Deep in the red

As seems to be the norm these days, Canada's new Federal government was careful to leak much of the bad news ahead of its first budget, which was tabled in Ottawa today.  Finance Minister Bill Morneau had walked back the campaign promise of small, temporary deficits, announcing weeks ago that even without new spending, the budget deficit was on track to hit C$18 billion for the 2016-17 fiscal year. This in turn removed any prospect of eliminating the deficit by the time of the next election (2019), as the Liberals had originally proposed.

So today's announcement of a $29.4 billion deficit for the current year came as little surprise.  An almost identical deficit is projected for next year, followed by a gradual decline to just below $18 billion by 2019-20.  The torrent of red ink reflects the new Government's determination to push ahead with its spending promises, despite the much-worse-than-expected fiscal situation it inherited. Most of the promised targets for increased spending get something: the amorphous "middle classes" (lower income tax, simplified and increased child benefits); infrastructure (albeit somewhat back-end loaded); aboriginal peoples (with a focus on education and clean water).  Among the losers: higher income earners, facing a new top tax bracket, and the military, starved for cash just as it was under the Tories.

From an economist's standpoint, one key assumption stands out. The government is projecting annual GDP growth of only 0.4 percent over the five-year planning horizon.  This is far lower than even the most pessimistic analysts' expectations, and well below the numbers Finance Minister Morneau tabled just a few weeks ago.  It's very clear that the government is hoping that somewhat faster growth will (a) increase revenues and thus keep the deficit lower than forecast and (b) allow Trudeau and Morneau to point to faster growth as proof that their damn the torpedoes approach is working.

That's politically astute; however, as Canadians learned back in the 1980s and 1990s, adopting a very long schedule for reducing the deficit is risky in itself -- the temptation to keep putting off the evil day of reckoning is very strong.  Deficit financing at a time of slow growth and cheap money is good economics, but we shall have to wait and see if this government, unlike so many of its predecessors on both left and right, will know when enough is enough.