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By Tegan Hill
and Milagros Palacios
The Fraser Institute

The latest economic news foreshadows recession. Canada’s persistent government deficits will only worsen the situation.

Tegan Hill

Tegan Hill

Recently, the U.S. stock market had its worst day in 2019, plunging 800 points. The bond market is showing weakness with short-term interest rates higher than long-term ones, a situation that preceded past recessions.

Growing trade disputes among global superpowers is eroding business confidence and affecting investment. This will have an important impact on Canada’s economy and finances.

Even before considering a recession, Canada’s federal finances were worrying. With no plan to balance the budget and government spending (per-person inflation-adjusted) at a record high, a recession in the U.S. would only amplify our fiscal problems. In many ways, the federal government is repeating the fiscal mistakes from the 1960s to the 1990s that led to persistent and prolonged deficits.

Milagros
Palacios

So what mistakes contributed to the deep and prolonged deficits over that period?

In 1966, as noted in a recent Fraser Institute study, the size of the deficit relative to the economy was only 0.7 per cent. But despite a period of higher-than-forecast revenues, the federal government routinely incurred deficits for more than 30 years. Nominal program spending grew at an average of 10 per cent annually, which is higher than what’s needed to offset the combined effects of inflation and population growth.

At its peak, the size of the deficit relative to the economy was nearly eight per cent in 1984. To put this in perspective, the government’s total program spending (excluding interest on debt) was 16.5 per cent of the economy that year.

Throughout this time, the federal government frequently stated the need for spending restraint. The government was at least concerned about growing spending, even if there was little action until reform in 1995.

Today, the government seems to approach federal finances in much the same way. The size of the deficit relative to the economy is 0.9 per cent, markedly similar to the situation in 1966. Since 2015, Ottawa has routinely spent all its higher-than-forecast revenues, program spending is growing at an average annual rate of 6.3 per cent (exceeding inflation plus population growth) and, considering interest rates are historically low, interest costs will likely continue to rise.

More worrisome, the federal government is forecasted to run deficits until 2040. And this doesn’t account for the likelihood of a recession. If a recession occurs – as many economic indicators predict – government revenues would automatically decline and expenditures would rise, deepening the deficit even before any action (stimulus spending, for example) from the government.

But Canada’s finances face an additional headwind that wasn’t present in the 1960s to 1990s. Today, the population is getting older because people are living longer and fertility rates are declining. This demographic shift will affect the ability of governments to raise tax revenues while at the same time create pressure for higher spending on benefits such as old age security and health care, increasing the risk of consistent deficits like we saw from 1965 to 1995.

Perhaps most alarming, the current federal Liberal government expresses no concern about the deficit, growing debt or historically high levels of spending.

The government would do well to craft and execute a plan to balance the budget within the next three years. If Ottawa continues on its current track of repeating past fiscal mistakes, Canada will risk incurring the deep and prolonged deficits of the past, particularly in the face of recession.

Tegan Hill and Milagros Palacios are analysts at the Fraser Institute.

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