Maybe the cupboard really is bare. In many ways the most interesting chart in Finance Minister Ralph Goodale’s first budget, delivered March 23, was the table ”œChanges in the Status Quo Fiscal Outlook since the November 2003 Economic and Fiscal Update” (reproduced here in table 1 ”” and I do realize only an econ- omist could find such a title interesting).
The headline expenditure in Goodale’s budget was $2.5 billion for health care ”” $2 billion for the provinces and $500 million to beef up Ottawa’s own public health program. If Ottawa has any legitimate role in the provision of health care it is for dealing with public health disasters such as epidemics, which do not honour provincial bound- aries. Why Health Canada now needs $500 million new dol- lars to perform what should have been its core health function all along is a question that needs asking but in the year following SARS probably won’t get it. The $2 billion for the provinces is fulfillment of a commitment made last year by the previous Liberal prime minister, he whose name dare not be spoken in Paul Martin’s Ottawa.
That commitment came with a condition. It would only be carried through on if the federal government’s budgetary situation permitted. Table 1 makes clear that the budgetary situation very nearly didn’t permit. As of last November’s fis- cal update, the feds were running a surplus of $2.3 billion for the fiscal year, which meant that if nothing changed, they were going to have to dip into the contingency reserve of $3 billion, which they don’t like doing. It also meant that sending $2 billion more to the provinces for health care would put them perilously close to running a deficit, which they really don’t like doing.
Since November, however, a couple of good things made their situation a little easier. Tax revenues came in higher than expected and slow economic growth in Ontario meant the federal equalization obligation fell by $2.3 billion. (Slower growth in Ontario means a smaller gap between the five-province ”œCanadian average” income, which includes Ontario, and income in the have-not provinces. That’s the gap equalization closes.) The net improvement in the budg- etary situation between November and the budget was $3.2 billion, which brought the overall bal- ance to $5.5 billion, more than enough to allow for the extra $2 billion in medicare transfers.
But notice what’s happened. The provinces are getting $2 billion in health transfers mainly because they’re losing ”” some of them are, at least ”” $2.3 billion in equalization. This helps explain the provinces’ gen- erally foul mood on budget day. It’s nicer to get $2 billion than not, but it would be nicer still if you hadn’t paid for it yourself.
On the other hand, the feds don’t yet have these equalization savings in hand. ”œThey will be recovered from the equalization-receiving provinces over time,” the budget documents tell us, with no mention of how difficult an extraction that may be in political terms, but ”œunder generally accepted accounting principles” the full $2.3 bil- lion must be entered as a receivable in the 2003-4 financial statements.
So, in sum, Ottawa spends $2 bil- lion more on health care because it got money out of the people it’s going to give the money to ”” except that it doesn’t really have the money yet because they haven’t paid it back yet. Could Enron have done it any better?
It gets worse. Recall that buoyant tax revenues and sinking equalization obligations had brought Ottawa’s sur- plus to a perfectly respectable $5.5 bil- lion for fiscal year 2003-4, up from $2.3 billion in November. But if you take that surplus and spend $2.5 bil- lion of it on health care, $1 billion on BSE and another $100 million on tax cuts for cities, that brings the surplus down to $1.9 billion, which means you end up dipping into the contin- gency reserve by $400 million more than you had planned to in November, despite the good fiscal things that have happened since.
As has been the custom in our fed- eral and provincial capitals for several decades now, whenever fiscal contin- gencies pinch, ministers shift the bur- den to future generations, who doubtless will perceive the shift more as a shaft. It’s true that if there are more pleasant surprises before the books are closed on the 2003-4 fiscal year, the $1.9 billion that the budget allocates to debt reduction may rise, but that’s pre- cisely the problem: the interests of future generations are treated as a resid- ual. Their claim on any monies is the very last to be honoured.
In fairness to Goodale, he is aware of this problem. And his is the first budget in Canadian history to establish an official target for the debt-to-GDP ratio (the ratio of the government’s debt to the country’s annual output of goods and services, which despite being a ratio is always quoted in per- centage terms). Thus he says he will reduce the ratio from its current 44 per- cent of GDP to 25 percent ”œwithin ten years,” a time-frame that leaves open the possibility of hitting the target before then. (Recall that Finance Minister Paul Martin met his zero deficit target earlier than planned.)
As the co-editor (with my McGill colleague Chris Ragan) of a recently- published IRPP book that says the country should establish a debt-to- GDP ratio of 25 percent, I’m bound to applaud Mr. Goodale for his sense of responsibility toward future genera- tions. In that book, Is the Debt War Over? Dispatches from Canada’s Fiscal Frontlines, TD Bank’s Don Drummond, formerly of the federal finance department, tells of how a debt ratio target was considered in the mid-1990s but rejected because, among other reasons, the ratio’s denominator was too unpredictable and hard to control. The government evidently now has got over that worry ”” or at least is willing to take a risk in the interest of fiscal responsibility. Good for them. They deserve our praise and congratulations.
