Northern Economist 2.0

Friday 9 June 2023

Interest and Debt

 

Wednesday's Bank of Canada rate increase reminds us once again that the era of cheap money is over not just for consumers and business but also governments. One of the notable features of the pandemic response in Canada was the enormous amount of federal fiscal stimulus injected into the economy.  Federal spending rose from $363 billion in fiscal 2019-20 to reach $639 billion in 2020-21 – an increase of 73 percent.  It then began to subside going down to $480 billion as reported in Budget 2023 but is set to resume an upward trend and reach $556 billion by 2027-28.  As of the 2022-23 fiscal year, federal spending is 37 percent higher than going into the pandemic meaning an average annual increase in spending of about 12 percent.  This has been funded by deficits which in turn have increased the federal net debt dramatically going from $813 billion in 2019-20 to $1.3 trillion by 2022-23 and is expected to reach just over $1.4 trillion by 2027-28.

 

The long-term implications of this spending and debt surge are of course debt service costs. As a result of recent interest rate increases, they are about to become in nominal terms the largest, they have ever been.  Using data from the federal Fiscal Reference Tables and Budget 2023, Figure 1 plots both the total annual amount of federal debt charges paid as well as the annual percent increase for the period 2000 to 2022 and then as forecast until 2028.  What is evident at a glance is that until 2021, annual debt charges had been on a downward trend falling from nearly $44 billion in 2011 to $20.4 billion in 2021.  Since then, they have soared growing 20 percent in 2022 and forecast at 41 percent and 27 percent growth in 2023 and 2024 respectively before subsiding.  Indeed, by 2028, annual debt service costs are anticipated under the current forecast to reach over $50 billion which surpasses even the peaks reached in the 1990s. 

 


 

 

Now of course, as a share of total federal government spending, these debt charges may seem less alarming as at less than ten percent of total expenditure, they are modest relative to peaks of nearly 30 percent or more in the 1990s and 1930s. However, it should be noted that the share of total federal government spending going to debt service more than doubled between 2021 and 2023 rising from 3.2 to 7.2 percent and is expected to keep rising to just over 9 percent by 2028.  Nothing to worry about you might think?  However, it all depends on what happens to interest rates.  The fact remains that not surprisingly there is a strong correlation between the growth rate of federal debt charges and the effective interest rate on the net federal debt.

 


 

 

Figure 2 plots the annual percent change in federal debt charges against the effective interest rate on the net debt since 1867 (calculated as debt charges divided by net debt) using data from A Federal Fiscal History, the federal Fiscal Reference Tables and Budget 2023.  With a linear trend fitted, there is a definite positive correlation that has a bigger impact than you might think.  On average, a one percentage point increase in the rate of interest is associated with a nearly two percent increase in debt charges.  Given such sensitivity, it is not a surprise that debt charges have doubled since 2021.  And the current situation is anything but average given the enormous stock of nominal debt meaning that even with the staggering of long-term government bond debt issue, small interest rate increases can have large increases in government debt interest costs.  Moreover, with the anemic real GDP growth forecasts and an increase in interest rates, the long-term sustainability of the federal fiscal position becomes more of an issue.  We are in for interesting times.

Monday 5 February 2018

What a 2.4 Percent Municipal Tax Levy Increase Really Means


Thunder Bay City Council has voted to pass the 2018 municipal budget and will formally ratify it at a vote this evening.  The Mayor and Council have of course been patting themselves on the back about how it is a “responsible budget” and how it keeps the tax levy increase in spending within the average of the last two terms of council.  The tax levy increase is now coming in a 2.4 percent now – just above the rate of inflation - which is down from the 3.03 percent increase that was originally on the way after several weeks of deliberation and debate.  This was managed by essentially taking out about $1 million from the city reserve fund to lower the levy against the advice of City administration it turns out who also noted that the reserves – used to cover unexpected costs or deficits throughout the year - have been declining since 2012

What this all really means is that this is an election year.  The average municipal tax revenue increase over the period 2011 to 2018 has averaged 3.3 percent and ranged from a high of 5.7 percent in 2015 to a low of 2.2 percent in each of 2014 and 2016.  The increase of 2.2 percent in 2014 was also during an election year and was followed by a 5.7 percent increase in 2015.  Keeping the increase low this year can be interpreted as a deliberate political strategy to not raise the ire of ratepayers in the lead up to the October election and one can expect a hefty increase to make up lost ground when the 2019 budget comes in.

