Balancing budgets make good politics and good policy

By Jason Clemens

The dominant political wisdom in Canada and the United States is that determined but slow, incremental action on deficits is a political winner. The logic is that citizens prefer balanced budgets and fiscal prudence in a broad sense, but are unwilling to accept the immediate pain of actual spending reductions. More specifically, the rationale is that citizens accept the idea of spending reductions until the specific details are laid bare, at which point they balk. This reasoning has led to a general response to deficits and rising debt whereby governments slow the growth of spending and hope that revenues catch up over time. It’s a “no pain, big gain” logic simply divorced from our recent experience (see above). It ignores the real risks of not moving forcefully to make our governments live within their means.

I. Playing catch-up is risky, too

Most governments in Canada are relying on a plan of slowing the growth in program spending coupled with higher revenues in the future to balance their budgets. Provincial deficit forecasts for 2011/12 range from a small surplus in Saskatchewan to a deficit of 2.6 per cent of GDP in Ontario. The federal deficit is forecast to be 1.9 per cent of GDP this year. All told, the provincial and federal governments expect to incur $57.6 billion in red ink this year (2011/12).

The time needed to balance provincial deficits with this strategy ranges from three years (2013/14) for British Columbia, Alberta, Nova Scotia, and Quebec to seven years (2017/18) for Ontario. The federal government’s plan is to balance its budget in 2014-15.

The federal government and six of the seven provinces that provided forecasts in their budgets rely on revenues catching up with slower spending growth. Revenue growth assumptions range from an annual average of 3.2 per cent in Manitoba to 7.3 per cent in Alberta. On the other hand, program spending is assumed to grow at much lower annual rates, ranging from 1.4 per cent in Ontario to 1.9 per cent in Quebec. The federal plan calls for revenues to grow, on average, by 5.6 per cent between 2011/12 and 2015/16 while program spending will be constrained to grow at 1.7 per cent annually.

Put differently, using the strategy currently in vogue means it will take a total of 40 provincial and federal annual budgets for all governments to reach balanced budgets. Of those 40 annual budgets, only three will actually contain reductions in program spending. Simply put, almost all the governments in Canada that face deficits are counting on a two-pronged strategy: slowing the growth in spending on the one hand and hoping for higher future revenues on the other.

Does such a strategy work? Both logically and historically, the evidence is not encouraging.

Let’s dispense first with the underlying premise of this strategy, namely that governments face little or no risk in simply slowing the growth of spending incrementally and allowing future revenue increases to bring the budget back into balance. An approach that truly faces lower risk is one with few ways in which things could go seriously wrong. When it comes to balancing a government’s books, an approach based on hoping that revenues grow strongly in the future coupled with modest spending restraint is pure fantasy.

Both the spending and the revenue side of such a strategy contain significant risks. For example, an economic slowdown such as Canada recently experienced causes spending to increase and revenues to decline. An unexpected natural disaster is another example that would certainly increase spending and potentially slow economic growth, which results in lower revenues. Higher than budgeted interest costs, which many expect to materialize in the near term, can be a source of unexpectedly higher spending.

Historically this approach of slowing the growth of spending coupled with a prayer for higher revenues is the exact approach taken by Canadian governments, both federal and provincial, during the 1980s and early 1990s. Their record of success in taming deficits and returning to balanced budgets is non-existent. Although some provincial governments experienced surpluses during this period, not one government in deficit successfully achieved a balanced budget using this approach and governments collectively remained in deficit throughout the period.

II. Understanding the political success of balancing budgets

This leads us to the second aspect of the argument, which is that determined and purposeful actions to reduce deficits are politically risky and result in electoral losses. The historical experience of the 1990s flips this theory on its head. Bluntly stated, balancing budgets with purpose and vigour can be a recipe for electoral success.

i) Chrétien Liberals: Smaller, Smarter Government Leads to Surpluses and Majority Governments

The experience of the Chrétien Liberals is perhaps the most poignant example in recent history. Prime Minister Jean Chrétien entered office with a $38.4 billion deficit, rising national debt, and interest payments consuming 32 per cent of revenues. The 1995 budget delivered by Finance Minister Paul Martin is justly characterized as the most important government document in a generation.

The budget called for a fundamental re-ordering and re-thinking of government based on “smaller . . .smarter government”. It implemented a nearly 10-per cent reduction in federal program spending over three years (figure 2), which included a nearly 12-per cent reduction in the public sector (figure 3). Massive cuts were made to departmental spending in transportation, agriculture, and support for business.

