A different take on Canada’s deficit-fighting story

Revisiting our fiscal “miracle”

by John Geddes

With the United States and European Union staggering under debt burdens, Canada’s success in sorting out its fiscal problems a decade and a half ago is often held up as an example to emulate. But it’s a model I often don’t recognize, even though I covered the turnaround story back in the 1990s.

For instance, there’s this recent Washington Post piece, which touts the “Maple Leaf Miracle.” “Facing an unprecedented fiscal crisis, Canada got down to work,” it says. “The country passed a landmark budget in 1995. The plan tilted heavily towards cutting expenditures but also included some new revenue (the ratio was about $7 in cuts for every $1 of revenue). Canada cut the civil service by about 25 percent and overhauled its pension program. The plan worked.”

An American or, say, German fiscal hawk might well perk up at that prescription—cut public spending ruthlessly, laying off one in four government workers, while boosting the tax haul only very modestly by comparison. Sounds like a plan. Except it’s not the one that actually transpired in Canada.

What really unfolded here over the crucial decade in question is, in the broadest strokes, as follows. When the Liberals started grappling with the fiscal crisis in 1995, the Canadian government was spending $173 billion a year and taking in just $137 billion in taxes and other revenues. Five years later, the government was, after some very short-term cuts, back to spending almost exactly the same amount, but raking in nearly a third more revenue, about $180 billion. After that, with the budget cruising along in surplus, spending climbed steadily to $207 billion over the next five years, as revenues kept right on growing to $212 billion by the 2005.

So it’s accurate to say that spending was restrained for a few years after former finance minister Paul Martin tabled his famous 1995 budget. And that jolt of austerity did help wipe out the deficit faster than anyone thought possible in the fiscal dark days of 1993 and ’94. But by far the main reason the red ink evaporated—until it rematerialized after the market meltdown of 2008—is that the Canadian economy grew smartly year after year during that period, and tax revenues more than kept pace.

Then there’s the matter of a quarter of federal jobs being axed. Nothing like that happened (as we see in this Statistics Canada overview). In 1995, the federal government’s workforce numbered 382,000. That total shrank no smaller than 326,500 in 1999. After touching that low ebb, Ottawa’s hiring picked up again, to the point where 380,700 were working for a federal pay cheque in 2006, the year the Liberals lost power to the Conservatives.

The real history of the Canadian fiscal reversal, then, is that firm but hardly harsh spending restraint proved sufficient because the economy cooperated by expanding steadily and rendering up taxes. I realize that simply advising, ‘You need to grow your way out of a fiscal mess,” isn’t much help. There are, though, a few more precise lessons to be learned from Canada’s deficit-fighting experience.

Firstly, it helps to fix your tax system. Canada’s is by no means perfect, but the overhaul boldly implemented by Michael Wilson, the former Conservative finance minister, in the late 1980s and early 1990s, paid off in the revenue surge that followed a few years later (for those lucky Liberals) when the economy picked up steam. Wilson had eliminated a raft of business tax preferences, allowing him to cut marginal corporate tax rates overall, and yet widen the base by making 84.1 per cent of corporate income subject to tax, up from just 72.4 per cent before his reforms (according to this handy review of federal tax changes). More famously (or infamously, depending on your perspective) he brought in the Goods and Services Tax, hated by everyone—except anyone who really understands taxation—and precisely the sort of value-added tax the U.S. so badly needs, and will probably never get.

Secondly, it’s possible—in fact, essential—to fix underfunded entitlement programs even as you balance your books. In 1996, the federal and provincial governments agreed to revamp the Canada Pension Plan. (Paul Wells recapped the uplifting tale here a few years back.) Politicians of all stripes, at both levels, agreed to boost the combined employer-employee contribution rate (basically a payroll tax) to 9.9 per cent in 2003 and beyond, from 5.6 per cent in 1996. A pillar of retirement income for millions of Canadians went from wobbly to sturdy. Taxpayers accepted having more money deducted from their pay in order to shore up such a key program. Then again, political demagogues weren’t screaming at them about their taxes rising and freedoms eroding.