In the end, a tax levy increasing at just above the rate of inflation is not much of an accomplishment given that it was done by dipping into the reserve fund.  While much was said during council debate about the hard decisions that have been made the fact remains that spending is going to go up by the amount originally agreed upon – just over 3 percent – but it is going to be subsidized by borrowing from the reserve fund. 

But then, cost control is hard work and in the end some of the efforts at cost control have backfired.  One need only look back at the attempt by Thunder Bay to reduce garbage collection costs in 2017 which were supposed to eliminate a truck and labour costs via attrition while at the same time reducing bag pick-up to two bags from three with additional bags requiring a tag.  And what was the end result?  After a period of chaos, the truck was reinstated but the three-bag limit was not and things have remained very quiet since.  So, one has to conclude that costs have remained the same while less garbage is being collected and revenue is probably up for the City from the bag tags. It was certainly a win for the City of Thunder Bay but not for rate payers who altogether have to pay more but are getting less.

We can expect more of the same next year after the dust clears from the election.  The current cast of councilors will largely be returned to office and the cycle will start anew. We will be paying more and getting less, and the debut will be a hefty tax levy increase to replenish the reserve fund as well as boost spending to make up for the previous year’s slowdown.  There will be the usual grumbling and complaints, but they will be dismissed because after all Thunder Bay voters are the ones doing this to themselves by falling for the same thing election after election.  Why would city politicians take them seriously when they complain?

Additional Note: February 6th - Well, the budget did pass last evening. Please note that the 2.4 percent levy increase coming in is "net" or after factoring in "new growth".  The gross levy increase is actually 3.13 percent.  Originally, the net increase was going to be close to 3 percent and the gross increase nearly 3.6 percent.  So, total spending is still going up 3 percent and the net is 2.4 because of the use of projected surplus funds from 2017 budget away from the reserve fund and towards the tax bill.  However, apparently there was an effort to move even more of the projected 2017 budget surplus away from the reserve but it did not succeed.  Of course the 3.13 percent does not mean that everyone's tax bill will be going up 3.13 percent or 2.4 percent if you are an "existing" ratepayer.  That is the total increase in tax financed expenditure. Much of the burden of the increase will go to residential ratepayers. See my post last month here for a more detailed discussion.   


Tuesday 14 February 2012

Northern Economist in the Winnipeg Free Press

 

Harper seeking a sustainable Canada


News headlines present what seem to be unconnected stories regarding government initiatives and yet there is an underlying strategy to what any government does. For example, recent weeks have seen the term "sustainability" being applied to describe federal government policies with respect to health transfers and pensions.
At the same time, there have been references to Canada forging new trade links with Asia and Europe. Coupled with all this is the looming federal budget, which is expected to unveil substantial budget cuts.
Linking all these items together is the agenda of Canada's present federal government, which can best be understood as a comprehensive strategy of national sustainability. That is, the pursuit of a strategy that will make Canada economically sustainable for the 21st century.
To borrow a Prairie metaphor, the government's vision is passing the farm on to our children via two policy pillars. First, is restructuring the public finances and second, the pursuit of an economic strategy designed to ensure long-term growth and opportunity by taking our trade eggs out of one basket.
Securing the public finances requires balancing the budget and making sure the national debt begins to decline as the prospect of rising interest rates and debt service costs may squeeze health and social programs.
The sustainability of government spending and elimination of the deficit in the long term requires government spending not rise faster than the resource base.
To this effect, federal health transfers will eventually rise at the rate of GDP growth. As for government pensions, there is ongoing discussion about reforms to Old Age Security to increase the eligibility age and thereby also limit spending. Eliminating the federal deficit primarily through expenditure reduction rather than revenue increases can also be seen as a calculated strategy of fiscal sustainability designed to keep our tax rates low for the purposes of international competitiveness.
Given that one third of our GDP is rooted in the export sector, Canada's economic viability also requires that we seek opportunities to grow our trading relationships. The pursuit of trade opportunities in Asia and Europe represents a long-term strategy to diversify our trade portfolio and is a departure from our monogamous historical trade patterns. First, we had Great Britain as our primary trade partner and directed most of our exports there. Then, we cultivated the United States as our trade partner, which at one point absorbed nearly 80 per cent of our exports.
Reliance on one major market for our goods makes us vulnerable to political and economic shocks. In the case of the U.S., while it represents a convenient and wealthy market for our wares, recent years have seen the Americans become increasingly inward looking and preoccupied with their border to the extent that trade with them has become increasingly more difficult. The shift away from the American market began during the world financial crisis and the Great Recession of 2009. Between 2005 and 2010, the value of exports to the U.S. dropped by 10 per cent and their share of our exports fell from 82 to 73 per cent. Over the same period, exports to the United Kingdom and Europe have grown as well as exports to other OECD countries, China and India. The pursuit of China as a market for Canadian energy also marks a departure from our previous continental approach to energy markets.
The federal government is following in the path of previous governments in crafting an economic strategy to secure Canada's sustainability as a nation. From 1867 to the Second World War, we were dominated by the national policies of land settlement, tariff protection and railway construction, which erected an east-west national space. The period from the end of the Second World War to the 1980s saw the pursuit of trade opportunities with the United States via agreements such as the Auto Pact with increasing dominance of the North American market leading to the 1988 Free Trade Agreement and NAFTA.
We are embarking on a 21st-century strategy of economic diversification with the pursuit of trade and investment opportunities with Asia and Europe. The continental economic vision of guaranteed access to the U.S. market has been increasingly under siege as a result of repeated lumber disputes, tighter border controls, and an economically weaker United States that is more inclined towards protectionism. In the face of these challenges to Canada's economic future, the government response is a strategy to balance the books and to make sure we will not be dependent on one international market for our future economic welfare. Who can really argue with that?

