Thinking About Structural Deficits
I am a great admirer of Arthur Donner and Doug Peters who have kept the flame of Keynesian economics alive in Canada for many years and regularly provide good progressive commentary. But I’m a bit out of sympathy with their column in today’s Toronto Star.
http://www.thestar.com/comment/article/590916
Their major argument is that Canada now faces structural deficits, and that tax increases will be needed after we return to full employment.
“The structural deficit means that tax increases, spending cuts or both will be needed to restore the Canadian government’s fiscal situation to a balanced position. Merely reaching full employment will not be enough. ”
That is entirely correct, and I entirely agree that, today and down the road, we are paying the price for the erosion of fiscal capacity by Liberal and Conservative government’s alike.
What I am a bit less keen on is the assumption that we should run balanced budgets after we return to full employment. That could, admittedly, be a long while depending on how full employment is defined, but the Bank of Canada would define it at the estimated ‘natural’ level of about 6%. I very much doubt that either household or business credit will expand very robustly for a good while yet, in which case we have to be thinking about public investment led growth for an extended period of time.  We have come to the end of a fairly extended period in which rising household debt drove growth as governments and the corporate sector both became large net savers, and I see no reason why we should not advocate an extended period of structural deficits to allow households to repair their balance sheets.
In an ideal world, public investment led growth will gradually crowd in enough private investment that government can pass the growth baton to business — but that’s not about to happen in the next few years.
Not to be misunderstood, we may want to restore fiscal capacity movign forward, but I would direct the proceeds to new investment rather than to trying to bring down deficits at too rapid a pace.
I think we should have some kind of plan to pay off the total debt over 30-50 years, and that structurally we should run a surplus about three-quarters of the time. Then its no sweat to run $30b deficits during a recession like this one, whether it lasts for one year or three.
But like you say, it depends on the circumstances, and we may be in for a prolonged period where deficits are necessary for more than two years.
One key problem with a structural fiscal deficit in Canada is that it gives the political conservative a justification to cut social programs. No matter what the government’s position on full employment, if it is willing to act on its belief, then there will never be a fiscal surplus. And raising taxes is a political suicide move — as was shown in the 90s Liberal government in Ontario. Thus, there will be an excuse to cut spending and for the conservative (with capital or small c) particularly on social programs.
Yesterday’s Obama budget puts the Canadian debate in perspective. The US will run a $1.8 trillion (12% of GDP) federal deficit in 2009.
The budget document (page #114) envisions reducing this deficit to 3% of GDP by 2013 and maintaining that level through 2019. Assuming long-term economic growth of 3% annually, this plan keeps the debt-GDP ratio constant at 66%-67%.
As Doug points out, there is much less political acceptance of deficits in Canada than in the US. However, as a matter of arithmetic, it is possible to continually run modest deficits without increasing the debt burden.