How to Combat Exploding Household Debt

To address Canada's record-high household debt, the government will first have to tackle our great income inequality.

Big headlines brought us the news that Canadian household debt has reached a record high compared to household income. The average family now owes $1.48 for every $1 of after-tax income, even more than our notoriously spendthrift American neighbours.

There was a lot of tut-tutting over this dismal news from the great and the good, and more than a bit of evocation of the Victorian era virtue of thrift. Bank of Canada Governor Mark Carney warned us not to mortgage and max out our credit cards to the hilt, and the banks called on the government to set stricter limits on mortgage borrowing.

Told as a morality story, this was beyond strange. Has the Bank of Canada not cut interest rates to near zero in a desperate attempt to get us to spend so as to shore up a sagging economy? And is it not the banks who have been earning big profits by extending credit to consumers all the way? As the writer of a letter to the Globe and Mail pointedly asked, if the banks are so worried about growing debt, why do they charge 19 per cent interest on credit cards?

The real story behind rising debt is hard to unravel. We know what the average debt is per household simply by dividing total debt by the total number of households, but we don't know exactly who among us has been doing all of the borrowing.

In 2005, the last time Statscan crunched the numbers on who holds debt and who holds assets, the bottom 40 per cent of households had no net wealth at all. Their debts were greater than their assets. The richest 10 per cent of Canadians owned 58 per cent of all wealth, and an even greater share of financial assets like shares, bonds, and bank accounts. For them, debt is not much of an issue.

Chances are that the rapid growth of mortgage debt, home equity lines of credit, and credit card debt over the past few years is mainly accounted for by younger households. Many are carrying a lot of student debt when they mortgage themselves to the hilt to get into the housing market, and even two incomes make it hard to avoid running up a balance on the credit cards.

The background to rising household debt has been stagnant wages for many middle and lower income Canadians, especially younger age groups. Over the past 20 years, only the top 20 per cent of earners have seen significant increases in their real incomes, with a huge chunk of that going to the very top one per cent, who actually got $1 in every $3 of increased income.

Seen in this light, increased borrowing by the majority of individuals does not reflect a moral lapse into profligate spending so much as a widespread attempt to match the growth in “average” living standards, which has been artificially inflated by growth of incomes at the top. The root cause of rising debt is rising income and wealth inequality.

Hidden in the Statscan release of the debt numbers is the fact that households now hold cash and short-term deposits amounting to a record $946 billion, or about one quarter of all financial assets. Ironically, the affluent are sitting on a veritable mountain of cash, while their neighbours are sinking deeper and deeper into debt.

What should governments do about the growth of household debt?

While tightening up the mortgage rules probably makes sense, the best way forward is to boost the incomes of heavily indebted borrowers. After all, while we may not want them to keep on borrowing, we surely do not want them to stop spending at a time when the economic recovery is so fragile.

How about diverting some money from those sitting on big piles of cash to other people who would actually spend it? We could, for example, raise income taxes on very high income earners to pay for higher child benefits, higher sales tax credits, and higher Employment Insurance benefits.

That may sound pretty radical. But, way back when I learned economics, it was pretty standard textbook stuff. If an economy is operating below capacity and with high unemployment (as we are) then the government can boost demand and jobs by shifting resources to those with a higher “marginal propensity to consume.”

Dealing with debt by redistributing income is the right way to go, both morally, and on the basis of economic logic.