Contrasting the Budget Rules of Chrétien and Trudeau: Part 1

With the federal deficit for 2020-21 now expected to easily exceed $110 billion and debt mounting, it’s worthwhile to compare the budget rules employed by the current government with those of the most fiscally successful government in modern Canadian history: Jean Chrétien’s Liberal government (1993-2003).

February 27, 2020 marked the 25th anniversary of the 1995 budget, one of the most historic budgets in Canadian history as it solved a three-decade long struggle with deficits and ever-increasing debt. The string of balanced budgets that followed set the stage for tax relief and a more prosperous economy for more than a decade.

Fraser Institute senior fellow David R. Henderson examined the budget rules of the Chrétien era as part of a series of essays celebrating the many successes of the 1995 budget. This blog, the first in a two-part series, includes sections exempted from that essay as well as a contrast between the Chrétien policies and those of Justin Trudeau’s government.

Chrétien’s Fiscal Anchor: Key Source of Their Success

As Henderson explained, a fiscal anchor refers to a fiscal or budget rule that governs all other financial decisions. It is the primary measure by which a government tests its taxing, spending, and borrowing policies. Finance Minister Paul Martin’s 1995 budget speech made clear that balancing the budget was the government’s top priority:

This government came into office because it believes that the nation’s priority must be jobs and growth. And it is because of that, not in spite of that, that we must act now to restore the nation’s finances to health. …The debt and deficit are not inventions of ideology. They are facts of arithmetic.

The minister’s speech was followed by real action. The budget introduced reductions in nominal program spending—all federal spending other than interest on the debt--from $120.0 billion in 1993-94 to a planned $107.9 billion in 1996-97, a decline of a little more than 10.0 per cent over three years.

The anchor or budget rule guiding the government’s financial decisions during this initial period was clearly to balance the budget mainly through spending reductions. The underlying test applied to any financial decision during this period was whether or not it supported achieving that goal.

This commitment to a balanced budget resulted in a balanced budget in 1997-98, the first in three decades. Achieving a balanced budget did not, however, change the fiscal anchor of the Chrétien government, which continued to emphasize the need for a balanced budget well after achieving it.

In his 1998 budget speech, Minister Martin went one step beyond the balanced-budget goal to indicate that the government wanted to “bring down the absolute level of debt.” Reducing the absolute level of the debt required not just balancing the budget but also actually running surpluses.

Two mechanisms were used to achieve this goal. First, a “contingency reserve” introduced in the 1996 budget was continued even after achieving a balanced budget. The amounts were initially $2.5 billion (and later $3.0 billion) per year. From 2000 to 2003 the government budgeted an additional $1.0 billion a year in “economic prudence.” These cushions in the budget meant that if the government met its revenue and spending plans were met, which it invariably did, these reserves were used for debt reduction.

The second method, which was not explicitly stated as policy, was a consistent underestimation of revenues. Figure 1 shows that except for 1995 itself, the government underestimated its revenues every year between 1995 and 2003.

The result of these policies coupled with ongoing spending restraint, was a string of surpluses beginning in 1997-98. The government’s nominal net debt—the difference between its gross debt and its financial assets—fell every year until 2008-09. In total, it declined by $92.7 billion, or 15.2 percent, from 1996-97 through 2007-08.

Trudeau: No Effective Fiscal Anchor

It’s difficult to imagine a starker contrast than with the Trudeau Liberals. In reviewing the financial performance of the government over the last four-and-a-half years, it’s hard to identify any effective fiscal rule guiding the government’s decisions and policies.

Trudeau entered office in 2015 with a commitment to increase spending financed largely by cumulative deficits on the order of $25.1 billion over three years and returning to a balanced budget in 2019-20. After being elected in late 2015, the new Trudeau government moved quickly to increase spending immediately with the expected budget balance for 2015-16 moving from a slight surplus to a small deficit.

The Trudeau government’s commitment to limited deficits over three years and a return to balance in 2019-20 were then fully discarded in the spring 2016 budget, less than six months after being elected. Budget 2016 included much larger increases in spending than originally anticipated, with larger deficits. The Trudeau government projected deficits of $29.4 billion in 2016-17 rather than the $10.0 billion deficit committed to during the 2015 campaign. Rather than balancing the budget in 2019-20 as committed to, the Trudeau government now forecasted a $17.7 billion deficit. And rather than a total of $25.1 billion in cumulative deficits over three years, the government was now forecasting deficits totaling $113.2 billion from 2016-17 to 2020-21 with no commitment to a balanced budget for the foreseeable future. Indeed, the Department of Finance in 2016 released its long-term financial projections showing the government was unlikely to balance the budget until 2055-56.

The government then shifted its fiscal goal to maintaining or lowering the “debt-to-GDP” ratio. Essentially the government committed to increasing the country’s national debt but at a rate lower than the rate of economic growth. Put differently, the government’s fiscal plan was anchored on the economy expanding at a faster rate than it planned to increase debt. As many economists including members of our team warned at the time, such a fiscal anchor works only in the absence of a recession. Once a recession occurs, the debt-to-GDP ratio naturally increases. Indeed, the Parliamentary Budget Office recently estimated that the debt-to-GDP ratio will now rise to 38.1 percent, before accounting for much of the government fiscal response to the COVID-19 pandemic.

Moreover, the government’s commitment to maintaining or reducing the country’s debt relative to the size of the economy doesn’t seem to be all that strong since the ratio actually increased between 2018-19 and 2019-20, well before the current recession. Specifically, the fall economic and financial update estimated that the debt-to-GDP ratio would increase slightly from 30.8 per cent in 2018-19 to 31.0 percent in 2019-20.

Simply put, the Trudeau government has not had an effective fiscal rule imposing discipline on its spending, taxing, and borrowing decisions, particularly when contrasted with the strict rules used successfully by the Chrétien government. This lack of fiscal discipline meant that the federal government was less prepared and less financially suited to respond to the current recession.

Part 2 of this series will show calculations estimating where the federal government would have been prior to the recession had the Trudeau government followed the fiscal rules (namely balanced budgets_ used by the Chrétien government.