1995 Vol 1, No. 1

1995 Vol 1, No. 1

The Debt and the Deficit: Myth and Reality

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How Paul Martin's Budget Will Affect YOU

Paul Martin's recent budget contained the biggest cuts to federal government spending since the demobilization of Canadian forces after World War II. The cutbacks in social spending and federal programs contained in this budget will cause real economic and personal hardship for hundreds of thousands of Canadians, and will fundamentally reshape Canadian society. For example, once the cuts are implemented, our federal government will be spending far less on programs (as a share of our GDP) than the U.S. federal government. Canadians have long believed that it was our larger public sector and more humane social programs which made us distinct from Americans. What will be left of our national identity once these cuts are completed?

Government and business leaders claim that there is simply no alternative to massive cuts in public programs. We are told that this is the only solution to Canada's growing debt problem. But is it really out-of-control public programs that have caused the deficit and the debt? When we examine the facts, we see that government has been getting smaller, not bigger--according to any number of measures, including government employment, program spending, or the generosity of our social programs. And our economy has become steadily more productive. So why can't we afford programs that we took for granted 20 years ago?

The real cause of our debt and deficit problem lies in the operation of the financial system. We have suffered from interest rates that have remained very high (relative to inflation) for the last 15 years, creating a long-run debt crisis that is now reaching its climax. These interest rates have created our debt, not "out-of-control" spending. And contrary to the promises of the financial wizards, interest rates are staying high, despite the federal spending cuts. One week after the budget, the prime lending rate at Canadian banks reached its highest level in two years.

The real problem is rooted in unstable global financial flows; unless we get the financial system under control, and bring interest rates down, there is no hope of avoiding a major debt meltdown. Let's look at some of the real facts behind our debt and deficit problems.

Too Much Public Spending?

First, is it true that government spending is out of control? Figure 1 shows that relative to Canada's population and total output, the number of federal civil servants (the solid line) and spending on actual federal government services (the dotted line) have been declining steadily for almost two decades.

By the third year of Paul Martin's cutbacks, our federal government will be smaller (in terms of both employment and programs) than it has been since the early 1960s. We are witnessing the dismantling of the welfare state that was built up in Canada through the 1960s and 1970s.

Not only has our government been getting smaller over the years, but Canadians have been paying more than enough taxes to support our slimmed-down public sector. Figure 2 compares federal revenues (the solid line) with spending on current programs and services, including transfer payments to other levels of government and to individual Canadians (the dotted line). In most years we have consistently collected more than enough taxes to pay for what the federal government does; relative to our actual spending, we have a surplus (called an "operating surplus"), not a deficit. By 1997, under Paul Martin's plan, this surplus will grow to $30 billion per year. In other words, we will be paying $30 billion per year more in taxes than we receive in actual government services and programs.

Government has been downsized. Taxes have increased, and are sufficient to pay for our public sector. So what has caused the deficit? The problem is that escalating interest payments have swamped the operating surplus, so that the government is still left with a deficit. Figure 3 shows that it is these interest payments (dotted line), most of which are received by well-off

investors and bond-holders, that explains the rise of our deficit (solid line) over the past 15 years. Even with Martin's huge cutbacks and a $30 billion operating surplus, in 1997 we will still have a forecast deficit of over $13 billion per year. Despite high taxes and reduced services, the public debt will still be growing, and Canadian taxpayers becoming even more in hock to the financiers.

Interest Rates & the Permanent Recession

Our current debt crisis can be traced back 15 years to the advent of very high interest rates. As shown in Figure 4, real interest rates (the interest rate minus the inflation rate) increased dramatically starting in about 1980. The average short-term rate rose by 600%; the average longer-run rate paid by the federal government more than doubled.

It was argued that these rates were needed to fight inflation. But they have stayed with us despite the virtual elimination of inflation. In reality, high interest rates shift economic power from producers to wealth-owners. They slow down the economy, creating a "permanent recession"; even in good economic times, growth is very slow by historic standards. High rates also create permanent unemployment to undermine workers and unions; and they allow investors to earn huge profits on safe, unproductive "paper" investments.

