Jean Soucy, Economics Division
Marion G. Wrobel, Senior Analyst
Revised 11 April 2000
BACKGROUND AND ANALYSIS
A. Measuring Deficit
Growth: Revenues and Expenditures
1. Operating Deficits
1991 Federal Budget and the Impact of the Recession
1992 Federal Budget and Economic Statement
1993 Federal Budget
1994 Federal Budget
1995 Federal Budget
1996 Federal Budget
The 1997 Federal Budget
The 1998 Federal Budget
The 1999 Federal Budget
13. The 2000 Federal Budget
B. The Growth in the Debt Load
C. The Evolution
of Federal Fiscal Policy and the Stability of the Debt
D. Who Holds the
In fiscal year 1984-85,
the Public Accounts deficit of the federal government reached a then unprecedented
$38,324 million, amounting to 8.6% of the Gross Domestic Product (GDP)
for the corresponding calendar year. Three years earlier, the federal
deficit had stood at $14,872 million, or 4.2% of GDP. The federal government
finally registered its second consecutive balanced budget in the last
complete fiscal year, with a surplus near $3 billion when measured
on a Public Accounts basis. Deficits in the latter part of the 1970s
were significantly higher than in the first part of that decade and they
ballooned even further in the 1980s and early 1990s. Furthermore, the
accumulation of debt, which had declined as a proportion of GDP until
the mid 1970s, grew at a rapid pace in the 1980s. As of 31 March 1975,
net public debt accounted for 16.8% of GDP. Today, based on Budget
2000, it is just above 61% of GDP, having declined from over 70%.
Conservative government put considerable emphasis on its policy of controlling
the deficit and debt. The current Liberal government had been committed
to reducing the deficit to 3% of GDP by 1996-97 and to 1% in 1998-99.
The 1996-97 target was bettered by more than $15,000 million. More
important, the federal government has met, and even surpassed, its objectives.
With the last surpluses, the government is now predicting another balanced
budget, or a small surplus, for 1999-00 and the two following years.
This paper examines how these two variables have changed over time, the
major influences affecting their size and the fiscal principles through
which the federal government hopes to control both.
BACKGROUND AND ANALYSIS
There are two popular methods
of presenting government expenditures and revenues: the Public Accounts
(PA) presentation is designed to provide parliamentarians with relevant
financial data; the National Accounts presentation is designed to measure
the impact of government spending and revenues on expenditure and income
flows in the economy. The National Accounts measure of the deficit tends
to be smaller than the PA measure. Both, however, have virtually identical
patterns over time. The discussion here will consider only Public Accounts
data since they are most familiar to parliamentarians. All statistics
will be consistent with those of the Budget Papers. For any year
cited, the reference is to the fiscal year ending 31 March of that
Table 1 presents some of
the more commonly cited statistics related to the deficit and debt, expressed
in nominal terms. Such numbers can be less than informative, so the following
discussion will refer to deficits, debt, etc. as ratios to the Gross Domestic
SOME FEDERAL FISCAL STATISTICS
(in million dollars)
1971 to 1975, the PA deficit was less than 2% of GDP. It rose steadily
to over 5% of GDP in 1979. After declining for several years it increased
sharply to 8.6% in 1985. After the previous federal government made deficit
reduction an important part of its fiscal policy, the deficit declined
to 4.4% of GDP in 1990. Subsequently, that trend changed. The 1994
deficit grew to 5.8% of GDP, after which it fell sharply, turning
to surplus in the last two fiscal years.
A. Measuring Deficit
Growth: Revenues and Expenditures
The deficit measures the
shortfall of revenues over expenditures in any year. In this sense, it
is simply a summary statistic. The changing pattern of the deficit is,
then, directly a consequence of changing patterns in revenues and expenditures.
The early 1970s were years
of expanding government; federal expenditures rose by an amount equal
to almost 3% of GDP, yet, since tax revenues also increased sharply in
this short period, the deficit increased only marginally. After 1975,
however, taxes fell dramatically, leading total revenues to decline from
a high of 19.2% of GDP to a low of 15.2% of GDP in 1980. In 1976, expenditures
increased by more than 1% of GDP and then fell by about 2% of GDP by 1980.
Such changes in the pattern of expenditures and revenues set the stage
for relatively large deficits. By the end of the 1970s, federal expenditures
accounted for a greater share of GDP than they had at the start of the
decade, even though government growth had moderated. Rather than financing
this growth through increased taxes, the government financed it through
From 1980 to 1982, both
expenditures and revenues grew slightly, and the deficit was relatively
stable. After 1982, the effects of the recession were felt. From then
until 1985 revenues declined by about 1% of GDP. Expenditures, however,
increased substantially, by more than 3% of GDP, peaking at 24.5% of GDP
in 1985. The deficit reduction plans of the previous government included
expenditure cuts and tax increases. From 1985 to 1987, tax revenues, which
increased by about 1% of GDP, were the primary source of revenue increases.
Over the same period, expenditures fell by almost 2% of GDP. The longer-term
projections indicated that expenditure reductions were to bear the brunt
of deficit cutting.
These patterns are presented
in Figure 1. The difference between total expenditures and total
revenues constitutes the deficit for each year. Projections beyond
fiscal year 1999-2000 contain a contingency reserve, resulting in forecasts
of balanced budgets, even though revenues are expected to exceed spending.