Finally, there’s the aftermath of the Liberal battle to eliminate the deficit. What might a government do after balancing its books? I’d point to two things, one to lift the spirits of fiscal conservatives, the other the warm the hearts of social liberals. In 2000, the Canadian government, now that it could afford to, introduced across-the-board personal and business tax cuts (read all about it here). And, in 2004, the federal government injected $40 billion over 10 years into health care, not perfecting universal insurance, to be sure, but reaffirming its commitment (in this deal) to the essential principle.

The path to fiscal health wasn’t as painful as we feared, or even as hard as is sometimes said in retrospect. The payoff, as it turned out, soon included something for everyone. It’s a happy, complicated story, and more instructive than the one that’s often told.




Browse

A different take on Canada’s deficit-fighting story

  1. John – you glazed over 5 years of zero spending increases as though that is an easy thing for the Federal government to do. You say it took 11 years before the Civil Service reached it’s 1995 levels and actually do so in what appears to be a criticism!

    I have a very simple question for you: what would Federal government spending be in 2011 if it was held flat for the last 5 years instead of growing at its actual rate? $50 billion less? $100 billion?

    Holding government spending flat for 5 years is a huge accomplishment which has a material impact on the state of a nation’s finances.

    • Exactly what I was thinking.

      Where would we be today if the conservatives had actually acted conservatively instead of boosting spending by over 7% per year since 2006?

      If over the past five years they’d held the line on spending like the Liberals did, we’d never have been in a deficit position in the first place!

      Where would we be today if they’d left the GST alone and cut income taxes instead?

      People would be more self sufficient and less reliant on government programs, something conservatives are supposed to be all about.

      What would the size of the civil service be today if Harper hadn’t hired over 30 000 people in the intervening five years?

      We wouldn’t be cutting the civil service willy nilly and pretending it involves foresight as the conservatives are doing today.

      All in all it seems to me that the conservatives have done nothing but rely on the situation Paul Martin left them while tinkering at the edges with policies that have degraded our position rather than enhance it.

      Paul Martin had the good sense to recognize the intelligent changes Michael Wilson made to our tax regime and actually worked to enhance the effect of those changes to the benefit of all Canadians rather than pandering to an exclusive voting base. Both of these men deserve to be recognized for rising above politics and doing the right thing.

      Hopefully we’ll see their like again someday, but I’m not holding my breath.

      • In 1995, the federal government’s workforce numbered 382,000. That total shrank no smaller than 326,500 in 1999. After touching that low ebb, Ottawa’s hiring picked up again, to the point where 380,700 were working for a federal pay cheque in 2006, the year the Liberals lost power to the Conservatives. 

        Why is Harper’s 30,000 hiring binge worse than Martin’s 53,500 hiring binge? I’m not excusing either one. But let’s not fudge facts here. Absurd growth in the federal public service has been with us since 1999. At least it’s ending now.

  2. Well Americans have been in denial about taxes ever since they dumped the tea in the harbour, so trust them to dwell on that aspect. LOL

    I remember Mulroney at one point saying that the interest on the debt was ‘eating us alive’, and he saw the solution as ‘growing us out of it’….hence free trade.

    I note that Harper, in spite of the high horse he rode in on, is now attempting more free trade deals in an effort to do the same thing.

    I just hope that’s not all he plans to do.  Most of our deals involve commodities, and we need to move on from there…plus sooner or later we’ll run out of countries to trade them with.

    I suspect Harper and Flaherty are pinning their hopes on oil and manufacturing returning …even though we are now in a new economy.

    • Yeah, too bad Harper disassembled all the trade teams the Liberals spent years cultivating eh?

      So much time and effort lost simply because Harper didn’t understand the need for a robust international trade focus.

      Given we’re a massive resource country with only 33 million people and Harper is supposedly an “economist” I’m not really sure why it took him so long to understand this very basic point.

      We live and breath off trade, and putting all our eggs in the American basket without concerted effort to expand our connections to other nations to add a few more legs to the stool was really quite foolish.

      Oh well, better late than never I suppose.

        • Interesting article and an excellent case in point.

        • Harper likes full control. He’d have a nervous tick if he took other important stakeholders on these trade missions.

          • LOL that’s true.  Someone might sneeze without his permission.

