The Centralization of Federal Power
Not only has the federal government grown faster than the private sector, but it has also grown relative to state and local governments. In other words, the US trend toward bigger government has gone hand in hand with a trend toward more centralized government in Washington, D.C.
The United States clearly finds itself in a fiscal crisis, brought on by excessive growth in government. Fortunately, there is a way out, as the Canadian example from the mid- to late-1990s demonstrates.
The Amazing Canadian Fiscal Turnaround
In the mid-1990s Canada was in a full-scale fiscal crisis. The federal government had run substantial budget deficits consistently for 20 years; Ottawa’s indebtedness was reaching crisis levels; and a third of all federal government revenue was being used simply to pay interest on the debt. The status quo had become unsustainable. Without significant fiscal reform, Canada was at risk of hitting the “debt wall” – when investors stop financing government debt.
The federal government was caught in an unsustainable cycle: Higher interest costs were leading to higher deficits, which required more borrowing, which further increased interest costs as investors demanded higher returns to compensate them for the increased riskiness of lending to the Canadian government.
The 1995 Budget – Ottawa Changes Course
After some lackluster reforms that were not commensurate with the scale of the problem, the Canadian government became serious when the Mexican peso collapsed in December 1994, and a January 1995 Wall Street Journal article argued that the Canadian government was near bankruptcy.
The catalyst came when the ruling Liberals delivered their austere budget on February 27, 1995. This document set in motion a fundamental change from the status quo and ultimately became a defining moment in Canada’s fiscal history. In his budget speech, finance minister Paul Martin boldly stated the new direction for the government and the government’s almost sole focus: Getting the debt and deficit under control.
The budget plan included a host of concrete actions such as
•a substantial reduction in the size of the federal government – spending and employees – to reduce the deficit;
•reform of government programs with an increased focus on efficiency;
•reform and a reduction of the employment insurance (EI) program;
•substantial reductions in business subsidies; and
•restructured and reduced provincial transfers.
Ottawa Cuts Federal Government Spending and Employment
The 1995 federal budget proposed cutting billions in spending, a cumulative reduction approaching a tenth of the budget over the first two years. In addition, the budget proposed reducing federal government employment by almost a sixth once fully implemented.
Getting Government Right – Program Review
The proposed reductions in program spending in the 1995 budget were largely the result of the program review. Ministers in every government department put their departments under the microscope. In particular they applied six tests to everything their departments did:
1.Does it serve the public interest?
2.Is government involvement necessary?
3.Is it an appropriate federal role?
4.What is the scope for public sector/private sector partnerships?
5.What is the scope for increased efficiency?
6.Is it affordable?
The program review led to a significant structural change in the federal government’s involvement in the Canadian economy. Major reforms included:
•Dramatic changes in the federal government’s involvement in large parts of Canada’s transportation system.
•A complete change to the federal government’s approach to agriculture, including a move away from an emphasis on income support to income stabilization.
•A massive reduction in the federal government’s involvement in the business sector, including a proposed 60 percent cut in subsidies to businesses.
•A change in the way in which departments delivered services to Canadians, including an increased focus on efficiency.
A significant source of savings was the move away from federal transfers based on federal-provincial cost-sharing programs to a block-grant approach in which the amount transferred by the federal government to the provinces did not depend on provincial spending. This decentralization of power both contained spending and allowed for experimentation and innovation.
Spending Cuts Far Outweighed Tax Hikes
Finance minister Paul Martin claimed in his 1995 budget speech that the government “must focus on cutting spending – not raising taxes.” It didn’t quite turn out that way, as the new budget did raise some taxes. Even so, for the next two years, spending reductions were more than four and a half times larger than revenue increases.
After the Reforms: Let the Good Times Roll
The importance of the 1995 fiscal reforms can scarcely be exaggerated. The size of the federal government shrank significantly, balancing its budget within three years, which yielded the first surplus the Canadian government had enjoyed in almost a quarter century. Canada’s federal government transformed itself from a fiscal basket case to the envy of the industrialized world.
Equally as important as the nominal reductions in outlays is how government spending and revenues compared with the economy. All told, federal government spending (program spending plus interest payments) fell by 17 percentage points of GDP over two years.
The federal government ran 11 consecutive budget surpluses beginning in 1997/98. Consistent surpluses meant a reduction in the dollar-value of federal debt. With the federal government paying down debt and the economy expanding, the total public debt plummeted from 80.5 percent of GDP in 1997/98 to 45 percent a decade later.
The Canadian experience shows that with courageous leadership and sound policy, even a serious fiscal crisis can be reversed in just a few short years. US policymakers should pay close attention to the lessons from Canada.
Canada’s Lessons for America
Before drawing specific lessons for the United States, it is useful to assess just how significant the Canadian reforms were. Whether we look at absolute federal spending in dollars, spending as a percentage of the economy, deficits, or total federal debt, the actual Canadian response to their fiscal crisis was far more austere than what has been proposed in the Bowles-Simpson and even the 2013 House Budget Resolution (“Paul Ryan plan”) proposals.
Lessons from Canada: Getting Spending Right
The single most important lesson to draw from the Canadian success is the need for sharp and immediate spending cuts. To translate the Canadian experience to the United States would imply