The public finances of the federal government are in a sorry state of affairs. While the financial crisis originating in the United States is partly to blame, policy choices made by the government are also a major factor. Looking to the future, the federal government will have to confront the deficit and make some important decisions about how to deal with it.

The federal government is expected to run a $54.2 billion deficit in 2009-2010. The Parliamentary Budget Office projects near-term future deficits to be $43.1 (10-11), $27.9 (11-12), $23.2 (12-13), $19.0 (13-14), for a total accumulated deficit over the period of $167.2 billion. This represents a 36% increase on the $463.7 billion net federal debt outstanding at the end of 2008-2009.

Consider the demographic challenge facing Canada over the same period. At the end of the period (2014), the leading edge of the boomer cohort will be in its mid-to-late-sixties. Over the following two decades from 2014-2033, our increasingly aged population will provide the cruel combination of both a smaller income tax base and a higher demand for government services, especially health care.

Statistics Canada, 2007, Canadian Demographics at a Glance, Catalogue number 91-003-XWE.

I suppose it is good news that the PBO's projections take demographics into account. However, its projections only extend to 2014, and the picture doesn't get any brighter thereafter. Once we've cranked up the net debt to $631 billion in 2014, we will not only have to balance the budget but also run significant operating surpluses to pay back the debt to a reasonable level. We will have to do so with a smaller income tax base (see demographics, above), higher demand for many government services, and higher interest payments on the debt.

In light of this rosy scenario, we must consider what to do now to mitigate these looming budgetary problems. Clearly, some combination of revenue increases and expenditure reductions will be necessary to balance the budget and run operating surpluses to offset the debt incurred over the next few years.

The simplest and most effective change we can make immediately would be to restore the GST to its previous level of seven per cent. The Conservative government slashed this tax by 28.5% over two years. The PBO estimates that each percentage point decrease in the GST costs the government $5.4 billion in revenue. Restoring the GST to 7% would provide $10.8 billion in revenue annually, or $52.4 billion over five years. We would still have to deal with a projected $114 billion deficit over the period, but it would be a good start. Considering that the GST cut was poor tax policy to begin with, let's start putting our fiscal house in order -- again! -- by reversing the ill-advised and short-sighted tax cut that the Conservatives brought in.

Update: The GST credit system provides relief to low income Canadians who pay sales taxes.