Budget season is coming up, and finance ministers across the country will be asking for plenty of advice. My suggestion for federal finance minister Chrystia Freeland is simple: Budget 2023 should contain a full chapter devoted to some of the fiscal challenges in our future, and why these should lead the federal government to begin some tough conversations with Canadians.
There are three big challenges to think about: the certain, the highly likely, and the probable.
The certain fiscal challenge is population aging. The Baby Boom generation, those born in the fifteen or so years after 1946, started retiring in the past several years and this process will continue for the next decade or so. As these people hit 65, they receive Old Age Security and maybe the Guaranteed Income Supplement, which combined is the single largest and fastest growing item in the federal budget—this year it is about $60 billion, and growing by several billion dollars annually. Many of these seniors will place heightened demands on our health-care system, and these costs are much larger for seniors than for younger Canadians. Provincial finance ministers know that health care is their largest and fastest growing item budget item, typically about 45 percent of their total spending. Altogether, these age-related expenditures are projected to rise by between three and four percentage points of national income over the next twenty years. So the federal government will be directly on the hook for the rising OAS and GIS costs, and will be facing increased demands from the provinces to transfer more and more money for provincially delivered health care. We are seeing this already, and it’s going to get worse in the years ahead.
The second fiscal challenge is the highly likely increase in public spending associated with achieving “net zero” carbon emissions by 2050. Climate change itself is certain, and the federal government has adopted a pretty clear climate plan, including a nation-wide carbon price that will rise to $170 per tonne by 2030. What is not yet clear is exactly how our economy will be transformed to achieve the net-zero goal, and how much public investment will be required along the way. But since the transition to net zero emissions will require the scaling up of existing clean technologies and the development of new ones, and since there will be much uncertainty along the way that makes private investment even riskier than usual, it is hard to believe that any future federal government will not commit significant public funding to this objective. We can’t put a precise number on how much public investment is likely to occur, but it will surely be measured in the tens of billions of dollars over the next several years.
The third challenge is the probable next economic crisis. Actually, it is certain that some crisis will occur—we just don’t know when or what type it will be. A recession in the near future is pretty likely, driven in part by the Bank of Canada’s interest-rate increases designed to bring down inflation. But this might be only the beginning. Perhaps Canadian house prices will collapse sharply, rather than decline gently as they have been doing for the past year. If house prices collapsed, we would likely avoid the worst of the financial crisis that occurred a decade ago in the United States, but there would no doubt be a recession which the federal government would choose to fight with significant increases in public spending, as it did back then. That “fiscal stimulus” amounted to about 5 percent of national income and lasted for two years. Or perhaps the next crisis will be another pandemic which will lead the federal government to provide the same kind of massive financial relief—roughly 15 percent of national income—that it did during the COVID-19 pandemic. Or maybe the next crisis will be something we’ve never experienced before, and which costs even more to address. We obviously can’t know.
But we can choose to be prepared. All three of these challenges will require new federal spending, and in some cases the demands will be very large. Minister Freeland can demonstrate her wisdom and fiscal prudence by acknowledging these challenges in budget 2023 and by starting to lay the groundwork for addressing them. If she does so, she stands the chance of having as superb a long-term reputation as Paul Martin, the Liberal finance minister who made difficult fiscal decisions in the mid 1990s and who is appropriately credited for bringing the government’s fiscal books back onto a solid footing.
At the heart of fiscal prudence is a recognition of the limits to public spending. There are limits to how much spending can be financed through higher taxation, as increasing income-tax rates is both politically unpopular and economically damaging. Limits also exist if the government takes the politically easier route of financing spending with budget deficits. If bondholders are not convinced of the government’s ability to service and repay the debt, the interest rates on the newly issued debt will rise, perhaps suddenly. Canada learned this lesson the hard way back in the mid-1990s, as did the short-lived British Prime Minister just a few months ago.
Simply spending more public money to address our future challenges is not prudent; but neither is ignoring the challenges themselves. Instead, the federal government needs to start thinking about the more difficult alternatives. Does some low-priority public spending need to be sacrificed to make room for the more important spending items? If so, this requires a serious conversation about priorities, which always tends to be divisive. Minister Freeland could demonstrate her wisdom on this point by launching a new “program review”, as was successfully done in the mid 1990s under the Chretien government. Do taxes need to rise and, if so, which ones and by how much? This requires a challenging discussion of how to reform our tax system, which is overdue in Canada—the previous tax reform having occurred in the late 1980s under the Mulroney government. Does fiscal prudence also require that the government brings its debt-to-GDP ratio quickly back to something like 35 percent so that it has the flexibility for an aggressive fiscal response when the next crisis occurs? Or do our still-low-but-rising interest rates mean that the government is safe to have a higher debt-to-GDP ratio?
These are not simple issues, and I don’t claim to have all the answers (though I certainly have some views). But the real point here is that Canadians need to be thinking about these issues in a careful and dispassionate way. And the best person in the federal government to lead this difficult conversation is the minister of finance, Chrystia Freeland. Will she take up the challenge?
This article was originally published in The Line.
About the Author 
Chris Ragan is an Associate Professor and the founding Director of McGill University’s Max Bell School of Public Policy.
Ragan was the Chair of Canada’s Ecofiscal Commission, which launched in November 2014 with a 5-year horizon to identify policy options to improve environmental and economic performance in Canada. He was also a member of the federal finance minister’s Advisory Council on Economic Growth, which operated from early 2016 to mid 2019. During 2010-12 he was the President of the Ottawa Economics Association. From 2010-13, Ragan held the David Dodge Chair in Monetary Policy at the C.D. Howe Institute, and for many years was a member of the Institute’s Monetary Policy Council. In 2009-10, Ragan served as the Clifford Clark Visiting Economist at Finance Canada; in 2004-05 he served as Special Advisor to the Governor of the Bank of Canada.
Chris Ragan’s published research focuses mostly on the conduct of macroeconomic policy. His 2004 book, co-edited with William Watson, is called Is the Debt War Over? In 2007 he published A Canadian Priorities Agenda, co-edited with Jeremy Leonard and France St-Hilaire from the Institute for Research on Public Policy. The Ecofiscal Commission’s The Way Forward (2015) was awarded the prestigious Doug Purvis Memorial Prize for the best work in Canadian economic policy.
Ragan is an enthusiastic teacher and public communicator. In 2007 he was awarded the Noel Fieldhouse teaching prize at McGill. He is the author of Economics (formerly co-authored with Richard Lipsey), which after sixteen editions is still the most widely used introductory economics textbook in Canada. Ragan also writes frequent columns for newspapers, most often in The Globe and Mail. He teaches in several MBA and Executive MBA programs, including at McGill, EDHEC in France, and in special courses offered by McKinsey & Company. He gives dozens of public speeches every year.
Ragan received his B.A. (Honours) in economics in 1984 from the University of Victoria and his M.A. in economics from Queen’s University in 1985. He then moved to Cambridge, Massachusetts where he completed his Ph.D. in economics at M.I.T. in 1989.
