Canada got themselves out of trouble. So can we.

| June 3 2012
Christopher Cook

Yesterday, I had the edifying pleasure of reading a piece from the Cato Institute that discusses the similarities between the economies of Canada and the United States, the paths we have taken, and the way to a better future being shown by Canada (PDF).

The introductory paragraphs set the stage.

Two decades ago Canada suffered a deep recession and teetered on the brink of a debt crisis caused by rising government spending. The Wall Street Journal said that growing debt was making Canada an “honorary member of the third world” with the “northern peso” as its currency. But Canada reversed course and cut spending, balanced its budget, and enacted various pro-market reforms. The economy boomed, unemployment plunged, and the formerly weak Canadian dollar soared to reach parity with the U.S. dollar.

In some ways the United States is in even worse fiscal shape today than Canada was two decades ago. For one thing baby boomers are now retiring in droves, which is pushing the federal government deeper into debt every year. America risks becoming a “first world” country like those in Europe, where huge deficit spending is wrecking economies and ruining opportunities for young people.

America needs to get its fiscal house in order, and Canada has shown how to do it. Our northern neighbor still has a large welfare state, but there is a lot we can learn from its efforts to restrain the government and adopt market-oriented reforms to spur strong economic growth.

Canada and America followed similar paths in many ways, both beginning with classical liberal, limited government systems, and both moving towards larger government in the 20th century. Again, following a strikingly similar path, Canada and the U.S. both adopted welfare programs in the 1960s, programs that were always actuarially unsound and quickly became bloated.

And then, again moving in a kind of political flying formation, Canada and the U.S. both headed rightward again in the 1980s:

Trudeau’s socialist grip on public policy began to weaken in the 1980s. The policies of Ronald Reagan and Margaret Thatcher were ascendant, and globalization was putting pressure on Canada to make reforms. In the mid-1980s, the Canadian central bank adopted a goal of price stability, which greatly reduced inflation and has kept it low and stable ever since. And following U.S. tax reforms in 1986, Canada enacted its own income tax cuts under Progressive Conservative prime minister Brian Mulroney.

Great Britain was part of this move, and partly inspired it, as well.

Thatcher’s privatization revolution also inspired reforms in Canada. The government privatized Air Canada in 1988, PetroCanada in 1991, and Canadian National Railways in 1995. All in all, Canada privatized about two dozen “crown corporations” in the late 1980s and early 1990s. In 1996 it even privatized the air traffic control system, which provides a good model for possible U.S. reforms. Privatization reduced government debt and helped spur economic growth by creating a more dynamic industrial structure.

Government spending was still a drag on the economy, however, so in the 1990s, the Canadians began real spending cuts:

In the first Liberal budget in 1994, Finance Minister Paul Martin provided some modest spending restraint. But in his second budget in 1995, he began serious cutting. In just two years, total noninterest spend-

ing fell by 10 percent, which would be like the U.S. Congress chopping $340 billion from this year’s noninterest federal spending of $3.4 trillion. When U.S. policymakers talk about “cutting” spending, they usually mean reducing spending growth rates, but the Canadians actually spent less when they reformed their budget in the 1990s.

The Canadian government cut defense, unemployment insurance, transportation, business subsidies, aid to provincial governments, and many other items. After the first two years of cuts, the government held spending growth to about 2 percent for the next three years. With this restraint, federal spending as a share of GDP plunged from 22 percent in 1995 to 17 percent by 2000. The spending share kept falling during the 2000s to reach 15 percent by 2006, which was the lowest level since the 1940s.

On sovereign debt, Canada is headed in the right direction, whereas  . . .

The spending reforms of the 1990s allowed the Canadian federal government to balance its budget every year between 1998 and 2008. The government’s debt plunged from 68 percent of GDP in 1995 to just 34 percent today. In the United States federal debt held by the public fell during the 1990s, reaching a low of 33 percent of GDP in 2001, but debt has soared since then to reach more than 70 percent today.

Canada’s results in the 1990s and 2000s are yet one more addition to the body of evidence that Keynesian principles are incorrect:

Canada’s fiscal reforms undermine the Keynesian notion that cutting government spending harms economic growth. Canada’s cuts were coincident with the beginning of a 15-year boom that only ended when the United States dragged Canada into recession in 2009. The Canadian unemployment rate plunged from more than 11 percent in the early 1990s to less than 7 percent by the end of that decade as the government shrank in size. After the 2009 recession, Canada has resumed solid growth and its unemployment rate today is about a percentage point lower than the U.S. rate.

Those who read these pages regularly know that I am a huge opponent of corporate taxes. They bring in very little revenue, but they have a major dampening effect on growth. Canada got religion on that subject:

The most dramatic cuts were to corporate taxes. The federal corporate tax rate was cut from 29 percent in 2000 to 15 percent in 2012. Most provinces also trimmed their corporate taxes, so that the overall average rate in Canada is just 27 percent today. By contrast, the average U.S. federal-state rate is 40 percent.

And the proof is in the pudding:

Canada’s federal corporate tax rate has been cut from 38 percent in the early 1980s to just 15 percent today. Despite the much lower rate, tax revenues have not declined. Indeed, corporate tax revenues averaged 2.1 percent of GDP during the 1980s and a slightly higher 2.3 percent during the 2000s.

Now compare Canada with the United States. In 2012, Canada is expecting to collect 1.9 percent of GDP in federal corporate income taxes with a 15 percent corporate tax rate. The United States is expecting to collect 1.6 percent of GDP at a 35 percent corporate tax rate. Thus, the high U.S. rate is not only bad for the economy, but it also doesn’t help the government collect any added revenue.

Canada has more federalism (a.k.a. subsidiarity, decentralization, etc.), and federalism works!

One of Canada’s strengths is that it is a decentralized federation. The provinces compete with each other over fiscal and economic matters, and they have wide latitude to pursue different policies. Federalism has allowed for healthy policy diversity in Canada, and it has promoted government restraint.

Government spending has become much more centralized in the United States than it has in Canada. In the United States, 71 percent of total government spending is federal and 29 percent is state-local. In Canada it’s the reverse—38 percent is federal and 62 percent is provincial-local.

The piece goes on to acknowledge that Canada also has a number of problems and is far from being a free-market paradise. But it has also, in the last decade, become a more economically free nation than the United States. It was one thing when we in the U.S. were only behind Hong Kong and Singapore on rankings of economic freedom. But now, we’ve dropped down—depending on which ranking system you’re looking at—to tenth, with Canada, New Zealand, and other nations ahead of us.

It’s time we take a cue from our friendly neighbors to the north and move away from the failed policies of statism, Keynesianism, and welfare-state capitalism. Canada is showing us the future, and the future works.

 

Thanks to Cato for an edifying look at this subject!

1 comments

Trackbacks

  1. […] in June, we posted a piece Canada got themselves out of trouble. So can we, which begins […]