The Finance Minister presented a budget ripe with spending, and deficient in responsibility. Canada’s been plunged back into the red, and there’s no way out of this hole for the foreseeable future. At least, Rona Ambrose and my Newsfeed say so.

But is the deficit as big as Mr. Morneau would have you believe? Not quite.

Deficit Projection and Accounting Fun

Revenues and expenditures are dictated by economic conditions. When consumption booms, tax receipts sky rocket and welfare/EI claims plummet. The opposite happens during a bust. Today we sit somewhere between a bust and boom.

The average private sector prediction for 2016’s real GDP growth is 1.4%. The government has lopped 0.4% off that prediction, leaving us a paltry 1.0% growth rate. Keeping with its pessimistic outlook, the Department of Finance has predicted oil will average $25 2016, 38% lower than the average private forecast of $40/bbl.

The Ministry is exercising caution. It topped its deficit forecast with a $6 billion contingency fund, in case the situation further deteriorates. Mr. Morneau also calculates a $6 billion revenue impact from the 0.4% they’ve removed from the growth forecast.

The Department’s skeptical economic outlook is warranted. Global headwinds have caused consistent downward revisions to most countries’ fiscal balance. Times are tough.

But Canada’s fundamentals are strong. Employment has increased by 125,000 people since October 2014. Non-energy GDP is up 2.2% in 2015. American imports of Canadian goods are set to rise, given the appreciation of the USD combined with normalization of Federal Reserve policy.

Things appear rosier than the Federal Government would like to admit. The table below is pulled straight from the budget. The red line represents the government’s 1.0% growth scenario, the green is 1.4%, and the dashed yellow line is the average of the 4 highest projections (unlikely).

The Actual Deficit

Assume private sector economists are correct, and we also don’t spend the contingency fund. That is $12 billion removed from the shortfall. This leaves us at a deficit of $17.4 billion, rather than the advertised $29.4 billion.

The Martin budgets ran a similar strategy, presenting low growth projections and surprising us with bountiful surpluses. Don’t be surprised if Mr. Morneau’s nominal budget deficit falls somewhere in the high teens or low twenties.

How Big is $29.4 Billion?

For the purposes of this section, let’s start with a $29 billion deficit. It’s a scary number. It is about half the size of Prime Minister Harper’s deficit at the height of the Great Recession. However, dealing in absolute numbers is not useful. $1000 is a lot of money to me. It doesn’t mean it counts.

Deficit-to-GDP is a useful measure. It is the ratio of the size of the deficit to the total GDP in a given year. It scales well: rich countries can run big deficits, poor countries must run proportionally smaller ones.

If the deficit is $29.4 billion, the deficit-to-GDP is approximately 1.5%. How does this compare to other deficits? In 2010, the deficit was 3.8%. In 1985, one of our worst fiscal years, the deficit was 8.3%. But 2016 isn’t 2010 or 1985.

The chart below goes back to 1950. I’ve drawn in approximately where the new deficit would fall (forgive the crude attempt).

The red blip is moderate, compared to historical levels. Neither huge nor negligible.

If the deficit is $17.4 billion, as projected in our earlier estimate, deficit-GDP is 0.9%, and the chart looks like this.

What’s it going to Cost Us?

The government’s fiscal anchor is reducing the debt-to-GDP ratio. It measures the size of our debt relative to our total Gross Domestic Product. It is a nice measurement of the size of debt, but doesn’t tell us much about fiscal burden and risk.

Greece’s debt-GDP was 105% before their crisis. The US is stable, hovering around 100%. Japan is humming along at 230%. The percentage-level isn’t a telling measure of fiscal sustainability. The movement in the level is what tells the story.

The Budget commits to reducing debt-GDP by 0.3% over 5 years, incurring temporal increases and decreases through that frame. Overall, debt-GDP remains stable. Our ability to raise revenues (if need be) to pay debt remains unchanged.

But debt-GDP doesn’t say much of debt servicing costs within our current fiscal scenario.

