Shifting the focus from deficit to debt-to-GDP

As the last patches of snow melt, Canadians are adjusting to both spring weather and the finance minister’s federal budget. As moderate deficits and a balanced budget disappear from the federal government’s list of promises, the Liberals are relying on sector spending to expand the economy, despite significantly increasing the national debt.

At the beginning of March, a TD Bank report estimated what the Liberal government’s likely fiscal path could mean for Canadians in the near future. TD economists suggested that the combination of expensive spending promises made during the election campaign and the commodities shock that crippled oil prices, the Liberals were heading for $150 billion in deficits over the next five years.

As it turns out, TD Bank was right on target. On March 22, Finance Minister Bill Morneau told Canadians they could expect a deficit of $30 billion in the first year of the Liberal mandate, despite the party’s campaign promise to cap annual deficits at $10 billion.

Concern for increasing debt

While Conservative opponents have shared their concerns about the predicted deficit increases and the Liberal government’s inability to keep one of its biggest election promises, some analysts insist an increased deficit will not be a problem.

“I don’t think economists generally are too hung up on the fact that the Liberals will be running deficits many times larger than what they committed to during the election campaign because so much has changed since then,” TD Bank economist Derek Burleton says. “Running deficits of $30 to 40 billion is not going to get them into an area of difficulty.”

However last month, Finance Minister Bill Morneau moved the government’s focus away from deficits and towards lowering the ratio between Canada’s net debt and gross domestic product. Stephen Tapp, a research director at the Institute for Research on Public Policy says this is exactly the area the federal government should be analyzing, rather than making annual deficit promises or predictions.

“I think most economists would agree that looking at the debt ratio is a smarter way to do it than by looking at the annual budget balance and deficits or surpluses,” Tapp says. “You can’t get a good enough picture for how the economy will look if you just focus on the budget in a given year, it’s better to look at how the economy will grow over a larger period of time.”

Currently, Canada’s debt-to-GDP ratio sits at 31 per cent, with an original Liberal promise to lower the ratio to 27 per cent by the end of their four year term. However, after the budget release, projections increased to include a debt-to-GDP ratio that would steadily increase each year, only falling to around 31.6 per cent in the 2019-2020 fiscal year.

Data comparing Canada’s federal government projections for the debt-to-GDP ratio before and after the 2016 federal budget.

Jean-François Perrault, chief economist at Scotiabank, says that the Liberal government’s predictions are not realistic. “The numbers are optimistic because a lot of the areas they are investing in, like infrastructure and money for households, import materials from other countries,” says Perrault. “So a lot of the money will likely leak out of the economy and therefore the GDP will not balance the debt, which is something the Liberals didn’t take into account when making their estimates.”

Even though Perrault says that the federal government’s debt-to-GDP projections might be off, the economist also says Canada is not in a bad position because the country is not as indebted as other countries in the G7. “The reality is the federal net debt-to-GDP ratio is pretty low by international standards,” says Perrault. “So it can rise a bit but in a few years it will gradually begin to fall.”

Tapp says a higher debt-to-GDP ratio by the end of the Liberals mandate may be problematic due to our current economic status.

“If we stay in this situation and the economy does not improve from its current shock, ideally you wouldn’t want the debt ratio to be any higher by the end of the Liberals term than it is now because it will make it only more difficult to pay back debts,” says Tapp.

Tapp says that it’s possible to still have a deficit and a debt-to-GDP ratio that is falling.

“The government can stick to running modest deficits and they can still have a declining debt ratio and with that, hopefully part of the economy will start to grow faster than the rate the debt is growing,” says Tapp. “However, a lot of it depends on certain things that may go wrong with the economy, things which are simply outside of the government’s control.”

Use the above data to find key words, like GDP, in the federal government’s 2016 budget.