Afraid of 2012? Remember the Budget of 1995: While the federal spending deficit today is almost identical to what the Liberals faced in 1995, the civil service should relax. The situations are fundamentally different.

Commentary, Taxation, Frontier Centre

The 1995 Liberals had no choice. That’s the real difference between the desperate budget of former Liberal finance minister Paul Martin and the less draconian edition due to be handed down next year by his Conservative counterpart, Jim Flaherty.

While the federal public service unions are preparing for the worst, Flaherty is proposing to trim departmental budgets just five per cent annually by 2015. Departments have been directed to prepare a second scenario involving cuts of 10 per cent, but even this measure of resolve would have been mocked by the financial establishment of 1995.

Martin shocked the unions by revealing departmental budgets were to be slashed an average of 19 per cent within three years. Some — such as Transport and Natural Resources — would be cut by 50 per cent. At the same time, the federal civil service would shrink by 14 per cent, representing some 45,000 bodies — roughly one-third from the National Capital Region.

“Things looked pretty scary at the time,” recalls John Manley, the Liberals’ industry minister at the time.

“We had to be really credible because we believed we would not have a second chance,” he said.

Manley — who for the past two years has been CEO of the Canadian Council of Chief Executives — was one of several cabinet ministers dispatched to foreign capitals on budget day. His job: to sell the message that Canada was finally getting serious about its finances. Federal debt was approaching 70 per cent of the country’s annual economic output, a level considered unsustainable at the time and more than double today’s ratio. In the weeks leading up to the budget, such was the global concern over Canada’s ability to manage its finances that the federal government had trouble selling some of its own debt.

Because Martin broke the mould — by cutting deeply into the civil service, privatizing major Crown corporations such as PetroCanada and CN Rail, and slashing subsidies to business by 60 per cent — he gave his successors a free hand in deciding how to achieve future savings.

Up to a point.

This is where politics comes in.

As member of Parliament for Ottawa South, Manley saw the impact of the 1995 budget cuts in a most personal way. A neighbour who lived four doors down the street lost his job at Manley’s Industry department. Manley often ran into constituents who had in some way been hurt by the budget. So, when he did some polling in his riding, he was surprised to discover 60 per cent supported the Liberal budget and nearly two-thirds felt it had apportioned the pain fairly. Apparently, Canadians were just as worried about the country’s finances as Wall Street.

What no one knew at the time was that nearly everything would break in Martin’s favour. The U.S. economy put on a growth spurt, and pulled in Canadian goods by the ton. Interest rates tumbled, thus reducing the cost of servicing Canada’s $568-billion debt. And the job of convincing government employees to leave the public sector was made easier by a rapidly recovering private sector. In the National Capital Region, tech giants such as Nortel Networks, JDSU and Newbridge Networks went on a hiring spree.

The result: it took Martin only three years to eradicate a $36.6-billion federal deficit and departing civil servants were quickly reabsorbed into the workforce.

Flaherty faces a much different calculation. He has a much better starting position because federal debt is less than half of what it was in 1995 as a percentage of the country’s annual output. But it may actually be tougher to achieve the necessary cuts to reach a budgetary surplus by 2015.

Here’s why:

Interest rates could rise rapidly. They’ve been held artificially low to prevent heavily indebted Western nations from slipping back into economic recession. Assuming economies continue to grow, central bankers will revert to more normal interest rates. Indeed, Flaherty is already projecting a rise in annual debt interest payments on the federal debt of $8.5 billion between now and 2015. The question is whether he’s being too optimistic.

The U.S., still by far Canada’s largest trading partner, appears to be on a growth track, but economists aren’t sure the trend will continue. This suggests Flaherty cannot count on a U.S.-led export boom, especially with the loonie worth in excess of $1.02 U.S. compared to 71.6 cents U.S. when Martin tabled his budget in 1995.

Canada’s private sector is not hiring to the same extent as in 1995. In the five years following Martin’s budget, the country’s employers added 1.5 million new jobs, most of them in the private sector. In the Ottawa area the number of high-tech employees soared from 29,000 in early 1995 to nearly 72,000 in early 2000 — easily making up for the loss of 15,000 federal government workers over the same period. While the health of the tech sector, currently with 45,000 employees, is improving, the nature of the industry has changed. Manufacturing, logistics and other specialized tasks are often outsourced to lower-cost countries.

Unlike the case with Martin, who cut social transfer payments by $5 billion a year, Flaherty has already pledged not to touch federal transfers. This means he must focus disproportionately on achieving cuts from $80 billion in annual federal program spending.

Which leads to the question of political will. There’s little doubt that Prime Minister Stephen Harper now has the wherewithal to push through spending cuts of considerable magnitude.

He also lives with the knowledge that it was on his watch that the federal civil service grew nearly 30 per cent during five years of minority government. Will he now reverse course with a vengeance?

Almost certainly there will be civil service job cuts. But the final tally will depend on a few imponderables. One is the question of how many of the tens of thousands of baby boomers still in government work will opt to retire in the next few years.

Also, in the coming year Flaherty may well discover that a strong economy is spinning off billions in fresh tax revenues. It’s possible that spending cuts may not even be necessary to close the spending gap.

To be sure, such an outcome is unlikely. But few politicians enjoy shrinking government. The temptation to wait and see will be there.

Finally, if Flaherty gets his numbers wrong, and the deficit is still with us in 2015, it won’t be the end of the world — thanks in large part to the advance work done by Martin.