1. Operating Deficits
In the 1990 federal budget,
the concept of the operating deficit was introduced (see Figure 2). The
operating deficit is the difference between program spending and total
revenue. It can also be calculated as the total deficit less gross debt
Until 1978, changes in the
deficit were directly related to changes in the operating deficit, which,
for the next few years, fell much faster than the total deficit. Debt
charges were becoming an increasingly important factor in determining
the growth of the deficit.
From 1982 to 1983 the deficit
rose sharply, largely in response to the recession. Figure 2 indicates
that an increase in the operating deficit was largely the cause. After
1983, it is clear that the operating deficit was becoming less influential
on the budgetary deficit of the federal government while debt charges
were becoming more so.
The operating deficit is
more sensitive than the total deficit to changes in the governments
fiscal stance, and to changes in economic conditions. After the previous
government was elected, the operating balance fell continually, going
into surplus in 1988. The recession generated an operating deficit once
again. Since 1998, it has moved to a surplus of around 5% of GDP.
2. Debt Charges
The debt charge in any year
is determined by the average stock of debt outstanding, multiplied by
the average interest rate applied to that debt. Some of the debt has a
long term to maturity and the interest rates for that component may be
much higher than prevailing rates. Newly issued debt, however, will have
interest rates that reflect current market conditions. The faster the
increase in the stock of debt, the greater will be the proportion of it
subject to prevailing interest rates.
The net debt
outstanding at any time is simply the sum of past deficits on a PA basis.
This amount, plus the amount of borrowing to acquire financial assets,
gives the gross debt total. Debt charges are therefore related both to
current interest rates, usually cited in discussions of the deficit, and
to past deficits, usually downplayed. If the federal debt comprises long-term
fixed rate debt, however, a sharp rise in interest rates will have little
immediate impact on net debt charges in a world of low deficits because
only small amounts of new debt have to be financed at current rates. With
large deficits, however, a large new stock of debt must be financed, and
at prevailing rates.
A debt load that is rapidly
growing as a result of high annual deficits, then, makes the budgetary
stance of the government more sensitive to temporarily high interest rates
because a higher proportion of the debt is subject to prevailing interest
3. Program Expenditures
Total expenditures, less
debt charges, constitute total spending on government programs. It is,
of course, spending on such programs that is at the heart of modern government.
During the heyday of government expansion, 1971 to 1976, it was the increase
in program spending which led to overall spending growth. In 1971, program
spending amounted to 15.6% of GDP and 87.9% of total federal spending;
at its peak, in 1976, it amounted to 19.5% of GDP and 89% of total spending.
Since then, program spendings
share of total outlay has declined. Even during the recession, it did
not achieve the relative share it held in 1976. Program spending fell
to about 75% of total spending by 1989. Since 1998, it has represented
less than 73% of total spending and should fluctuate between 71.5% and
72.5% by 2001-2002. In that year, program spending should equal only 11.6%
of the GDP.
Program expenditures can
be further disaggregated in a number of ways. In past federal budgets,
the Department of Finance has divided expenditures into statutory and
non-statutory expenditures. In 1985, statutory expenditures accounted
for 55.4% of total program expenditures and by 1989, were expected to
rise to 57.9%.
No such disaggregation is
available for the years before 1984; changed accounting definitions make
a longer-term series potentially misleading. Nevertheless the major statutory
expenditures are obvious: UIC benefits, OAS benefits, Family Allowances,
Canada Assistance Plan, the cash portion of Established Programs Financing
and fiscal transfers. According to a Bank of Canada study, most of the
increase in expenditures before 1984 can be accounted for by increased
spending on statutory programs. As is evident from budgetary statistics,
this trend has continued since 1984.
4. The 1991 Federal Budget
and the Impact of the Recession
With the onset of the recession,
the federal government had to revise some of its fiscal projections. The
deficit for 1990-91, forecast in 1990 at $28,500 million, was now expected
to total $30,500 million. For 1991-92, the picture was even gloomier.
In the 1990 budget, the government had been predicting a declining deficit
of $26,800 million. In 1991, despite new initiatives to control the deficit,
amounting to $4,500 million in spending cuts and increased taxes, the
deficit was still expected to remain at $30,500 million. In other words,
the recession and Gulf hostilities had led to a 30% increase in the status
quo 1991-92 deficit.
5. The 1992 Federal Budget
and Economic Statement
The 1992 budget increased
the deficit projections for 1991-92 by $900 million and for 1992-93 by
$3,500 million. Despite the fact that public debt charges had fallen with
the decline in interest rates, the recent poor economic performance had
dramatically increased the upward pressure on the deficit. This was moderated
somewhat by policy actions. As a consequence, the Department of Finance
had predicted that the debt-to-GDP ratio would continue to rise for another
year, peaking at about 63% of GDP; it now appeared that it would continue
to rise to over 65% of GDP. By 31 March 1994, the net debt of the
federal government was expected to be $20,000 million more than had
been projected at the time of the 1992 budget.
6. The 1993 Federal Budget
Once again, the federal
government had failed to achieve its deficit targets. The estimate for
1992-93 was now $35,500 million, $1,100 million higher than expected in
December 1992. Cumulative deficits from 1992-93 to 1996-97 were now expected
to be $53,600 million higher than had been forecast in the 1992 budget.
