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1993 Report of the Auditor General of Canada

Assistant Auditor General: Ron Thompson
Responsible Auditor: Jeff Greenberg

Main Points

5.1 Persistent deficits and growing debt have been part of the government's financial condition for two decades. Hard choices lie ahead. We hope this chapter will help to explain why.

5.2 Canadians need a better understanding of what deficits and debt mean. Part of this learning process includes understanding the elements that make up the federal deficit and debt. We also explain some of the practical difficulties of deficit reduction plans - both those that scale back expenditures and those that increase revenues.

5.3 In the chapter, we suggest five simple indicators of financial condition and call on the government to report them in a consistent manner from one year to the next. The idea is to help Canadians gain an appreciation of the problem rather than point them toward specific solutions.

5.4 But looking at where we've been is not enough; it is also necessary to see where we're going. For this reason, we propose that three of the simple indicators of financial condition plus a new one, the cost of missing deficit targets, be used as future-oriented indicators. We encourage the government to report this information. And we explain how positive short- to medium-term trends can mask negative long-term problems.

5.5 We conclude by suggesting that governments do not create deficits and debt in isolation from demands by the Canadian people. We point out that Canadians must feel part of any solution to the government's financial woes, and we discuss recent proposals to make the budget process more open.

5.6 In summary, the more informed Canadians become about the implications of deficits and debt, the easier it will be for the government to make the difficult decisions that lie ahead and the easier it will be for the public to accept those decisions.

Introduction

5.7 Two years ago, as part of our concern for the understandability of the government's financial condition, we raised the notion of a financial scorecard. We did this so that Canadians could better assess the success of economic planning and execution by the government, and the reasons for any deviations from its plans. Last year, we suggested the need for simple indicators, for future-oriented information about the government's financial condition, and for a forum for rational discussion. We also indicated that a study should be done on these matters. This chapter is a product of that study.

5.8 Last April, as part of that exercise, we hosted a colloquium on deficits and debt. We asked 35 prominent Canadians representing different areas of the economy to discuss the implications of annual deficits and accumulated debt. We also asked them to comment on appropriate ways to report these numbers and on the role of a legislative auditor. One of the issues discussed was the need for simple but meaningful information; virtually every participant agreed that there was a serious lack of understanding among Canadians about the meaning of deficits and debt, let alone any consensus on solutions.

What Can the Auditor General of Canada Do?

5.9 Public sector deficits and debt are among the most important policy issues we face today because of the concerns they raise about issues related to the financial ability of the government to carry out its economic and social programs.

5.10 First and foremost among these issues is the question of our ability to carry the level of debt we have incurred. The financial experts we consulted say that most countries become aware of a concern about their ability to pay their debts only after a reaction by the financial community. They also say that although it is not appropriate for the Auditor General to comment on the financial viability or the solvency of the federal government, the Auditor General does have a responsibility to comment on important issues like annual deficits and accumulated debt. This means weighing our words very carefully when commenting on the financial condition of the government.

5.11 We believe that we have a responsibility to encourage the federal government to provide enough relevant, reliable and understandable information about its financial condition to allow Canadians and their elected representatives to gain an appreciation of deficits and debt and to draw their own conclusions about their implications.

A Layman's Guide to Deficits and Debt

The Purpose of the "Guide" Is Educational

5.12 In this section, we hope to do two things: first, demystify the meaning of deficits and debt; and second, explain, in financial terms, what it means to reduce the annual deficit and the growth in accumulated debt.

5.13 We do this because many people think that getting rid of the annual deficit means simply eliminating waste and getting rid of a few public servants - a myth that needs dispelling. There are also those who think the annual deficit can be eliminated by getting rid of government programs - not their favoured program, but someone else's program, or by raising taxes - not their taxes, but someone else's taxes. Our objective is to dispel the idea that eliminating the deficit or reducing its relative significance will be easy or painless.

5.14 Experts will, of course, realize that there are complexities we did not touch on, but we hope that they will agree that there are significant barriers to dealing with them until there is a better and more widespread level of understanding.

Deficits Versus Financial Requirements

5.15 The Minister of Finance focusses on two of many measures when presenting a budget. The first is the annual deficit, which measures the shortfall between annual revenues and expenditures. The second is the annual financial requirements, which represent the amount of money the government will have to borrow in open financial markets. The difference between these two measures is made up by other sources of funds, such as borrowing from government employee pension contributions. For 1991-92, the annual deficit was $34.6 billion, or $1,260 per capita, while the financial requirements were $31.8 billion (excluding foreign exchange transactions).

Gross Debt Versus Net Debt

5.16 To calculate the accumulated deficit, or net debt, this annual deficit is added to every annual deficit or surplus since Confederation, arriving at a total of $423.1 billion, or $15,440 per capita, by 31 March 1992.

5.17 The gross debt, $466.7 billion at 31 March 1992, is an alternative number sometimes used for measuring federal indebtedness. This represents the total liabilities of the federal government as reported in its summary financial statements. The difference between gross debt and net debt is the reported value of financial assets held by the federal government.

5.18 These financial assets include investments, loans and advances, and liquid assets such as receivables and cash. Examples include investments in Crown corporations like the Canada Mortgage and Housing Corporation and loans to foreign governments.

5.19 Assets reported by the government, however, do not include any tangible physical assets like buildings and airports, or intangibles like the government's investment in health and education. Whenever items of these kinds are acquired today, their costs are treated as expenditures in the year they were purchased.

