As we emerge from the recession, Canada is in better fiscal shape than many industrialized countries. That others are worse off does not change the reality that Canada faces significant fiscal challenges. The International Monetary Fund (IMF) estimates that Canadian governments require a fiscal adjustment (expenditure decrease plus revenue increase) of approximately five percent of GDP over the medium-term to place our country on solid fiscal footing. This is a daunting challenge considering that population aging will strain healthcare budgets. For the foreseeable future, governments in Canada will likely face budget pressures comparable to those confronted in the early 1990s.
The budget challenges of the 1990s necessitated disciplined austerity measures that eventually produced a string of federal surpluses, catapulting Canada to the comparatively strong fiscal position it presently enjoys. Unfortunately, from 2005 on federal spending has increased at a rate exceeding economic growth. According to the Canadian Taxpayers Federation, had program spending been limited to the combined rates of inflation and population growth (2.7%) since Paul Martin’s first budget in 2003-04, there would be a surplus now of $25 billion.
This lack of spending discipline combined with the stimulus spending launched after the 2008 recession are responsible for the fiscal crunch we face today. The time is ripe to launch an era of intelligent austerity based on a two pronged plan to 1) modernize the operations of the federal civil service, and 2) reduce unnecessary duplication of functions and spending between the feds and the provinces, including a strong signal that the federal government intends to pursue a comprehensive plan to fix increasingly counterproductive transfer payment programs.
With massive retirements now impacting the federal civil service, the timing is ripe to modernize and downsize. With thousands of job classifications the system remains organized along traditional bureaucratic lines. It is highly regulated and focused on processes instead of results. Its unwieldy compensation model contains strong incentives toward maximizing internal spending and staffing. The federal government should adopt less-regulated, best practices modelled by Australia and New Zealand, which re-orient agency incentives toward the efficient production of outputs, giving line departments more control over their activities and asset management.
Second, the federal government needs to focus back on its traditional functions like foreign policy, defence, crime prevention and enforcing free trade in the federation by shifting its spending away from areas of provincial jurisdictions like healthcare, daycare, and education. This would reduce unnecessary overlaps and duplication while allowing provinces more freedom to experiment with innovative models, particularly in healthcare.
This brings us to transfer programs, particularly equalization.
The current transfer system is broken. The $14 billion equalization program is especially problematic. Enormous amounts of money are pumped into governments of the perennial have-not provinces each year, and the result is ever-growing bureaucracy and inefficient spending. Politically popular but extremely expensive provincial policies such as rock-bottom university tuitions (which do almost nothing to boost participation) and subsidized hydroelectric power (which encourages overuse of natural resources) in Manitoba and Quebec are enabled by equalization.
The budget should announce that equalization payments will be reduced by five percent at the earliest possible date, for savings of approximately $750 million annually. This should be a first step toward reforming Canada’s system of transfers. More substantive changes would follow negotiations featuring a transfer of tax points. The reform objective should be to extricate federal power from areas of provincial responsibility to promote accountability and to reduce duplicative spending. While Manitoba, Quebec, and others may persist in inefficient spending, a reduction in equalization payments this year would send a message that they will soon have to find a way to pay for it themselves.
These steps would significantly reduce expenditures. Turning to revenues, the government should go ahead with planned corporate tax reductions. Canada’s ongoing policy of reducing corporate taxes has promoted competitiveness and is part of the reason we have weathered the global economic storm comparatively well. It would be a mistake to turn back now. To help offset revenue losses, we should reduce corporate subsidies. This would enhance the competitiveness of firms across the economy, instead of benefitting politically favoured companies.
In the March budget, the federal government must begin tackling the long-term fiscal challenges we face. The budget can start to restore fiscal balance by winding up emergency stimulus efforts, trimming spending in provincial jurisdiction, and signalling the federal government’s intent to seriously begin reforming transfers that bloat up low performing provincial spending.
Delaying will worsen the problem and we will eventually face the painful across-the-board cuts and tax increases that have come to the United Kingdom and are likely coming in the United States. The federal government can help us avoid this unhappy fate by delivering a simple message, loud and clear, with its new budget: the era of smarter, less duplicative government has arrived.
An abridged version of this appeared in the National Post, March 18, 2011.