On the other hand, Goodale prob- ably didn’t get into public life expecting unalloyed praise for anything he does, and I don’t want to disappoint him, so:
To begin with, 10 years isn’t very ambitious. The budget itself notes that the debt-to-GDP ratio has already fallen from ”œa post World War II peak of 68.4 percent in 1995-96 to 44.2 percent in 2002-03” ”” in other words, by 24.2 percentage points in eight years. Reducing it by another 20 percentage points in ten years there- fore means slowing the pace of debt reduction by between a quarter and a third. Goodale argues, correctly, that reducing the debt ratio will lower another key ratio, the interest ratio (that is, the share of federal revenues that goes to pay interest on the debt). In the early 1990s more than a third of federal revenues went to pay interest, which is a main reason Canadians were so angry about their taxes dur- ing those years. With so much federal money going to interest, they paid a lot more in tax than they received in public services. At the moment, the interest burden is about 20 cents on the dollar. Once the debt gets to 25 percent of GDP, however, it will be down to 12 cents on the dollar of fed- eral revenues, just a penny more than it was in the mid-1970s.
Is that the right level? In our debt book, Bev Dahlby of the University of Alberta calculated that the economic efficiency gains from no longer having to tax Canadians in order to pay debt interest work out to about 15 cents on the dollar of debt, which is a pretty good rate of return no matter how you look at it. Goodale’s own take on the benefits of reduced interest payments is that money that used to go to interest can instead be used to finance other worthwhile public projects, including paying for the baby boomers’ retire- ments. But senior boomers are coming on line pretty quickly. The cohort born in 1946 hits 65 in just seven more years. Speed clearly is of the essence.
A second problem: the debt reduc- tion project doesn’t get off to a very good start. This year the forecast reduction is, as indicated, just $1.9 billion. Next year it goes back up to the recently customary $3 billion. But at the moment that’s only possible because the government will make $2 billion on its sale of Petro- Canada, its one-time window on the oil industry. By selling these corporate assets, Ottawa is reducing its net worth. Unless it retires $5 billion of debt next year, it won’t really be carrying through on the net $3 billion reduction it says it wants. As a rule, asset sales shouldn’t be used to finance current expenditures.
Finally, there’s the psychological drawback that Goodale is continuing the practice of running surpluses by stealth. As a practical matter, the government is aim- ing for an annual surplus of $3 billion. Yet it refuses to admit that. Sometime in the 1990s then finance minister Paul Martin decided that while he could sell Canadians on the need for a balanced budget, selling them on the need for debt reduction was just too hard. So he instituted the practice of establishing a contingency reserve that, if not used, goes to debt reduction. Surplus remains a dirty word. Instead of openly budgeting for one the government officially aims for a balanced budget, including a $3 bil- lion contingency reserve that goes to debt reduction through the back door.
Canadians have matured since the 1990s. They now clearly under- stand the difficulties posed by deficits. (In fact, they probably understood them well before official Ottawa did.) They might well be capable of understanding that reducing debt means reducing taxes on subsequent generations of Canadians ”” their own children and grandchildren. Most people seem to understand the ethical appeal of leaving their children a natural environment at least as attractive as they themselves inherited. Why shouldn’t the same be true for the fiscal environment? If this or a future government were to take that view, it would make ”œdebt reduction” a budget line like any other and establish a contingency reserve over and above its budgeted surplus.
On budget day the contrary argu- ment was put by NDP leader Jack Layton (who, incidentally, grossly mis- estimated the government’s debt reduction ambitions at $200 billion, an appalling exaggeration barely noticed by the press). ”œIt’s like paying down the mortgage faster when you’ve got a leaky roof, a sick grandmother and your child is trying to go to university. I don’t know a single family that would do what Paul Martin is doing with our economy.” But he’s wrong. Most Canadian families probably do go to great lengths to keep paying their mortgages even when times are tough. And if the alternative to speeding up their mortgage payments is to pass that debt on to their kids, I bet most Canadian families would say no.
Our debt book conclud- ed that although there are good reasons in economic efficiency for reducing the debt, in the end debt policy is really about intergenera- tional fairness. What obligations should one generation impose on succeeding generations? Most of the contributors to the book seemed to think the generation that lived through the Great Depression and fought and won the Second World War was justified in sharing its fiscal burden with its children. As a boomer myself, I can’t believe my generation’s figura- tively leaky roof, sick mother and tuition obligations compare with the difficulties faced by our parents and grandparents. I expect that if you pressed him, baby boomer Ralph Goodale would probably agree. His next budget, if there is a second Goodale budget, should reflect that.