5.20 With respect to the tangible physical assets, the Public Sector Accounting and Auditing Board of the Canadian Institute of Chartered Accountants currently has a project under way to develop and propose accounting conventions for reporting them. We support their efforts because we believe that reporting physical assets will contribute to better decision making in the public sector, such as whether to rent or to build office space. We also believe that this will help officials recognize the value of aging infrastructure, and make their decisions about replacing or upgrading it easier. Finally, amortizing the costs of assets over their lifetime will improve our assessment of the true cost of programs.

5.21 Current accounting practices do not take into consideration the impact of inflation on the value of assets or liabilities. They also do not recognize other items, such as the cost of meeting the expectations of Canadians for future pension benefits.

5.22 This is a complex subject and we make these comments because we believe that accounting conventions should be helpful to managers in making decisions about the choices between consumption and capital expenditures. But bear in mind any decisions to report these physical facilities as assets will not reduce our gross debt and therefore our interest charges on that debt.

What Does a Zero Deficit Mean?

5.23 The accumulated debt of an enterprise, whether in the public or private sector, will continue to grow as long as its expenditures exceed its revenues. This is a simple arithmetic reality. The federal government's accumulated deficit of $423.1 billion will stop growing only if its annual deficit, currently at $34.6 billion, is reduced to zero. For this to happen, revenues from all sources, like taxes, user fees and return on investments, must equal all expenditures, both the cost of running programs and the cost of servicing the debt.

5.24 Currently the federal government, most provincial governments and many political parties are calling for some form of deficit reduction. Some call for the elimination of annual deficits in a prescribed number of years while others call for a reduction in relation to gross domestic product (GDP). GDP is a measure of the value of goods and services produced in Canada in a given year, sometimes referred to as Canada's annual income.

5.25 Some countries have proposed that limits be set. For example, in the European community, all member countries must strive, under the proposed Maastricht Treaty, to achieve, as a minimum, either a 60 percent debt-to-GDP ratio or a 3 percent deficit-to-GDP ratio.

What Are the Components of a Deficit?

5.26 As the Governor of the Bank of Canada told the House of Commons Standing Committee on Finance during its recent hearings on the national debt, annual deficits arise from the interaction of program spending (i.e., expenditures other than interest costs), revenues, and interest costs.

Program spending
5.27 The Minister of Finance reminded members at these hearings that there are only two ways of bringing down costs in the program area. The first is "reducing those program expenditures" and the second is "finding better ways to administer, distribute, and ensure that these programs are delivered in the manner that gives you good value for the dollar."

5.28 Administrative change . In 1991-92, the federal government spent $156 billion including debt interest costs of $41 billion. Exhibit 5.1 gives a broad breakdown of this $156 billion. Approximately $17 billion is taken up by expenditures on government operations, the administrative cost of operating programs, excluding the $11 billion for running the Department of National Defence. Of the $17 billion, wages and salaries of public servants represent $13 billion. This means that with the annual deficit running at $34 billion, even if government salary costs could somehow be reduced to zero, the annual deficit would still be $21 billion.

5.29 Program reform. Some $82 billion of total federal spending represents transfers to individuals, provincial governments and others, and an additional $5 billion in expenditures is provided to Crown corporations. While expenditures on these activities represent a substantial source for scaling back on spending, accomplishing this scaling back would be most difficult. Marcel Côté, the keynote speaker at our colloquium, noted:

Powerful coalitions rapidly mobilized by interest groups can inflict significant political costs on governments who dare to propose radical changes. The political market operates in its perverse way to protect special interests. . . . The "iconization" of government programs has seriously misdirected budget reduction policies. Governments do not abandon programs; they squeeze them.
5.30 The implication of his remarks is not that programs can't be changed or even abandoned, but that bringing about such reform takes considerable effort, which may bring with it a degree of unpopularity.

5.31 The need for evaluation . The entrenchment of programs, particularly those that do not require annual parliamentary authority to spend money, is exacerbated by the limited number of reasonably objective program evaluations to help government decide which programs should be changed or eliminated. In Chapter 1 and in Chapters 8 to 10 of this year's Report we comment on the failure of program evaluation to examine the overall effectiveness of major government initiatives. We discovered that not only is Parliament ill informed about the effectiveness of programs, but the will to make program evaluation happen within government is simply not there.

Revenue
5.32 Revenue is the second component of annual deficits. Exhibit 5.2 shows the value of tax revenue for 1991-92 to be $113 billion.

5.33 This $113 billion is a net figure after allowing for income tax deductions, exemptions and credits commonly called ``tax expenditures". Since these are netted out at the time of assessment, there is no accurate means of assessing what gross revenue might be.

5.34 When most people think of increasing tax revenue to reduce the annual deficit, they often focus on such areas as reducing the tax loss resulting from unreported economic activity, sometimes called the "underground economy", making changes in tax policy, or stimulating economic activity to increase economic growth.

5.35 Tax loss from the "underground economy ". There is the perception today that people are increasingly finding ways of evading taxation - both income tax and excise tax like the GST. Those who do pay their required taxes often feel that they are paying more than their fair share. Increasing efforts on enforcing tax compliance not only would address this concern about fairness, but would have the ancillary effect of increasing revenue. Currently, we have no accurate measure of the value of this tax gap. Department of Finance officials have estimated that the tax loss due to tobacco smuggling alone could be as high as $600 million annually.