For example, Figure 5 shows the dramatic changes in labour markets since the onset of the permanent recession. Unemployment has doubled, on average; as a result, real wages have been declining. High interest rates slow down economic growth by increasing the cost of business investment and major consumer purchases. And economic stagnation automatically creates public deficits, for two reasons: tax revenues fall (as people are laid off and consumer spending falls), but the cost of social programs like UI increases (due to higher unemployment).

From 1950 to 1980, the average rate of economic growth in Canada was over 5%--faster than the 4.5% growth we experienced for one year in 1994, a very good year for Canada's economy, and more than twice as fast as average growth since 1980. As Figure 6 shows, this allowed the federal government to have a roughly balanced budget during this time, despite the fact that we dramatically expanded our public sector and social programs. Since 1980, however, with permanent economic stagnation, our deficit has ballooned--not because of out-of-control spending, but because of high interest rates.

Regulating Big Money: The Only Solution

Fifteen years of chronic deficits have now piled up into a huge, long-run debt burden for Canadian taxpayers. The only possible solution is to address the true cause of our financial crisis: high interest rates and slow growth. Paul Martin's "slash-and-burn" strategy cannot work: it doesn't touch the high interest rates which are the true problem, and it only worsens the underlying weakness in the economy (by cutting spending and eliminating jobs). The only solution is to bring interest rates down and rejuvenate economic growth. (The next issue of Economic and Social Action will contained detailed suggestions on how interest rates could be reduced.)

Dramatic proof of this is provided in Figure 7. The top line shows our actual federal deficit (as a share of GDP). The bottom line shows the deficit if the real interest rate on federal debt had remained at the same level as during 1950-1980 (instead of doubling after 1980). And this doesn't take into account the positive impacts of lower interest rates on economic growth; it only considers the effect of lower rates on the government's own interest payments. Were it not for higher interest rates, we would have a balanced budget today.

The CAW recently participated in a cooperative effort to design an Alternative Federal Budget. This budget was based on lowering interest rates and stimulating economic growth. Thanks to the spin-off benefits of faster growth for the federal treasury, this alternate budget was able to meet the same deficit reduction goal as Paul Martin, while actually increasing federal support for UI and transfer payments to the provinces. Table 1 compares the main features of the Alternative Budget and Paul Martin's budget.

Recession and Deficits: Who Benefits?

We are told that we must all tighten our belts to help solve Canada's debt crisis. But in reality, not everyone is being asked to suffer, and some lucky individuals are benefiting in a big way. For example, as shown in Figure 8, working and middle-class Canadians are paying more income taxes to help offset the huge interest payments to generally well-off investors and bond-holders. But average tax rates for corporations (who earned all-time record profits in Canada in 1994), and the income tax rate for high-income Canadians, both declined thanks to generous tax breaks.

In fact, the debt and the deficit themselves--while they are a huge burden for Canadian taxpayers and the public sector--are actually money in the pocket for investors. By 1997 we will pay out over $50 billion per year in interest payments to financial institutions and bond-holders. This is far more than we spend on all of the social programs that were recently reviewed by Human Resources Minister Lloyd Axworthy (including UI, post-secondary education, and welfare and child poverty benefits). High-income households and foreign investors receive the lion's share of these interest payments; the most recent statistics (for 1992) indicate that some 45% of all investment income in Canada is received by the richest one-fifth of households. Interest payments are definitely a welfare program for well-off investors--the most expensive welfare program we have.

Canada's banks and financial institutions have also profited handsomely from the financial crisis of our government. What shows up as a liability for taxpayers (our huge debt) is at the same time a lucrative asset for these financiers. Canada's chartered banks received record profits last year of over $4 billion, fuelled largely by the same rise in interest rates which is bankrupting our government. Details on bank profits and outlandish bank salaries are provided in Table 2. As shown in Figure 9, the assets of the banks (dotted line) have also grown very rapidly--about as fast in recent years as has the public debt (solid line)! This is not surprising, since the banks themselves own a large and growing share of the federal debt--$75 billion last year and growing. Taxpayer's dollars are funnelled directly to the banks in the form of interest on this debt. Banks are even allowed to recycle these assets into other profit-making loans; our federal debt quite literally gives the banks a license to print money.

