Chapter 8
How Much do You Really Owe?
Forbes publishes a list of the world's richest people. Who would it put on its list of the world's poorest? Surely, America's young people would lead the rankings. Each one is shackled to a ball and chain of debt—hammered into place by an older generation—before he even begins to compete. Their parents and grandparents bequeath them public debt and unfunded obligations of more than $200 trillion. It hardly seems fair.
Bill Bonner, The Daily Reckoning
So now that you've had a glimpse of the pension problems facing the majority of Canadians, let's look at how they affect you. How much money do you owe and how do you intend to repay it before you die? We're not talking about your personal debts here, your mortgage, credit cards, line of credit, and bank loans. You may have been very careful with your personal financial planning. Your governments have not been as careful, however. We are talking about your share of the money that the federal, provincial, and municipal governments of Canada have borrowed on your behalf to meet the various commitments that they have decided are worth borrowing for. And also the multiple future commitments these governments have taken on that you have agreed to pay for. Yes, you.
Well, okay, maybe you didn't exactly agree to pay these debts. In fact, we're guessing that you're not really aware of many of these commitments that you are financially responsible for, but the fact remains that you will have to pay your share. Still not getting the picture? Pour yourself a coffee (or maybe a stiff drink would be better), sit down, and let us give you a brief summary.
Federal Government Deficits, Debts, and Commitments
You may be familiar with terms such as “deficit” and “debt,” which are often used during the course of budget discussions when the media covers our federal government and its policy-making procedures. Basically it works like this: The federal government decides to implement certain plans such as buying planes or submarines for the military, funding the arts, or making foreign aid donations—or just paying its staff, which is an ever-growing expense. It also transfers funds to the provinces and territories. In 2009, Ottawa transferred $26.9 billion to fund provincial health care.1 This money comes from taxes. The main source of federal revenue is income tax ($116 billion personal, $29 billion corporate), which accounts for about 65 per cent of the $218 billion in revenue collected in 2010. Most of the remainder comes from consumption taxes, such as those on gasoline, energy, and duties and excise taxes. The government also collected $17 billion in employment insurance (EI) contributions that year.2
In addition to collecting taxes, the government makes future commitments on your behalf. These include promises to fund pensions to government workers, plus the Canada Pension Plan (CPP), Old Age Security (OAS), and the Guaranteed Income Supplement (GIS). This of course is a great idea, because how else could these massive national projects and services be financed if not through the joint contributions of all Canadians? The problem is that our federal government, for most of our lifetime, has run a yearly deficit on its annual plans, meaning that each year it spends more than it collects. This is known as “deficit financing” and is practised by pretty much every government in the Western world. The Economist's Global Debt Clock estimates current (August, 2011) total worldwide federal government debt as $40.1 trillion, increasing at about $5 million per minute. The term “deficit,” then, is used to describe the annual shortfall—the difference between the money collected each year by our governments and the money spent each year by those governments. The term “net debt,” meanwhile, is the running total of all previous unpaid deficits, money spent that we had to borrow. Pension commitments and future health care costs, on the other hand, are known as “long-term liabilities,” because the federal government does not have the money set aside to pay these obligations—but they guarantee to pay them when they come due. The combined net debt and the long-term liabilities are known as the gross debt. Guess where this money is going to come from? (Hint—look in the mirror.)
This was not always the case. In past generations, up until the late 1960s, our federal government operated on a cash flow basis (like a business). The government spent only what it raised in taxes, except during emergencies, such as the Great Depression and World War II, or to fund massive nation-building projects such as the Canadian Pacific Railway in the 1800s. Yet, even here, the government quickly repaid the funds it borrowed. After World War II, Canada owed only $8 billion, a figure that changed little until Pierre Trudeau became prime minister.3
Mr. Trudeau, who remains the darling of the baby boomer generation and is remembered as one of Canada's greatest leaders, decided it was pragmatic to borrow a little money each year in order to provide us with more services faster—to build Canada as a “just society” a little faster than cash flow could provide. The plan was based on the idea that we could afford this temporary debt, which we generally pay only the interest on, and would pay the balance later when our economy was bigger and generating more tax revenue.