5.36 Tax policy . Tax policy can cover a wide area ranging from the kind of tax employed (e.g. income tax versus consumption tax) to the rate of taxation. Choosing the ``right" tax or the ``right" rate to increase revenues is not always a straightforward issue. For example, increasing the rate may not lead to an increase in revenue. That is, there may be some threshold above which increases in the rate of taxation have a negative effect on economic activity.

5.37 At the same time, there is a concern that there are a number of loopholes within the existing tax system that make tax avoidance an "art form". This concern stems both from the loss in revenue at a time of increasing debt and from the desire for fair treatment under the tax system.

5.38 In our 1992 Report we commented on the hundreds of millions of dollars lost in tax revenue because of the tax rules on foreign source income and foreign affiliates.

5.39 These are some of the difficult policy questions that make government deficit reduction decisions all the more intractable.

5.40 Changes in economic activity . Improving economic performance is another way of increasing tax revenue. Some Keynesian economists suggest that the principal problem with high annual deficits is not the expenditure side, but the shortfall in revenue due to slow economic growth and underutilized economic capacity. Whether government priorities for deficit reduction should focus on economic growth through stimulation or on expenditure reduction is a matter of policy and political persuasion. Our concern is that the government demonstrate to Canadians the symptoms and future implications of high deficits and growing debt in order to develop the consensus necessary for dealing with them.

The cost of borrowing
5.41 The cost of borrowing is the third area that affects the annual deficit. In 1991-92, the interest on the debt was $41 billion. This cost of borrowing and its compounding effect have a significant impact on Canada's annual deficits. From Confederation up to 1991-92, the federal government accumulated a net debt of $423 billion. Of this, $37 billion represents the accumulated shortfall in meeting the cost of government programs since Confederation. The remainder, $386 billion, represents the amount the government has borrowed to service the debt created by previous annual shortfalls.

5.42 We do not take a position on whether budgets should be balanced, or accumulated debt should be reduced. We are simply illustrating the long-term effects of compounding interest charges.

5.43 The amount of debt . The total cost of borrowing is influenced by three factors: the amount of debt, its management, and the rate of interest on the portfolio of debt. Exhibit 5.3 shows that, since Confederation, Canada has consistently used debt financing to cover some of the cost of operations. By the end of World War II, the accumulated debt was at $13 billion, giving a debt-to-GDP ratio of approximately 108 percent. Most observers of government financing would agree that the high debt-to-GDP ratio at the end of World War II was caused by the need to generate substantial industrial production for the war effort without resorting to taxation to cover its full cost. This meant that immediately after the war, there was considerable room for expenditure reduction through cuts in defence spending.

5.44 Twenty-nine years later, debt had doubled to $27 billion while output had surged from $12 billion to $152 billion, resulting in a debt-to-GDP ratio of 18 percent in 1975. Since then, the debt-to-GDP ratio has risen steadily to its present level of about 62 percent in 1992.

5.45 Managing the debt . An important component of managing the amount of debt is to minimize the interest costs by striking a balance between the short- and long-term bonds that a government issues. In doing so, achieving lowest cost is only one objective; stabilizing the interest costs and minimizing risk are others. Debt portfolio management is carried out to meet many objectives, which may not always be consistent with reducing the current annual deficit.

5.46 Interest on the debt . The most obvious factor affecting the cost of borrowing is the interest rate. The setting of interest rates is commonly thought of as the responsibility of the Bank of Canada.

5.47 The Bank of Canada maintains that while its actions influence the rates, particularly short-term rates, it has even less influence today than it once had. The Governor of the Bank of Canada argues that his current role is to manage the Canadian money supply in a way that encourages investor and saver confidence in the "future value of money"; in other words, price stability. In doing this, the Bank of Canada has to take into consideration the globalization of financial markets.

5.48 During the Finance Committee hearings, the Governor of the Bank of Canada also suggested that such policies do have "some . . . effect on the level of short-term interest rates." But the more fundamental effect on the whole spectrum of long- and short-term nominal interest rates, and hence on the annual deficit, comes from the degree of price stability.

Summary

5.49 In this section, we have provided a layman's guide to the meaning of deficits and debt. We have described some of the various instruments a government has at its disposal to influence the annual deficit. We also showed that reducing the deficit by any one of these is not an easy matter. Institutions, rigidities and conflicting objectives make the business of deficit control very difficult.

5.50 We pointed out that looking for ways to reduce the impact of annual deficits should not be restricted to administrative reform alone. We reminded members of Parliament and all Canadians that only 15 percent of program funding is spent on administering government operations. This should not be interpreted as meaning that because the potential for administrative savings is small, it is not worth achieving. Every dollar saved contributes to deficit reduction.

5.51 In focussing on administrative change, the government is seeking ways of operating more effectively and/or at less cost. This does not, however, draw attention to the choices that governments sometimes have to make among alternative policies and programs as a means of saving money. These choices can have a significant impact on the economic and social wealth of the country. Such decisions to change or eliminate programs are part of the politics of running government.

5.52 In this regard, we note that the Prime Minister indicated that the reform she announced on 25 June 1993 was "the largest reform of the structure of the federal government in Canadian history." The first two phases, departmental restructuring and streamlining, have already begun. The third phase, which is to include a fundamental review of the role of government, is scheduled to begin this fall. This is the kind of review that is necessary if governments and Parliament believe that difficult policy choices are called for to bring deficits and debt under control.

