That old deficit war re-revisited: the tale of the taxes

by John Geddes

How much can a government afford to cut spending if economic growth is tepid? It’s a question Finance Minister Jim Flaherty must be asking himself these days, poor guy. No doubt Flaherty would like to keep cutting to shrink the deficit, but as the economy weakens, he’s coming under pressure for another round of stimulus spending.

This was not a problem then-finance minister Paul Martin faced back in the mid-1990s. In those days, economic growth was bettering all expectations, and spinning off more tax revenues that Martin’s fiscal strategists foresaw. I’ve argued this helped him mightily in his deficit-shrinking task, easing the need to reduce spending.

My colleague Andrew Coyne says I’m wrong. He contends that “deep cuts in spending” did the job. “How deep?,” he writes. “From $122-billion in the year [Jean Chrétien’s Liberals] took office, and $123-billion after their first budget, spending was slashed over the next two years by $12-billion.”

For the sake of clarity, I propose we look at the period from the first year Jean Chrétien’s government was in office to the year they balanced the books. That would be 1993-94 to 1997-98. Spending fell six per cent during that key span, from $122 billion to $115 billion, or $7 billion less. During those years, revenues rose 30 per cent from $124 billion to $161 billion, or $37 billion more.

How is it again that spending restraint mattered more than the taxes churned out by a booming economy?

 




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That old deficit war re-revisited: the tale of the taxes

  1. Modeled Behavior Tweet ~ Conservative and liberal economists should stop arguing, the confidence fairy rides animal spirits.

    Obviously I agree with Coyne’s argument more than Geddes but we actually don’t understand economics all that well. 

    Ottawa getting its fiscal affairs in order mid 1990s gave Canadians the confidence to go out and shop? 

    Also, cheap and abundant money helped but we are paying for it now. 

    • Yup.  Cuts were made, real cuts, but the “booming economy” was on the backs of any Canadian foolish enough to think the 80-cent Canadian dollar was gonna be worth something useful over the next five years.  That devaluation was a deliberate (result of the) choice made by Chretien & Martin.

  2. Yes, spending was cut, which caused a lot of hardship….but mostly we simply outgrew the problem.

    That’s where Flaherty should be concentrating his efforts…growing the GDP, not adding to the problem by slashing spending and putting more people out of work.  Unemployed people don’t buy goods, or houses or pay taxes…which makes things worse, not better.

    Pay no mind to Coyne…he’s too excited about getting his kilt out of mothballs now that we’re going back to ‘royal’.  LOL

  3. Coyne’s point seemed to involve the costs when accounting for inflation and population increase. Without bothering to look up exact numbers, inflation should be around or greater than 8%, population increase somewhere around 5% in those four years. Using terrible but approximate math, that accounts for almost have the increase in revenue (bringing it to ~17%) and turns the government savings from 6% to almost 20%, all from expected values.

    The point is, revenue and spending are both supposed to grow. Indicating that one grew faster than the other fell in nominal terms is rather unhelpful and somewhat misleading. So I agree with Coyne’s interpretation of the numbers – the federal Liberals debt reduction strategy, in terms of direct numbers, relied more on spending cuts than revenue increase, though the margin between the two is not overwhelming.

    On what that means, however, I think I’m more in your corner. Spending cuts didn’t do all the work, not even close, and spending cuts are much easier to absorb in times of growth than times of hardship. If we try to cut before growth is established, our economy will be worse off and the debt situation will remain largely unsolved (see Great Depression for historical examples, Ireland, Britain and Greece for modern ones).

  4. It’s much fun to see the argument, but the takeaway is, tax cuts isn’t something either one of these fiscal conservatives are arguing in support of.

  5. Sure, but doesn’t this argument only work if you stipulate that 37 billion is a larger number than 7 billion???

    I’m not sure that all of our politicians would be willing to concede that point.

  6. I’m with Geddes on this one.  It wasn’t just spending cuts, although those played an important role.  It was also a booming, robustly growing economy.

    • Canada wasn’t the only country with a robustly growing economy in the nineties, but Canada is one of a few, if not alone, in having reduced its debt and eliminated its deficit. The US was very, very prosperous in the nineties !

  7. Stephen Gordon in today’s G&M gives a good take of what went on – looks like Geddes is the winner here.

    “The Canadian federal government’s deficit in fiscal year 1992-93 was 5.6 per cent of GDP; five years later, it recorded a surplus.

