A federal government runs a large deficit. The ratio of federal debt to Gross Domestic Product approaches 70 percent. Voters have gotten used to large federal spending programs. Does that sound like the United States? Well, yes. But it also describes Canada in 1993. Yet, just 16 years later, Canada’s federal debt had fallen from almost 70 percent to only 29 percent of GDP. Moreover, every year between 1997 and 2008, Canada’s federal government had a budget surplus. In one fiscal year, 2000-2001, its surplus was a whopping 1.8 percent of GDP. If the U.S. government had such a surplus today, that would amount to a cool $263 billion rather than the current deficit of over $1.5 trillion.
The Canadian Liberal government, under the Prime Minister Jean Chretien and Finance Minister (and later Prime Minister) Paul Martin created the turnaround mainly with spending cuts. The ratio of spending cuts to tax increases was about six to one. Canada’s government didn’t cut just the growth rate of government spending: it cut absolute spending on many programs.
As a result, federal spending on programs (all spending except for interest on the federal debt) fell from a high of 17.5 percent of GDP in 1992-93 to 11.3 percent in 2000-01. Prominent Canadian economist Thomas Courchene noted correctly that this was the lowest percent “in more than half a century.”
We often hear that cutting government budgets causes “pain.” But that depends on what is cut. By selling the air traffic control system to a private non-profit company, NAV Canada, the Canadian government netted $1.4 billion and saved $200 million annually. And NAV Canada has revolutionized air traffic control in Canada, putting Canada decades ahead of the antiquated U.S. system.
Canada’s government also cut spending on unemployment insurance. At its most profligate, Canada’s program had paid unemployed people in some regions up to 42 weeks of benefits if they had worked as little as eight weeks. One of the Canadian government’s first budget reforms was to raise the minimum amount of time worked to be eligible for benefits to 12 weeks in high-unemployment regions and 20 weeks in low-unemployment regions. Did this cause pain to people who had to work a little longer? Sure, but it also reined in a program that subsidized idleness.
As Finance Minister, Paul Martin became a strong believer in reining in government spending. He vowed to reduce the deficit “come hell or high water,” a phrase that became the title of his memoirs. Early on, two outside pressures helped him in this effort. One was a Wall Street Journal editorial that referred to Canada’s dollar as “the northern peso.” The other was that two weeks before Martin’s fiscal year 1996 budget was introduced, Moody’s Investor Service had put the Canadian government on a “credit watch” because of the government’s high debt/GDP ratio.
Martin was also helped by the Reform Party, a surging party with its basis in western Canada, and two private groups, the Canadian Taxpayers Foundation and the National Citizens’ Coalition. All pushed for even bigger spending cuts.
Many economists think that large cuts in government spending will cause, in the short run at least, a large increase in unemployment. But Canada’s experience, like the U.S. experience after World War II, does not bear this out. As government spending as a percent of GDP fell through the last half of the 1990s, the unemployment rate fell too. Also, Canada had high economic growth. From 1997 to 2000, when government spending as a percent of GDP fell, Canada’s economic growth was between four and five percent per year.
The payoff from the budget cuts was a string of budget surpluses that allowed Chretien and Martin to cut taxes. They restored full indexation of income tax brackets so that inflation alone could no longer put people in higher brackets. With an eye on global competition for capital, they cut the flat corporate income tax rate, in stages, from 28 percent to 21 percent and excluded 50 percent of capital gains from taxation, up from only 25 percent. Martin and Chretien eliminated the five-percent surtax on high-income individuals and added a 26-percent bracket for the people in the lower-income portion of what had previously been the 29-percent bracket. Since then, the corporate income tax rate has been cut, in stages, to 16.5 percent. Prime Minister Stephen Harper, with a Conservative Party majority, plans to cut the corporate tax rate to 15 percent in 2012. Canada’s government is saying, in effect, “Give me your highly taxed owners of capital yearning to breathe free, I lift my lamp beside Calgary and Toronto.”