The Need for Simple Indicators

Why Do We Need Simple Indicators?

5.53 In the previous section, we explained the meaning of deficits and debt and some of the public policy choices influencing them. We believe, however, that the public ought to know more than that; they should also know why deficit reduction is important. One member of Parliament made the point well when questioning the Minister of Finance in the recent committee hearings on this matter. He said:

My belief is that we have to move Canadians along with us. In other words, it's incumbent upon us as members of Parliament to spell it out so it's understood. In other words, none of us can be part of the solution unless we really understand what the problem is.
5.54 Last year, we indicated the need for simple indicators in regard to annual deficits and accumulated debt. We felt then, as we do today, that there is a need for Canadians and their elected representatives to be able to make their own assessment about the financial condition of the federal deficit and debt. In a sense we are calling for a set of indicators that would allow parliamentarians and all Canadians to recognize the symptoms of a problem, not the cure: measures that would give them an insight into the consequences of running annual deficits that, between 1945-46 and 1974-75, never exceeded $2.1 billion, but since then have grown steadily to the current level of $34.6 billion. (In constant 1992 dollars, this represents an increase from $6.1 billion in 1974-75 to $34.6 billion in 1991-92.)

5.55 We believe that to achieve that understanding, Canadians ought to get a sense of the extent of taxation relative to national income, and its use; not in the detailed sense of how the tax dollar is distributed among various economic and social programs, but in terms of the percentages used to pay interest on the debt and the amount remaining to cover programs that contribute to the overall well-being of the country. We also believe that Canadians should have an appreciation of the extent to which the government is relying on deficit financing to meet its revenue needs. Finally, we think that Canadians ought to know whether these growing tax dollars represent a greater or lesser drain on the economy.

Characteristics of Simple Indicators

5.56 At the colloquium, participants indicated that no single indicator about deficits and debt could be sufficient. They pointed out that a set of three to six indicators was needed and that these indicators should:

  • be clear and precise;
  • be reported at regular intervals on a consistent basis;
  • include federal and national (federal plus provincial) deficits/debt information; and
  • incorporate historical trends and comparative data for other countries.

A Set of Indicators

5.57 We believe that the following five indicators could give Canadians and their elected representatives an insight into what deficits and debt mean to them:

  • interest bite;
  • program share;
  • expenditure ratio;
  • tax bite; and
  • debt-to-GDP ratio.
These are described below.
Interest bite
5.58 Last year, we referred to a measure of interest payments on the debt expressed as a percentage of revenues, which we called the interest bite. We suggested this measure, which is already used periodically in government documents, because it seemed to us that Canadians were concerned with the amount of money they give to the government in the form of taxes and user charges and what happens to it. Exhibit 5.4 shows this interest bite for the federal government from 1968 to 1992. It shows that it has gone up from 13 to 33 percent over this period. This means that for every dollar collected, 13 cents were used to cover the interest payments on the debt in 1968, while today this has almost tripled to 33 cents.

5.59 We believe that this is a helpful indicator because many Canadians know what it means to pay interest on a debt, particularly debts that are relatively large compared to their income, like a mortgage. The interest bite is a similar concept.

5.60 Whether this interest bite is too high is not really possible to determine with any precision. What is clear is that, over a long period, it has been continually rising, with the result that relatively less is available, without additional taxation or borrowing, for the real business of government - contributing to the well-being of Canadians. Our second indicator, the program share, looks at this aspect.

Program share
5.61 The program share measures the percentage of revenues devoted to program spending.

5.62 When the program share is less than 100 percent it means that the government is running an operating surplus - it is spending less on programs, excluding interest payments on the debt, than it receives in taxes and user charges. When it is greater than 100 percent it means that the government is running an annual operating deficit - spending more on programs than it receives. This means that the government must borrow to meet operating expenditures. A rising interest bite means that a decreasing amount of revenue is available to provide services to citizens. Exhibit 5.5 shows that, for the federal government, the program share exceeded 100 percent from 1975 to 1987; that is, for 13 years, we were spending more on programs than we collected in revenues. Since then, the program share has fallen below 100 percent; it dropped to 90 percent in 1991 but rose again last year to 95 percent.

5.63 Whether program share should be more, less, or equal to 100 percent is a matter of political choice; that choice is constrained by the size of the debt servicing charges, the rates of taxation, and the political decisions about the size and role of government. However, it is clear that a program share of greater than 100 percent - spending more on programs than collecting in revenues - can lead only to growing debt.

Expenditure ratio
5.64 The question remains as to whether total spending, the combination of program spending and interest payments, is becoming more or less of a burden to Canadians. Our third indicator, the expenditure ratio, sheds some light on this by measuring total expenditures as a percentage of total revenues.

5.65 When the expenditure ratio exceeds 100 percent, it means that the government is relying on deficit financing to meet some of its expenditures. For example, an expenditure ratio of 125 percent means that the government is financing 25 percent of its expenditures by borrowing. An expenditure ratio that exceeds 100 percent and continues to rise means that the government is increasingly using deficit financing to meet its expenditure commitments. Exhibit 5.6 shows that the annual deficit was taking on a growing importance from 1970 to 1985, rising from 98 percent (no deficit) to 154 percent. This meant that, in 1985, the government had to borrow 54 percent more than it received in revenues to meet its expenditure commitments. Over the next eight years, this declined to 126 percent. In the last year, it has edged up again to 128 percent.

