Thursday 9 April 2015

But not an annually balanced budget!



               In my previous post, I noted that government debts and deficits do matter. Christians should support those who take seriously the reduction of deficits. That, however, does not mean that we should seek to have the governments’ budget balanced every year.

Business Cycles and government Finances


               Our striving for balanced government finances must take account of the Business Cycle.  

              
                
While business cycles may vary in length and severity, good economic (boom) times will invariably end and be replaced at some time with bad times (recession/depression). Those, however, will also pass and, eventually, make room for better times. The most recent example of this cycle has been the “great recession” beginning in 2008 from which we are only slowly emerging. To seek to keep the budget balanced throughout an economic cycle would be counter-productive. Rather, we should strive to balance the budget over a business cycle.

               Suppose the government’s tax revenues were equal to its expenditures (in balance) at the peak of an economic cycle (left of the diagram). If the economy, then, goes into a downturn, government finances automatically go into deficit. People buy less when they lose their jobs or face the prospect of that possibility. Business sales go down; profits decrease; business income tax payments go down. Similarly, when people lose their jobs and lose income, less personal income tax is paid. As people spend less, sales tax receipts go down. Thus, government revenues decrease. In addition, royalty income from resource production—oil, gas and mining—will go down. At the same time, expenditures go up automatically because employment insurance benefits and additional social services have to be paid. The government goes into deficit if it takes no new action. These effects, which economists call "automatic stabilizers", are a "good thing". Without them, the recession would be worse!

               If the budget is to be balanced at all times, the government would have increase taxes and/or decrease its spending. However, in a period of recession, that is exactly the opposite of what is needed! Increased business taxes would cause further job losses as some production becomes unprofitable and businesses reduce new investment even more than the bad economic outlook has already caused them to do. Similarly, increases in personal taxes will reduce consumption even further and those lost sales will further add to unemployment. In fact, most governments will, in recessionary period, increase government spending on infrastructure such as roads, to stimulate the economy and fight the rise in unemployment.

Balanced Budget Legislation

            The problems created by the business cycle are the reason why legislation or constitutional amendments to require a balanced budget(BBL) does not work. While such a requirement has been put in place in many Canadian provinces, U.S. states and several countries, most such provisions make an exception for times of war, national emergency, or recession, or allow the legislature to suspend the rule by a supermajority vote.  As I write this, Canada’s federal finance minister is expected to announce a new proposal to implement BBL federally. The legislation would include:
  • Deficits only in response to a recession or "extraordinary circumstance, that, is war or natural disaster, with a cost exceeding $3 billion in a year."
  • A requirement for the finance minister to testify before the Commons finance committee within 30 days of a published deficit to present a plan and "concrete timelines" to return to balanced budgets.
  • A freeze on operating spending and a five per cent wage freeze for cabinet ministers and deputy ministers, following a published deficit.
               As could be expected, a recent Canadian study found that balanced-budget laws were no match for the Great Recession. Many provinces simply suspended their legislation to allow for deficits. The report’s authors conclude that, for the most part, balanced-budget laws in Canada have failed to live up to expectations. “It seems clear that, like any other piece of legislation, BBL is only as strong as the political will and public support underlying it,” they say[1]. Moreover, any subsequent Parliament can simply abolish the legislation or simply ignore it.

               In fact, as we noted, BBL cannot work without loopholes. Our goal should not be to balance the budget each and every year. Rather, it should be balanced over a business cycle. That is in periods of prosperity, we should be running surpluses and, during economic downturns, we can accept deficits. If we had no debt, the total of the surpluses should equal the total of the deficits. Unfortunately, that is not easy. No one can forecast the length of a recession and the following recovery. Economics cycles don’t look like the stylized diagram I drew above. Consequently, we should err on the cautious side and run significant surpluses and pay down debt during prosperity and keep our deficits as small as possible during recessions. That is all the more, the case, when we already have significant government debt!

Focus on the Debt

               In fact, economist Jock Finlayson, chief policy officer at the Business Council of British Columbia, argues that governments should concentrate more on public debt than the accounting of any particular year[2]. It is accumulative debt, not deficits, which we should be worrying about. That point is even more germane in Canada now that the federal budget is about to go into surplus. Should we continue to hold the line on spending? Should government debt be totally repaid? Please note that this is not a totally ridiculous question. A generation ago, most citizens would automatically have believed that the answer is “yes”. During the Second World War, we piled up considerable government debt to pay for the war. However, after the war, that debt was gradually reduced to virtually nil. More recent history is illustrated below[3].

Figure 1
               It is helpful to chart our debt as a percentage of GDP. Figure 1 above shows our total public debt (federal, provincial and municipal) for the last 10 years. The Canadian data shows that our total debt was slowly decreasing until the Great Recession began. Since then it has increased to 87% of GDP and has the declined marginally. Although the federal government is expected to be balanced the coming year, continued provincial deficits will no doubt mean this ratio does not improve quickly. The U.S. , however, has jumped drastically from a reasonably acceptable range of 38% right up to 82.2%.
Figure 2 below, puts our performance in wider context. Canada and the U.S., comparatively, are not the worst—almost the same as Germany which is considered by many to be the height of financial rectitude. 


On an alternative scale of comparison (Figure 3), public debt per person, Canada, which owes $46,000 for every man women and child, looks even worse—worse than the weak links in Europe![4] The folks “down under” are able to do significantly better! Note that on this comparison Spain, which has had liquidity problems and austerity protests, looks better than us! We are, thus, not all that far from the brink!



Conclusion

               If we are to leave our country to our children at least as well off as we received it, the above data shows that our public debt must still be reduced significantly. That is, particularly, true when we take into account further unfunded liabilities such as old age pensions and medical expenditures that we are already committed to!

               It may be argued that a lot of the debt was used to invest for the future.  However, a lot of that was necessary only to maintain and replace existing deteriorating infrastructure. Given the existing backlog in necessary spending (our local city council member recently estimated that at the current rate of expenditure it would take more than 100 years to replace our aging roads, sewers and water pipes), very significant capital expenditures will be continually required just to stay in place.  Given that a large portion of these capital expenditures are merely replacements, burdening our children with new debt is hardly justified!

               Surpluses, then, are not “slurpusses”[5] that can be slurped up by myriad of new initiatives. Rather, at this stage, they should be used to pay down debt. Given the increase in debt over the recent recession, a lot of surpluses are necessary to cover the debt increases of the last recession—let alone pay down the previously incurred debt. Whether the debt needs to be totally paid off can be decided in the future. For now continued surpluses (and reasonable “austerity” will be required to get us down to reasonably acceptable levels—such as those in Australia and New Zealand.

[Click on "comments" below to express you response to this post. Given the need for tight financial stewardship, I would like to undertake a totally unscientific poll. Please answer the following question: What area/item would you consider to be the best to cut government spending—i.e. what government expenditures do you consider to be the least important? Note, I’m not looking for researched answers—just your opinions(as representative of the average voter)]

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[2] Ibid
[3] To get reasonable comparability, all data is taken from The Economist, http://www.economist.com/content/global_debt_clock Their global debt clock, showed total global government debt to be in excess of $55,765,852,056,000 and increasing at the rate of $150,000 or so every second!
[4] Probably because these have not been able to borrow as much due to the apparent riskiness of their position
[5] William Watson, “Should we spend the slurpus?” National Post, Oct. 2014, FP13

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