The blind spot for damage wrought by shutdowns and travel bans reflects a disconnect between policy-making priorities and the realities facing the private sector, while ignoring emergent order.

The consequences are now visible for all to see. They compel a broad-based liberation of the economy. Allowing people to go back to work will not suffice. Canada should undertake long-overdue reforms such as allowing for abundant energy. Two options that sit well with the electorate are (1) internal free trade and (2) relaxed occupational licensing.

Internal trade is a mess of arcane protectionism that robs Canadians of 4 GDP percentage points every year. Provinces must face the new reality and revamp and honour the Canadian Free Trade Agreement.

Occupational licenses need to go or at least be portable across the provinces. Too many workers cannot change careers for lack of accreditation, registration, or licences that have little to do with consumer protection. The result of this thinly veiled cronyism is more expensive services for Canadians and a depressed labour market.

As noted by the Tourism Industry Association, Canada also cannot afford to lose tourism, worth over $100 billion in annual revenue: “We compete with countries around the world who are way ahead of us in terms of discussing, planning, and supporting a restart. … We cannot keep the visitor economy closed indefinitely.”

Every stalled business is a double-edged sword: lower tax revenues and more people eligible for unemployment benefits. Air Canada CEO Calin Rovinescu notes the tight border closure has been disproportionate. He and his chief medical officer have urged reduced quarantine requirements and a list of exempt, low-risk countries.

Atlantic provinces have demonstrated reopening the economy can protect the health of citizens and public finances. On July 21, Statistics Canada showed drops in retail sales were less severe in provinces that had contained the virus early on and begun rolling back shutdowns. The economies of Nova Scotia, New Brunswick, and Prince Edward Island will shrink 3.8 percent, 3.2 percent, and 3 percent, respectively, less than the national 6 percent.

Governments must strike a balance between medical concerns and economic hardship. The private sector, if given the opportunity, can develop protocols to mitigate risks and give oxygen to ailing firms and workers.

Fergus Hodgson is the founder and executive editor of Latin American intelligence publication Antigua Report.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.