‘But how will you pay for it?’

What much of the media discussion of government spending and finances gets wrong
Photo: joanne clifford
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‘But how will you pay for it?’ This is a common refrain on the campaign trail. The political parties promise everything from tax cuts to universal pharmacare. Understandably, people want to know how the government will afford these promises. But the question is based on a misunderstanding of the government’s deficit and debt.

When you and I spend more than our income, eventually we must earn more than we spend to repay our debt. That’s because we are currency users. The government, however, is a currency issuer. That means it can create whatever financial resources are needed.

To fund its deficits, the Government of Canada borrows money through the Bank of Canada. About 80 per cent of the money it borrows comes from the private sector through the sale of bonds and treasury bills. The remaining 20 per cent is borrowed from the Bank of Canada.

The Bank of Canada is wholly owned by the federal government. Therefore, the money created is both an asset and a liability of the government. In other words, the Government of Canada borrows the money from itself.

If the government wants to expand its deficit, it can simply increase the amount that it borrows from itself.

Government spending generates economic activity.

If we are going to debate what the government can and should do, we must first understand the basic facts of government finance.

Imagine the Government of Canada increases its infrastructure spending by $50 billion. It pays that $50 billion to construction companies to improve roads, repair bridges, add rail lines, expand harbours, on and on. The companies hire workers and buy supplies. The workers will spend on consumer goods, while some will get saved for future purchases. The supplier will buy their own supplies. They may use the money to upgrade or expand their facilities. The effects of that extra $50 billion will ripple throughout the economy with more hiring and more demand for other goods and services.

The ability of the federal government to create financial resources to fund its spending does not mean we can create unlimited amounts of money. However the constraints are material, not financial.

Returning to the infrastructure spending example, among the supplies needed will be cement. If Canada’s cement manufacturers have spare productive capacity, they can easily increase their output to satisfy the new demand. However, if they are already working at full capacity, the increased demand will drive up prices. This too will ripple through the economy, increasing other prices. These increased prices can dampen economic activity. For example, private developers may have to shelve plans if the cost of cement rises too high.

There are a variety of mechanisms to deal with rising inflation, including increased taxes. The Government of Canada does not need taxes to finance its operations. Rather, taxes are a way to reduce some of the competing demand for resources.

The fact that the federal government can create any financial resources it needs to fund its spending is one side of the money matter. The other side is that government debt is also private sector assets. When the government runs a deficit, it creates more financial resources.

The $50 billion in additional infrastructure spending has not only given Canadians new and improved infrastructure, it has also added $50 billion in financial resources into the economy.

When the government runs a surplus, the private sector is put into a deficit. We must ask of any political party that plans to run a surplus: why is it a good idea to reduce the financial resources in the economy?

Briefly, it is worth emphasizing that only the federal government is a currency issuer. Every other level of government is a currency user. That means the provinces and municipalities face different financial constraints than the federal government. This reality needs to be understood when we discuss the fiscal relationship between the levels of government.

If we are going to debate what the government can and should do, we must first understand the basic facts of government finance. Affordability is not a matter of the availability of money. Affordability is about the effects of the money in the economy. Once we understand these basics, then we can have a truly informed debate about our spending priorities and what we choose to afford.

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