How Will the Budget Affect Workers?

The banks and bond-holders are clearly profiting from our financial mess; they are not being asked to tighten their belts. But for most Canadian workers, our whole economic direction--not just the budget itself--poses a dire threat. We are heading for a grim, hyper-competitive, U.S.-style economy and labour market. High interest rates will keep the economy unsteady and unemployment high. The starvation of the public sector will undermine our "social wage": that is, the value of services we receive by virtue of being citizens, not just workers. The "flexible", low-wage labour market will weaken protections for workers--including UI, labour standards, and bargaining rights.

In the long-run, with our public sector shrinking back to the size of the 1950s, we can expect the labour market to start to revert back to the 1950s as well--when unions were weak, minimum wages non-existent, wages and benefits very low. The expansion of public programs through the 1960s and 1970s provided a basis for the real wage gains that workers won in the private sector. A strong economy and a strong public sector gave workers more options: other jobs to go to, other sources of income to fall back on. This strengthened our bargaining position with employers, and underwrote our bargaining victories during this time. The current attempt to dismantle the postwar welfare state is motivated primarily by the desire of employers to undo these gains. The economic direction heralded by this budget will ultimately hurt all workers in Canada--private sector or public sector.

The budget will also have some specific, immediate impacts on workers and on upcoming bargaining. Here are some highlights:

Unemployment Insurance:
Martin announced another $700 million annual cut to UI, on top of the $2.4 billion he cut last year. Unemployed workers are thus contributing over $3 billion per year to deficit reduction. It will be even harder to obtain bene-fits, especially in hard-hit regions of the country. Already, the share of unemployed Canadians who can qualify for UI has fallen almost as low as in the U.S. JM/lc/opeiu343 One important implication of this for collective bargaining is an increase in the cost of SUB plans. Because SUB programs top-up UI payments to a certain negotiated percentage of earnings, a rela-tively small cut to UI can have a huge effect on SUB premiums. Last year's UI cut doubled the average cost of a typi-cal SUB plan; this year's cut will add another one-third. We can expect fierce demands from employers to either down-grade SUB protection or else offer offsetting concessions in other bene-fits. Ultimately, even without concessions, SUB benefits will not be paid if the SUB plans are bankrupt.
Health Benefits:
With major cuts in transfers to the provinces, we can expect further privatization of our health-care system--more excluded procedures, more co-payments. We can attempt to cover these costs at the bargaining table, but they will be expensive for employers, and will affect our ability to win higher wages. The ultimate cost at the bargaining table of negotiating expanded health insurance: $1000 or more per worker per year.
Transforming the Social Wage into a Private Wage:
By cutting back the provision of socialized benefits, the government is essentially offloading their costs onto the private-sector bargaining process. Many Canadians (who lack a union) will be unable to recoup these costs, heightening social inequal-ity and tension. Even where unions can negotiate private alternatives to public services, the costs will be high for both workers and employers. For exam-ple, in the U.S. (where many more bene-fits are provided privately), non-wage benefits in manufacturing cost $3500 per year per employee more than in Canada. Trying to negotiate these additional benefits in Canada will prevent us from winning other wage and benefit improve-ments; ironically, it will also elim-inate an important source of Canada's current cost advantage in manufacturing.
Taxes on Benefits:
Ironically, even while offloading benefits to the private sector, there are hints that those benefits may become taxable in future years (as they are in Quebec and B.C.). This would reduce a worker's take-home pay by as much as $3000 per year.
Severance Payments:
Until now, workers who received a retirement allowance or some other form of severance package could transfer $2000 per year of service into an RRSP. This allowance will be phased out by excluding years of service after 1995. This amounts to a special tax on laid-off workers.

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