Mike Moffatt

Aug 19, 2019

5 min read

Fiscal responsibility and surpluses are not the same thing. We confuse them at our peril.

A follow-up to: Interest payments are NOT why Ontarians can’t have nice things.

Near the bottom of the piece on interest payments I wrote:

None of this is to suggest that Ontario’s fiscal policies were optimal in the past, nor does it suggest what future fiscal policies should be.

Although buried, this was not meant to be a throw-away line. The Ontario government might decide to do all kinds of things — cut social spending, cut taxes, cut hair. The point of the piece was that debt interest payments weren’t forcing any of those choices, because those payments are below Ontario’s historic average in real, per capita terms.

Sure doesn’t look like debt interest payments are crowding out Ontario’s ability to pay for other priorities.

The idea that a jurisdiction, any jurisdiction should not eliminate their deficit as soon as possible strikes many as deeply unwise, because “fiscally responsible” and “no deficit in good times” have become so intertwined. I believed that most Canadians who think about government debts and deficits have a mental model that looks something like this:

This is an oversimplification, naturally, but I think a pretty good one.

This viewpoint is problematic, in part because it ignores a whole lot of context, including the magnitude of the surplus/deficit, demographics, interest rates, the policies of the countries we’re competing with for foreign direct investment, etc. All of those should matter when designing fiscal policy.

More importantly, this mental model is problematic, because it leads to all kinds of wasteful fiscal policy (on both the spending and tax side), the very thing we’re trying to avoid. The direction of the sign on a government’s income statement tells you very little on how responsibly they’re treating taxpayer money and, in some cases, provides incentives for governments to act wastefully.

There’s two prime examples, both from federal politics, where this mental model caused all parties to advocate for fiscal policies that could not be justified by their (small) return-on-investment.

First, let’s revisit the structural fiscal deficit for the federal government, going back to 1975:

Source: Laurentian Bank Securities

From 1998 to 2004, the federal government was running pretty significant structural surpluses and using that money to pay down debt. The case for doing so was fairly straight-forward: interest rates were in the 3–6% range, so in the federal government’s mind they were receiving a better return-on-investment from reducing debt than they would from using the money for something else (social spending, tax cuts, etc.). They weren’t necessarily right, but the case was strong.

Source: Statistics Canada

Case 1: 2004–08 Irresponsible Fiscal Policy and a Surplus

Fast forward to the 2004 election, where the Liberals are knocked down to a minority by a unified Conservative Party and Jack Layton’s resurgent NDP, the Liberals could no longer run large surpluses under the assumption that they would be in power for decades. From late 2004 to the 2008 election, parties could not find a way to dispose of these surpluses fast enough. Every half-baked idea imaginable ended up in some party’s platform, with a complete disregard of whether it was a good return-on-investment. The Conservatives ended up winning in 2006 and eliminated the surplus mostly through a cut in the GST (about the worst possible tax cut in terms of return-on-investment and growing Canadian productivity), pushing the federal government into a structural deficit in the 2007–08 fiscal year, a year before the recession started. The 2007–08 structural deficit likely would have happened under any 2006 election outcome; there was a cross-party consensus that these surpluses needed to be used up. I was heavily involved with the Green Party at that time, I was constantly in disbelief by the reckless spending and tax promises made by the other parties.

In terms of federal fiscal policy, the 2004–08 period is easily the most fiscally irresponsible I have seen in my adult lifetime, despite the federal government consistently running surpluses. The mere existence of surpluses did not somehow make these governments (or the parties in opposition) “fiscally responsible”.

The flipside, of course, is also not true, that large deficits necessarily mean fiscal responsibility.

Case 2: 2010- Irresponsible Fiscal Policy and a Surplus

Let’s turn our attention to the financial crisis. During the 2009–10 fiscal year, the government had a cyclical deficit of well over $30 billion, thanks to the recession that lasted until May 2009 and the slow economy that followed. This cyclical deficit was down to a few billion by 2011–12, and all but disappeared by 2012–13.

Now look at the structural deficits. The two largest structural deficits run by the federal government were in 2011–12 and 2012–13, a few years after the recession ended. These weren’t completely useless; they do help the economy from backsliding. But they’re not injecting money into the economy when it needs it most.

The federal government spent easily over $50 billion trying to stimulate an economy, a few years after the recession had passed. There was no reason whatsoever that the Bank of Canada, in 2011–13, could not have done all the heavy lifting from that point on. That’s not to suggest all the money was wasted; some of the fiscal measures may have also boosted long-run productivity (particularly since interest rates were near zero, so the opportunity cost of those measures was atypically low). And, as before, this need for stimulus spending (well after the end of the recession) was taken by an article of faith by all parties. It’s easy to understand why: times were still bad and that made it the economically responsible thing to do.

Conclusion

Whenever I write or tweet something along the lines of the Ontario government isn’t getting crushed by interest payments, someone will invariably interpret it as turning a blind eye to wasteful spending (or, worse, advocating for it). That’s silly, of course, nobody is a fan of wasteful spending, particularly me. I’m Scottish-Canadian; copper-wire was invented by two of my ancestors fighting over a penny.

If we want to put an end to wasteful fiscal policy, we’re going to have to abandon our mental model and stop using surpluses (and deficits) as a proxy for responsibility.