President and Board Chair, New Westminster Chamber of Commerce and President, Integrated Analytics & Research Ltd.
The $1.2 Trillion Federal Debt – Should we Worry?
The current federal debt to GDP ratio is expected to rise to about 49% by the end of 2020-21 from the 31% it is currently – an 18% increase. Adding the provincial debt loads to get a picture of total debt to GDP, Canada will be at about 103% assuming that the provinces have not increased their debt loads in the wake of COVID-19. This will place Canada’s debt to GDP ratio in the same range as the United States (pre-COVID) 108% and slightly higher than Spain’s 97% (2018) level. Should we be concerned? The short answer is yes. Should we be panic? The definitive answer is no. Not unless there is no economic growth or a second wave of COVID-19 necessitates more debt. Even then, panic is not called for unless spending is inappropriately targeted.
Debt to GDP Ratio:
Canada’s total government debt (all levels of government) last topped 100% in 1996 (at 100.2%). At that time, federal government expenditures on servicing the debt amounted to about 1/3 of all its expenditures (over $40 billion in debt service costs). In 1996 the 10-year bond yield was over 7%. By comparison, current federal debt service costs are $23 billion (7% of revenues) with the 10-year bond yield at a little over 0.5%. However, the costs of increased debt for the Canadian government can be expected to add about $10 billion or more to the annual debt service costs going forward. This is an amount equivalent to the total spent on federal infrastructure in 2019.
But 1995/96 was not a good time for Canada. Under then Finance Minister Paul Martin, substantial cuts to transfers to provinces as well as substantial cuts to government programs were made to get the deficit under control, reduce the debt service costs and introduce fiscal discipline. 2020/21 is not 1995/96. The situation of a pandemic differs from years of regular program spending exceeding fiscal capacity. An increase in program spending is exactly what the political climate of a minority government, is pressuring for.
The real costs of servicing Canada’s debt are sensitive, obviously, to interest rates, and economic growth. Interest rates are likely to remain comparatively low in the short term but in the longer run, as governments increasingly compete for borrowing, are likely to increase. The “crowding out” effect is that government borrowing competes with private borrowing leading to interest rate increase. This is even more the case if there is a robust economic recovery and the private sector once again begins to borrow for investment in new plant and equipment. Further, interest rates on federal government debt will necessarily increase as Canada’s bond rating has declined marginally. A post-COVID recovery and economic growth will restore revenues, and assuming some level of fiscal discipline, lower the debt to GDP ratio and the real burden of debt. The hope is for economic recovery post-COVID-!9. But hope, as we all know, is not a strategy.
The Political Climate:
What can we expect of government policy? There are several political considerations which overall point to a continuation of the current Liberal government for nine months to 1 year. Within that period it will be so concerned with re-election that the impetus for reducing expenditures will be modest. It will want to stay on message as best it can and demonstrate some level of fiscal discipline while not hurting its base of support and while continuing to etch away at the NDP support. We need to remind ourselves that:
- 1. The federal government is in a minority situation and requires the support of ONE and only ONE other party (Conservative, NDP, Bloc).
- 2. It will require all 3 other parties to defeat the Liberals (the Green Party does not have official Party status).
- 3. The Liberals will not want to backtrack on core promises from the 2019 election and will want to expand on its environmental commitments.
- 4. The Conservatives are in a leadership race and will not wish to defeat the government until the fall at the earliest (after a new leader is in place).
- 5. The NDP is at 17% in the polls and would likely lose seats to the Liberals if an election was called.
- 6. The Liberals have substantial support for the COVID-19 relief measures they have rolled out and stand at 37% in the polls. This will drop after the Conservative have a new leader and as the fallout from the Morneau resignation and the ethics investigation into Trudeau creep into public consciousness.
- 7. No party will likely wish an election until after the pandemic has more-or-less has passed. This could change depending on the polls.
- 8. The Liberals are, once again, weakened by an ethics investigation into the PM. This will lead to calls for his resignation and a tendency of the opposition parties to concentrate on this weakness and on Finance Minister Morneau’s resignation.
- 9. The Liberals will be in damage control mode trying to seize the agenda in the September 2020 Speech From the Throne by rolling out popular new programs. Cautious voices will try to introduce some fiscal discipline but likely, as the Morneau resignation demonstrates, fail.
- 10. Calls from the BQ for a confidence vote will fall on deaf ears from the NDP (at least) and have been blunted by the fact that the Throne Speech is, in itself a confidence vote.
Economic considerations would also suggest no strong shifts in government policy for this period (nine months to a year). Economic growth is rebounding modestly and there are no signs that interest rates will skyrocket any time soon. There will be calls for a fall economic update, for a robust recovery plan, and the introduction of measures to fix the gaps in the current COVID-19 relief measures but these will largely be priming the public for an eventual non-confidence vote – probably not successful in the fall but possibly succeeding in or by March 2021. Of course, a March 2021 budget will be a confidence vote in itself and the budget will be portrayed by the NDP as being inequitable and having no plan, by the Conservatives as being reckless, and as not benefiting Quebec by the Bloc. .
What is Coming:
So, what is the best estimate of what is to come?
Short Run (1-9 Months)
- 1. Increases in:
- a. Employment Insurance: A shift toward a Guaranteed Annual Income including contractors and “gig economy” workers
- b. Funding for seniors’ facilities – pre-budget announcements and consultations with provinces (it is asserted as provincial jurisdiction)
- c. Funding for daycare – pre-budget announcements and consultations with provinces (also asserted as provincial jurisdiction)
- d. Funding for infrastructure in Indigenous communities
- e. Funding for environmental programs/energy transition projects (modest for now)
- f. Infrastructure in Canada’s largest cities (Toronto/Montreal/Vancouver)
- 2. Stay the course in:
- a. Foreign aid
- b. Transfer payments to provinces and persons
- c. Taxation (except some modest programs on innovation/entrepreneurship)
- 3. Potential cuts in:
- a. Military procurement
- b. Minor line items (i.e. an announcement of a review of all expenditures)
- c. Police
Long Run: The March federal budget
- 1. All the measures discussed above
- 2. Major announcements on environment and transition away from fossil fuels
- 3. Tax cuts as stimulus:
- a. GST
- b. Personal Income Taxes (for the “middle class”)
- c. Small business
- 4. Tax increases (as “fair share”)
- a. Large Corporations (“loopholes” closed)
- b. The wealthy
- c. A potential wealth tax or financial transactions tax
- d. Sin taxes (tobacco and alcohol)
Toward a June 2021 Election?
In the very long run (more than nine-months), assuming a federal election and a Liberal majority, there will likely need to be some measure of austerity introduced as interest rates increase and the economy rebounds only modestly - not at unprecedented rates. This may take the form of further tax increases, and/or cuts to transfer payments to the provinces. Assuming a Conservative victory, many of the measures introduced by the Liberals will be rolled back particularly any increases in corporate or wealth taxes and maybe transfers to the provinces for daycare and senior’s facilities. Certainly, the environment will take on a different priority than currently declared by the Liberal government if the Conservatives win a June 2021 (approximately) election.
All this being said, it is important that Canada not panic, that we do not try to re-open the economy too quickly because a significant second wave of COVID-19 will force lockdown, require even more government expenditures (and debt), stall growth, and harm the most vulnerable (again). If all of this comes to pass, an election is likely in June 2021. However, a day is a long time in politics. Nine months to a year from now is an eternity.
*Viewpoints and opinions expressed in this posting are those of the author and not necessarily those of the New Westminster Chamber of Commerce nor of Integrated Analytics & Research Ltd.