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The Toronto Blue Jays were opening a fresh season with back-to-back World Series championships under their belt. Kurt Cobain died and joined the 27 Club. And a newly elected government in Ottawa made a modest commitment to reduce the federal budget deficit to three per cent of gross domestic product (GDP) within three years. That was a generation ago, when Jean Chretien was prime minister, Paul Martin his minister of finance, and Canada was facing a fiscal crisis.
The three per cent target was aimed at stabilizing a deficit and debt spiral that began two decades before but by the early 1990s was at a tipping point. With a deficit of six per cent of GDP and a debt level of about 70 per cent, the target on its own didn’t erase these dire numbers—achieving that would require very deep, painful and controversial spending cuts, with long-lasting implications for federal programs, services to Canadians, and financial transfers to the provinces. But the three per cent objective did impose a regimen on the government and sent an important signal to markets and Canadians that Ottawa was getting serious about public finances.
Within a few years surpluses were being posted for the first time in a quarter century. The concept of the fiscal “anchor”—a way to insert more discipline in the spending and borrowing proclivities of politicians—had come to Ottawa for real.
During the surplus era, which lasted about a decade, the fiscal anchor survived, albeit mutated. Over that period the scars of austerity remained visible on the body politic and in the federal public service. One should be cautious with the new financial windfall, went the thinking, as it would likely be ephemeral. Plus, Ottawa still had a large debt hanging overhead.
As the millennium approached Fiscal Anchor 2.0 was introduced: the debt to GDP ratio would be put on a permanent downward track. In addition, half of any surplus would be allocated to debt reduction and tax cuts. A belt was added to these suspenders during the short-lived government of Paul Martin, adding the target of driving the debt ratio down to 25 per cent within ten years.
Three years later the 2008 global financial crisis blew this architecture to smithereens. In short order the surpluses evaporated and the Conservative government of Stephen Harper—as part of an international response to the global economic meltdown—engaged in Keynesian stimulus and produced the largest nominal dollar deficit in Canadian history to that point.
This approach succeeded in stabilizing the economy and it was affordable because of the conditions the previous fiscal anchors had helped create. Federal public finances were sound in absolute terms, by historical standards, and compared with peer nations. Partly as a result, Canada weathered that recession better than the U.S. or Europe.
As soon as the crisis abated, the Harper government re-established a fiscal anchor, in this case a balanced budget objective. It was an ambitious goal that took a lot of effort to achieve—including a spending restraint exercise known as the deficit reduction action plan. The federal budget was balanced during Mr. Harper’s final year in office.
That same year, 2015, Justin Trudeau’s Liberals came into power. The Trudeau Liberals were not wedded to the same fiscal orthodoxy. Rather, their promise was to hold to deficits of no more than $10 billion per year in their first two years of office and by 2019 to balance the budget and reduce the debt ratio to 27 per cent of GDP. Yet another fiscal anchor came to life.
But the combination of historically low interest rates and fiscal discipline not being in the Trudeau government’s DNA resulted in the abandonment of the deficit ceiling before the pandemic hit. The budget has never been balanced during the Trudeau years, and the debt ratio has remained well above 27 per cent.
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Then the COVID-19 crisis descended on Canada, and modest deficits immediately gave way to the largest in Canadian history. This was appropriate in the circumstances as Canada was hardly alone in so doing.
As Canada emerged from the pandemic crisis and the extraordinary fiscal stimulus it wrought, Ottawa was pressured to re-establish a fiscal anchor. What would it be this time around?
Reaching back for the declining debt to GDP ratio was the chosen path. It’s an anchor tailor-made for a government that has increased annual spending by $151 billion since taking office and jacked up the federal public service by 31 per cent or nearly 80,000 employees: Modest deficits can be run year after year and the debt size relative to the economy can still decline.
New approach needed for reviewing government spending
Nevertheless, the most recent federal budget weighed that anchor. The fiscal anchor idea, alive and well in various incarnations for a generation, can now be pronounced dead, drowned in a sea of red ink. Budget 2023, in contrast with the November 2022 fall economic statement, projects a rising debt to GDP ratio this year, dropping ever so slightly next year (an election year), but still remaining over 40 per cent. The government’s 2024 pre-election budget will almost certainly be larded with further big spending items, meaning those debt projections should be taken with the grain of salt they deserve.
Expert opinion is split on whether the budget is profligate or fiscally sustainable. After all, this is not science or math but a matter of political economy and economic forecasting. And as John Kenneth Galbraith once remarked, “economic forecasting was invented to make astrology look respectable.”
Finance Minister Chrystia Freeland stated in her budget speech that we are at “an inflection point”…“the most significant economic transformation since the Industrial Revolution.” Alas, there is nothing transformative or historic in the spending and tax measures contained in Freeland’s latest budget.
But one thing from the 2023 budget might end up being historically important. Canadians could look back a decade from now and point to this as the moment when Ottawa’s already weakened fiscal moorings came unhinged, leading to yet another painful fiscal reckoning.