Should governments pursue debt reduction or provide more stimulus spending to help right the economic ship? Spending reductions and balanced budgets are key

 Leaders at the most recent G20 summit in Toronto were singing a different fiscal tune than at the last summit in Pittsburgh. While the leaders declared the need “to follow through on delivering existing stimulus plans,” the primary emphasis was on “the importance of sustainable public finances.” The leaders even committed to at least “halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016.”

Interestingly, the G20 promises are precisely in line with the Federal Conservatives economic plan: keep the stimulus going for 2011/12 and then gradually try to balance the budget over the next five years.

Canadians should expect more.

The federal government has an opportunity to set Canada apart from the rest of the world, the way the then Liberal government did in 1995 when it introduced a plan to reduce spending and balance the budget.

It was the federal Liberals under Jean Chretien and Paul Martin who, after one false start, brought real reform to federal finances with their 1995 budget. This initiated a remarkable fiscal transformation that, in part, made Canada the envy of the developed world. Spending reductions, balanced budgets, debt repayment, tax relief and improved competitiveness all contributed to our outstanding economic performance from 1997 to 2007.

In 1995, Chretien and Martin proposed cutting program spending by almost nine per cent over just two years in order to get a handle on federal spending. These weren’t reductions in spending growth. These were actual reductions in spending.

The federal government not only achieved the spending cuts proposed, but actually outperformed the goal and reduced spending from $123.2 billion to $111.3 billion (a reduction of 9.7 per cent) in just two years. In doing so, they reduced the size of the federal government relative to the overall economy from 16 per cent to 13.3 per cent.

Unlike the current government, the Liberals did not protect or insulate any spending from review. Recall that the Tories have explicitly stated they will not reduce or change transfers to the provinces. For the Liberals under Chretien and Martin, everything was up for review, as it should be. Transfers to the provinces were reduced, business subsidies and spending on transportation were slashed, military spending was cut, and even Employment Insurance was reduced through badly needed reforms. Critically, the Liberals also reformed spending in order to get more from less.

The combination of spending reductions, an improving economy (which was not just a coincidence), and falling interest rates resulted in the first balanced budget in over two generations in just three years. Thankfully, this historic achievement was then followed by a series of budgets that reduced personal and business taxes in a way that promoted economic growth by encouraging, rather than discouraging, the things Canada needs more of, such as investment, savings, and entrepreneurship.

If Canada is to get back on the path of sustainable prosperity and balanced budgets, it needs to learn, or perhaps re-learn, the lessons of the 1990s. The federal government and its provincial counterparts need to reduce and reform spending more quickly to bring budgets into balance again.

The sooner governments get their fiscal houses in order, the sooner the fiscal room can be created to refocus on improving Canada’s ability to attract investment and create jobs. And that should be done by reducing taxes, not increasing government spending. In fact, the academic literature provides ample evidence that incentive-improving tax relief encourages economic activity, whereas government spending does not.

For instance, an important recent analysis by Harvard economists Alberto Alesina and Silvia Ardagna of stimulus initiatives in Canada and 20 other industrialized countries from 1970 to 2007 found that successful stimulus initiatives – those that increase economic growth –focus on tax cuts while unsuccessful ones rely on government spending.

The focus for both the federal and British Columbian governments should be to significantly reduce uncompetitive personal income tax rates. Canada maintains among the highest marginal personal income tax rates on middle and upper income earners among the G7 countries. And British Columbia’s top personal income tax rate (14.7 per cent) is still nearly 50 per cent higher than Alberta’s (10 per cent).

Rather than continue to increase spending, Canadian governments should set Canada on the path to greater prosperity. Spending cuts, balanced budgets, and tax relief worked wonders once before. Canadians need them again.