A different take on Canada’s deficit-fighting story

Revisiting our fiscal “miracle”

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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.