Matthew Lau: COVID-style deficits are no longer necessary

What year is this? The calendar says 2022, but judging from the fiscal balances in the federal and provincial government budgets over the past two months, some politicians apparently think we’re still in 2020.

Sizable budget deficits, of course, made some sense two years ago—the pandemic made necessary some extraordinary public health expenditures including compensation for business owners and other lockdown victims. Moreover, the recession reduced revenues and made some programs (employment insurance, for example) more expensive. To be sure, there’s a good case to be made that governments overspent in 2020 and that the deficits were too large. Nevertheless, the idea that governments should run deficits during a pandemic was completely reasonable.

But it’s now—to repeat—the year 2022. The pandemic is largely behind us, the recession is over, and government deficits are now not so reasonable.^{1Do Budget Deficits Matter? Essays on the Implications of Government Deficits and Debt https://www.fraserinstitute.org/studies/do-budget-deficits-matter-essays-on-the-implications-of-government-deficits-and-debt} To their credit, the New Brunswick and Alberta governments tabled balanced budgets this year. The federal and other provincial governments, alas, are less responsible.^{2High spending and more borrowing common theme across Canada https://www.fraserinstitute.org/blogs/high-spending-and-more-borrowing-common-theme-across-canada} The federal budget calls for a $52.8 billion deficit this year, driven by continued elevated spending levels, and no balanced budgets in its five-year plan. The Ontario government plans a $19.9 billion deficit this year and continued deficits until 2027-28, the British Columbia government a $5.5 billion deficit this year and no balanced budgets in its three-year plan, and the other provinces’ ongoing deficits of varying sizes, in some cases with no timeline to reach budget balance.

In selling their ambitious spending programs to the public, politicians like to use the word “invest” a lot. Government doesn’t spend our money, it only “invests” it. The Trudeau government’s budget, for example, has a section titled “Investing in a Green Transition That Will Support Jobs and Growth,” followed by a section on “Investing in Our Economic Capacity and Security” and then “Investing in an Inclusive Workforce.”

But the word “investing” shouldn’t fool anyone.

This is consumption spending, not investment. And to the extent that any real investment is taking place, it bears little responsibility for this year’s deficit. When governments invest in capital assets, such as physical infrastructure, the cost of the asset is capitalized and amortized over the life of the asset, and only the amortization expense is reflected in the annual deficit.

Politicians also often attempt to justify spending by claiming it stimulates the economy. The phrase “stimulus spending” does not actually appear in the latest federal budget but it appeared in the 2021 budget, to the tune of $100 billion and even referenced a “fiscal multiplier,” which is a measure of how much stimulus spending actually stimulates the economy. A multiplier above 1.0 suggests the spending stimulates private-sector activity; a multiplier below 1.0 suggests it crowds out private activity. Much of the debate about multipliers took place in 2009-10 as governments around the world enacted significant stimulus programs, with the preponderance of the evidence contradicting the theory that such spending is beneficial.

“The fiscal stimulus package,” Harvard economist Robert Barro wrote of a possible U.S. stimulus package in 2010 to follow the one already implemented in 2009, “is a way to get an extra $600 billion of public spending at the cost of $900 billion in private expenditure. That is a bad deal.” While some economists claimed the government spending multiplier was 1.57, other economists objected to their “highly questionable” assumptions, and using newer models, concluded that “the multipliers are less than one as consumption and investment are crowded out. The impact in the first year is very small” and in later years “the multipliers turn negative.” International Monetary Fund economists similarly estimated^{3The Administration and the IMF on the Multiplier https://www.hoover.org/research/administration-and-imf-multiplier} a multiplier that begins at 0.7 and fades over time to around 0.1, and later studies also found multipliers well below one.^{4Government Spending Multipliers in Good Times and in Bad: Evidence from US Historical Data https://econweb.ucsd.edu/~vramey/research/Ramey_Zubairy_JPE_published.pdf}

Government spends other people’s money less wisely than people spend their own money, and today’s deficit-spending discourages productive economic activity. Canadian governments that continue to spend and run deficits, in consequence, are doing economic harm. Deficits, though perhaps not of the magnitude that many governments incurred, made some sense in 2020. This year, however, deficits are unjustified and the federal plan, in particular, to continue with indefinite deficits appears reckless.