Tax bite
5.66 We believe that Canadians also need to know the extent to which the federal government is using Canada's national income to meet its commitments for program spending and debt servicing. The tax bite, which is a measure of tax revenues as a percentage of total national income or gross domestic product (GDP), provides this picture.

5.67 Exhibit 5.7 shows that the tax bite was rising considerably from 1968 to 1975. After the tax reform in 1975, the federal government introduced automatic indexation to both transfer payments and personal income tax. As a result, the tax bite fell from a high of 18 percent in 1975 to about 14 percent in 1980. Since then, the general trend for the tax bite has been progressively upward to about 17 percent today.

5.68 In other words, the federal government, through a combination of different approaches to tax collection and changes in tax policy, has been taking an increasing share of national income to meet its current commitments for interest payments and program spending.

Debt-to-GDP ratio
5.69 Our final indicator is the debt-to-GDP ratio, which measures the total volume of debt in the context of national income. We include this ratio because it is the most commonly used measure of public debt relative to the economy. Over time, the debt-to-GDP ratio reflects the ability of an economy to generate sufficient income to cover its debt. A rising value means that the volume of debt is growing faster than the income base a government draws on to meet its debt obligations.

5.70 Like the interest bite, it may not be possible to determine when the amount of debt a country is carrying is higher than its economic capacity to pay the interest on it. As Marcel Côté indicated at our colloquium, ". . . a debt-to-GDP ratio as high as 150 percent [for all levels of government] by the year 2000 is conceivable, although definitely not recommended." Exhibit 5.3 shows that, for the federal government, the debt-to-GDP ratio currently stands at 62 percent and has been on the upswing since 1975, when it was at 18 percent.

5.71 We think that these five indicators, the interest bite, program share, expenditure ratio, tax bite, and debt-to-GDP ratio, when viewed over time on a consistent basis, would allow the average Canadian to make a fair assessment of the impact of large annual deficits and a growing accumulated debt.

5.72 The first four indicators give Canadians a sense of what is happening to their taxes and the extent to which they have to contribute relative to the national income. They show that since the early 1970s an increasing percentage of their taxes are going to interest on the debt - the interest bite. They also show that a smaller percentage is going to the programs Canadians receive - the program share. Next, they show that an increasing amount of the expenditures of the federal government is coming from borrowing - the expenditure ratio. Finally, they show that in spite of increased deficit financing, the government has been taking a larger amount out of the economy in the form of taxes to meet its commitments - the tax bite.

5.73 The fifth indicator, the debt-to-GDP, illustrates that, on the whole, the federal public debt has been growing faster than the economy.

The Absence of National Indicators

5.74 Canada is a federated nation with multiple levels of government, each of which accumulates debt in some form or another. The indicators we described shed light on the federal financial condition only. Yet, while there are these multiple levels of government, there is only one taxpayer. This means that, for the average taxpayer, the financial condition of the federal government cannot be viewed in isolation from the entire public sector debt in Canada.

5.75 We believe that it is important to present the trends for each of the five indicators we propose, both for the federal government and for the federal and provincial governments combined, so that Canadians can get a sense of the financial health of all of Canada, not just one level of government.

5.76 In the mid-1980s, the Canadian Institute of Chartered Accountants issued guidelines on general standards of government financial statement presentation in an attempt to standardize government financial reporting across Canada.

5.77 The federal government and the provinces have moved toward implementation of these general standards. However, some have moved more quickly, and further, than others. The result is that there continue to be some inconsistencies in accounting policies among the various jurisdictions. These differences can be significant and, while they can be adjusted for, they seriously hamper the ability to compile consistent, comparable and audited national financial information. In addition, it is difficult to obtain historical data adjusted for these changes in accounting policies.

Summary

5.78 We have suggested, for illustrative purposes, a number of indicators to help Canadians understand public sector deficits and debt. We believe that it is clearly the responsibility of government to define and produce an appropriate set of such indicators. We are aware that the federal government periodically produces indicators, like the interest bite and the debt-to-GDP ratio, in a variety of published reports. We believe, however, that the government should regularly produce a consistent set of indicators consolidated in a single source. In fact, if the government carries through with the Comptroller General's commitment to the Public Accounts Committee to produce a succinct Annual Financial Report of the Government of Canada, this might be an appropriate place to provide them.

5.79 Finally, we believe that the federal and provincial governments should continue to move toward full implementation of the Public Sector Accounting and Auditing Board reporting guidelines. This would make their audited public accounts information consistent. We also believe that the federal government should consolidate and report this information so that Canadians will have the opportunity to understand the symptoms of public sector deficits and debt for all political jurisdictions in Canada. In this regard, we support the initiative that was begun in May 1993, when the federal and provincial ministers of finance met to establish joint objectives for the reduction and elimination of deficits.

Future Trends

A Need for Longer-term Information

5.80 In the "layman's guide" section of this chapter, we indicated that three factors influence annual deficits: expenditures, revenues, and borrowing costs. The corollary of this is that there are only two things causing a large and growing debt - persistent annual deficits incurred over a long period and compounding interest, a point we made in last year's Report. The consequence of this simple fact is that bringing a growing debt under control cannot happen easily in the short term. Yet by the nature of our political system, governments usually present budgets annually and are held to account for their fiscal management at that time, as well as at elections. The problem is that the outward manifestation of bringing deficits and growing debt under control is not necessarily visible in a one- to five-year time frame.

