Why Trudeau Will Have a Hard Time Financing His Election Agenda

By Theophilos Argitis

Prime Minister Justin Trudeau’s low-key budget Tuesday will mark a major inflection point for Canada as the federal government’s interest burden rises for the first time in two decades.

Since the country got its finances in order in the 1990s, Conservative and Liberal administrations have combined to deliver tax cuts and spending increases worth more than C$100 billion ($79 billion) annually. And much of that fiscal space has come from a shrinking interest burden.

As a share of total spending, public debt charges are poised to rise after falling to their lowest ever outside of the two World Wars.

Why are debt charges starting to rise? For one, Canadian governments have collectively borrowed about C$200 billion since the recession, more than offsetting the debt reduction that took place before then. And that larger debt load is beginning to take its toll.

Two, global interest rates — which had been on a steady downward trajectory for two decades — have reversed course and are headed higher. In Canada, a sustained 1-percentage-point increase in interest rates would expand the deficit by C$900 million in the first year, rising to C$3.3 billion annually after five years, according to government projections from the 2017 budget.

Operating Surplus

Here’s another way to look at public debt charges. To keep a budget roughly balanced, a government needs to run an operating surplus (revenue minus expenses) that is about the same as public debt charges. A balanced budget cancels those two items out.

So, the amount of interest paid on debt can go a long way in determining how loose or tight fiscal policy can get. When the public debt burden falls, as it has for the past two decades, there is scope to cut taxes or increase spending and keep the budget balanced at the same time.

When interest payments on debt hold steady or even increase, that leaves less scope for governments to take initiatives without running deficits or raising revenue.

It should come as no surprise then that Canada’s recent run of deficits have coincided with a slowing of the public debt charge “windfall.”

All this could be a problem if Trudeau has any intentions of seeking re-election on an ambitious second-term agenda. Until now, even with the run-up in deficits, the fiscal track is suggesting caution remains the order of the day.

Just Like Harper

Since defeating former Prime Minister Stephen Harper in 2015, Trudeau has taken what was a structural balance under the Conservatives to a small structural deficit. A federal budget operating surplus of about 1 percent of GDP has been brought to a level just above zero. Which means revenues right now just about match expenses, and Canada’s deficit essentially represents borrowing to pay interest on its debt.

But the Liberals have been saying much of this extra spending — direct program expenses in particular — is just temporary. The October fiscal update projected the operating surplus would widen back to about 1 percent of GDP by 2022, as department spending slows.

In other words, Trudeau’s fiscal base case in his second mandate would be for a tightening of fiscal policy — hardly the foundation of something ambitious. In fact, if all goes as planned, Canada’s fiscal picture in about five years’ time will resemble — at a macro level at least — Harper’s last Conservative budget.

In the October update, transfers to provinces were seen at about 3.3 percent of GDP by 2022, program expenses at 5.7 percent (down from 6.5 percent now) and revenue at about 14.5 percent. That’s not too different from what Harper left behind. One difference is more elevated spending on transfers to individuals thanks to, among other things, increased money for child benefits. And a small structural deficit to pay for that.

https://www.bloomberg.com/news/articles/2018-02-26/why-trudeau-will-have-a-hard-time-financing-his-election-agenda

Categorised in: Canadian News