The initial reaction on reading the new report by the Parliamentary Budget Officer was to curl up into a ball and turn out the lights.
The “illustrative scenarios” presented by the PBO reveal the combination of the COVID pandemic and the oil-price shock has put Canada on course to rack up a deficit of $252.1 billion this year, or 12.7 per cent of the country’s economic output.
In that event, the value of goods and services produced in Canada will have fallen by 12 per cent for the fiscal year, even with a modest rebound in the second half.
If the outlook proves correct, tax revenues will fall by $60 billion, while program spending will increase $168 billion — fully one-quarter of GDP — compared with the previous year.
To put those numbers into context, they are the worst in Canadian history.
Even in the depths of the Great Depression, real GDP did not fall by 12 per cent in a single year (there were four consecutive years in the early 1930s where growth was in negative territory, but the drop was never as precipitous). The deficit would also be greater than in any single year during the Depression, as a percentage of the economy.
So is Canada insolvent? Can it ever pay back a national debt that may total nearly $1 trillion?
The good news is debt can be rolled over. Economic historian Livio Di Matteo of Lakehead University notes that Britain was still paying off Napoleonic-era debt well into the 20th century.
Interest rates on new debt are also at historic lows and, in theory, much of the $146 billion in emergency spending is temporary in nature.
If the economy is growing slowly and you raise taxes on income and capital, it is going to slow growth even more
The PBO sees the federal debt-to-GDP ratio rising to 48.4 per cent this year, but that is nowhere near the 66.6-per-cent peak in 1995–96, when 38 cents of every tax dollar was used to pay the interest on the national debt.
The Liberals can be justly criticized for entering the crisis in fiscal deficit but, even then, the Canadian economy was in a much healthier state than it was in the mid-90s.
That perspective may be enough to persuade readers to uncurl from the foetal position.
However, there is no room for complacency.
A curious editorial in The Globe and Mail this week suggested the government’s game plan should be similar to that employed in the immediate post-war period when, not only did Canada not pay off the national debt, it added to it.
This was manageable because the weight of the debt fell. The economy grew faster than debt.
However, replicating those conditions smacks of wishful thinking. GDP growth in the 1950s and 1960s averaged 5.7 per cent, thanks to the liberalization of world trade, a demographic surge, a rise in consumer spending, a natural resource boom and the auto pact with the U.S.
Canada experienced 35 consecutive years of growth in the post-war period, according to Di Livio’s calculations.
Given the uncertainty in the economy, the PBO does not make any growth projections beyond the end of the year. But does anyone think that Canada is on the brink of a new golden age of prosperity that will rejuvenate the economy?
People see the handwriting on the wall
The comparison with the post-war period is not pretty. We are currently seeing a rise in trade protectionism. To compound things, we have an aging population, a resource price crash and record household debt.
It’s clear now, if it wasn’t before, that the exit from this crisis is going to be painful and protracted.
There are going to be more demands to provide relief to specific industries not yet covered by government aid programs. This week has already seen the Canadian Federation of Agriculture seeking $2.6 billion, as processing plant closures and other supply-chain disruptions threaten food security. The National Airlines Council says the airline industry is under “significant threat” as its members try to cope with a 90 per cent drop in capacity.
The PBO noted that additional fiscal measures may also include stimulus spending to ensure the economy reaches “lift-off speed.”
The government is going to be faced with some unpalatable choices that will require a retreat from emergency spending and may necessitate an increase in taxation.
The most logical move for any government desperate for cash would be an increase in the goods and services tax.
Yet as Brian Mulroney noted in his autobiography, the tax on everything that moves was and remains “as unloved as any measure could possibly be.” Raising it would be political martyrdom.
A more palatable and natural alternative for this most progressive of governments would be to squeeze the rich, either through an increase in capital gains tax or the kind of wealth tax that the NDP proposed in the last election — one per cent of the value of household assets above $20 million.
The PBO estimated that the tax might raise $9 billion, but the experience in other jurisdictions like France was the introduction of wealth taxes leads to a flight of capital. The tax was criticized, and subsequently reformed, by French President Emmanuel Macron, who said it was unfair to those who invested in the productive economy.
One tax lawyer I spoke with said that high-net-worth individuals are already anticipating their departure from Canada at a time when their asset values have decreased and the exit tax is cheaper. “People see the handwriting on the wall,” he said.
Even before the crisis hit, there was speculation that the Liberals were keen to raise the capital-gains inclusion rate to 75 per cent from the current 50 per cent — a measure the PBO estimated could raise $8 billion in tax revenues.
But cooler heads may caution against such a tax grab. Marginal income tax rates in most provinces are already over 50 per cent and Canada has had trouble attracting capital. Real business investment has fallen 10 per cent in the past four years.
“If the economy is growing slowly and you raise taxes on income and capital, it is going to slow growth even more,” said Di Livio.
What the PBO report makes stark is that there are going to be no easy choices.
jivison@postmedia.com
Twitter.com/IvisonJ