5.81 We believe that the government ought to provide Parliament and the public with information on the long-range direction it is taking in this area. In this section, we propose four indicators for this purpose. They are:

  • debt-to-GDP;
  • interest bite;
  • expenditure ratio; and
  • the full cost of accumulating annual deficits.
5.82 The first three have already been defined in the previous section. The fourth, the "full cost of accumulating annual deficits", is proposed because we think the public ought to get a sense of the true financial cost of accumulating deficits: not just the current cost, but the probable future or downstream costs as well.

The Full Cost of Accumulating Annual Deficits

5.83 When individuals take out loans today, to buy a car for example, a common practice is for lenders to inform them what the total cost of the loan will be when the debt is paid in full. This means calculating the total value of all future payments of the debt, both principal and interest.

5.84 This information is important for public borrowing as well. It would allow Canadians to compare the total cost of annual deficits from one budget to another in order to see the financial implications of missing targets, due either to unexpected economic conditions or to the setting of optimistic assumptions in the hope that this, in itself, might contribute to an improving economy. To illustrate this we compared the 1992 Budget with the 1993 Budget.

5.85 In its 1992 Budget, the government indicated that it expected the 1992-93 deficit to be $27.5 billion. It also provided medium-term targets for economic variables like inflation, unemployment and interest rates. Based on those assumptions, the government stated that by 1996-97 the annual deficit would fall to $5.5 billion and the net debt would be $498 billion. Using these same assumptions, but projecting them a little further, we estimated that by 1997-98 the deficit will be eliminated and the net debt will remain at $498 billion.

5.86 In its 1993 Budget, the government reported that its annual deficit target for 1992-93 had changed and was now expected to be $35.5 billion - $8 billion higher than forecast a year earlier. Based on its new medium-term forecast, the government now expects, that by 1997-98, the deficit will fall to $8 billion and the net accumulated debt will be $563 billion. Using these 1993 assumptions, we estimated that the deficit will be eliminated by 1998-99 and the net debt will stay at $563 billion.

5.87 Exhibit 5.8 compares the two budgets by showing the forecasts for the annual deficits and the net debt for each year from 1992-93 to 1998-99.

5.88 It shows that in its 1993 Budget, when the government announced revisions to its 1992 economic plan, these seemingly small revisions led to an increase of $8 billion in the deficit. By 1998-99, the year in which current government plans are expected to yield a balanced budget, this higher 1993 deficit could lead to an increase of $65 billion in the accumulated net debt. In other words, there is a real cost to missing targets, regardless of the reason.

Longer-term Assessments

5.89 In addition to assessing the total cost of accumulating annual deficits, we should be able to understand the longer-term implications of short- to medium-term plans as set down in budgets. For example, if the five-year economic targets that were announced in the 1993 Budget are met, they will likely lead to a balanced budget by the year 1999. What governments will do if that happens is simply not assessable. Whether they choose to run surpluses or continue to balance the budget is a matter of policy. The only certainty is that, in a growing economy, the impact of the cost of servicing the debt would be lessened.

5.90 Alternatively, if balanced budgets are not in the government's announced medium-term economic plans, or if deviations from current plans occur, both of which appear to generate stability in the medium term, we need a way to assess whether these same plans, if continued, would also lead to long-term stability. To get a sense of this, we developed two "what if" scenarios to illustrate the relationship between medium-term outlooks and the longer term.

5.91 For example, we used our own model to calculate the debt-to-GDP ratio, the interest bite, and the expenditure ratio to the year 2032 using two "what if" scenarios for economic targets that differ from the government's medium-term targets announced in the 1993 Budget. These scenarios, along with the government's 1993 targets, are shown in Exhibit 5.9 .

5.92 In our first "what if" scenario, we used the government's medium-term assumptions for inflation of 1.5 percent and interest rates of 6 percent. However, we set a lower growth figure for GDP - 4.5 percent rather than the 6 percent target used in the 1993 Budget. We also set revenues and expenditures growing at the same rate as GDP - 4.5 percent. In our second scenario, we set inflation at 1.5 percent, GDP, expenditures and revenues growing at 4 percent and interest rates at 6.5 percent.

5.93 We did not establish these scenarios because we believe that the government targets will turn out to be incorrect. On the contrary, we hope that the government forecasts do come true and that the annual deficit will be eliminated by 1998-99. However, expectations are not always met; revenues and GDP do not always grow as fast as expected; governments are sometimes forced to move away from expenditure containment programs; and finally, interest rates do not always remain as low as we would hope. If these deviations occur, it is possible for short- to medium-term results to look as if annual deficits and accumulated debt are being controlled, while the longer-term outlook would show signs of economic instability.

5.94 The results based on these "what if" scenarios are displayed in Exhibits 5.10 and 5.11 . The first scenario shows the interest bite and the expenditure ratio declining very gradually from 1994 to 2003. This would imply that the government would be using a shrinking portion of revenues to meet interest costs and having to borrow a smaller proportion of revenues to meet its expenditures. While this apparent good news is happening, there is the conflicting message of the persistent rise in the debt-to-GDP ratio over the same period, as shown in Exhibit 5.12 . After 2003 the interest bite and expenditure ratio stop declining and stabilize for the next few years. Then they begin to rise. All the while, the debt-to-GDP ratio continues to rise.

