More myths have been spun around the issue of government debts and deficits than around any other

matter of public policy.

We have been led to believe that Canada has sunk deeply and dangerously into debt because "we have

been living beyond our means." We have been told that the financial crisis was caused by our demands

for "lavish" public programs and services that the country really couldn't afford. We are warned that,

unless governments drastically cut spending on these services and curb our "unhealthy" dependence

on them, Canada could "hit the debt wall." No one would lend us money any more. Our standard of

living would fall to Third World levels. "Is this the kind of legacy," we are asked accusingly, "that you

want to leave your children?"

With this grim scenario pounded into us day after day, it's no wonder that most of us have been

persuaded that getting out of debt must be our governments' No. 1 priority--no matter how much it

hurts the poor, the weak, the jobless, the disadvantaged. We've become resigned to all the cutbacks

that have been imposed on us in the name of deficit reduction. "It's for your own good," we're assured.

"Your children and grandchildren will thank you for not passing on all this debt for them to pay off."

Some of us may wonder if our children will really be thankful for standards of health care, education,

unemployment insurance, and other public services that are much lower than we enjoyed. But our

concerns are dismissed by the "experts" in politics, in business and in the media. They promise us that,

when all the public debt is paid off and we get back on a sound fiscal footing, prosperity will return and

everybody will be better off.

Increasingly, however, more and more of us are beginning to doubt these glib assurances. We see

interest rates staying unreasonably high, and government debt rising as a result, and we doubt whether

all this debt was really caused by government overspending. We see profits soar for the banks and

large corporations while more and more of us have our wages frozen or even lose our jobs, and we

doubt that the deficit-reducing pain is being equitably shared.

These doubts are well-founded. Most of the things we've been told about public debt and deficits are

simply not true. But it's important to the wealthy and powerful elite who concoct these myths that we

continue to believe them. Because, as long as we believe them, we'll keep on accepting the hardships

being imposed on us.

We won't like the high interest rates. We won't like having so many people out of work and so many of

them being cut off UI. We won't like the growing poverty and destitution that afflict millions of us,

especially the impoverishment of growing numbers of children. But we'll grudgingly accept all this

misery as an atonement for our past sin--the sin of demanding so much "coddling" from our

governments that we forced them to borrow excessively to feed our dependence.

The politicians, the business executives, the bankers and the stock market speculators profit from the

guilt they have made us feel. It enables them to grab an increasingly larger share of the national

income. They have fed us many myths about public spending and debt to reinforce our feelings of guilt

and repentance. As long as we can be made to think we are to blame for the financial mess our

governments are in, the politicians, business leaders and bankers who are really responsible for the

debts and deficits will continue to enjoy their power and affluence--at our expense.

They don't want us to find out that what they've been telling us about government finances is false--that

what we have come to regard as self-evident facts are really myths. They know that, if we uncovered

the truth, we would no longer passively allow them to tear down our country's most cherished programs,

values and institutions.

The deficit is their all-purpose excuse for this devastation. Without it, they would be seen to be

dismantling our welfare state solely for the purpose of enhancing their own wealth and power. We can't

ignore the deficit or the debt. The horrendous debt-servicing costs are draining billions from

government coffers that could otherwise be put to constructive use. But we have to focus on the real

causes of this fiscal problem and come to grips with them, instead of scapegoating and dismantling the

welfare state.

At the centre of the deficit debate is a political contest for the hearts and minds of Canadians--a

struggle to influence and control public opinion. With much at stake, powerful groups do not hesitate to

throw their weight around.

Corporations finance political parties: both the Liberals and Conservatives receive over 50% of their

funds from business. Corporations sponsor "think tanks" such as the C.D Howe and Fraser Institutes

to promote their preferred economic issues. Most importantly, corporations own the media.

At various times, corporations have targeted international competitiveness, inflation, and the deficit as

their major concerns. Interestingly, they see reducing government spending as the best way of dealing

with all of these problems.

For the wealthy, inflation is regarded as a form of theft. It reduces both the capital value of their stocks

and bonds, as well as the income derived from them. On the other hand, high interest rates, the

preferred instrument for fighting inflation (along with government spending cuts), enable them to fatten

their income gains.

Perversely, however, trying to reduce the deficit through government spending cuts and fighting

inflation through high interest rates tend to weaken the economy and thus increase the deficit and the

debt. In fact, these very policies have been followed in recent years, and they have produced a weaker

economy, as well as a growing national debt.

When real interest rates exceed the rate of economic growth, the debt grows faster than the ability to

pay it down, because government tax revenue can't keep pace. Governments then resort to borrowing

more just to meet the interest payments on the national debt. This spiral of rising interest payments,

leading to a growing debt, poses a serious problem for public finance. But further spending cuts,

supposedly to reduce the deficit, only make things worse, since they reduce the capacity to repay the

accumulated debt.

Canadian governments have not "overspent" on programs and services, either in actual terms or in

comparison with other countries.

In 1994-95, for example, the federal government collected $123.9 billion in revenue, while spending

$119.1 billion on services and programs, leaving an operating surplus of $4.6 billion.

An even larger operating surplus was projected for 1995-96, this time $11.5 billion.

This is not unusual. Spending on programs in Canada has rarely exceeded government revenue since

World War II. In fact, the deficits incurred on program spending since 1975 total just $67 billion--a

relatively small percentage of the total accumulated debt.