      • So much time and effort lost simply because Harper didn’t understand the need for a robust international trade focus. 
        He’s signed more free trade deals in 5 years than the Liberals did in 13. And all that with a minority government. And he’s aggressively pursuing more, including a huge deal with the EU. He’s also sent out feelers to Japan and Korea. So how is it that he never focused on international trade? 

        I’ll be the first to admit that the EU deal is probably DOA, given that it will require Harper to throw his remaining six Quebec MPs under the bus, as the EU will NEVER accept anything less than the total dissolution of supply management. But with enough new seats in the West to compensate in time for the next election, Harper might surprise us yet. 

  3. The mythology around this situation has always been a puzzlement to me. I was alive,
    well, and politically active during this period. And what I saw was a deficit that was eradicated
    within a couple of years … before most of the announced cuts had really kicked in. Then a series
    of surplus that grew to the point that showed Mr. Martin to be the Mr. Dithers that he was later
    labelled for different reasons. He re-funded health care because that’s the showcase program. He
    made gestures with poverty reduction and social housing because nobody really gives a damn about
    poor people any more. He announced his famous “thirds” plan for surplus use and then ignored it.
    It was all an exhibition of improvisation worthy of Mingus in full roar.

    Anyway, a related article from last year …

    http://www.newdeal20.org/2010/06/09/the-united-kingdom-draws-the-wrong-lessons-from-canada-12009/

    And the sad fact that the growth that drove it all was largely a piggy-back on the US tech bubble
    does not inspire confidence in any future process.

    • Well stated. They road the coat tails of the US tech bubble and devalued-and-exported their way out of trouble. The rest they trimmed from provincial budgets, massive EI overpayments, and the public service pension fund (about $30 billion from that same fund which is now an underfunded albatross around the government’s neck.) Now that those low hanging fruit have all been picked (raided?) where is the money going to come from to balance the budget this time? 

    • Great link. Marshall Auerback makes the crucial point that public fiscal contraction resulted in greater private household debt overhang — the same dynamic that occurred under the Clinton surplus. Which begs the question: what were the merits of the budget balancing exercise to begin with?

      • Household debt grew as a result of excessively low interest rates and low lending standards i.e. printing too much money. They did not grow because of government cutbacks. 

        • On the basis of the simple accounting identity that government deficit = non-government surpluses I find it implausible that fiscal contraction had no effect on households’ debt levels.

          To state that debt grew because of low interest rates and poor lending standards is to focus in on the micro whilst ignoring aggregate sector balances between gov. and non-gov. Its not false, but its a fallacy of composition to consider it the cause underlying the whole picture.

          http://neweconomicperspectives.blogspot.com/2009/07/employing-krugmans-cross-farewell-mr.html

          http://wallstreetpit.com/8568-the-sector-financial-balances-model-of-aggregate-demand

          • That’s not just a simple accounting identity, it is a grossly oversimplified and misleading one. I am not arguing that it has ZERO effect. I am arguing that there are myriad factors that cause personal debt levels to go up or down, government deficit/surplus position being only one, and not anywhere near the most important one. 

  4. The whole point of Keynesian fiscal policy is to make your cutbacks in a boom period. It’s not that “wow, Canada only did well then because the 90s were awesome”, it’s that that’s the only right time to actually take that sort of action.

    Cutting in the midst of a recession/depression is, according to those same ideas, the absolute worst thing to do, but other countries are going to do it anyway. And thanks to the global integration of economies, we’ll all pay the price for their ineptitude. Lovin’ it.

    • Sort of, but Keynes never anticipated a sovereign debt crisis. In that situation you have to be careful that increased spending has a pretty high multiplier effect – enough so that it actually reduces the deficit. That is not the case for a lot of the things that were lumped into the stimulus, at least in the US. Also, the degree of economic openness prevailing today means that many of the beneficiaries of the stimulus will lie abroad. 

    • Keynes would gag if he were to witness the modern-day “Keynesians” who use his name to defend their theories today. Keynes never envisioned government debt levels as high as they are today, save for periods of global conflict like WWII. He certainly did not support massive stimulus at a time when governments were already wilting under enormous debt burdens. 

  5. You miss the key element behind the Canadian growth “miracle”. Interest rates interest rates interest rates. The recession of the early 90s was especially fierce because the governor of the Bank of Canada, Crow, was a believer in zero inflation (ie. if the bank targeted zero inflation, and was credible enough, expectations would follow). 

