Even if the federal government were not to announce a single new expenditure in next week's budget, Canada could be expected to face a deficit between $10-billion and $15-billion. Spending to help combat the recession means the deficit will be at least double (possibly triple) that size, and that at least four years of deficits likely lie ahead.
A broad consensus has formed around the idea that a plunge into the red is a frightening but unavoidable consequence of the economic downturn, and the fiscal laxity that preceded it. But Canadians sacrificed too much in the 1990s to bring their government into surplus for a return to an endless cycle of structural deficits; to fall back into that trap would betray their trust and their long-term interests. That is why it is incumbent upon the government to accompany the deficit spending with a plan to get out of it.
This would be much easier if new fiscal anchors, notably a specific debt-to-GDP ratio, had been firmly established after the books were balanced. Such anchors may be more difficult to set now that political will has shifted toward increasing rather than limiting the size of government, but that trend also renders them all the more important.
Canada's debt-to-GDP ratio, projected at 30 per cent in the last federal budget, is a far cry from its peak of 70 per cent in the mid-1990s and places it in better position than most other Western nations. But continuing to reduce that ratio always made good sense, particularly with the demands of an aging population – the baby boomers reaching senior citizenship – soon placing additional strains on government services. If Canada winds up with ever increasing debt burden, it will grow harder and harder to provide those services without deficits becoming a mainstay. Even if it does not reach 25 per cent by 2011-12, as forecast last year, the debt-to-GDP ratio must continue a downward trend toward that benchmark, and ideally beyond that to 20 per cent. It cannot be allowed to climb over 30 per cent again.
An additional anchor, limiting program spending to a percentage of GDP, would further prevent Canada from sliding into a long-term pattern of deficits.
That ratio has hovered around 13 per cent for the past few years, which is higher than it needs to be – especially since it has not taken into account the Conservatives' grab-bag of expenditures (such as money for parents enrolling their children in sports programs, and for the purchase of workmen's tools) dressed up as tax credits. It should not be allowed to go much higher.
How to meet these targets? It won't be easy, since Ottawa squandered a surplus that could have given it much-needed flexibility during the recession. It is too late to reverse the most flagrantly ill-advised fiscal policy of the current government – a two-point reduction of the GST that has cost billions in revenues in return for little economic benefit. But there are ways to impose fiscal discipline even at a time when “stimulus” is the most popular buzzword.
To avoid a long-term structural deficit, permanent financial commitments should be avoided where possible. Infrastructure investments that can be completed within a reasonable time-frame fit the bill, provided that they are of long-term benefit rather than make-work projects. (A return on infrastructure investments made during a time when capital costs are low should help improve the federal balance sheet down the road by boosting productivity.) The same goes for short-term funding for research and development projects.
If the government insists upon the dubious method of tax relief to boost consumer spending, it could be in the form of refundable tax credits targeted at low-income groups. (For those whose income is too low to have enough tax to be credited against, this would produce an actual cheque into the hands of the poor.) Even increases to the amounts paid out in Employment Insurance could be made temporary.
To the extent that the government does commit to long-term expenditures, there is plenty of room to curb existing spending without adversely affecting the economy. This would also help counterbalance major short-term spending increases. The government could prove its commitment to fiscal responsibility by conducting a comprehensive review of the efficiency of all program spending, along with those tax expenditures the Conservatives are so fond of. By freeing up money from investments found to be providing inadequate value, the government could reduce the amount of its deficit, to finance more effective public investments.
The government cannot be expected, given the economic uncertainties that span the globe, to provide a specific date when Canada will be out of recession. But with next week's budget, it will be asking Canadians to temporarily suspend the implicit fiscal contract of the past 10 years that Ottawa, after a generation of profligacy, will not stray from balancing its books.
In return, the government has the opportunity and the responsibility to provide a road map out of deficits through a specific debt-to-GDP target and a narrow spending-to-GDP range. It should also commit itself to a reasonable time frame after growth has been restored for getting out of deficit.
Only then will Canadians have the tools with which to hold their government to account for holding up their end of the fiscal bargain.