The deficit picture painted
in the 1993 budget closely resembled those presented in previous budgets,
with substantial rapid declines expected two or three years ahead. These
forecasts had so far always failed to be realized: in the 1980s, unexpectedly
high interest rates had foiled the governments plans; in 1993, unexpectedly
low revenue yields were responsible.
Some suspected that the
move to a world of low inflation had had a negative impact on the deficit,
at least temporarily. Since most program spending is set without regard
to inflation or nominal GDP, an unexpected reduction in inflation would
not reduce the bulk of program spending. Revenues, on the other hand,
decline directly with reduced inflation because of its effect on nominal
GDP. Moreover, since the tax system was not perfectly indexed to inflation,
lowering the rate of inflation below 3% had an added revenue-contracting
effect as the government lost the full effect of the inflation tax.
The governments deficit
reduction strategy was based upon: (1) strong economic growth starting
in 1993, which was supposed to boost revenues; (2) control of program
expenditure; and (3) reduced interest rates to keep the debt servicing
burden almost constant despite the growing net debt. This budget saw continuing
declines in interest rates because of continued low inflation and revenue
growth, which was expected to result from real output growth of over 4%
per year through to 1998; employment growth in excess of 3% per year,
and an unemployment rate falling to 7.5% by 1998. It was recognized that
failure to meet these goals could derail the governments forecasts.
7. The 1994 Federal Budget
The 1993 federal budget
forecast deficits for 1992-93 and 1993-94 at $35,500 million and
$32,600 million respectively. The 1994 budget gave figures of $40,500
million and $45,700 million respectively; the two-year increase in
net debt amounted to $18,000 million. Despite the $5,000-million
increase in the deficit for 1992-93, financial requirements had increased
by only $100 million from the amount cited in the budget; financial
requirements for 1993-94, however, were up by over $7,000 million.
The budget indicated that,
in the absence of policy changes, deficits would be substantially higher
over the next few years than had been forecast by the previous government.
Economic and technical factors were expected to increase the cumulative
debt by $39,000 million from 1993-94 to 1995-96. It was claimed that the
Progressive Conservative governments failure to pass legislation
proposed in past budgets would contribute an additional $5,300 million
to the cumulative debt over the same period.
By 31 March 1996, the net
debt was expected to equal 75% of GDP. The 1992 budget had predicted that
it would equal only 55% of GDP by that date.
8. The 1995 Federal Budget
The 1992-93 federal deficit,
according to the 1993 budget, was $35,500 million. It turned out to be
$41,000 million and grew further to $42,000 million the year after. In
1994-95 it fell to $37,900 million (and it could have fallen even further,
to $35,300 million). The figure was inflated because of two restructuring
costs charged to the 1994-95 year: an ex gratia payment of $1,600
million to western farmland owners in compensation for the elimination
of the Western Grain Transportation Act subsidies and $1,000 million
for early departure incentives for public servants. The deficit was projected
to continue falling to $24,300 million in 1996-97, meeting the governments
stated interim target of 3% of GDP.
The 1995 budget focused
on deficit cutting. Over a three-year period, measures implemented in
this budget were expected to keep the cumulative deficit $29,000 million
below what it would otherwise have been. Expenditure cuts in this package
were about seven times greater than revenue increases. In the first year
the ratio was closer to 4:1.
This short-term deficit
decline was enhanced by the governments decision to allow the UI
Account to generate more than a $5,000 million surplus, prior to allowing
UI premiums to decline after 1996. The purpose was to avoid increasing
premiums during an economic downturn, when the account would normally
go into deficit.
The deficit projections
for 1995-96 and 1996-97 contained contingency reserves of $2,500 million
and $3,000 million respectively. These reserves were designed to provide
the government with a buffer in the event that economic conditions, in
particular interest rates, did not turn out to be as favourable as predicted.
In other words, the governments model, given its economic assumptions,
generated better deficit results than those cited in the budget. Indeed,
when combined with the fact that the economic assumptions used by the
government were more pessimistic than those of private sector forecasters,
the underlying deficit projected for 1996-1997 was about $19,000 million,
rather than the $24,300 million figure cited in the budget.
The 1995 budget did not
provide a forecast of the 1997-98 deficit, even though it did include
estimates of the impact of budgetary measures for that year. Indeed, 46%
of the deficit cutting measures were to be effective in 1997-98. Thus
it was predicted that the deficit for that year could be under $18,000
million, amounting to as little as 2% of GDP, something that had not been
seen for 20 years and that was expected to result in a reduction in the
At 31 March 1993, the net
public debt stood at $466,200 million, compared to $358,000 million in
1990 and in contrast to the $428,000 million that the 1990 budget had
forecast for 1993. By 31 March 1997, it was expected to reach $603 million.
Over the next two years the net debt was expected to stabilize at about
73.5% of Gross Domestic Product.
Public debt charges were
expected to exceed $50,000 million by 1996-97, due to both the continually
increasing debt and rising interest rates. Short-term interest rates for
1995, for example, were projected to be 8.5%, compared to the 4.8% projected
in the 1994 budget.