These determined efforts to reduce spending and bring it in line with expected revenues brought quick results. Within two budget cycles, the federal budget was balanced and debt began to decline. In addition, interest costs, which create a wedge between what the government collects and what it can actually spend on programs, began to decline, which meant more money became available for program spending and tax relief.

The electoral results were equally as stunning. The Chrétien Liberals won three consecutive majority governments, two of which occurred after the reform-minded budget of 1995 and the ensuing cuts to spending and public sector employment (1997 and 2000). The three successive majorities recorded by Prime Minister Chrétien markedly outdid the electoral record of his mentor, Prime Minister Pierre Trudeau. Indeed, one has to return to the example of Prime Minister Mackenzie King back in 1935 to 1945 to find a regime able to achieve three consecutive majority governments.

Provincial experiences

There are also vivid provincial examples in which governments enact difficult decisions on purpose in order to achieve balanced budgets and by doing so win the confidence of their electorate in successive majority governments. Two western examples and the high-profile experience of Ontario are worth considering.

ii) Saskatchewan: First reforming government

Saskatchewan was the first Canadian government in the 1990s to tackle its deficit in a legitimate manner. Roy Romanow’s New Democratic Party​ (NDP) was elected in 1991 after 10 years of Progressive Conservative Party rule in Saskatchewan. They ran on a platform of balancing the provincial budget and returning fiscal prudence to Regina. In the spring of 1992, the government delivered its first budget, which began to deal honestly with the province’s $845 million deficit. The government relied on reviewing all current government spending, with no sacred cows, and a commitment to cut spending first before considering tax increases.

The budget set in motion policies that would eventually eliminate more than 20 programs while reducing public sector employment. In total, the budget reduced spending by $73.1 million, which reduced the provincial deficit by nearly 40 per cent. The Romanow government also increased taxes to reduce the deficit further.

The following budget (1993) introduced both additional spending reductions and tax increases. The spending cuts totalled $141 million, including eliminating one quarter of all government agencies, boards and commissions and controversial reductions in transfers for hospitals, schools, universities, colleges, and municipalities.

As illustrated in figure 3, Saskatchewan also reduced its public sector. While the percentage reduction in Saskatchewan (2.9 per cent) was measurably smaller than the cuts made by the federal government, Alberta, and Ontario, they are nonetheless important to recognize as a factor in the spending reductions implemented by Saskatchewan. In particular, it is worth noting that the public sector unions and their members were a core constituency of the NDP in Saskatchewan, which made the reductions more difficult politically.

The Romanow government achieved a balanced budget two years ahead of schedule through a combined policy of tax increases and spending reductions. In just three years, the NDP government went from an $845 million budget deficit to a $128 million surplus.

The current thinking would predict electoral loss for the Romanow NDP. Instead, Romanow led his party to a second majority government in 1995 and captured 72 per cent of the available seats. The NDP formed a coalition government with the Saskatchewan Liberal Party after the 1999 election and returned to a majority in 2003, although Romanow retired in 2001. The tough decisions enacted by the Romanow government led to majority government, not electoral ruin.

iii) Alberta: Aggressive action to establish an Alberta Advantage

Premier Ralph Klein​ took over the mantle of leadership for the Progressive Conservatives in Alberta in 1992 during a period of great fiscal upheaval. Alberta’s finances were literally spiralling out of control in the early 1990s. Alberta’s spending, which had been premised on high oil prices, simply could not adjust to the new reality of lower oil prices, and left the provincial government on a path of unsustainable spending. As Klein arrived in office (1992), the province’s deficit reached $3.3 billion (nearly 4.5 per cent of GDP), provincial debt had increased to $20 billion, and interest costs were consuming about 10 per cent of revenues.

It is fair to say that the first two budgets of Ralph Klein’s tenure as Premier of Alberta​ fundamentally changed the status quo in Alberta and Canada. Premier Klein’s first two budgets (1993 and 1994) reduced program spending, decreased government employment, and set a clear goal of a balanced budget in four years. The Deficit Elimination Act mandated reductions in the deficit and required deeper spending cuts the following year if targets were not met in the current year. The government took an across-the-board approach, with 14 of the 17 government departments experiencing reductions in their budgets, and with some seeing the size of their budgets reduced by more than a quarter.

