FINANCIAL POST
IF I WERE FINANCE MINISTER ON BUDGET DAY.
If I were finance minister, I’d be asking myself the following question: With a recovery just getting going following a deep recession, should I act like Marc Lalonde in 1983 or Paul Martin in 1994? Or should I chart my own course?
Lalonde’s 1983 budget followed a severe recession in 1982 that resulted in a deficit of $25.3 billion for the fiscal year 1982-83, equivalent to eight per cent of GDP or $61.9 billion in today’s dollars. His response? Allow an even larger deficit! Fully $31.2 billion for 1983-84 (or $76.3 billion in $2021). Lalonde’s philosophy? “I set out with two goals: to ensure that recovery firmly takes hold and that it be durable … I am relying on the dynamism and creativity of the private sector to bring about durable recovery.”
Lalonde’s recovery program included infrastructure spending, tax credits for investment and equity financing, and greater support for new housing, employment grants and child care. He raised two taxes: applying a six per cent tax to radio and television services and clawing back a $200 income tax reduction that had mainly benefited higher-income taxpayers.
As for addressing the elephant-size deficit, Lalonde promised to get federal spending back to pre-recession levels as a share of GDP. As we know today, the 1983 federal budget was a failure in terms of fiscal prudence. From 1975 on, in fact, federal revenues failed to cover program spending, let alone interest payments on the debt, and that persistent shortfall led to an immense buildup of public debt. Along with inflation and high interest rates, it set the stage for the dramatic fiscal crisis soon after Paul Martin became minister in 1993.
Martin’s first budget, in 1994, not to be confused with his epoch-making budget in 1995, followed a deep recession two years earlier. Though the 1993-94 deficit was a whopping $45 billion ($70.8 billion in $2021) Martin reduced it to only $43.5 billion. In his speech, Martin’s declared the usual objectives: “A Canada with a system of training that lets our workers lead the economy, rather than being left behind … A Canada that leads in technology, rather than leaning on the technology of others … A Canada where our public finances are in order, not ruin.”
The budget included limited spending on youth employment, the Atlantic fishery, social policy reforms with the provinces and infrastructure. Its most significant change was in addressing distortions caused by a poorly designed employment insurance program and rolling back hikes to contribution rates to 1993 levels. Other changes included a reduction in business subsidies, tax preferences for home ownership and a small sales tax increase.
Though Martin’s 1994 budget failed to fully address the federal government’s fiscal problems, it was a coherent approach to recovery: some targeted, growth-oriented spending, expenditure restraint and social policy reforms. Compared to Lalonde, Martin was far more focused on the bottom line.
So what would I do? Like Lalonde, I would rely on the private sector to secure recovery and, like Martin, I would establish firm fiscal rules to indicate that the debt burden will be reduced, not by tax hikes that suck oxygen out of the economy, but by spending reforms.
Today’s world is not the same as Lalonde’s or Martin’s, of course. Although Canada’s public debt has surged recently because of the humongous 2020 deficit, interest rates are very low so debt service is a lower share of GDP than before 1994. But low interest rates are a lure to politicians to overspend. Canada cannot continue piling up public debt faster than GDP without risking a fiscal crisis.
Moreover, because of Canada’s painstakingly slow vaccine rollout (at least compared to the U.K., the U.S. and roughly four dozen other countries) the health crisis is not yet over. Temporary fiscal support will have to continue for sectors like airlines, accommodation and entertainment where the threat of layoffs and bankruptcies remains.
In this environment, any remaining temporary spending needs to be more targeted than in 2020. Forget commitments to $100 billion in new spending, not until the economy is back on its feet and finances are under control, if then. We should not roll the dice that interest and inflation rates won’t abruptly take off in the next few years, creating a vicious 1980s-style cycle of tax increases and slow growth.
We need two fiscal rules: balance the budget within seven years and cap federal debt at no more than 50 per cent of GDP. And these rules should be legislated, so as to solidify the government’s commitment to them.
To achieve these objectives and bring federal expenditure down to its pre-pandemic level, we need to reintroduce Martin-style expenditure restraint, including digitization of public services. And, as with Lalonde’s speech, though not necessarily his actions, our focus should be on reinvigorating the private sector. A major Canadian weakness in pre-pandemic days was poor labour productivity performance and weak investment.
We should reform the income tax to lower tax rates and reduce or eliminate many tax preferences, allowing us to produce the same revenue at lower economic cost. We need to streamline regulation and simplify climate policy so that we rely mainly on carbon pricing and support for the development and export of carbon-reducing technologies, taking care to harmonize our approach with the U.S.
In sum, if I were finance minister, I would draw on the best of Lalonde and Martin. Fiscal prudence and removing obstacles to private investment should be the budget’s themes.
RELY ON THE PRIVATE SECTOR TO SECURE RECOVERY.