Kenney government should learn from past deficit-reduction plans

The Government of Alberta is racking up debt—quickly. The province has accumulated $35 billion in new debt over the past half-decade and will run another $20 billion budget deficit this year.

If the Kenney government wants to eliminate the deficit and stop the rapid debt accumulation, it must do one of two things—either reduce spending or increase taxes. A review of the province’s fiscal history underscores the effectiveness of these two different approaches.

Let’s start by going back to the 1990s when Alberta faced some of the largest deficits in its history. Back then, Ralph Klein’s government committed to eliminate the deficit through spending reductions, and that’s just what it did, by reducing (inflation-adjusted) per-person spending by more than 20 per cent.

Fast-forward to the mid-2010s, when a rapid commodity price drop and sharp recession (combined with government spending growth over the previous decade-and-a-half) once again produced a large budget deficit. This time, the government of Rachel Notley took a different approach and increased (inflation-adjusted) per-person spending, although only slightly.

The Notley government’s plan was to keep spending growth in check (without actually making any spending reductions) and hope for increased revenue to shrink the deficit over time. To this end, Premier Notley raised personal income and corporate income tax rates. This strategy, of hoping for revenue growth to eliminate the deficit, was not successful and Alberta has run large budget deficits every year since 2015/16.

In short, in the 1990s, Alberta successfully eliminated the deficit through spending reductions whereas the attempts in the mid-2010s to eliminate a large deficit by increasing taxes (while hoping for revenue gains) failed.

And spending reductions have worked elsewhere to eliminate deficits. In the 1990s, for instance, the NDP government of Roy Romanow in Saskatchewan and the Liberal federal government of Jean Chretien both reduced spending substantially and eliminated large budget deficits.

It’s also important to consider which kind of deficit-elimination strategy is better for economic growth. Research from late Harvard professor Alberto Alesina and colleagues shows that, in economically developed countries, trying to fight deficits with higher taxes hurts the economy much more than slaying deficits via spending reductions.

Today, Alberta once again faces a large budget deficit, and Premier Kenney faces some hard decisions. If the Kenney government wants to eliminate the deficit quickly, Canada’s history suggests that spending reductions are the most likely path to successfully achieve this goal. Further, international evidence suggests this approach will give the economy the best chance at a robust recovery. Once the COVID crisis is over and the government turns to deficit-reduction, it should keep this domestic and international evidence front of mind as it formulates its fiscal plan.