PBO published its annual Fiscal Sustainability Report (FSR) on 27 February 2020. A key finding of the report was that,
“Current fiscal policy at the federal level is sustainable over the long term. PBO estimates that the federal government could permanently increase spending or reduce taxes by 1.8 per cent of GDP ($41 billion in current dollars) while maintaining net debt at its current (2018) level of 28.5 per cent of GDP over the long term.”
— Fiscal Sustainability Report 2020
PBO’s estimate of federal fiscal room was based on long-term projections over a 75-year horizon, conditional on several key assumptions. For example, maintaining the current revenue and program structures (as of our November 2019 Economic and Fiscal Outlook and the Government’s Economic and Fiscal Update 2019) on top of long-term economic and demographic trends. And, that the federal net debt-to-GDP ratio would return to its current (2018) level after 75 years. Further, PBO’s estimate was an estimate of permanent fiscal room in which measures could be implemented immediately and would grow in line with GDP each and every year. [1]
More important, the context for estimating fiscal room was to determine whether under the current tax burden, the federal government had room to introduce new permanent measures, taking into account the economic and demographic impacts of population ageing. These measures could be implemented “while maintaining fiscal sustainability” which we defined as returning the federal debt-to-GDP ratio to its current value in the year 2093. As we have noted, the choice of the current debt ratio for the endpoint is somewhat arbitrary but is used by international organizations to assess fiscal sustainability.
While our framework serves as a useful guide in such a context, it is ill-equipped to guide fiscal policy decisions during an economic and public health crisis such as the COVID-19 pandemic.
An essential distinction is the permanence of policy measures. The current situation calls for immediate and robust policy actions to face these unforeseen and exceptional circumstances. For example, the measures that were implemented during the peak years of World War II resulted in massive deficits (e.g., averaging 21 per cent of GNP per year over 1942 to 1945 [2]); however, they were not permanent in nature. Indeed, shortly following World War II, the federal government registered the largest-ever budgetary surplus as a share of the economy (5 per cent of GNP in 1947).
The direct federal fiscal measures announced to date (as of 19 March 2020) amounting to almost $30 billion (1.3 per cent of GDP) are not intended to be made permanent, nor are the other temporary support measures such as the $55 billion deferral of tax installments/payments and loans.
Thus, given the temporary nature of these measures, the Government’s debt-to-GDP position prior to the COVID-19 crisis and credit market access at historically low rates, the amount of temporary fiscal measures that the Government could undertake is well in excess of PBO’s estimate of permanent fiscal room in a given year ($41 billion).
Once the economy recovers and the public health emergency subsides, the temporary support provided by the Government will no longer be necessary and should therefore be allowed to sunset. The fiscal track will return to its “sustainable” path, resulting in fiscal room for future permanent measures. It is important to note, however, that this may not be the case if temporary measures were extended.
In the short and medium term, the federal debt-to-GDP ratio will be significantly higher compared to its current low level (historically and internationally) due to the additional support measures and the negative impact on GDP. Once the temporary measures expire and the economy recovers, the federal debt-to-GDP ratio should stabilize and then start declining under pre-crisis fiscal policy settings. However, should some of the measures be extended or made permanent, the federal debt ratio could keep rising. [3]
[1] In addition, PBO’s estimate of federal fiscal room was based on Statistics Canada’s Government Finance Statistics (GFS) and not the more familiar Public Accounts framework used in the Government’s budgets and updates. Using internationally consistent GFS supports comparative fiscal analysis by overcoming definitional and accounting differences across governments and government sectors.
[2] PBO calculations based on the Historical Statistics of Canada. Available at: https://www150.statcan.gc.ca/n1/pub/11-516-x/3000140-eng.htm.
[3] That said, stabilizing the federal debt-to-GDP ratio at a higher level—compared to stabilizing it at the current pre-crisis level—would not likely result in a fiscal cost if the federal borrowing rate remains below the nominal growth rate of the economy. Stabilizing it at a higher level would require running a larger primary deficit (relative to the size of the economy). For further discussion of the fiscal and welfare costs of public debt with low interest rates, see Peterson Institute for International Economics Working Paper 19-4, Public Debt and Low Interest Rates, by Olivier Blanchard. Available at: https://www.piie.com/system/files/documents/wp19-4.pdf. Although Blanchard notes that “even without fiscal costs, public debt reduces capital accumulation and may therefore have welfare costs. However, welfare costs may be smaller than typically assumed.”