My View: State budget mess: We can learn from Canada

My View: State budget mess: We can learn from Canada

California’s new budget deal is a short-term fix that leaves the Golden State without a long-term solution to its financial woes. More often than not, lessons from our neighbors to the north concern what not to do. However, in the case of budgets, there is much to gain by replicating the Canadian experience post-1994.

That was the first governing year of the Liberal Party, a center-left stronghold of Canadian politics. The government projected a deficit of roughly $40 billion on program spending totaling a little more than $120 billion. Federal debt stood at almost 69 percent of gross domestic product and the cost of interest payments was nearly 38 percent of federal spending. Canada was widely considered a G-7 laggard, and the International Monetary Fund was monitoring the country’s situation. Critically, the Liberal government recognized two core realities of the situation facing it.

One, the status quo was not sustainable and change would have to come quickly. Two, the long-term solution could not be simply to increase taxes. Indeed, the center-left government realized that taxes needed to be lowered. This was not an ideologically driven realization. If anything, the Liberal Party has always stood for political practicality based on retaining power. It realized that Canada, like all countries in a global economy, competes for investment, skilled labor and entrepreneurship. If it wanted to thrive in the future, it needed to have competitive tax rates.

The Liberal Party then embarked on a historic reform of federal finances. The center-left Liberals launched a government-wide review of spending and implemented large reductions across a number of departments. They also reduced transfer payments to the provinces and cut public sector employment by 45,000, a reduction of 14 percent over three years. They reduced business subsidies and initiated privatization of government-owned enterprises, particularly in transportation.

In most of these situations, the Liberal Party government changed how money was spent and focused on reforming programs to achieve better results. This was not a mere accounting exercise and, indeed, proved a great success. In many cases, the reforms made the programs more effective while costing less.

While difficult in the short term, these reforms resulted in an almost immediate improvement in the nation’s finances and have now placed Canada at the forefront of fiscal policy in the industrialized world. In a three-year period, the country was able to balance its books, begin paying down debt and reducing taxes, and, yes, begin to spend again.

Today, Canada’s federal debt stands at less than 32 percent of GDP, and interest costs are down to 13 percent of spending. Program spending has almost doubled to more than $208 billion. And the country has implemented large-scale tax relief for individuals and business. The national sales tax has been reduced from 7 percent to 5 percent, and the national corporate income tax is being reduced from 28 percent to 15 percent. These are important lessons for California, whose budget woes are reminiscent of those of Canada.

The recent budget solution in Sacramento is a short-term fix, and the Golden State will face another challenge in 2009. Doing nothing or resorting to gimmicks won’t get the job done. The solution, as it was in Canada, must be to reduce spending over the next two to three years. In that period, the state must review both what it spends and how it spends, with a goal of getting more for less.

Such reforms will create a platform for stable finances in the future, at which time the Democrats and Republicans can resume their debate over tax relief versus new spending. For now, the Canadian experience confirms that the status quo is not sustainable and, more importantly, that it cannot be solved by simply taxing more.

About the writer:
Jason Clemens is the director of research at the Pacific Research Institute in San Francisco (www.pacificresearch.org). Before joining PRI, he was the director of fiscal studies at the Canadian-based Fraser Institute for more than 10 years.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.