The risk of American elephant tail



Pierre Trudeau pondered the influence of the United States on Canada, comparing it to sleeping next to an elephant. No matter how well intentioned the pachyderm is, “… you get affected by every twitch and growl,” he said.

This is most certainly true of US fiscal policy, says Martin Eichenbaum, professor of economics at Northwestern University, in his remarks for the Jack Mintz Conference from the CD Howe Institute.

Dr Eichenbaum, an international researcher at the institute, says that Canada’s fiscal policy, even if Ottawa continues with larger deficits, is probably not in a dangerous zone, as gross domestic product growth would continue to exceed the debt growth. As long as GDP growth rates are higher than the interest rate on public debt, a country’s debt burden will decrease relative to the size of the economy. Or, in mathematical terms, if rg, then a fiscal disaster looms.

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The Northwestern University professor warns that assurances that Canada’s relatively positive fiscal position is on the right side of this equation misses the real danger – that the United States is not. Canada had primary surpluses (the budget balance excluding debt service charges) before the pandemic. The United States was not. Even if interest rates hit zero, the United States would still have a large deficit.

Of course, interest rates will rise sooner or later. And as Dr. Eichenbaum points out, it won’t take much hike to push America’s finances into dangerous territory. Interest rates must be at least 3.5 percentage points lower than GDP growth to keep the US debt burden from rising relative to the economy. It would be far from being in sync with the patterns of the past two decades. Without serious deficit cuts, the United States could head into a scenario where international markets conclude that the country’s finances are unsustainable, he argues. In this event, US interest rates would skyrocket and economic growth would collapse.

This economic pain, much more than a tick or a growl, would rumble across the border. The likelihood of such a fiscal disaster may seem remote – just an American elephant tail risk – but Canada would be well advised to purchase insurance, in the form of locking in long-term debt at low rates. today, the professor says Eichenbaum.

Tax matters

In response to a recent Tax and Spend report on how Ottawa’s pandemic-related spending resulted in a boon to the provinces, an online reader asked if there had been an increase in tax revenue from sale in addition to the unexpected increase in personal and corporate income taxes. In his Final accounts for fiscal year 2020-21, Ontario disclosed a relatively small increase in its sales tax revenue, at least compared to its budget projections. Sales tax revenue was $ 26.6 billion, more than the budget estimate of $ 24.9 billion, but lower than the $ 28.6 billion in 2019-20. In contrast, personal and corporate income taxes were both higher in 2020-2021 than in 2019-20. Part of the reason for this much weaker effect: The hundreds of billions of dollars that have been swallowed up – including funds to support the Ottawa pandemic – have yet to be spent. So this sales tax increase may well happen, but not quite yet.

Campaign element

Hiring freeze: It has been four months since Ottawa launched its latest wage subsidy, the Hiring Canada Stimulus Program (CRHP). But the Canada Revenue Agency has yet to fulfill its pledge to release data on the program, which pays employers up to 50 percent of the increase in salary expenses. The agency has diligently released regular updates on Canada’s Emergency Wage Subsidy Program, starting shortly after its launch in May 2020. This is not the case for the CRHP; So far, there has been no visibility into how the hundreds of millions of dollars budgeted for the program are being spent. The Liberals have pledged to extend the CRHP until the end of the fiscal year, bringing the total projected cost of the program to around $ 1 billion – and giving the CRA an additional five months to share data on the program.

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