The impact of debt accumulation
and high debt servicing costs was very evident in the projections presented
for 1996-97. For that year, the government was forecasting a deficit of
$24,300 million at the same time that it was anticipating an operating
surplus (i.e., an excess of revenues over program spending) amounting
to $29,000 million, by far the highest ever recorded. Balancing the budget
several years after that would require operating surpluses in excess of
$50,000 million per year. This is a perfect example of the consequences
of spending not financed by current taxes. Clearly, deficit financing
does not avoid tax financing of expenditures, it merely defers that taxation.
9. The 1996 Federal Budget
The government maintained
in this budget that it would meet its 1995-96 deficit target of $32,700
million, although there was a strong chance that the final result would
be somewhat lower. The deficit target of $24,300 million for 1996-97 was
also maintained and a $17,000 million target was formally established
for 1997-98. Several analysts contended that the deficit would fall below
these targets as well.
The poor performance of
the economy in 1995 had resulted in revenues that were lower than predicted
in the budget of 1995. This was offset by the lower interest rates that
had kept debt service charges from growing as rapidly as originally anticipated.
The operating surplus continued to grow, although at a slower pace than
had been expected the year before, and was expected to reach $35,000 million
by 1997-98, amounting to 4.2% of GDP.
The Minister of Finance
stated several times in his budget speech that the government would balance
its budget, so the targets could be seen as interim. Given the pattern
of deficit reduction since 1993-94, it was hoped that a target for a balanced
budget could well be established for the fiscal year 1999-2000. Indeed,
the forecasters who appeared before the House of Commons Standing Committee
on Finance during its pre-budget consultations generally believed that
budgetary balance should be achieved no later than that date.
Federal budget-making continued
to be cautious, using prudent economic assumptions plus a contingency
reserve to protect against unforeseen events. Thus revenue and spending
measures were a little stronger than necessary, ensuring that targets
would be met. Interest rate assumptions were 50 basis points higher than
the private sector average forecast for 1996 and 80 basis points higher
for 1997. (The budget attributed the larger prudence factor for 1997 to
the compelling arguments made by the Finance Committee about higher political
risk in 1997.) As a result, the budgets growth assumptions were
slightly below those of the private sector, which were already low. The
use of private sector economic assumptions generated a forecast deficit
closer to 1.5% of GDP, as contrasted with the 2% target. Furthermore,
measures introduced in the 1996 budget suggested that the 1998-99 deficit
could be close to 1% of GDP, barring any unforeseen deterioration in the
economy and barring any increase in interest rates.
It appeared on the surface
that the Minister of Finance could set a 1% deficit target for 1998-99,
consistent with past practice, requiring only about $3,000 million or
so in additional restraint measures. The Minister faced a very real difficulty,
however. The government was currently using employment insurance premiums
well above those needed to meet annual program costs, as revenue to reduce
the deficit. The justification for this was the fact that, in the early
1990s, what was then called the UI account had amassed a large cumulative
deficit that still stood at $3,900 million as of 31 March 1995. The 1995
budget had proposed that the government would keep premiums above those
needed to meet annual costs so as to allow the account to pay off the
past accumulated deficit and amass a cumulative surplus somewhat in excess
of $5,000 million by the end of 1996; this surplus would then be maintained.
This was interpreted as meaning that premiums would subsequently be reduced
to a level commensurate with annual costs.
Strong pressure came from
the private sector to let premiums fall, so that employers and employees
could enjoy the benefits of declining program costs. Rates were reduced,
albeit very modestly, and the premiums for 1997 were to be set tin the
fall of 1996. The budgets revenue and spending outlook tables, however,
suggested that the fund would continue to enjoy a large annual surplus
in 1997-98. The cumulative surplus could then be twice as high as that
suggested in the 1995 budget.
It was known that if employment
insurance premiums were reduced substantially for 1997, the revenue outlook
presented in the budget would be put in doubt. If the 2% target for 1997-98
was to be sacrosanct, the loss in premium income had to be offset elsewhere
-- the shortfall could not be funded by the contingency reserve. Other
taxes would have to be increased or further spending cuts sought. Thus
there were potentially some difficult decisions for 1997-98. They could
only be avoided by maintaining premiums and allowing the account to continue
to amass a cumulative surplus of about $10 billion by the end of 1997-98.
In addition, the government
altered the timing of employment insurance premium payments to make it
consistent with that for CPP premium payments. Until then, weekly premiums
had been based on the lesser of maximum insurable earnings or actual earnings.
As of January 1997, weekly premiums would be based upon actual weekly
earnings; once the maximum annual premiums were reached, further premium
payments would cease. Those who earned maximum insurable earnings or less
would continue to pay premiums over a 52-week period. Those who earned
more would pay their premiums over a shorter period of time. Someone earning
$80,000 per year would pay all of the premiums in the first half of the
year and pay nothing in the latter half.
This administrative change
had no effect on total premium liabilities of employees and employers.
But the timing change did affect the reported government deficit. By advancing
premium payments, starting in 1997, the deficit for 1996-97 was expected
to be $1,500 million to $1,800 million less than stated in the budget.
The impact on future fiscal years would be neutral. Nevertheless, this
one-time administrative change had the potential to reduce future debt
servicing costs by about $100 million per year.
The budget also did not
take into account proceeds from the sale of assets in 1996-97, in particular
the sale of grain hopper cars and the air navigation system. The budgetary
impact of these sales depended upon the amount received as well as the
accounting treatment of the assets. Newspaper accounts at the time suggested
that the gains from sale could be $1,500 million.
