Canada’s Fiscal Reforms:Lessons for the United StatesLessons for the United States

Ch i Ed dChris EdwardsDirector, Tax Policy Studies, Cato InstituteEditor www DownsizingGovernment orgEditor, www.DownsizingGovernment.org

November 2012

U.S. Fiscal CrisisO i f d l d fi it f >$1 t illiOngoing federal deficits of >$1 trillion.Federal “debt held by the public” soared from 36% of GDP in 2007 to more than 70% todayGDP in 2007 to more than 70% today.Federal spending of 23% of GDP today is up from 18% in 2001 when the budget was last balancedin 2001, when the budget was last balanced. CBO “current policy” projections show federal spending rising to more than 40% of GDP by 2050rising to more than 40% of GDP by 2050.Without spending cuts, there will be rising pressure to raise tax rates. But American businesses already faceraise tax rates. But American businesses already face intense global competition.

50%

Federal Spending under Current Policies, % GDP

Interest42 8%

40%Other SpendingHealth Care

42.8%

30%24.1%

31.1%

20%18.2%

10%

0%2000 2010 2030 2050

Canada’s Fiscal History in Brief

Pre-1960s: Relatively small government.1960s-1980s: Rising government spending. High i fl ti N ti li tiinflation. Nationalization.1980s: Central bank cuts inflation. U.S.-Canada Free Trade Modest tax rate cuts PrivatizationTrade. Modest tax rate cuts. Privatization.1990s: Major spending cuts. Federal budget balanced every year, 1998-2008. Privatization.2000s: Large corporate tax rate cuts. Substantial individual income tax cuts.

Canada’s Fiscal Crisis of the Early 1990s

Deep recession.Federal deficits of >5% of GDP 1979-1994.Federal debt soared to 68% of GDP. Interest costs consumed 1/3 of federal revenues.Wall Street Journal called Canada an “honorary member of the third world” and the Canadian dollar the “northern peso.”High and uncompetitive tax rates.

Total Government Spending, Percent of GDP

Total Government Spending, Percent of GDP

50% OECD Average50% OECD Average

40%

45%

Canada

45%

30%

35%

United States40% Canada

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 35%

United States

30%1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

30 Federal Spending as a Share of GDP

25

20 20

United States

Canada15

10 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Canada Federal Spending CutsFederal spending cut from 23 3% in 1993 to 15 8%Federal spending cut from 23.3% in 1993 to 15.8% today.In two years (1996/1997), federal spending was cutIn two years (1996/1997), federal spending was cut 10%, then held to 2% growth for three more years.What was cut? Defense, government workforce, farm subsidies, unemployment insurance, transportation, business subsidies, foreign aid, grants to provinces.Canada Pension Plan converted from pay as you goCanada Pension Plan converted from pay-as-you-go to partly pre-funded system in 1997. Solvent for the next 75 years.y

Shares of Total Government Spending

United States Canada

State/Local Federal

Federal

29% 38%

71% Provincial/Local 62%

Canada Tax CutsPersonal Income Tax Cuts

1980s 2000s: Modest tax rate cuts The top federal/provincial rate is 46%1980s-2000s: Modest tax rate cuts. The top federal/provincial rate is 46%.2000: Full indexing of federal income tax brackets.2000: Federal capital gains rate cut from 19% to 15%.2008: Tax Free Savings Accounts enacted2008: Tax Free Savings Accounts enacted.

Corporate Income Tax Cuts1987-1988: Federal rate cut 38% to 29%.2000 2004 F d l t t 29% t 22%2000-2004: Federal rate cut 29% to 22%.2007-2012: Federal rate cut to 15%.2000-2012: Average provincial rate cut 13% to 11%.

VAT (“Goods and Services Tax”)Added in 1991. Current rate is 5%.Good news: Repealed a 13.5% Manufacturers Sales Tax. Also, provincial harmonization has reduced the sales tax burden on investmentharmonization has reduced the sales tax burden on investment.Bad news: Future money machine for government?

403.0Canada Federal Corporate Tax Rates and Revenues

Tax Rate % (right axis)

30

352.5

Tax Rate % (right axis)

20

25

1.5

2.0

15

20

1.0

1.5

Tax Revenues % GDP (left axis)

5

10

0.5

00.01980 1985 1990 1995 2000 2005 2010