Livio Di Matteo is professor of economics at Lakehead University.
Republished from the Winnipeg Free Press print edition February 13, 2012 A10

Tuesday 7 February 2012

New Health Fiscal Sustainability Report Released


A new report on the fiscal sustainability of public health care in Canada was just released by the Canadian Health Services Research Foundation.  The report is titled “The Fiscal Sustainability of Canadian Publicly Funded Healthcare Systems and the Policy Response to the Fiscal Gap” and is authored by myself and Rosanna Di Matteo and is available on the CHSRF web site.  For a summary of the results, see below:



Key Messages
  • Fiscal sustainability generally refers to the extent to which spending growth matches growth in measures of a society’s resource base. Since 1975, real per capita government health spending in Canada has risen at an average annual rate of 2.3%, in excess of the growth in real per capita GDP, government revenues, federal transfers and total government expenditures.
  • Five expenditure scenarios were constructed, using regression determinants and growth extrapolation approaches, for Canada as a whole, each of the ten provinces and the territories for the period 2010–2035.
  • For Canada as a whole, real per capita public healthcare spending from 2010 to 2035 can be expected to grow anywhere from 78% to 115% and reach a level in 2035 in 2010 dollars ranging from $6,552 to $8,798 per capita.
  • For the provinces, the average increase across the ten provinces from 2010 to 2035 in real per capita provincial government health spending ranges from 81% to 160%. Average estimated spending in 2035 ranges from a low of $6,711 to a high of $10,819 per capita.
  • For the Yukon, real per capita public healthcare spending between 2010 and 2035 can be expected to increase from a low of 142% to a high of 652% – a range in 2035 of $14,316 to $41,089 per capita. For the Northwest Territories and Nunavut, low-end growth was 57% while the highest growth was 281%. Spending in 2035 would be estimated to range from a low of $12,423 to a high of $32,557 per capita.
  • In terms of the fiscal gap, annual compound growth rates for forecast government health spending exceed those for government revenue growth for most scenarios and jurisdictions. For Canada as a whole, the public healthcare expenditure-to-GDP ratio could rise to as little as 9.5% or to as much as 13.4% by 2035 from the current 7.6%. The territories and most provinces generally also see increases in the public healthcare expenditure-to-GDP ratio by 2035.
  • Under the extrapolation assumption that health expenditure trends for the 1996 to 2008 period continue but with lower economic growth, government health spending in Canada in 2035 would reach $8,798 per capita and the public healthcare expenditure-to-GDP ratio would reach 13.4%. This projected increase is equivalent to an increase in public spending today of about $2,797 per capita, possibly requiring up to a 15% increase in per capita revenues.
  • Potential policy solutions to make public healthcare spending more sustainable include controlling and restructuring expenditure, raising additional tax revenues, creating a federal health tax to generate revenues for a national health endowment fund, and allowing for a greater private role in healthcare spending.