While the federal government
was able to establish an achievable deficit target for 1997-98 (2% of
GDP), it was recognized that further difficult choices could not be avoided
if the budget was to be balanced by the end of the millennium.
The fact that the Minister
could announce a 2% target for 1997-98 yet introduce deficit-cutting measures
that, on balance, amounted to less than $200 million, indicated that the
previous years budget had been responsible for that target. The
1996 budgets impact would really be felt only in 1998-99, and only
The casual reader of the
budget might have inferred that economic growth in 1996 should decline.
Given the fact that 1995 was generally acknowledged to be a bad year,
this conclusion might have been disconcerting and, since most analysts
were predicting a better year for 1996, also confusing.
The growth assumptions in
the 1996 budget were based on a comparison between the average GDP in
one year and average GDP in the preceding year. Thus some of the strong
performance in 1994 was attributed to a 2.2% growth rate in 1995, and
some of the poor performance in 1995 was attributed to a predicted 1.8%
growth in 1996. A look at growth achieved during a calendar year
showed that the growth rate for 1995 had been 0.6% and the expected rate
for 1996 was 2.5%, a rate four times higher.
10. The 1997 Federal
Unlike previous budgets,
this one did not continue to insist that the deficit target for the current
fiscal year, i.e. 1996-97, would be met. Instead, it announced that, at
$19,000 million (2.4% of GDP), the deficit would be at least $5,300 million
below the target. Indeed, some speculated that the final tally could be
The Department of Finances
Fiscal Monitor showed a $2,191-million surplus for December 1996
and a cumulative deficit for the first nine months of the fiscal year
that was $13,185 million less than that of the year before, which eventually
came in at $28,600. The document cautioned readers not to draw overly
optimistic conclusions from these trends as past government initiatives
had altered the timing of revenues and expenditures over the course of
the fiscal year. Revenues to date had also been affected by one-time events
such as the sale of the air navigation system.
Another change from previous
budgets was the fact that the contingency reserve for the upcoming fiscal
year was kept at $3,000 million, rather than being reduced to $2,500 million
as had been the case in the past.
This budget introduced a
variety of measures that were likely to increase the debt by a total of
$3,400 million over four years. The $19,000-million deficit figure for
the year could have been $18,200 but for the $800-million cash infusion
into the Canada Foundation for Innovation. Other measures, some announced
prior to the budget under the headings "Investing in Jobs and Growth"
and "Investing in a Stronger Society," were expected to add
to spending over the next three years. These new initiatives were to be
funded in part by reallocations from other areas and higher taxes (e.g.,
tobacco excise tax increases and an extension of the temporary tax on
banks), but mostly from borrowing. Despite these new measures, however,
program spending was still falling as planned and future deficit targets
were not in jeopardy.
The budget outlined why
the deficit fell below the target expressed in the previous years
budget. Revenues, with the exception of the Corporate Income Tax, were
generally lower than predicted by that budget -- on balance they were
$2,000 million lower. Program spending was $800 million lower than forecast
while public debt charges were $2,300 million lower because interest rates
had declined rapidly during the year. In total, these economic factors
reduced the deficit by $1,100 million.
One-time factors, such as
the sale of the air navigation system and the acceleration of EI premium
collections, contributed another $2,500 million to deficit reduction.
Since neither of these was a new initiative, however, it could be argued
that both should have been taken into account in the budget of the previous
year. This was especially true of the acceleration of EI premiums, whose
impact should not have been difficult to estimate. The sale of the air
navigation system was somewhat more problematic, as the date of the deals
closing could have been subject to uncertainty.
Finally, the government
did not need to make use of the contingency reserve, thereby saving another
$2,500 million. When added to the newly announced $800-million contribution
to the Canada Foundation for Innovation, these factors were expected to
lead to a deficit at least $5,300 million below target. At the time of
the budget, however, three months remained in the fiscal year, and no
data were available for the end-of-year reconciliation. As a result, it
was known that the deficit could still fall below $19,000 million.
This budget also acknowledged
the improved fiscal position of most Canadian provinces. As with the federal
government, the fall in provincial deficits was largely due to reduced
program spending, coupled with the benefits associated with lower interest
rates. The budget noted that the reduction in interest rates from January
1995 to December 1996 had saved provincial governments a total of $1,800
million, equal to 1.2% of spending. Although Canada still had a debt-to-GDP
ratio that was exceeded only by Italys among the G-7 nations, our
total government deficit was expected to be the lowest in the G-7 starting
this year. It was predicted that, as of 1998, Canada would be the only
G-7 nation to have a balanced government account when measured on a national
accounts basis. This compared favourably with American deficits of more
than 1.5% of GDP, German and Japanese deficits of more than 2% of GDP,
and deficits in France, the United Kingdom and Italy of 3% or more of
This budget continued the
governments use of prudent economic forecasting -- it added 80 basis
points to the private sector average for three-month Treasury Bills and
50 basis points to the private sector average for 10-year government bond
rates. The governments forecast for growth was 3.2% in 1997, declining
to 2.65% in 1998.
The fiscal year 1996-97
was expected to mark the end of the continual growth in the debt-to-GDP
ratio. That ratio was expected to start its decline, resulting in a fall
to 73.1% of GDP, down from the peak of 74.4%.
