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Hub Explainer: Why the government’s plan to cut the deficit may be too optimistic

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Finance Minister Chrystia Freeland delivered a stimulus-heavy budget last month that focused on the COVID-19 pandemic, post-pandemic recovery, energy transition and reduction of economic inequality.

The budget commits to $101.4 billion in spending, with marquee items including a commitment of $30 billion over the next five years for a national child care program, an extension of pandemic supports and incentives for the development of zero-emissions energy technology.

Canadians can expect a $354 billion deficit this year but the government projects that the red ink will soon taper off to slightly less eye-popping figures through a combination of restrained spending and economic growth.

“Growth is coming,” Freeland says in the document’s foreword. “We can afford this ambitious budget because the spending we propose today is responsible and sustainable.”

The government’s growth agenda has already come under serious scrutiny, but are the spending projections realistic about the amount of red ink Canadian’s can expect in the future?

How is the economy doing?

The budget projects economic growth of 5.8 percent in 2021, 4.0 percent in 2022, and then levelling off to about 2.0 per cent in 2023-25. There are two key takeaways from this.

First, the budget anticipates that real GDP will reach its pre-pandemic levels over the course of 2021. This raises a fundamental question of whether $100 billion in stimulus spending over three years is even necessary.

Second, the budget anticipates that Canada’s economy will return to about 2 percent growth for 2023-25, which it describes as “reflecting a return to trend long-run growth rates.” That means, by the government’s own projections, the country’s growth will be sluggish over the long run.

Will the government get deficits – and the debt – under control?

The budget projects the deficit to fall from $354.2 billion in 2020-21 to $154.7 billion in the current year and continue falling steadily thereafter. But even by 2025-26, it still projects deficits as high as $30 billion. This is higher than the deficits the government was running prior to the pandemic, even if program spending conforms to the projections.

The net effect will be a significant increase in the federal debt. It stood at $634.4 billion in 2015-16. It is now $1.1 trillion and projected to reach $1.4 trillion by 2025-26. In short, the government will have more than doubled the federal debt over a 10-year period.

Crucially, the likelihood of program spending remaining within the government’s projections seems far-fetched. It would require a degree of spending control that we have not seen since 2014-15.

Why the spending numbers might be too optimistic

Annual program spending grew, on average, by 6.4 percent in the first five years of the Trudeau government. It spiked in 2020-21 due to the pandemic and is projected to significantly fluctuate in the subsequent two years as pandemic-related relief is gradually wound down and new stimulus measures are enacted.

Spending is then projected to settle down to more conventional year-over-year changes beginning in 2023-24. The government is projecting that program spending will grow by 2.6 percent that year and an average of 2.8 percent between 2023-24 and 2025-26.

There may be reasons to doubt that the government will sustain annual program spending growth below 3 percent over this period. It would effectively amount to a more than 50-percent cut in year-over-year spending growth relative to pre-pandemic levels. How the government intends to exercise such fiscal restraint after increasing spending by nearly 40 percent in its first five years is largely unexplained.

If the past is prologue, there’s a good probability that average spending growth will amount to something closer to 6.4 percent than 2.8 percent. The result would be to put considerable pressure on the budget deficit.

One example: Program spending is projected to grow by 2.6 percent from $428.7 billion to $439.7 billion between 2022-23 and 2023-24. If it were to grow by 6.4 percent instead, it would go from $428.7 billion to $456.1 billion and the deficit would go from $51 billion to $67.4 billion.

The outcome would potentially be longer and larger deficits than is currently projected. The real story here, then, may not be about how the deficit is shrinking but rather that the medium-term risk is more to the downside than to the upside.

Federal budget sparks economic growth concerns

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When the Liberal government came to power, it quickly tried to shift the focus away from deficits and onto the debt-to-GDP ratio. The rationale was politically and economically straightforward: if Canada’s GDP rises along with the debt, then the ratio doesn’t spiral.

But now, with deficits ballooning and the government pledging to grow its way out of mounting debt, an essay at The Hub about the budget’s lack of a plan for economic growth was front and centre at question period on Friday.

“After doubling our federal debt in only six years, and spending close to a trillion dollars, not moving the needle on long-term growth would be the worst possible legacy of this budget,” said Pierre Poilievre, the Conservative Party’s jobs and industry critic, who was quoting an essay published at The Hub by Robert Asselin, the senior vice-president of policy at the Business Council of Canada.

The government’s priority is, first and foremost, to protect jobs that are immediately under threat by the economic shock of the pandemic, said Sean Fraser, the parliamentary secretary to Finance Minister Chrystia Freeland, in response.

“I will remind (Poilievre) that one of the most important things we can do to contribute to a growth-oriented recovery is preserve the jobs that we have now,” said Fraser.

After tabling the budget last week, Freeland declared her commitment to economic growth as an escape hatch from the debt that is rapidly piling up on the country’s books.

“The best way to pay our debts is to grow our economy,” said Freeland.

With the country facing a $354 billion deficit in 2020-21 and the following year’s books projecting a deficit of $155 billion, economists have warned that while it’s possible to use economic growth to grow the country out of debt, it’s a slow and risky process.

“If another recession or two hits, debt will rise. If an expansion continues unabated, debt will fall. We just don’t know which of the two will happen. It may be prudent to prepare for the worst,” wrote Trevor Tombe, a University of Calgary economist.

There has been a rising chorus lately warning about lacklustre growth in Canada.

Earlier this month, Scotiabank CEO Brian Porter warned about the “two percent trap” Canada has fallen into and recommended pro-growth policies as the country emerges from the pandemic. At the top of Porter’s list were increased child benefits and child tax credits, a capital investment grant for businesses, and increased free trade between provinces.

That’s the kind of thing Asselin found wanting in last week’s budget.

“Although some of the objectives and proposed measures… should be applauded, it is hard to find a coherent growth plan,” wrote Asselin.