Wednesday, November 10, 2010

How Canada Balanced Their Budget

The big economic (also political) news item today was the release of the draft proposal of the federal deficit commission, which immediately drew sharp reactions from nearly all quarters.

It reminded me of a recent article by Bill Ragsdale, who runs the excellent investment newsletter Good Fortune. He passes along an edited review by David Hay of "The Canadian Century, Moving Out of America's Shadow."

Before reading it, remember that economic situations are seldom if ever 100% analogous; in particular, the recent global economic crisis qualifies as an order of magnitide worse than simply the "extended recession" of which he speaks, and we know now that 1995 was in the early stages of an economic boom which of course greatly helped the Canadian cause. Right now the U.S. economy is still pretty much on life support, and despite recent campaign rhetoric, we can't switch from stimulus to austerity too fast or the shock would be extemely detrimental (we tried something like that in 1937 which caused a new recession while we were still trying to climb out of the Great Depression). Still, the new Congress would do well to study this plan and move toward something like it.

Here is the article:

A Fresh Re-Start For The US?

Fifteen years ago Canada had many of the US's current problems: an extended recession, unfunded pension costs, spending way out of proportion to their economy and an increasing question on the ability to pay future debts. Their leadership used vastly different solutions than the US.

One-third of Canadian government revenues were being devoured by interest costs on rapidly escalating debt then 130% of GDP. Canada had become one of the developed world's most socialized economies, with the government accounting for 53% of the country's GDP. Growth was stagnating, while debt levels were dangerously mounting. Canada's AAA credit rating was lost, and it was treated as an unreliable borrower.

Then Canada achieved stunning progress in a mere three years at both federal and provincial levels.
  1. Finance Minister Paul Martin unveiled a shocking budget in early 1995 reducing spending by 8.8% over two years.

  2. Federal government employment was reduced by 14%.

  3. Federal grants to the provinces were reduced by 14%, but they were given greater local control.

  4. Some taxes were raised, but spending cuts were four times tax hikes.

  5. Canada's welfare system was dramatically modified, with incentives to better use the funds.

  6. Corporate tax rates were cut by nearly a third, taxes on corporate capital were abolished, and personal income and capital gains taxes were reduced.

  7. A consumption tax was instituted to pay for the tax cuts. Initially very unpopular, it was a key part of the rehab plan.

  8. The Canada Pension Plan moved scheduled payroll taxes increases forward but reduced the limit from 14% to 10%. This produced immediate surpluses that were invested in higher-returning corporate securities. The plan is well-funded today and actuarially sound.

The federal budget was balanced within three years. Despite accusations the poor would suffer, the percentage of welfare recipients fell in just a few short years from 10.7% of the population to 6.8% by 2000; the percentage of Canadians classified as low-income plunged by over 30%. Canada went on to produce eleven straight budget surpluses while reducing their federal debt from 80% of GDP to 45%. Further demonstrating how quickly good policy can turn things around, the provinces enacted similar measures. Canada's economy grew at 3.3% per year versus the developed-world average of 2.7%.

Canada's experience demonstrates replacing bad policies with good ones leads to dramatic and rapid improvement, with the shift to financial soundness restoring confidence and actually boosting long-term growth.

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