Why household overspending is worse than the federal deficit

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Just in time for the season of federal and provincial budgets comes a new line of thinking that deficits aren’t so bad after all.

Government deficits, that is. Households that spend more than they earn are headed for trouble. There are no new economic theories to explain this away.

The case for playing down the risks of government deficits has been made by Olivier Blanchard, a former chief economist of the International Monetary Fund. The IMF is a group of 189 countries that promotes financial stability, trade and economic growth. You might recall the IMF’s warnings in the mid-1990s that harsh measures were needed to attack the federal deficit of the time.

Canada’s back in deficit again, and so are many provinces. But, at least for the federal government, this spending shortfall may be manageable.

One of the big criticisms of government budget deficits is that they can result in a bigger tax burden on the next generation. Mr. Blanchard’s analysis minimizes this risk in the case of governments that are able to borrow at an interest rate that is lower than the growth rate on the economy. Simply put, growth in the economy should enable these governments to pay what they owe without having to raise taxes in the future.

The interest rate on 10-year bonds issued by the federal government to finance its operations has consistently been below the year-over-year growth rate in economic output over the past 30 years or so. So maybe the deficit figure the federal government will announce in its budget Tuesday isn’t the problem its critics will say it is. That’s up for debate.

There are no excuses to be made about household deficits because the math doesn’t work. Individuals pay much higher interest rates to borrow than governments, If you’re buying a house or renewing a mortgage, a fair deal on the popular five-year fixed rate would be 3.5 per cent. That’s double the rate on the federal government’s 10-year bond. Home equity lines of credit (HELOCs) typically run from 4.45 to 4.95 per cent these days. Loan rates could be double the cost of HELOCs or more, and credit cards charge crazy interest rates of roughly 12 to 23 per cent.

Economic growth that increases the flow of tax dollars can help a government stay on top of its deficits. Overspending households need wage increases, and therein lies a problem.

As discussed in my recent look at why Canadians are feeling so stressed about money, median wage increases have been disappointingly low. Average weekly wages for workers aged 25 and up rose 1.5 per cent in February, compared to the same period last year. Meanwhile, growth in non-mortgage debt in the final three months of last year was 3 per cent, according to the credit-monitoring firm Equifax Canada.

Governments can ultimately raise taxes to meet their debt obligations – that’s why they get preferential interest rates. Individuals who have overborrowed must cut spending. The easiest cut of all is savings. There is a direct line to be drawn from chronic household overspending and underfunded retirement savings.

People carrying more debt than they can handle may also have to sell assets such as a car or even a house. In a recent survey of 1,515 people, one in five of those who had debts said they will need to sell an asset to pay off debt in 2019. The survey was commissioned by the Financial Planning Standards Council and the non-profit debt-counselling agency Credit Canada.

Any discussion of deficits, government or household, has to include the purpose of money being borrowed. Deficit spending by governments can produce a net benefit if it results in improved hospitals, highways or public transit. Household overspending never makes sense.

A limited, manageable amount of debt to buy a house, get a university degree or invest in stocks or a business can definitely make sense. Pushing beyond that – using debt to spend more than you earn – means pain ahead. Governments can tax their way out of their accumulated deficits, but households may need a machete.