Nor has our federal government spent more on programs and services than most other countries. The

latest OECD international comparison in fact shows that Canada spends less on social programs, as a

percentage of its GDP, than do 13 other countries, including "poorer" nations like Greece and Spain.

Canada's social spending reached a peak of nearly 19% of GDP in the depths of the 1991-93

recession, but has since dropped to about 16%. It is projected to fall even further, to 14%, as a result

of the Liberal government's massive funding cuts--those already made and those planned in future

budgets.

Our social programs, far from being overly generous, are inferior to those elsewhere in the developed

world, as shown in the annual OECD surveys. Our unemployment insurance system, for example,

ranks 15th in benefits among OECD countries. In France, which devotes 28% of its GDP to social

spending, subsidized child care is available to all children under the age of 6. In Sweden, women get a

year's paid maternity leave with their jobs and benefits guaranteed. All the European countries, in fact,

provide a better and wider range of social services than does Canada.

A Statistics Canada study found that government spending, far from being the main cause of Canada's

accumulated national debt since the mid-1970s, was responsible for only 6% of it.

The chief culprit is the Bank of Canada and its decision since the early 1980s to maintain excessively

high real interest rates. Prior to 1982, real interest rates--the rate of interest charged above the

inflation rate--averaged only about 2%, and often went lower. (In the late 1970s it was below 1%.)

Since then, it has averaged more than 6% and on occasion has reached 8%.

The result has been to raise the cost of borrowing for everyone, including Canadian governments.

That's why, despite spending less on programs and services than they receive in revenue, they have

still run up huge deficits: because of the effects of compounding interest payments.

The reason the federal government recorded a $39.7 billion deficit in 1994-95, instead of a $4.6 billion

surplus, was because of the $44.3 billion it had to pay the banks, bondholders and foreign

money-lenders in interest that year. For 1995-96 its interest payments were projected to be $47.3

billion, wiping out what would otherwise be an $11.5 billion surplus on program spending and creating a

budgetary deficit of $35.8 billion.

In February 1995, the Dominion Bond Rating Service released a study which attributed the vast

majority of the federal debt--93% of it since 1984--to compounding high interest rates. The study noted

that, between 1984 and 1994, the federal debt ballooned from just $94 billion to a staggering $508

billion, primarily "due to the compounding interest on the relatively modest program expenditure

deficiency." It is these sustained high interest rates, the bond rating agency concluded, "which are

driving the deficit today."

To illustrate the key role of interest rates, we need only compare the effects of borrowing $1 million at

2% (the historic level of real interest rates) and borrowing the same amount at 10%. At the reasonable

2% rate, it would take 36 years of compound interest for the $1 million to double to $2 million. But at

10% interest, the same loan doubles in just seven years. In 36 years it would double and redouble five

times to $32 million.

The irony of the current debate is that those who say the elimination of the deficit should be the

overriding priority for government ignore the inexcusably high real interest rates, and the destructive

effects of compound interest, and instead favour policies which will ultimately worsen the deficit. Those

who argue for lower interest rates (along with more job creation and fair tax reforms) actually have

policy alternatives that will bring the deficit spiral under control.

Federal government spending on programs and services has been growing more slowly than all other

spending in the economy. Measured by this spending, government is shrinking. By 1996-97,

government programs are projected to be a smaller share of all spending than at any time since 1947. It

makes no sense, therefore, to talk about government spending being out of control.

It helps to remember that government spending is an important component of national income,

because most of it consists of transfer payments to individuals and other levels of government. This

money is largely spent on the purchase of goods and services, which creates jobs. Cutting government

spending thus lowers national income, which in turn lowers employment. It is estimated that a drop in

government program spending of one billion dollars leads to the loss of between 20,000 and 30,000

jobs elsewhere in the economy.

A cut in government spending of $1.00 does not in fact lead to a reduction of $1.00 in the deficit. Why

not? First, because a portion of the unspent dollar would have come back to the government in taxes.

With an average tax rate of 25%, the amount saved by the spending reduction of $1.00 thus falls to 75

cents. Second, the spending reduction has an impact on the rest of the economy: it leads to lost

employment and income. Some additional spending becomes necessary to pay for the income support

of those who have lost their jobs. The government may find itself spending as much as 40 cents out of

the dollar on various kinds of social assistance.

Third, the dollar not spent by the government represents lost income for local grocery stores, other

small businesses, and landlords. They not only pay less in taxes as a result, but they may also decide to

cut back on their own spending for goods and services. This precipitates a vicious circle, in which

government cuts lead to lower national income, followed by less business spending, which in turn leads

to a further fall in national income. The experience of the Great Depression taught us that government

has a responsibility for the overall health of the economy. Falling prices and incomes caused a

cumulative economic decline, because low wages could not lead to more employment, nor could low

prices encourage increased consumer spending. Breaking out of this vicious circle required increased

government spending: investment spending and consumption spending. Without a boost from

government policy, the economy would stagnate.

The remedies for falling prices and incomes were: first, to use government spending on programs and

services to get the economy growing; second, to use taxation and social spending to redistribute income

towards people who would spend it; third, to use government investment to create jobs directly; and

fourth, to ensure that affordable credit was available to finance both public and private investment.

These remedies are as appropriate today as they have ever been.

----

(This article is an excerpt from "10 Deficit Myths," a new 40-page booklet which Duncan Cameron

and Ed Finn have co-authored and which can be obtained for $5 a copy from the CCPA.)