    I can’t think of any country where the conditions for a (relatively) pain-free deficit-reduction program are satisfied. U.S. employment has barely begun to recover from the recession, and current rates of job creation suggest that it will be many years before its labour markets reach pre-crisis levels of activity. Moreover, the Federal Reserve doesn’t have the room to manoeuvre that the Bank of Canada did in 1995: interest rates are already at the lower bound. And unlike Canada in the 1990s, the U.S. doesn’t have a rapidly-growing trading partner ten times its size.”

    http://www.theglobeandmail.com/report-on-business/economy/economy-lab/stephen-gordon/canadas-experience-wont-help-global-deficit-fighters/article2133332/ 

  8. There’s also the example of Alberta in the 90s.  Was it Klein’s cuts or the energy boom that finally did the trick?  I’d put my money on oil.  In good times or bad, Coyne will incline towards austerity because he’s a moralist.

  9. The problem is that -6% growth in spending is not normal by any stretch of the imagination. In ordinary times, government spending (in real dollars) grows at over 2% (so more than 10.5% over 5 years). And I haven’t even accounted for inflation.   

    Andrew’s problem is that he can’t properly articulate a response to such an argument because of his advocacy of unrealistic benchmarks of what a cut is (his usual standard is a reduction in real spending per capita). I think it is a convenient way in which to disavow just about every fiscal conservative as “really not that austere”.

    In the real world, absolute cuts in government spending are rare. What is more common, and more feasible are cuts relative to the long term trajectory of government spending – spending less than you would ordinarily have planned to spend. 

    I don’t contest that growth was important. But as much as it was fiscally important, the political cover it gave the Chretien government (and the provincial governments that had to implement most of the cuts) was of even greater importance. 

  10. Your point is academic. We ain`t gettin` sustained growth of 6% annually any time soon in Canada, so if we want to keep our fisca lhouse in order then spending cuts are the only way.

    Once them thar entitlements start to be drawn down by the boomers, instead of being paid into, we`ll really be up the creek around these parts, unless we can get spending under control a decade or two in advance.

  11. “…Spending fell six per cent during that key span, from $122 billion to $115 billion, or $7 billion less. During those years, revenues rose 30 per cent from $124 billion to $161 billion, or $37 billion more….”

    Obviously this is a matter of which emphasis a person thinks matters most, the fact that a government actually made cuts and sustained them for over five years, or the fact that the economy grew very quickly. For me the former is the key point, and for very good reason.

    While clearly the revenue growth explains the double digit billions in surpluses, what would have happened if instead of actually cutting spending by 6% over that five year period, the government did what most governments tend to do and INCREASE spending when they realize the money coming in?

    I’ve rarely seen any government even hold the line on spending, let alone actually cut it, and during boom times no less, so who’s kidding who here? Most governments would have frittered it away with vote candy. In fact most during that time period did.

    It was the Liberal’s dedication to cutting that allowed the boom to benefit us so much.

    I mean for pete’s sake look at Harper since he took power: He’s raised spending by at least 6% PER YEAR since 2006. 

    The compounding on those increases coupled with politically motivated tax cuts that made little economic sense would’ve reduced that surplus by billions and billions of dollars and not nearly as much debt would’ve been paid, thus more in interest charges and less in the way of future surpluses.

    In fact that’s essentially what’s happened since he took power, and thus here we are, so people need to get real: The most amazing aspect of that 90′s time period is that a government not only held the line on increases, but actually made cuts during a boom period when most politicians the world over would’ve been salivating like kids in a candy store over the votes they could buy, which is precisely what Harper did when he took power.

    My kingdom for another Finance Minister with the sense that Michael Wilson and Paul Martin showed: a dedication to doing the right thing, not the popular thing.

  12. This blog from WCI from 12010 is worth referencing (a similar piece recently posted on the G&M) , as well as the comments. Paul Krugman of the NY Times also referenced it (see comments for link).

    http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/06/on-the-lessons-to-be-learned-from-the-elimination-of-the-canadian-federal-deficit-in-the-1990s.html

    Krugman had argued elsewhere that Canada, through the BofC and lower interest rates in the 1990s had pursued a beggar thy neighbour strategy, its recovery very much related to a booming US economy through the 90′s.

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