Nobody seemed too concerned about it at the time. After all, we were in the midst of the biggest economic boom in history, so borrowing against our future seemed like a good idea. Besides, it made politicians look good when they could provide more and more services . . . and pay government employees more and more money . . . and promise their staff (and themselves) better and better pensions. This was 1968. It wasn't a problem in 1969. Or in 1970. Or in 1971. We think you get the picture. But by 1975 we owed $54.3 billion in gross debt, and by 1981, $123.5 billion. Trudeau left office in 1984, but by then the policy of promising more and more to attract votes was part of the political process. Brian Mulroney took over and kept up the pace. By 1993, Mulroney's last year as prime minister, we owed $607.2 billion.4 Truth is, we're not sure that average Canadians really had a clue of what this meant to them in the long-term. Most Canadians today don't really understand this form of government finance either. So let us give you the numbers.
Federal Debt Passes $500 Billion
Canada's federal (net) debt grew steadily between 5 per cent and 10 per cent per year until 1975 when it began to explode; growing for the next 12 years at more than 20 per cent per year. It broke the $100-billion mark in 1981 and the $200-billion mark in 1985. While the growth slowed in 1988, our federal debt continued to climb, breaking $300 billion in 1988, $400 billion 1992, and $500 billion in 1994. It peaked in 1997 at $563 billion.5
Over the past decade it had slowly declined to $458 billion in 2008. Now this has all changed. Our federal debt grew by $5.8 billion in 2008–09, by $53.8 billion in 2009–2010 and is expected to grow by $49.2 billion in 2010–2011. Further, it's expected to grow through at least 2014–2015.
Canada's debt re-passed the $500 billion mark at 4:55:46 a.m. on December 2, 2009.
(Courtesy taxpayer.com) 6
In 2009 we paid $29 billion in interest on net debt.7 This is more than the federal government transferred to the provinces for health care last year. Just think—if there was no debt interest to pay we could double our federal spending on health care. We repaid no principal. In 2010, the net debt increased by approximately $59.6 billion because of stimulus spending to prop up bankrupt companies such as General Motors, and is expected to increase by an additional $49.2 billion in 2010–2011. By 2011 the federal government had an outstanding gross debt of $883.3 billion.
Okay, let's stop for a minute before you start to glaze over and lose sight of the point here, which probably happens every time you read news reports on this topic. The point is that you owe this money. Yes, you. This federal gross debt amounts to $26,7668 ($883.3 billion) for each person in your family. When can we expect your cheque to cover this?
But wait, it gets better. Federal government debt is only one form of debt—there is also provincial debt. And with those debts included, my friends, the bill jumps to more than $1.2 TRILLION (or roughly $35,000 per person). The Economist's Global Debt Clock—an independent third-party appraisal—lists Canada's government debt at $1.234 trillion as of June 2011.
As we mentioned, we generally pay yearly interest on the net debt at current interest rates averaging about 3–4 per cent, which works out to $30–40 billion per year currently. Since 2000–2001 we have paid $383 billion9 in interest—money that could have gone into services, hospitals, schools, and roads. However, logic suggests that Canada will have to pay this debt back at some point. Can you do that? Did you say your cheque is in the mail?
Now before we go on to the other debts you owe (yes, there are more), we need to make sure you understand a key point: This is your debt, not “the government's” debt. We say that because this gap in understanding is one reason the situation has gotten so far out of hand. The idea held by most Canadians is that the government and its bureaucrats are somehow separate from us. “They” collect taxes and “they” spend taxes and “they” borrow money and “they” are responsible for the debt, and it is “their” problem.
Wrong. Politicians work for you. You “appointed” them through the democratic electoral process and gave them the freedom to borrow on your behalf and spend on your behalf, but eventually YOU will be the one paying this back. Or your children. Or your grandchildren.
Okay, is the picture clear now? The federal government has borrowed money but it will have to collect that money from you in order to pay it back. And that money has been spent. It's gone. And next year the government will be borrowing more, which you will have to pay back some time in the future.
So that's a quick look at the federal situation. Our provincial governments have followed suit, consistently spending more than they can collect and also running massive operating debts. Let's take a look.
