Blogs & Comment

Why the federal government shouldn’t balance the budget

The obsession with balanced budgets is a relic of ’90s economics. It’s a dangerous delusion today

Finance minister Paul Martin speaking in Parliament in 1997

Then finance minister Paul Martin delivering his budget speech in February 1997. Times have changed, but the political consensus on balanced budgets remains the same. (Tom Hanson/CP)

Nothing can shake Canada’s political class from its obsession with balanced budgets—not even the prospect of a recession.

As the collapse in oil prices prompted the Bank of Canada to cut interest rates, finance ministers remained under the spell of fiscal prudence. Those who were plunged into red ink promised to get back in the black as quickly as possible. Those who remained on solid ground carried on as if nothing had happened. Federal Finance Minister Joe Oliver insisted balanced budgets were the only way to ensure long-term prosperity, a sentiment with which Opposition leader Tom Mulcair agrees. In B.C., Finance Minister Michael de Jong said his government would not force “future generations to pay for our groceries.”

It’s been 20 years since Paul Martin declared he would erase the federal government’s chronic deficit, “come hell or high water.” The world has changed a lot since then. Economic thinking has evolved. Yet Canada’s politicians carry on like it is the 1990s, convinced there is a binary relationship between balanced budgets and economic growth.

The International Monetary Fund was at one time the intellectual force behind fiscal probity, but lately it has adopted a more nuanced view. New IMF research shows that what matters most is a country’s “fiscal space”—the amount of debt a jurisdiction can easily finance. Greece, for example, has no fiscal space. Nor do Italy or Japan, whose debts far exceed the size of their economies.

Canada, on the other hand, has plenty of fiscal space. There are some exceptions, but for the most part, Canadian governments have their debts under control. The federal debt-to-GDP ratio is about 30%, nowhere near the danger zone. The provincial average is roughly the same.

The political consensus on balanced budgets risks condemning Canada to economic mediocrity. Gross domestic product might expand 2% this year, an exceptionally poor growth rate. By making balanced budgets sacrosanct, governments have put an artificial ceiling on the economy’s potential. The Bank of Canada estimated in April that public spending will contribute just one-fifth of a percentage point to GDP growth this year. In 2014, that contribution was zero.

The point isn’t that Canadian governments were misguided in the 1990s. Back then, we were headed for a debt crisis. But economic conditions have changed dramatically. American demand is subdued; China’s once-in-a-lifetime boom is over, and commodity prices have declined as a result. Achieving economic growth will be much more difficult going forward. Canada’s standard of living will suffer if the country fails to adjust.

No one would counsel a return to unchecked spending. But the magical thinking around balanced budgets should stop. Canada’s debt is a sunk cost, not an anchor. The IMF now advises that countries with enough fiscal room to manoeuvre should think twice about reducing debt for the sake of it. If debt is manageable, economic growth should be the priority. An expanding economy will reduce the debt burden organically.

The preoccupation with balanced budgets limits what fiscal authorities are willing to do to boost growth. The federal Conservative government said in its April budget that it would cut the tax rate on small business profits to 9%, matching a New Democratic policy. Why not 8%? Or a broader tax cut that covers more businesses? Because Canadian economic policy is made within arbitrary parameters based on outdated thinking.

All national parties promise to spend on infrastructure, but the potential impact is limited by their leaders’ unwillingness to borrow, even though bond markets will loan Ottawa money for 50 years at less than 3% interest and for 10 years at less than 2%. That’s essentially free money that could be used to boost growth and productivity. But Canada’s leaders would rather have an uncompetitive economy that does little better than muddle along, so long as they can declare the budget balanced.

That is worse than an obsession. It’s delusional.