The 1998 Federal Budget
In this budget, the Minister
of Finance projected that the budget would be balanced in that fiscal
year (1997-98), and that the same would hold true for the next two years
of the budget planning cycle. In fact, he did better than he announced;
a $3.5 billion surplus was achieved in 1998, something unprecedented
in the modern fiscal history of the federal government. According to the
budget, the net debt fell to 67.8% of GDP in 1998.
performance came from $10,000 million in tax revenues above what
was anticipated in the previous years budget. Much higher corporate
income tax receipts and GST revenues accounted for most of this. Program
spending was down $3,000 million from the previous years projections,
largely due to lower EI benefits. Public debt charges were lower than
expected, and the $3,000 million contingency reserve was not needed.
In accordance with the recommendations
of the Auditor General, the government revised the way it recorded interest
costs associated with public sector pension plans. This reduced interest
costs by about $0.6 billion in 1998. With the budgetary surplus,
the federal government was able to decrease the public debt. This debt
passed from $583.2 billion in 1996-97 to $579.7 billion in 1997-98
the first reduction since 1969.
The government used prudent
economic assumptions to avoid the effects of the Asian financial crisis,
which touched three-fifths of all countries in the world. This step, together
with its use of a contingency reserve of $3 billion that year, gave
the government a $6-billion cushion each year. If recent history is any
guide, the use of prudent budgeting practices should mean a net debt in
1999-2000 closer to $571 billion than the peak of $583.2 billion
in 1997. Thus, the net debt-to-GDP ratio would be closer to 61% than the
63% cited in the budget. The government has taken prudence to new heights
In the past, the government
added 80 basis points to the private sector average forecast for short-term
interest rates in order to arrive at its prudent assumption; for long-term
interest rates, it added 50 basis points. The 1998 budget added 100 basis
points to both the short- and long-term interest rates when making its
prudent interest rate assumption.
12. The 1999 Federal
The 1998 budget was balanced
(and in fact had a surplus) and the 1999 budget continued this trend.
The federal government expected that the budget would be at least balanced
until 2000-01. The net debt was expected to stay at almost the same
level as this years $579.1 billion, amounting to 65.3% of GDP,
with expectations for 62% of GDP for the 2001 budget.
If claims of a balanced
budget proved to be well founded, the $3-billion Contingency Reserve was
to be used to reduce the public debt. Ever since 1995-1996, the debt-to-GDP
ratio had been decreasing. This unusual situation was almost exclusive
to Canada among the G-7 countries with the notable exception of the United
States. The federal government was aware that it would have to
maintain its prudent approach to budgets in order to stay on this path.
The 2000 Federal Budget
The fiscal year that ended
in 1999 showed a second consecutive surplus, although, at $2.9 billion,
it was slightly smaller than that of the previous year.
The federal government continues
to forecast balanced budgets until 2001-02. It does not issue forecasts
over a longer period, however, even though the Economic and Fiscal Update
1999 contained five-year projections for public debate purposes.
As stated in the November
1999 update, the federal government will use an economic "prudence"
reserve, in addition to the existing $3-billion contingency reserve. This
was confirmed in Budget 2000. The federal government forecasts balanced
budgets from 1999-00 until 2001-02. The net public debt, $576.8 billion
in 1999 and standing at 64.4% of the GDP, is expected to remain at this
nominal level over the same period. Thus, the net-public-debt-to-GDP ratio
would amount to 55.2%, which is expected to fall to under 50% in 2004-05.
If the contingency reserve
proves not to be needed and is used to pay down the debt instead, the
nominal debt level would fall to $567.8 billion, 54.3% of GDP. Even at
this level, this ratio would continue to be higher than the average of
Budgetary revenues are expected
to increase by 2.8% in 1999-00, falling to 1.3% in 2000-01 as a result
of tax relief measures announced in the Budget. Budgetary revenues would
experience stronger growth in 2001-2002.
Program spending is expected
to rise by 3.7% in 1999-00, largely because of the $2.5-billion CHST cash
supplement and $1.3 billion for initiatives to make the economy more innovative.
If the federal government introduces no additional initiatives, program
spending will increase by only 0.4% in 2000-01; however, a sharper increase
(4.7%) is already forecast for 2001-02.
Public debt charges are
expected to fluctuate around $42 billion until 2001-02. The debt is less
sensitive to interest rate changes because of the increased proportion
of fixed-rate debt.
B. The Growth in the Debt
For the two decades ending
in 1975, federal net debt had been slowly declining as a proportion of
GDP. It reached a low of about 17% in 1975, as compared with 36% in 1956.
(During World War II it had exceeded 100% of GDP but this percentage was
quickly reduced after the war.) Since 1982, net debt has grown by an amount
equal to almost 40% of todays GDP.
The level of net debt equals
the cumulative total of past deficits on a Public Accounts basis. It is,
then, a stock measure of past annual flows. Net debt therefore provides
an alternative view of annual government deficits and might be useful
in generating other perspectives on fiscal policy.
Figure 3 highlights the
rapid growth of federal government net debt in the 1980s. As at 31 March
1982 it stood at 28.25% of GDP. By 31 March 1987 it had reached 51.8%
of GDP, as a result of the very high annual deficits experienced in the
intervening years. It peaked at about 72% of GDP in 1995-96, before
The relationship between
debt growth and deficits can be demonstrated by the following relationship:
(1) The change in (Net Debt/GDP)
= (Operating Deficit)/GDP
+ (Net Debt/GDP)*(interest rate - GDP Growth)
The ratio of debt to GDP
increases directly as a result of the ratio of operating deficits to GDP.
