Christopher Ragan, "Canada's Looming Fiscal Squeeze," November

20
Figure 11
Government
taxes and
expenditures
as a share of
GDP
Since taxes are generally applied to income (or to consumption expenditure, which is a relatively stable share
of income), tax revenues will remain approximately constant as a share of GDP if tax rates are held constant.
Under the assumption that tax rates are unchanged, therefore, the T/GDP line in Figure 11 is horizontal. 8
Public spending on healthcare and elderly benefits is, however, expected to increase as a share of GDP, and
so the G/GDP line is upward sloping. From the projections in Figures 8 and 9, annual spending will increase
gradually every year and by 2040 will be approximately 4.2 percentage points higher than its level in 2015. 9
Since most people are accustomed to thinking about government spending and tax revenues as shares of GDP
rather than in per capita terms, we use Figure 11 to examine the cumulative size of the fiscal squeeze.
Confronted with
spending demands
that rise faster
than tax revenues,
future Canadian
governments will be
faced with three
broad choices.
THE FISCAL SquEEzE AS A SHARE oF GDP
Confronted with spending demands that rise faster than tax revenues, future Canadian
governments will be faced with three broad choices. First, they can attempt to reduce
the growth rate of overall spending. Second, they can attempt to increase the growth
rate of revenues through increases in tax rates. Finally, they can choose to increase the
scale of public borrowing. of course, the third option is not a permanent solution
since government debt eventually needs to be repaid and such repayment ultimately
requires a command over resources, which in turn requires either spending reductions
or increases in tax revenues. but it is worthwhile considering this third option to get
a sense of the cumulative scale of the fiscal squeeze and why some fundamental fiscal
adjustment will almost certainly be necessary.
Consider the hypothetical situation in which future Canadian governments, when
confronted with the realities of the fiscal squeeze, choose to make no adjustments in
their overall spending or taxation but instead simply add to their public borrowing
as a means of financing the fiscal squeeze. How much new public debt would be incurred in this situation
between 2015 and 2040? Figure 11 provides a rough estimate. The area of the shaded triangle shows the
cumulative borrowing that would take place over the 25-year period, and is equal to 52.5 percentage points of
GDP (25 years × 4.2 percentage points × ½ = 52.5 percentage points).
Christopher Ragan: Canada’s Looming Fiscal Squeeze
G/GDP
T/GDP
2015 2040
4.2 ppts
8 The overall Canadian tax system is slightly progressive, so a 10 percent increase in GDP leads to a slightly larger than 10 percent increase in
tax revenues. As a result, constant tax rates would result in a slightly upward sloping T/GDP line. This small effect is ignored here.
9 Note from Figures 8 and 9 that the projected increases in spending are approximately linear through time, each year seeing a roughly
constant increase in spending as a share of GDP. For this reason, Figures 10 and 11 are constructed with the simplifying assumption of linearity.