Quebec, don’t fall prey to fiscal illusion

Quebec’s budget surplus, it was recently revealed, will now stand between an estimated $3.4 billion and $4.6 billion, which is well above the previously estimated surplus of $1.7 billion. Given Quebec’s long history of budget deficits well above the Canadian average since 1960, this is good news. In fact, Quebec is now a fiscal champion in Canada.

But as soon as this larger surplus estimate was announced, numerous were the calls to increase spending on this or that public service. The Legault government should ignore those calls for several important reasons.

First, Quebec’s provincial government is still heavily indebted relative to other Canadian provinces. In 2018, the government’s net debt represented 43 per cent of the economy. All other provinces, save Newfoundland and Labrador (at 44.4 per cent), have smaller debt burdens. Small changes in international interest rates would increase the service cost of that large debt, which is why, in spite of all the improvements in recent years, Quebec remains vulnerable.

This vulnerability will be magnified when the term of bonds expires and they must be “rolled over.” The proper course of action would be to find ways to keep both taxes and expenditures down (at the very least, they should increase at a slower pace than the overall economy).

Second, there’s the far more serious threat of fiscal illusion—that the public’s perception of the true costs and benefits of government expenditures is misconstrued. As long as the costs of taxation are underestimated and that the benefits of public expenditures are overestimated, there’s fiscal illusion.

The illusion incites governments to increase spending. More importantly, government can increase the misperception by running deficits, which may have important economic costs in the long-run but whose short-run consequences are smaller. Under fiscal illusion, governments reap more electoral rewards from deficits than from surpluses, and even more from spending more as opposed to taxing more. Thus, the illusion is self-reinforcing.

It’s this illusion that led Quebec to its high debt burden. Provincial governments since the 1960s increased spending well ahead of revenues, leading Quebec from being the province with one of the smallest governments in Canada to one with the largest. During that era, the net public debt ballooned rapidly from the low point of two per cent of the economy in 1959 to the peak of 51 per cent in 2013.

The same is true with public spending, as it went from 5.8 per cent of the economy to 26.3 per cent over the same time period. Eventually, corrective steps must be taken and the governments that take such steps do not get important electoral rewards for doing so.

Compounding the problem of fiscal illusion is that the costs and benefits of public policy are not equally distributed. Numerous interest groups gain considerably from this or that program but the cost is spread equally over the entire population. These groups thus invest considerable resources in convincing the government to enact their desired policies and they face little resistance from the general public (who may even be unaware of the policy development for which they will pay).

The Legault government, because it’s on the “good” side of the fiscal illusion problem, faces a great temptation to indulge in greater levels of spending. It stands to gain popularity from spending more, or reducing taxes without reducing spending. However, this will only make Quebec worse off in the future and will force future governments to reduce spending more drastically or increase taxes.

Given Quebec’s current situation, it would be best if the government exercised restraint and refused to indulge in this costly illusion.