    Interest rates reached about 15% in the early 90s as a result. However, they continued to fall all through the rest of the decade, going below 5% by 1997. This had a directly stimulative effect on the economy, that more than offset the depressive impact of spending cuts. In fact the timing of the rate decrease looks a great deal like the feds coordinated with the B of C (http://worthwhile.typepad.com/.a/6a00d83451688169e201348804d9e9970c-800wi ). Secondly, declining interest rates resulted in a weaker dollar, which spurred on exports. 

    This is important, because it means that the Canadian “miracle” cannot be replicated abroad under current circumstances. Most major economies already have interest rates at or near zero. Monetary expansions are only possible through dangerous operations like quantitative easing. Secondly, the decline in the value of the Canadian dollar through the 90s was only possible because we were the only ones enacting low dollar policies. If everybody did the same thing at the same time, nobody’s currency would drop. 

    Also, other commenters have correctly noted that 5 years of zero growth is quite a feat. I’d go beyond that and point out that when accounting for inflation, 180 billion in 2000 dollars is 166 billion in 1995 dollars. So in other words you had a cut in spending of about 4%. Think about how antsy we get when the economy falls 4% over 5 years instead of growing by over 10%, and you have a good picture of the anguish of those dependent on government spending in the late 90s. Actually it may be worse than that, because the growth of government has generally exceeded that of the economy since WWII. 

    • You point out what repeatedly blows my mind in every revisionist history about the Chretien-Martin “miracle.”  Every Canadian with C$ assets paid a huuuuuge price in loonie devaluation.  It was every bit as (or maybe more) harmful to Canadians’ standard of living as would have been a massive tax increase.  But since everyone kept working for ever-more-worthless income, it was politically do-able, and a lot of us remained happily employed (and tax-paying) Canadians as a result.  It was booming economic growth according to anyone (i.e. just about everyone) who failed to notice how weak was our wealth creation.  It is sad that, even in hindsight, so many fail to catch on.

      That we have been able to hold our own AND appreciate the value of our dollar is testament to more recent (though not immediately recent) Canadian virtues and the absolute insanity of so many of our (allegedly) first-world brethren.

      • And yet, if they hadn’t done so, where would be today?

        Frankly, no matter how it’s done, cuts hurt.

        At least they found a way to make those cuts in a manner that didn’t destroy the economy.

      • I do believe a lot of people underestimate the damage that devaluation of our currency did during the 1990s. That devaluation, plus a continued high immigration intake, did much to turn Canada into a low wage backwater of call centres and other mindless “service” work. We only avoided that scenario because of the resource boom that started around 2000 or so. Those same resource industries are sneered at and dismissed by numerous “thinkers” who believe that we rely on them too much. In fact, it was/is our resource economy that saved us from the depths of the 2008 collapse. 

        I fully agree that we need to do more to repatriate our manufacturing base, and I’m as worried as anyone that this doesn’t seem to be happening. But the reality is, our dependence on resource industries has been a strength, not a weakness. 

    • The price stability and low interest rates we enjoyed during the latter half of the 1990s were made possible precisely because of John Crow’s unyielding war against inflation in the early part of the decade. By the time he was replaced, inflation was indeed near zero, and remained muted for the rest of the decade. 

      We’ve since lapsed back into an easy money stance, and we’ve got a massive housing bubble to show for it. There will be hell to pay for that in the near future, and we’ll need some future John Crow to make the tough decisions and clean up the mess once again. 

      John Crow did for Canada in the early 1990s what Paul Volcker did for the US in the early 1980s: wrestled a persistent, cancerous, destructive inflation to the ground with a ruthless “tight money” policy that rewarded saving, punished borrowing, and restored price stability. Without price stability, no economy can grow for long. 

      The fight against inflation is necessarily a painful and often economically destructive process. But there is no shortcut. Like any other war of self-defense, the only thing worse than fighting inflation is not fighting it. A lesson we’re about to learn all over again as our current easy money stance does its damage. 

  6. I seem to recall there was a not inconsiderable amount of “downloading” of progrm costs to the provinces. Was I dreaming this or was it just provincial politicians just covering THEIR butts?

