Canadian governments are lot more indebted than we think. And I don’t just mean the vast add-ons now taking place and for coming years. No, what I mean is that the official public debt figures mask the true debt position of our governments. This can send the wrong signal to taxpayers that we are OK when we are not.
The IMF reports that federal, provincial and local government net debt (assets deducted from liabilities) was only 26 per cent of GDP in 2019. By these numbers, Canada looks to be in good shape to weather the COVID crisis, with the 13th best net debt position among 35 advanced countries. (The best include Australia, the Scandinavian countries and Switzerland among others). The IMF also forecasts our debt burden will rise to 40 per cent of GDP in 2020 on a national accounts basis. That’s not including new spending on post-secondary students and the elderly and other subsidies announced this past month — so expect the number to be even greater just for this year.
But these net debt numbers suffer from some serious limitations. Be warned: we have entered a new phase of high indebtedness that we’re leaving for future generations.
First, national accounting (unlike the public accounting used in federal and provincial budgets) does not include government employee pension plan liabilities — the money we will all owe to retired civil servants that isn’t covered by a corresponding asset. Add at least another 15 per cent of GDP for this item to the 2019 debt load. Government pension liabilities will easily surpass that in 2020 as asset returns tank and discounted liabilities rise sharply because of low interest rates. (With lower interest rates it takes more money to cover a given future pension obligation.)
Second, to get to net debt we subtract Canada and Quebec Pension Plan assets from our overall debt. But we ignore any liabilities these plans will pay out beyond one year. Unless governments renege on future CPP and QPP pension benefits, adding in these future obligations raises our 2019 net debt by another 14 per cent of GDP.
Third, both financial and non-financial assets, like roads, bridges and other public capital, are carried at book value. But the 2020 market downturn means a government wishing to sell financial assets to avoid rolling over debt will have less money on its hands. Financial values generally do come back over time. But non-financial assets, of which over 90 per cent are held by provincial and local government, are a different, more troubling matter. They typically earn little financial return and are highly illiquid. If governments need money to cover debt repayments, their non-financial assets will have few buyers unless they are privatized at low prices. If we don’t follow the usual practice of subtracting non-financial assets from liabilities, the net debt burden would be higher by another 53 per cent.
And we’re not finished yet. Governments also have major unfunded liabilities such as Old Age Security, Guaranteed Income Supplements, age-related tax credits, seniors’ drug plans, long-term care facilities and health care benefits. The IMF estimates that on its own unfunded health-care spending for the next 30 years adds up to another 42 per cent of GDP.
Add it all up and Canada’s debt burden is $3.2 trillion. That’s 166 per cent of GDP — fully four times the IMF forecast for 2020.
Financial liabilities require governments to pay interest every year. In 2019, our interest expense was $65 billion, about a quarter what we spend on health care. The 2020 deficits alone will add roughly another $3.5 billion in interest expense for federal and provincial governments, assuming low interest rates continue. As for other parts of net debt, such as public employee pension plans and growing public expenditures due to an aging population, more bond financing will be needed to cover these, as well — unless governments cut other spending or raise taxes.
And that’s just 2020. It is unlikely we’ll get to a balanced budget for many years, given the public’s evident belief that governments have limitless cash. In fact, if things don’t improve by fall, still further spending will put us even deeper in the hole.
Creditors eventually will want Canadian governments to have sustainable fiscal plans. If not, they will downgrade our debt, leading to higher interest rates. This has already happened to Alberta, which has the lowest debt-to-GDP ratio of all the provinces but also the second highest credit spread over Canada 10-year bonds. The most serious problems arise in countries that lose capital inflows, have falling currencies and can’t repay their international loans. That was Argentina this past week.
Governments whose fiscal plans don’t impress markets often resort to printing money, which leads to higher demand for goods and services. The COVID-induced supply shock is like the oil price shocks of the 1970s. Monetary expansion and a relaxation of Bank of Canada targets could push up consumer prices, leading to higher inflation and interest rates. For now, Canada has a good credit rating. But let’s not forget: we almost had to go to cap-in-hand to the IMF to bail us out in 1994 because of our very high debt.
We all hope economic recovery is in our future. It will come, though, only with a plan that restores Canada’s fiscal health.
Jack M. Mintz is the President’s Fellow at the University of Calgary’s School of Public Policy.
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May 27, 2020 at 05:00PM
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