Trudeau's Debut Deficit Marks Fiscal Shift in Canada: Q&A

  • Activist Liberals aim to spark growth after Harper's austerity
  • With 49 shortfalls over 70 years, red ink is historical norm

For the first time in more than 30 years, Canada is getting back into the red willingly.

Prime Minister Justin Trudeau’s newly elected Liberals will release a budget next month that doles out more money for infrastructure, family allowances and employment-insurance benefits, among other things, all financed unapologetically by borrowing.

Justin Trudeau

Photographer: Matthew Lloyd/Bloomberg

While controversial given the country’s recent record, the move in many ways is a return to the historical norm. How normal? Canada has run 110 deficits since it was formed in 1867, and in the 70 years since the end of World War II the federal government has run shortfalls 49 times.

How large will Trudeau’s deficits be?

They won’t be insignificant. Finance Minister Bill Morneau released new forecasts Monday suggesting Canada will run deficits in the vicinity of C$30 billion ($22 billion) in the fiscal year that begins April 1, as the slump in crude prices takes a bigger bite out of the nation’s finances than previously thought.

A C$30 billion deficit would be 1.5 percent of GDP. That’s a fiscal swing of 1.4 points, from an expected deficit of 0.1 percent of GDP in the current year. Since the end of World War II, there have been only four one-year expansionary fiscal swings of more than 1.4 percentage points of GDP.

How did we get here?

Canada is emerging from the longest stretch of fiscal consolidation in its history. The three-decade focus on deficit and debt reduction -- triggered by runaway budget gaps in the 1970s and 1980s under the prime minister’s father, Pierre Trudeau -- meant policy makers forfeited the use of taxes and expenditures to achieve other goals.

To be sure, the country did run a deficit of C$56 billion in 2009 during the global recession. But in the years that followed former Prime Minister Stephen Harper and his Conservative government made eliminating the deficit a priority regardless of the policy’s drag on the economy and despite pressure from the U.S. to ease off.

Stephen Wicary/Bloomberg

Why now?

Trudeau’s argument goes something like this. Infrastructure is crumbling. Growth has stalled. Incomes for large swaths of the population have been stagnant while growing for the rich few, increasing inequality and weighing on growth. With interest rates at record lows, there’s a historic opportunity to use the borrowing power of the federal government to enhance growth for years to come. 

The Bank of Canada has also been touting the benefits of using fiscal policy at a time when borrowing costs are at near zero.

When has Canada run deficits in the past?

1) During war. Canada’s budget deficits rose to more than 20 percent of GDP in the 1940s, when the country’s federal debt surpassed GDP. Canada also ran up massive deficits during World War I, with its debt tripling during that conflict, and borrowed to finance its participation in the Korean War.

2) There is also a long history of using budgets as counter-cyclical policy, allowing deficits to grow during downturns and shrink in better times. There was one stretch between 1950 and 1970 -- under both Liberals and Conservatives -- when a practice of seeking to fine-tune the expansion with fiscal policy was convention, with budget balances ranging from surpluses totaling 1.5 percent of GDP to deficits of 2.5 percent. For example, former Liberal Prime Minister Lester Pearson introduced a popular income tax cut in 1965 as a stimulative measure only to reverse it one year later amid worries the economy was overheating.

3) When there are runaway shortfalls. In the 1970s and early 1980s, the counter-cyclical policy of the previous two decades turned into a perpetual effort to stimulate the economy, with both spending increases and tax cuts. Combined with weak growth, the increasing costs of Canada’s nascent social security system and soaring interest rates, the country fell into a debt hole that took three decades to climb out from.

Where does Trudeau’s budget fit in?

Trudeau’s debut will be a departure from the balanced-budget doctrine, even as his government remains reluctant to abandon fiscal rules altogether. Morneau still talks about balancing the budget “over time” and insists that at the very least he will reduce debt as a share of GDP.

The new prime minister has tried to distance himself from his father’s economic record. His approach may be closest to the fiscal plans of Pearson in the 1960s with its emphasis on investment spending, industrial policy to grow the manufacturing sector (the ministry of industry was created in 1963) built around a narrative to boost long-term growth and productivity, and a commitment to more foreign aid and social programs.

Pearson did this even as he brought down the national debt as a share of GDP in every year he was in office (another Trudeau goal). He kept deficits small and raised taxes when needed.

Trudeau too is promising only a temporary deficit increase and has baked in some moderate tax increases to help minimize the borrowing.

Of course, the Pearson story doesn’t exactly end well. The full costs of social programs Pearson created in the 1960s weren’t felt until after he left office, replaced by Trudeau’s father. Once the economic crisis hit in 1974, tax hikes weren’t enough to cope with the new strains on revenue and expenditures, propelling the nation into a debt spiral. 

Pearson offers both a model and a cautionary tale for Trudeau. Expanding states do well in times of growth; in bad times, not so well.

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