5.95 In the second scenario, as illustrated in Exhibits 5.10 and 5.11 , the interest bite and expenditure ratio also decline, but even more gradually than in our first scenario, and level out around 1996. Then they both begin to rise and by 2032 are substantially higher than they are today. All the while, as Exhibit 5.12 shows, the debt-to-GDP ratio rises persistently and more steeply than in the first scenario.

5.96 These two "what if" scenarios illustrate the importance of knowing the long-term implications of short- to medium-term plans. They show that Canadians and their elected representatives need to make sure that governments are aware of these longer-term financial outlooks and report them regularly. Without that vigilance we run the risk of discovering that good financial news is not always what it seems to be, particularly when we look beyond the short- to medium-term signals. In particular we are concerned that people be wary of the argument that says: "We didn't achieve what we set out to do, but at least we are on the right path."

Summary

5.97 Our purpose in focussing on the need for governments to report longer-term trends has been twofold: first, we wanted to illustrate that it costs all of us when governments, on our behalf, persistently accumulate deficits. If governments report that there is a real cost greater than the annual shortfall between expenditures and revenues, just as the total costs of a car loan are greater than the purchase price of the car, we can appreciate the full cost of debt and draw an informed judgment as to whether continuing annual deficits are in our best interest.

5.98 Second, we wanted to illustrate that it is often dangerous to assume that if the short- to medium-term projections lead to acceptable results, the future will also unfold favourably. The point is that we have to be vigilant that governments inform us about the implications of their borrowing, not because they borrow against our wishes but because they borrow on our behalf, and we are not always aware of the implications of that borrowing.

Forum for Rational Discussion

5.99 Last year, Chapter 1 of the Report indicated that, along with the need for simple indicators and future-oriented information, there was a need for a vehicle within our system of government that would allow for rational discussion on this important issue. We continue to believe this is important, but we also believe that part of the problem is with Canadians themselves and their perception of the problem.

Personalizing the Problem

5.100 Canadians need to recognize that annual deficits and accumulated debt are created not just by politicians but by all of us. Political leaders simply meet our demands. We have become all too capable of putting enough pressure on our governments to provide the things we want. We became used to the high rates of real economic growth and low rates of interest in the 1960s and early 1970s and expected them to continue. When they did not, the result was growing deficits for 16 of the last 20 years.

5.101 Even those who believe that the problem with annual deficits is not with excessive expenditures, but with inadequate revenues, would agree that deficits cannot grow relative to GDP in perpetuity. They simply differ with the current government as to where the first priority should be - reducing expenditures versus stimulating job creation and economic growth.

5.102 The problem we have created, with the complicity of government, is in failing to recognize that for every dollar spent, a dollar has to be generated, either by taxation, user charges, or borrowing. Marcel Côté reminded us at the colloquium of the political reality that:

. . . politicians respond to pressures from special interest groups and rely upon the whole population to pay for the resulting costs. Members of special interest groups think that they get a free ride while the rest of society picks up the bill. After a while, everybody belongs to some special interest group, and benefits tend to even out.
5.103 Consistent with this is the mistaken belief that annual deficits and accumulated debt are not our problem but that of the politicians and bureaucrats who created them. Some people think that when governments raise taxes they should do all they can to escape paying. But those who behave in this way also expect to continue to receive their education and health services and the many other social benefits they have become all too accustomed to receiving from their government.

5.104 Deficits and debt are everyone's problem. Until we personalize them and make the numbers and the information behind the numbers more meaningful to individual Canadians, not simply by expressing them in per capita terms, we will live in a way that is consistent with the expression: "Don't tax you, don't tax me, tax the fellow behind the tree."

A Parliamentary Forum

5.105 Taking ownership of the problem is only part of the issue. We also have to feel that we are part of the solution. That means feeling that our concerns about deficits and debt are being listened to and discussed rationally by our elected representatives.

5.106 Concerns about a receptive and responsive parliamentary government are not new. They were raised by the Lambert Commission in 1979, by public accounts committees in the past, by previous ministers of Finance and by the Prime Minister.

5.107 In June 1993, the Public Policy Forum issued a report entitled Making Government Work . That report began with the following comment:

Canadians are alienated from the institutions and processes which govern them at precisely the moment when they are being asked to absorb economic body blows. Canadian society has changed rapidly in the past few decades, and government has failed to keep pace.
5.108 That report went on to comment on the need for change that included "relaxing the command and control administration of . . . party caucus." It argued the need for this because it saw "power as being too highly concentrated in the hands of the Prime Minister and Cabinet with a correspondingly limited role for Parliament." We reported these very same problems and constraints in Chapter 6 of last year's Report, when we commented on the frustrations of ordinary members of Parliament in not having any influence on the annual spending of money.

5.109 The Public Policy Forum document calls for an opening up of the budget process so that parliamentary committees can have a meaningful role. It reminded members that:

Governments and opposition parties alike are responsible for this situation: the former by invoking the principle of budget secrecy to justify announcing measures without open consultation . . . the latter by demanding resignation when there is advance disclosure of any budget item, no matter how innocuous. . . .
5.110 The report calls for the tabling of budgetary information and plans sufficiently early to allow parliamentary and public input before final decisions are made. It also suggests that this could be done within our Western style of parliamentary democracy.

