How much of a COVID-19 bailout can the federal government afford?
Preliminary estimates based on federal bailout announcements to April 22
- APEC estimates the federal government still has plenty of fiscal capacity to continue its COVID-19 bailout. This is because Canada’s federal debt-to-GDP ratios are low relative to other advanced economies and the extra tax revenues to service the higher debt are currently relatively modest.
- Existing measures are necessary to help individuals, businesses and other organizations bridge the gap until they can start working and producing again.
- The full scope and duration of the required bailout and stimulus for the recovery is still unknown.
- It is important to understand that all Canadians will be paying for these deficit-financed bailouts in higher tax rates (or reduced spending) for years to come.
- The federal deficit in 2020/21 was projected to be $28 billion before COVID-19. APEC projects it will increase to about $200 billion (over 9% of GDP) due to the economic shutdown and federal support programs.
- The federal debt-to-GDP ratio was projected to be 31% before COVID-19. The federal debt-to-GDP ratio is currently low relative to other developed countries. However, this is not the case when debts of all levels of government are considered.
- A decline in nominal GDP in 2020 will increase the baseline federal debt-to-GDP ratio to 33%. An increase in the deficit due to lower revenues and increased spending will increase the debt-to-GDP ratio to 41%.
COVID-19 Bailout Costs
- As of April 22, APEC estimates existing federal COVID-19 direct supports to individuals, businesses and other organizations amount to about $120 billion. These measures, along with lower revenues due to the great shutdown, will push this year’s federal deficit to about $200 billion (over 9% of GDP).
- This increase in the deficit will add about $2 billion to annual debt service charges based on current interest rates. This will push up the debt-to-GDP ratio by more than 7 percentage points. Allowing for the recession-induced decline in GDP, the debt-to-GDP ratio will rise by 10 percentage points.
- Higher debt service charges will require an increase in overall tax revenues of at least 0.7%. This could be funded by increasing:
- the general corporate income tax rate from 15% to 16% or
- the lowest federal income tax rate from 15% to 16.5% or
- the GST from 5% to 5.3%.
- APEC’s estimates assume the increased debt is renewed at maturity so only interest payments need to be financed. This and other key risks are highlighted below.
APEC’s assessment rests on some key assumptions. There are several risks to highlight:
- Speed of the economic recovery
APEC’s analysis is based upon the increase in this year’s deficit only. An economic recovery in 2021/22 will automatically help to shrink the deficit as economic activity rebounds, tax revenues recover and EI payments decline. However, recessions typically lead to several years of deficits before revenues rise or spending is restrained to restore fiscal balance. A prolonged series of larger deficits would quickly add to total debt, raising debt service charges even further and hence require a larger increase in tax rates.
- COVID-19 policy measures or economic stimulus in the next fiscal year
APEC assumes the COVID-19 policy measures occur in 2020/21. The federal deficit will automatically fall in 2021/22 by the amount of this year’s bailout. A continuation of COVID-19 income support, further bailouts, or other economic stimulus in 2021/22 would add to the debt, debt service costs and resulting tax rates.
- Higher borrowing costs
Interest costs on a 10-year government bond were estimated at 1.15%, well below recent historical levels. If today’s borrowing costs increase due to investor concern about rising government debt, this will push up the estimated debt service costs. For example, an increase of 25 basis points in borrowing costs (to 1.4%) would increase debt service costs in this example by $0.4 billion. This will require higher tax rates to service this additional debt. It does not account for the higher cost of refinancing all existing federal government debt as it becomes due for repayment.
- Debt repayment
APEC’s analysis assumes the increased debt is never repaid. That is, new bonds are issued to repay existing bondholders at maturity. In practice, governments borrow more money than they currently need and invest some of this (in sinking funds) to ensure they have the funds to repay or retire debt when it is due. This would add to the total borrowing costs required now and hence required tax revenues.
- Rising interest rates
If interest rates rise in the future, this will increase debt service costs and hence future taxes. This will be especially important when debt needs to be refinanced.
- Provincial government bailout
APEC’s estimates do not include COVID-19 supports provided by provincial governments, which will lead to higher provincial taxes. Neither do they include any allowance for increased federal transfers to provinces or municipalities