Ottawa’s “new” debt target is good policyThe Harper government’s plan to bring the federal debt down to 25 percent of GDP is more than just politics. Setting targets often works.
The federal government used the opportunity at last week’s G-20 meetings in Russia to announce a new policy target: to reduce federal debt to 25 percent of GDP. This announcement was aimed at two audiences. To the international community Ottawa was signaling that it still clings to the debt reduction agenda laid out in previous G-20 meetings and still advocates reducing elevated public debt levels.
And for the Canadian audience, true to the Harper government’s incremental approach to policy-making, this policy target was a missing (and subtly inserted) piece of the puzzle of the federal government’s fiscal plan. While one can contest the means and the ends, the government has now articulated a clear and likely achievable fiscal strategy: it wants to shrink the federal government’s size over the long term by reducing spending today, balancing the budget tomorrow and offering tax cuts in their next election platform.
Setting this new target has two redeeming qualities. First, it’s good politics, as the Conservatives will use it to support their narrative of being prudent fiscal managers. Second, it has the benefit of being good policy — provided a few more pieces are added to the fiscal puzzle.
Having a medium-term fiscal target gives the government a sense of direction and helps anchor public expectations of future policy choices. A well-articulated plan, even if it’s imperfect, beats having no plan. When people want to achieve goals, explicit targets help them resist temptation and keep their eyes on the prize.
Some recent evidence also suggests that fiscal targets can actually work in practice. For instance, in my March 2013 article in Canadian Public Policy (http://economics.ca/cgi/jab?journal=cpp&article=v39n1p0045) I find that Canadian provinces with legislated debt targets generally had lower public debt levels (analyzing all provinces over 1981-2007 and controlling for factors including economic performance and the decision to adopt a target). I estimate that debt targets lowered debt-to-GDP ratios by 1.5 percentage points on average in the sample period.
While not huge, this is nothing to sneeze at in the context of a future fiscal squeeze from an aging population.
Those with good recall may feel a sense of déjà vu with the Harper government’s announcement. In 2004, the Liberals also had a 25 percent debt target, which the Conservatives then appropriated in 2006 (both of these targets would essentially have been met by now had they been respected). The global recession and fiscal stimulus package intervened, raising the federal debt-to-GDP ratio from its earlier downward path to where it now stands at around 34 percent (see the figure). So much for past promises.
Critics say this latest pledge just recycles these old targets, but with a delayed timeline, and that it simply reflects the “status quo” fiscal path (i.e., it assumes no major new policy initiatives or economic disruptions). As such, it merely rationalizes fiscal policy in the years ahead — it constrains it somewhat, perhaps but it does not fundamentally alter it. And if we couldn’t achieve this target last time, why would we achieve it now? As the government highlighted in its announcement, achieving the 25 percent target depends on the economy meeting performance expectations (as it should be: if you win the lottery, you’ll pay off your mortgage faster, but if you lose your job, you may need to borrow more).
Detractors will also question the rather arbitrary choice of the target and timeline. Why choose a 25 percent debt level rather than, say, 20 percent or even 50 percent? There’s little evidence to suggest that public debt matters much for advanced economies, provided it remains within a reasonable range. And while lower debt is generally better, since it reduces the government’s borrowing costs and frees up resources for other uses, not all government debt is bad. Some debt funds long-term investments that provide broader social returns, such as infrastructure spending.
Astute taxpayers will also complain that while they care about the federal government’s debt burden, they also care about those of other levels of government and of public pension plans. (If federal tax rates fell in the future while provincial rates rose to fund, let’s say, health care spending, then this wouldn’t leave the after-tax incomes of households any farther ahead.)
In fact, in 2007, the government had a much broader — and preferable — target: to erase total government net debt by 2021. Today the Harper government argues that despite transferring money to the provinces, they are not accountable for the provincial fiscal results. The federal government now prefers focusing on the narrower federal target over which they have more control.
While this “new” debt target should be welcomed, some unfinished business remains. Transparent long-term budget targets require transparent long-term budget projections. Finance Canada should release these in the upcoming fall update to buttress this target’s credibility in the eyes of the public and financial markets.
Transparency also involves educating the public to that fact that indefinite surpluses are not the only route to reducing the debt-to-GDP ratio. It could also occur with modest deficits, provided these deficits grow more slowly than the economy.
Monitoring and enforcement are other big concerns. In eight years, few of today’s politicians will still be in office. Therefore, the government should create supporting legislation that includes a clause that commits it to regularly release the government’s long-term budget forecasts. Independent monitoring of compliance with this new target should be assigned to Parliament, with analysis provided from the Parliamentary Budget Office, which already releases such reports annually.
This “new” debt target is not new. Yes, it is too narrow a measure of government debt, and similar targets were missed earlier. Nor is it overly ambitious, given the current fiscal outlook. But even if it was only adopted for political reasons, setting this target has the merit of being good public policy. And doing so should help reduce our federal debt.