5.111 The Lambert Commission proposed 14 years ago that the government provide Parliament with an autumn accounting of its fiscal plans and proposals for the coming five years. We concur with this timing because it would be consistent with the tabling of the Public Accounts and the proposed Annual Financial Report.

5.112 Most recently, the Minister of Finance issued a news release entitled Opening Up the Budget , where he indicated that a fall presentation to Parliament ". . . will provide for a more open consultation process by publicly announcing economic, fiscal and other major policy options under consideration and involving parliamentarians and the public more fully."

5.113 All this information could be referred to a standing committee for discussion. This approach could also provide a forum for the government to present its anticipated succinct annual financial report, which might include our suggested indicators on deficits and debt, as well as the indicators of future trends. In this way, the government could make very useful information available to Parliament before the government is committed to a budget that will continue to generate parliamentary confrontation. In this way, members of Parliament could see future plans along with past performance and debate them before government plans are etched in stone.

5.114 Opening up the budget process to allow parliamentarians to participate would certainly contribute to a more meaningful dialogue on deficits, debt and the expectations of the public. However, there would still remain the stumbling block known in our parliamentary institution as the confidence convention: the notion that the party forming the government must be able to demonstrate that it enjoys the support of a majority of the members of the House of Commons on most pieces of financial legislation. The Standing Committee on House Management noted in its April 1993 report on reforming the House that to change this confidence convention does not require amendments to the Standing Orders of the House of Commons. Rather it requires a better understanding of the rights and responsibilities of individual members and a recognition that "Canadians want to feel that their members of Parliament have opportunities to vote freely and they expect them to do it more often."

5.115 The Standing Committee's concerns with the confidence convention, particularly as they relate to the House of Commons' review of the Estimates, are directly related to the lack of respect, or time, that members of the House give to the financial business of the executive. Yet the "power of the purse" is a fundamental responsibility of the House that was won many centuries ago at enormous cost.

5.116 We do not believe that the Auditor General needs to add to the many useful suggestions that are already available publicly on ways to improve the commitment of members of Parliament to the financial affairs of the country. The three reports we have referred to, along with the many past proposals for budget reform by the government, including the most recent one by the Minister of Finance on 10 August 1993 and the speech by the Prime Minister the day before, speak eloquently on this matter. Opening up the budget process, and providing Parliament with more complete information in the autumn, including broad-based spending information, would allow for a more informed debate and greater input from Parliament and the public.

5.117 We recognize that this is a complex business and that we have only touched the surface. There are many other issues that affect the effectiveness of the role of parliamentarians, like the size and skills of their staff, as well as their access to sensitive information. These matters, as well as others, require much more study than we have given them. But overall, we think that the reforms currently proposed can only make a positive contribution to the financial management of the country. We strongly support any action that encourages members of Parliament to take a more active and constructive approach to the financial affairs of our nation.

Conclusion

5.118 This chapter is about information on deficits and debt. We focussed on a better understanding of the meaning of the federal government's annual deficits and accumulated debt so that members of Parliament and all Canadians could appreciate the difficulty in dealing with the significant gap between expenditures and revenues. We reminded everyone that coming to terms with this financial problem will not be done by reducing expenditures through the elimination of waste or by administrative reform alone. It will also require a rethinking of the services that we, as Canadians, have come to expect of the government. And it will all have to be done in a way that does not inhibit growth in the Canadian economy and the essential investment in our future.

5.119 To enhance the average Canadian's understanding of the financial health of the federal public sector, we proposed a number of simple indicators as an illustration of the kind of information the government should produce to allow Canadians to appreciate the persistence of deficits and growing debt.

5.120 We also illustrated the importance of the need for information about medium- to longer-term trends, so that Canadians would be more critical of claims that we are on the right path even though we have not met our targets. We showed how optimistic short- to medium-term projections may not always lead to a healthy longer-term outlook.

5.121 We reminded all Canadians that persistent annual deficits and growing debt are not the government's problem, but everyone's problem. Governments did not create this debt without our approbation. Solving it will require the willingness of everyone, not at the expense of others but by the combined efforts of all of us.

5.122 Yet, in spite of the growing concern that many people have had about deficits and debt, Parliament has not provided fertile ground for a meaningful dialogue among our elected representatives to address these concerns. Proposals for parliamentary reform to open up the budget process and to encourage parliamentary input in the fiscal plans of government have been made continually over the last decade. A parliamentary forum to debate these issues is necessary if we are to understand and reach a consensus for dealing with these persistent deficits and the growing debt.

5.123 In conclusion, we remind Canadians that public sector deficits and debt are not the sole purview of the federal government. In a federal state with multiple layers of government, persistent annual deficits and growing accumulated debt are everyone's problem. In her background paper for our colloquium, Judith Maxwell pointed out that there are three governments and only one taxpayer. Donald Savoie reminded us that provincial governments, faced with reduced federal transfers "either cut or reduce their level of service, or increase taxes or their own annual deficits." This means that no one level of government can reduce its deficit and debt burden at the expense of another. Nor can any one level of government solve its financial problem, particularly in the eyes of the investment community, until all governments in Canada do so. We may be in separate cabins, but we are all in the same boat.

5.124 The more informed Canadians become on the subject, the easier it will be for our political leaders to make the difficult decisions.