The increase is also related to the ratio of existing debt to GDP, multiplied
by the difference between the interest rate charged on the debt and the
growth rate of GDP. If the interest rate charged on outstanding debt is
equal to the rate of GDP growth, then the debt-to-GDP ratio can be stabilized
by financing all program spending through taxes: i.e., running a zero
operating deficit. If the interest rate charged on outstanding debt exceeds
the rate of GDP growth, then an operating surplus must be realized for
stabilization. To reduce the ratio of debt to GDP, even larger operating
surpluses must be achieved.
It is useful to examine
this relationship between the ratio of debt to GDP, the operating deficit,
interest rates and GDP growth in order to translate the fiscal principles
guiding this government into deficit constraints.
These conclusions about
the primary deficit say nothing about the overall size of the deficit
which would be needed to stabilize the debt-to-GDP ratio. This would depend
upon the target debt ratio set by the federal government. To maintain
a stable debt ratio, the following relationship would hold:
(2) Deficit/GDP = (Debt/GDP)*GDP
If the debt-to-GDP ratio
is 75% and GDP is growing at 5% per year, a deficit equal to 3.75% of
GDP will stabilize the debt ratio. If the debt-to-GDP ratio is only 25%,
the deficit cannot exceed 1.5% of GDP. A 1985 paper on the deficit issued
by the Minister of Finance proposed another fiscal goal: to reduce the
debt-to-GDP ratio to no more than 25% of GDP, a level that existed prior
to the 1980s.
Figure 3 also highlights
the performance of forecasts of the debt-to-GDP ratio. At the beginning
of the last decade, forecasts always underestimated the actual figures,
while in the most recent budgets the forecasts have overestimated them.
Once such a long-run target
debt-to-GDP ratio is achieved, it can be maintained by running deficits
which do not exceed about 1.25% of GDP, based on a 5% growth rate. But,
though it could maintain it, such a deficit would not be enough to achieve
that target in the first place. For example, if interest rates match GDP
growth rates, the debt ratio can be reduced by three percentage points
per year by running an operating surplus equal to 4% of GDP. Many analysts
were suggesting a more modest short-term goal of reducing the debt-to-GDP
ratio to about 60%. Such a target could reasonably be achieved within
five years. Based on Public Account figures, the debt-to-GDP ratio
would reach the 60% level in fiscal year 2000-01.
C. The Evolution
of Federal Fiscal Policy and the Stability of the Debt
The federal net debt is
now declining as a proportion of GDP. This decline is substantial and
is expected to continue for a number of years, reversing much of the two-decade
increase in the debt-to-GDP ratio. It might be useful to examine the factors
that have determined the trends in this ratio.
Figure 4 presents federal
fiscal policy and economic conditions since 1963. This chart plots three
variables: 1) the excess interest rate, which is the difference between
the average interest rate on federal government debt and the rate of growth
of the economy; 2) the stability ratio, which is defined as the excess
interest rate multiplied by the net debt-to-GDP ratio; and 3) the operating
surplus of the federal government, expressed as a percentage of GDP. The
operating balance is the difference between total revenues and program
spending. The stability ratio indicates the operating balance, expressed
as a percentage of GDP, that is needed to keep the debt-to-GDP ratio constant.
If the operating balance is higher, the net debt-to-GDP ratio will fall.
From these variables, we
can distinguish four periods, as determined by economic conditions and
fiscal policy stance.
Until the mid-1970s, the economy generated growth rates that substantially
exceeded the rate of interest paid on government debt. This meant that
the federal government could have run operating deficits while still stabilizing
the debt-to-GDP ratio over time. But the government did the contrary.
It ran operating surpluses and, consequently, the debt-to-GDP ratio fell.
One could say that this was a period in which government fiscal policy
was prudent and economic conditions were favourable. The federal government
borrowed on an annual basis, but in order to finance only part of its
debt servicing costs. By the last few years of this period, however, federal
fiscal policy was starting to become significantly looser.
From the mid-1970s to the early 1980s, economic conditions continued favourable.
Economic growth continued to exceed interest rates and hence the stability
ratio was still negative. The fiscal stance of the federal government
deteriorated, however. It started, on a regular basis, to run operating
deficits that were, on balance, large enough to cause the debt-to-GDP
ratio to rise slowly. The federal government was now borrowing to finance
all its interest costs as well as some program spending. The post-war
trend in the net debt-to-GDP ratio had finally reversed.
From early in the decade to about 1988, fiscal policy became even looser
than in the previous period, although by mid-decade that trend had been
reversed. Nevertheless, operating deficits were larger than in the previous
period, in part due to the recession. The turnaround in economic conditions
would exacerbate the effect of looser fiscal policy. The stability ratio
turned positive as interest rates exceeded the rate of growth. Thus, the
government had to run operating surpluses in an attempt to stabilize the
debt. Stabilization was not achieved, however, and the debt-to-GDP ratio
As we entered the new decade, interest rates were still exceeding economic
growth by quite a large margin. This situation, coupled with the high
net debt-to-GDP ratio that resulted from the deficits of the 1980s, meant
that very large operating surpluses were required to stabilize the debt.