The current total of all provincial (including territories) net debt as of 2010 is $388.3 billion,10 with annual interest payments of $21 billion! The federal government transferred $62 billion to the provinces last year and yet the provincial deficits still increased by $48 billion, so you can see the mess we are in. Leaders in the field are Ontario with a $193.6-billion debt (now officially a “have-not” province which receives billions in federal equalization payments from other provinces each year) and Québec with a $142.8-billion debt. The provinces have not even calculated their gross debt liabilities from healthcare. William Gairdner, a leading government debt watchdog in Canada, estimates that Canada's gross debt is in the range of $2.4 trillion once health care long-term liabilities are estimated.11
So whether you live in one of these failing provinces or not, our transfer system guarantees that you will share in the payback. This adds $11,000 to the bill that every man, woman, and child owes. You owe this and will pay it back one way or the other through income taxes, sales taxes, hidden taxes, and in some cases, just plainly outrageous and blatant tax grabs such as the Ontario government health “premium,” introduced in 2004. Faced with ever-growing deficits in the health care system, Ontario's Liberals instituted a health tax payable by all taxpayers, but said it wasn't a “tax,” it was a “premium,” even though it was based on taxable income. Despite the absurdity of the semantics, Liberals today continue to use the term premium. According to the government website, “the Ontario Health Premium is not related to the Employer Health Tax for Ontario. Each year, revenue from the Ontario Health Premium contributes approximately $2.8 billion to the health care system.”12
Governments are particularly creative when it comes to rearranging taxes to raise more money. They will have to become even more creative in the years to come. The Harmonized Sales Tax is one example of rearranging the deck chairs on the Titanic to raise more money from the same victims. Most provinces are moving full speed ahead into casinos, lotteries, and online gambling in an effort to collect more money from the public. How much more can you afford to pay?
Let's not Forget Municipal Debt
Municipalities are prevented by law from borrowing money to finance yearly spending. However they do receive a range of payments from provincial and federal governments to offset some of their costs when faced with a deficit. Their biggest costs, of course, are employee salaries and benefits (which continue to increase faster than the rate of inflation), and pensions. And their pensions are all in deficit.
Municipalities raise the bulk of their income from business and property taxes. Attracting business is a highly competitive activity as cities with a larger business community are in a better position to provide the services Canadians have come to expect. However, as we know, the large manufacturing companies that were the backbone of the Canadian economy in the last century, with their high salaries, huge land requirements, and significant tax contributions, are a thing of the past. The majority of new jobs in the last two decades have been created by small businesses and through self-employment. A large percentage of people today work at home, as opposed to commercial offices or factories, and do not pay commercial property taxes, which are considerably higher than residential taxes. This declining tax base from the manufacturing sector forces the transfer of municipal costs to residents so that property taxes continue to rise at rates higher than other cost-of-living increases. In December 1999 the manufacturing sector in Canada employed 2.32 million workers. By 2011 this had dropped to 1.78 million.13
This is particularly significant for the boomers who are moving into retirement age and generally own large homes with big property tax bills. With diminished private sector pensions and escalating property taxes we can expect a massive property shift as boomers are forced to sell their homes because they can no longer afford to live in them.
So even though your municipality can't run a deficit budget it can commit you to significant future expenses to pay the defined benefit pensions and OPEBs that have been negotiated for your city employees and politicians. You can run, but you can't hide.
How much are these municipal pension deficits? Using Hamilton as an example, the average homeowner there is looking at a deficit of about $2,700 that needs to be added to property tax bills. Extrapolate that across the country and you get another $6.5 billion in pension shortfalls. When combined with budget pressures to provide services, these deficits threaten to bankrupt our municipalities, or drain provincial and federal coffers, creating even more deficits, debt, and interest payments.
What Does that all Mean?
Put it all together and it means that every man, woman, and child in Canada owes somewhere between $36,000—the official government number—and $72,000 when all long-term liabilities are estimated.14 Add spiralling personal debt to the mix (currently at $25,597 per person15), and you can see that our entire country is heading off the edge of a cliff with no real hope of maintaining our collective standard of living.
Sooner or later this bill will have to be paid, and the reshuffling of cash and assets will change our society as we know it, creating a new class of haves and have-nots that will rival British society of the 18th and 19th centuries. We will have a new segment of society—the senior's gentry, if you will, of well-to-do retired former civil servants whom former California Governor Arnold Schwarzenegger called the “protected class”16—and a huge group of seniors living under or near the poverty line. The effect of this segmentation of our seniors will trickle down to the working middle class, who typically bear the brunt of all taxation.