    • It was mostly whining over the healthcare cuts in my opinion. They suddenly couldn’t rely on a broken mechanism to magnify their funds by simply raising spending.

      It may be the federal government’s fault that they became addicted to that reliable funding stream, but it wasn’t sustainable, so thank god Martin took the heat and cut it back.

      • We’re back in the doo doo again with 6% escalator clauses for healthcare funding from now to perpetuity. That’s something that will need to be addressed. 

  7. One point missed in this article is what happened with healthcare spending.

    At the time of the cuts the federal government was funding 50% of the healthcare budget.

    However this poorly thought out policy resulted in a windfall for the provinces and drove spending through the roof.

    At that time a premier could run on a platform to say increase healthcare spending by 10%, knowing they would only really be paying 5% more because the feds would kick in the rest.

    Since healthcare is a provincial juridiction, the federal government couldn’t do anything to reign in the spending.

    Despite the blowback, Martin cut that contribution to 25% and instead linked any additional amounts to transfer payments, limiting the ability of Premiers to milk the cow dry.

    It was unpopular but the right thing to do. I’m not sure how this important point got missed?

    • The federal share was never anything approaching 50%. That 50-50 formula agreed upon in the 70s is the stuff of myth. It was never meant to be 50-50. It was always meant to be 50% provincial, and the remaining 50% was split 50-50. Martin just restored that original balance. Then he graduated from Finance Minister to Prime Minister and completely destroyed his earlier progress by agreeing to the 6% escalator. Harper has also embraced that same escalator in perpetuity it seems, and there will be hell to pay for that down the road. 

  8. You forgot the part where transfer payment cuts offloaded the deficit problem to the provinces which made a combination of painful cuts (to health and education) to the derision of voters everywhere (Rae Days in Ontario, Filmon Fridays in Manitoba) and further offloading to municipalities which neglected maintenance of infrastucture to cope and one could argue that most have never recovered from that infrastucture deficit.

    • All very true. But this speaks to a major flaw in our federation: The fact that one level of government (federal) raises most of the tax revenue, but other levels of government provide most of the services that are important to us. The point was driven home to me in 2008, when Parliament was prorogued, and a bus strike was going on in Ottawa. Nobody even noticed the prorogation – it had ZERO effect on life in Ottawa. But one stinkin’ municipal service went on strike, and the whole city was upside down overnight. It was HELL. 

      Think of it. Everything really important in our day to day lives is municipal or provincial. It has become increasingly evident to me that outside of criminal law, immigration, border services, the military, foreign affairs, CPP and EI, we really don’t need the federal government that much at all. Yet they have the most taxing power and pull in the most revenue. 

  9. The Liberals’ deficit fight in the 1990s coincided very nicely (and very luckily) with the biggest economic boom the world has ever seen. Also, they benefited greatly from the tax reform done by Mulroney, mainly the GST. They really only required very minor tweaking. The rest was just piggy-backing on the booming US economy, and leveraging their voracious appetite for imports with a devalued loonie. We no longer have that huge, thriving economy next door, which means we cannot devalue-and-export our way out of it this time. Balancing the budget this time around is going to take some pretty draconian cuts. I’ve yet to see anything that convinces me that the Conservatives – or any of the other parties – have the stones it takes to do it.

  10. Interesting article and very informative discussion here.  

    I take from it all that the best choice of economic policy depends on the state of the economy. Exercise and a reduced diet are the best treatment for overweight, but tragically the wrong one for anorexia.

    What is the problem?  The problem is a growth in poverty that is causing misery and generating social disorder, while at the same time increasing the wealth of the wealthy in the expectation that a wealthy wealthy class will make the world a better place for all. 

    In the current conversation, the dominant prescription for this condition is to reduce the services that mitigate misery while increasing the services that attempt to control disorder. The wealthy, at least those represented by our government, would rather populate prisons than populate schools and hospitals. 

    That is a problem. Looking back to the successes of the  past, into times very different from now, is not useful or relevant to our problem now.

    • We haven’t really reduced services that mitigate misery have we? Healthcare has seen ENORMOUS increases in spending, with more to come. (Irresponsible in my view, but those are the facts.)  So I don’t know where you get this idea that hospitals are underfunded. 

Your email address will not be published. Required fields are marked *