All told, Klein oversaw a government spending decrease from $16.1 billion in his first year to $12.7 billion in 1996/97, a reduction of more than 20 per cent (figure 2). Part of the contracted program spending included a large reduction in public sector employment between 1993 and 1997. Specifically, total public sector employment in Alberta was reduced by 14.1 per cent over this period (figure 3).

The Klein Conservatives achieved a budget surplus of 1.1 per cent of GDP in 1994/95, just the second year of Klein’s tenure, and well ahead of schedule. The reforms enacted led to a long period of surpluses (figure 5), which allowed the province to eliminate its net debt and build up rainy-day funds for the future.

The result of the determined and expeditious actions of the Alberta Progressive Conservatives​ was an improvement in their electoral performance. Klein actually increased his margin of victory in both the 1997 and 2001 elections (figure 6). Interestingly, some pundits blamed the reduction in his margin in 2004 on a loss of vision and increased spending. While the electorate in Alberta may be more conservative than any other jurisdiction in the country, the deep and painful cuts implemented by the Klein government challenged a number of powerful vested interests in the province. However, the result was not electoral loss but rather improved and consecutive majority governments.

iv) Central Canada follows suit: Ontario’s Mike Harris​ and the Common Sense Revolution

The historic reforms begun in Saskatchewan, amplified in Alberta, and extended in Ottawa established the foundation for fiscal reforms in Canada’s most populated province and the nation’s largest economy: Ontario. There is no doubt that Ontario was in a fiscal crisis by the early 1990s. The provincial deficit had exploded to almost $11 billion. Over just a five-year period beginning in 1989/90, the provincial government had accumulated $49 billion in debt. Interest costs were consuming 17 per cent of available revenues by 1994/95.

In 1995, Mike Harris, the leader of the third party in Ontario, led the Progressive Conservatives to a majority government based on the promise of returning the province to fiscal prudence and economic prosperity through a Common Sense Revolution. Prior to even presenting a full-year budget, the Harris Progressive Conservatives moved to address the province’s fiscal imbalance. They implemented a reduction of $850 million in program spending, along with reductions in capital spending of some $307 million. Each minister was additionally required to identify reductions of $500 million.

The Harris Progressive Conservatives presented a three-year austerity plan in their first budget (1996). Combining lessons from the federal Liberals and the Alberta Progressive Conservatives, the government implemented a tough budget in 1996, with a multi-year plan to achieve a balanced budget by 2000/01 even while reducing taxes immediately to improve economic incentives and competitiveness. Program spending was reduced immediately, although not to the same degree as observed in other provinces (figure 2). The plan included reductions in administration costs, cuts in subsidies to businesses, reduced funding to agencies, boards, and commissions, and reductions in government grants. Public sector employment was reduced by a little over 11 per cent (figure 3)

The turnaround in the deficit, while a year ahead of schedule, was not as quick as what was achieved in Alberta and Saskatchewan or federally under the Liberals. A major part of the reason was that the Harris Progressive Conservatives implemented substantial tax relief concurrently with their reductions in spending. The tax reductions delayed the balancing of the budget, but were critical to restoring investment and business confidence in the province and the beginning of restored tax competitiveness. After five years, the Harris government turned a substantial $11-billion deficit into a small surplus of $300 million, while dramatically reducing taxes.

Again, the electoral consequences for the Harris Conservatives confound the current conventional wisdom. Even though many of the programs were supported by concentrated special interests, meaningful reductions in program spending were implemented. Yet despite these actions, the Harris Conservatives were returned to power in 1999 with a majority government. This was the first two-term consecutive majority government elected in Ontario since Conservatives achieved the same in 1967 and 1971.

Conclusion: purposeful deficit reduction is good politics

The Canadian public, and more narrowly the Canadian electorate, understand both the short-term and long-term costs of running deficits, accumulating debt, and increasing interest costs. Canadian political culture now demands balanced budgets, fiscal prudence, and a path towards lower taxes. Such actions, when done deliberately and with purpose, have led to great, indeed, historical electoral success at both the federal and provincial levels. Thus, a win-win opportunity exists for Canadian politicians who pursue effective deficit reduction policies: their electorates enjoy better economic policies and fruits of such efforts while the politicians themselves enjoy electoral success.

Jason Clemens is the director of research at the Macdonald-Laurier Institute http://www.macdonaldlaurier.ca/.

Tags: Budget, Canada, Politics

Category: Business, Politics