We are already seeing the effects of our government's financial failings in a middle-class quality-of-life that by all standards is lower than that of our parents. We now have two parents working in virtually every home, and yet personal debts are at an all-time high. Today there are five workers for every pensioner and once the baby boomers are all in their pension years—about 2025—there will be only 2.5 workers for each pensioner. Not only will these workers have to pay for underfunded pensions, they will also have to begin the virtually endless process of retiring our government debts.
Figure 8.1: Ratio of Active Members to Retirees
Can you imagine any way that this equation can work in your favour? If you are up-to-date about current events, you know that every think tank has consistently stated that our health care system can't survive in its current model. And you know that none of our governments can meet the demand for the services we expect.
Perhaps you are one of the lucky ones who have a gold-plated pension, indexed for inflation, and guaranteed by the taxpayers. However, keep this in mind: Our tax system is designed to take from those who have and give to those who don't. This has been wrongly interpreted as a kind of Robin Hood-esque “take from the rich to give to the poor” program, but actually the rich still control their own wealth. They may simply move it offshore where it is not taxable, invest in foreign economies, or just use their lobbying power to create, as they have already, a taxation system that favours their continued accumulation and retention of wealth. The trend of the rich getting richer has been going on for decades. According to StatsCan, the median income of the bottom 20 per cent of Canadians dropped 20.6 per cent from 1980 to 2005, while those in the top 20 per cent increased wealth by 16.4 per cent. The middle 60 per cent stayed almost exactly the same.17 This is proof that Canada's progressive tax system is not working.
No, we are not likely to become a “tax the wealthy” country. What we might expect, however, is that the increasing group of wealthy middle-class pensioners will face ever-higher taxes, user fees, and clawbacks. Of course that's just speculation. There will be growing political pressure from people who don't have those wonderful pensions and who can only hope that the governments of the future will right this imbalance. On the other hand, since the very people making this decision are beneficiaries of the current situation, would it really, really surprise you if they try everything in their power to leave things the way they are?
We are the first to take an in-depth look at the inequity of our current public sector pension plans. The media, in the future, will be full of reports, studies, and opinions highlighting this disparity and calling out for reform. Yet we expect our governments' answer to this will be to study ways of improving private sector pensions. Indeed, they have no interest in reforming their own pensions downward. Their attitude is “Hey, we're set for life, let's leave that the way it is and see if we can find ways for you guys to save more money for your pensions.”
Some would suggest that the future can't be foretold, but we can predict Canada's future if drastic changes aren't made soon. Canada is on the same path as every other Western country—aging population, low birth rate, diminishing wealth-creating economic sector (the segment of the gross domestic product related to making products rather than providing services), growing public sector with early retirement and substantial pensions, and an unsustainable health care system. Some countries waited too late to make changes and became the canaries in the mine, sending a warning. Some have already heeded the warning and begun the painful changes necessary to restore faith in their ability to manage their economy for the future. Others, such as Canada, remain with their heads in the sand, going along as if nothing is wrong, believing it's business as usual.
This is a collapse that has been building for more than three decades, but the global financial meltdown of 2008 and the steady retirement of the Boomers have caused many people to take a longer-term view and question the sustainability of our economic model. With so many eyes turned to the financial world, it didn't take long for some people to realize that not only were the banks fallible, but our Western economies are also built on false pretenses. The current focus on public debt levels worldwide, early retirement of the public sector, and the constant deficit financing of government services have triggered a wave of crisis that has yet to seriously hit our shores—in the form of government cutbacks, pension defaults, higher borrowing rates, and escalating unemployment—but will very soon if changes are not made.