2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 Revenues 291.2 287.7 302 315.3 329.3 344.4 Expenses 270.9 291.4 304.6 308.7 314.2 323.2 Debt Charges 25.7 25.7 26.4 29.4 32.8 35.5 Debt Charges %Revenues 8.83% 8.93% 8.74% 9.32% 9.96% 10.31% Debt %GDP 31.20% 32.50% 32.40% 32.10% 31.60% 30.90%

The above table is the projected fiscal outlook. Direct your attention to Debt Charges as a Percentage of Revenues. This is the percentage of revenue the government will dedicate to paying down our debt. And, most of the time, it grows. Now most that increase is our repayment of the Economic Action Plan. But 5-10 years down the line, you’ll probably see that line begin to increase again due to the current deficit.

That is the cost of deficits. It is neither massive nor small. But that estimate, as well as the Debt-to-GDP estimate, is predicated on the assumption of a –very- low growth environment. I think they’re underpromising.

The Actual Actual Deficit

Most municipal governments operate their finances through two accounts: capital and consumption accounts. The City of Ottawa separates its Light Rail/Transit account from its day-to-day account. Consumption balances, while capital requires borrowing. Corporations function similarly, using financial markets to drive their growth.

If investment funds are allocated by rule, debt-equity, or debt-GDP in the national case, should remain on target. We can infer that Canada targets a debt-GDP level below 31.2%, given the behavior of the current and previous governments.

Canada’s Federal government operates this way. Consumption is near balance, on average, but investment is borrowed. Meanwhile, debt-GDP falls.

So, what’s the actual deficit.

Assuming growth hits 1.4%, which means the contingency fund won’t be used, the nominal deficit is $17.4 billion. But what if we account for our capital account? I argue that our capital account is infrastructure spending. It generates some return in productivity gains and decreased future spending commitments. It might not be an incredible investment, but it is a capital account.

The Budget allocates $11.9 billion to infrastructure. Subtracting that from the adjusted nominal deficit of $17.4 billion, we have a $5.5 billion deficit. This number accounts for private sector predicted growth, an unused contingency fund, and a capital account. Again, this is contingent on a debt-GDP ratio that approaches a certain target, which is what the Canadian government has done for some time.

I understand that a split capital and consumption account is not what is presented in our budgets, but it is how governments seem to operate (even if they don’t tell you).

What Does a $5.5 Billion Deficit Mean?

5.5 sounds a lot smaller than 29.4. Because it is. It also means that if normal growth is somewhere around 2%, the budget should balance on average. That means, over time, we’re on track to nearly eliminate the Canadian debt.

I think Mr. Morneau is fully aware of this. We’re on a fiscally stable path, and Canadians shouldn’t anguish over the state of our finances. Many do not like to admit it, but the previous government left the new government with a cyclical surplus in the consumption account. The new government has done the unpopular thing and pledged to run what will likely be permanent nominal deficits.

Budget 2016 gets Two Thumbs Up.

I hope this little write-up has taught you that nominal deficits aren’t necessarily real, and big numbers aren’t scary when you use ratios.

Miscellaneous Thoughts

If the Debt-GDP target is below 31.2%, I wonder what it is. There are some interesting arguments stating government debt needs to exist at some low level to provide liquidity in the bond market. But I don’t know.

The Budget attributes a 1.5% decline in GDP to the oil shock. That’s huge! Does that mean growth would be 2.5-3% otherwise? I have a hard time believing that.

125,000 jobs were added, but unemployment still went up. The Budget chalks that up to increased labour participation, which is sometimes a great sign. I’d call it ambiguous.

The budget acknowledges that the personal income tax changes and family benefits have zero stimulative effect on the economy. 80% of the stimulus is infrastructure spending.

They don’t include the stimulant effect of infrastructure spending in the 1.0% growth scenario, which is really weird. So if you add the stimulus to their forecast, it becomes 1.4%. Consider that private sector economists probably factored expected stimulus spending into their projections. Something smells fishy with their accounting.

Splitting consumption and capital accounts is probably never going to happen. But I think it’s how they operate de facto. They just don’t really talk about it.