Although fiscal policy in the first half of the 1990s was clearly tighter
than in the past, it was not sufficient to stabilize the debt ratio. The
change in fiscal policy was too little and too late.
The latter half of the 1990s
is in a sense a distinct period. The stability ratio has declined substantially
on account of falling interest rates and improved growth. It remains higher
than during period C because the excess interest rate is applied to a
large stock of net debt. The operating surplus has grown substantially
and finally stands at a higher level than the stability ratio. With
strong growth and absolute declines in the net debt, the ratio of debt
to GDP is falling substantially, from 71.2% in 1995-96 to an expected
55% in 2001-02. Balanced budgets are generating an operating surplus
equal to about 5% of GDP, which is well above that needed to stabilize
the debt-to-GDP ratio.
D. Who Holds the Debt
Figure 5 highlights
the changing nature of the groups holding Government of Canada marketable
debt. There are two rather dramatic trends. The Bank of Canada significantly
reduced its importance as a holder of government debt in the 1980s. The
absolute amount of its debt holdings increased from $16,000 million
in 1980 to more than $27,000 million. This represents less than 6%
of the total, compared to 19.5% in 1980. The other dramatic change
was the increase in holdings by foreigners since 1984, although the share
declined steadily since 1993. Foreigner now hold nearly 22% of
the debt (about $100,000 million), up from 11% in 1980.
Since 1990, a new trend
has become evident, whereby chartered banks hold ever-increasing amounts
of federal government debt. From 1990 to the end of 1995, holdings
more than trebled, to near $80,000 million. Chartered banks held
over $60,000 million of federal debt as of the end of 1999.
The size of the federal
deficit is affected every time the federal government undertakes some
spending measure or alters the system of taxation. Virtually all government
measures therefore affect the deficit. Approximately once every year,
the Minister of Finance presents a budget in which the governments
future spending and taxation plans are outlined.
1971 - The UI system was substantially expanded and liberalized with the
passage of Bill C-229.
1974 - Family allowance payments were increased to $20 per month per eligible
child and began to be considered as taxable income. The monthly payment
also became subject to indexation.
- Bill C-27 was passed to tighten up the liberalized UI system. It increased
eligibility requirements and reduced maximum weeks of benefits for a wide
range of UI recipients.
- The Child Tax Credit was introduced. The maximum benefit was set at
$200 per eligible child.
- Family allowance benefits were reduced by about 22% starting in January.
and 1984 - Indexation factors for government expenditures were limited
to 6% and 5% respectively for these two years.
1985 - The federal budget limited indexation to CPI increases greater
than three percentage points. This partial indexation applied to a wide
variety of tax measures and some social programs.
1987 - The federal government tabled its White Paper on tax reform. This
reform was designed to alter the distribution of tax liabilities between
taxpayers and types of income. It was to be revenue-neutral and so have
no direct effect on the deficit.
1987 - The federal government announced its National Strategy on Child
Care which proposed an enhanced Deduction for Child Care Exemptions, an
increased Child Tax Credit for families without receipts for child care
expenses, and new cost-sharing arrangements with the provinces. These
measures were expected to cost the federal government $5,400 million over
the next seven years.
1991 - The federal budget announced legislated limits on future program
spending as well as the establishment of a Debt Servicing and Reduction
Fund into which all GST revenues would flow.
1993 - The Department of Finance calculated that the 1992-93 deficit would
be $40,500 million, $5,000 million higher than stated in the
The Minister of Finance estimated that the 1993-94 deficit would be between
$44,000 million and $46,000 million. This was as much as $13,400 million
higher than the amount predicted in the 1993 budget.
1994 - The first Liberal budget predicted that the 1993-94 budget deficit
would reach $45,700 million. The government still maintained that it would
be able to reduce the deficit to 3% of GDP in three years.
1998 - Many months after the 1998 budget, Finance Minister Paul Martin
announced the first balanced budget since the 1970s and a surplus of $3.5 billion.
1999 - After a second balanced budget, Finance Minister Paul Martin announced
a five-year plan for forecasting purposes. The cumulative surplus was
expected to reach $95 billion over that period.
C. "An Overview of Different Measures of Government Deficits and
Debt." Canadian Economic Observer, November 1989, p. 3.1-3.20.
Department of Finance. The Fiscal Plan. Ottawa, various issues.
Department of Finance. The Federal Deficit in Perspective. Ottawa,
Department of Finance. Reducing the Deficit and Controlling the National
Debt. Ottawa, November 1985.
Department of Finance. Tax Reform 1987. Ottawa, June 1987.
Department of Finance. Debt Operations Report. Ottawa, September
Department of Finance. A New Framework for Economic Policy. Ottawa,
Department of Finance. Annual Financial Report of the Government of
Canada. Ottawa, 1994.
Department of Finance. The Economic and Fiscal Update. Ottawa,
Department of Finance. The Economic and Fiscal Update. Ottawa,
Government Revenues, Expenditures and Deficits Since 1970." Bank
of Canada Review, October 1985.
H. and P. Cross. "The Growth of the Federal Debt." Canadian
Economic Observer, June 1991.
M.J. How Ottawa Spends, 1987-88: Restraining the State. Methuen,
* The original version of this Current Issue
Review was published in March 1988; the paper has been regularly updated
since that time.