In 2009 the countries of Iceland, Greece, and Ireland essentially declared bankruptcy. Portugal, Italy, and Spain teeter on the precipice. The United States, Canada, the United Kingdom, and France suffered financial meltdowns of varying degrees, forcing, for the first time in a generation, a serious examination of their governance structures. One of the conditions of the bailout in Ireland was that the country use its pension reserves to finance its spending,18 an ominous warning to pensioners everywhere. Once the reserves are spent on general government costs, how will they be replaced? Ireland is being pressured to raise corporate taxes in return for a lower interest rate on the bailout funds, a move that would make Ireland less attractive to investors and divert more business growth to the countries that are providing the bailout money. This would put Ireland between a rock and a hard place since the country needs more business investment to rebuild its economy. Once the fox is in the henhouse, none of the chickens are safe.
Ireland's banking collapse has triggered the largest emigration of Irish since the potato famine that caused so many to move to America in the 1840s.19 With unemployment expected to reach 16 per cent, many breadwinners are simply leaving their families to work overseas.
Portugal was the next to fall. Despite months of claiming it would not accept a European Union bailout—which comes with provisions that limit a government's ability to control its own economy—by April 2011 Portugal had agreed to accept a $110-billion package conditional on spending cuts, tax increases, and privatization of some government assets and services.
These collapses are ignored in Canada on the premise that they are small economies, but the differences between them and us are only time and amount. We are following exactly the same path, and the result is somewhat inevitable without real changes.
Larger European countries that recognize this danger have already started to make the necessary changes. Spain is next in line for collapse. Its economy is larger than those of Greece, Ireland, and Portugal combined. Spain's government is the union-backed Spanish Socialist Workers' Party. Despite this strong connection, the Party passed laws to reduce the power of unions and implemented a series of austerity moves to reduce spending. Spain has the added burden of a 20 per cent unemployment rate, the highest in Europe. The country's economic growth is predicted to be less than 1 per cent in 2011,20 offering no hope of the “higher revenues” that failing governments—such as Canada's—hold out as the solution to their endless deficits and mounting debt. Spaniards responded with a general strike on September 29, 2010, which included fires in the streets of Barcelona, but there is no other way out for Spain.
In France, 1.2 million people joined one of five nationwide strikes in October 2010 as workers protested the government's plan to raise the retirement age from 60 to 62. Strike-related disruptions led to cancelled flights and trains, closed ports, stopped the fuel industry, and brought France to a standstill for several days but had no affect on the government's decision, which is designed to salvage the pension system by saving on two years' worth of payments. At 62, France would still have the lowest retirement age in the developed world. In Canada there is talk of raising the retirement age to 67 for CPP, OAS, and GIS eligibility. Of course that would not affect those in the bell jar—government workers and politicians who cut their own deals to receive pensions after a specific period of service, regardless of age.
In the United Kingdom, a $128-billion budget cutback over four years will see the loss of up to 500,000 public sector jobs, the biggest fiscal tightening since World War II.21 England intends to cut $28.5 billion in welfare payments, child benefits, and public housing, and raise its retirement age to 66.
The U.S. of A.
And then there's the U.S. of A. This is a story much closer to home. The U.S. economy suffers from the same maturation disease that we have—an older, less productive, and more expensive workforce that makes it unattractive to industry. Even its own companies are choosing not to invest there. A study by the Business Roundtable and the United States Council Foundation,22 an American trade and commerce think tank, found that the percentage of profits of U.S.-based multinational companies that came from their foreign holdings had increased from only 17 per cent in 1977 to 48.6 per cent in 2006. President Barack Obama, noting that U.S. companies are sitting on $2 trillion in assets, has asked them to invest in the U.S., but it is unlikely that this will happen as long as other countries are more appealing (which will probably be the case for the next 50 years). Official unemployment remains above 9 per cent, but many credible economists say the real rate is 16 per cent to 22 per cent,23 meaning there are less people with money to spend on consumer goods, which would stimulate the economy. Meanwhile, both public and personal debt are at record highs.
Canada's debt levels are at record highs. What are Canadian politicians doing about this? Having elections and promising more spending. Oh yes—and promising to stop deficit financing in a few years, but not right now. The federal debt under the Conservatives' 2011 election promises is expected to increase by $172 billion over the next four years before it miraculously balances. The federal Conservatives say they will balance the budget without raising taxes or cutting services. That would be a magic trick of epic proportions. Even the government's own parliamentary budget officer, Kevin Page, doesn't think this is going to happen, saying we have a “structural deficit”—meaning one that is built into the process and can't be eliminated—of $10 billion per year.24