The most important fiscal action taken by the Conservative government after being elected in 2006 was to cut the GST by two points. At the time (and ever since) every credible economist in Canada recommended against it. Was it necessary and are we better or worse off as a result?
The Conservative government has for years claimed that it would eliminate the deficit of $55.6 billion recorded in 2009-10 by 2015-16. This would show that the Conservative government could be trusted to manage the fiscal affairs of the government better than any other political party. Indeed the government has been aggressively cutting government spending on programs and services since 2010. And despite recent declines in oil prices, the federal deficit will be eliminated in 2015-16 and possibly even one year earlier. (refer to our previous article)
But were the cuts to programs and services really necessary and could the deficit have been eliminated earlier without them? The answer is “no” and “yes”.
In 2006 the Conservative government inherited a structural surplus of $13.8 billion (just under 1 % of GDP). This represented a major correction from a deficit of $39.0 billion (5.5% of GDP) in 1992-93. The debt to GDP ratio had fallen steadily from a high of 67.1 per cent in 1995-96 to 28.2 percent in 2008-09. Program spending had fallen to a record low of 11.9 per cent of GDP in 1999-00, down from a high of 17.0 percent in 1992-93.
Never before in Canada had a newly elected government inherited a “sustainable” fiscal structure: a structure that had produced 11 years of surpluses and a declining debt burden. The fiscal situation could not have been better for the Conservatives.
From a fiscal perspective there was nothing the Conservative government really had to do. Public sector employment had been cut and the size of the government reduced dramatically; program spending was at an historical low; the largest income tax cut (personal and corporate) had been introduced in 2000; the tax burden on Canadians had fallen by 1.5 percent of GDP. The debt burden was at a post War low and was expected to decline further.
The Liberal government had in fact turned out to be the best “fiscal conservative government” ever.
And that was a problem for Stephen Harper.
He couldn’t stand the thought that historians would see Jean Chretien and Paul Martin as better fiscal managers than him. He couldn’t accept what was being handed to him “on a golden platter” by a Liberal government.
He had to prove his own “fiscal bona fides”. And for that he would need a “fiscal problem” that he could fix with tough spending cuts and public service layoffs. If he could do this, then he would make “sound fiscal management” his “brand” for the duration of his government. All he would need would be a good advertising campaign.
And of course, we know that this is exactly what happened.
The first step was for Harper to adopt an approach that had been used (unsuccessfully) by President Reagan in the U.S., referred to as “starve the beast and eliminate the deficit”. It was, on paper at least, a very simple and attractive strategy. The idea was to cut off revenues from the “beast” (i.e., government) and then argue that the resulting deficits were bad for the economy and that government programs and services would have to be cut to eliminate the deficit and stop the debt from increasing. In doing so, the ”beast” would be reduced in size and the private sector would become so “deliriously happy” that they would immediately start investing and become the engine of growth.
Unfortunately for him it didn’t turn out that way.
It wasn’t hard for the newly elected Conservative government to find a way to cut off revenues to the “beast”. During the 2006 election campaign the Conservative party had promised to cut the GST by two points. One thing we do know from recent policy announcements, Conservatives will live up to their election commitments no matter how bad they are as policy commitments. This is unfortunate since if the Prime Minister had chosen instead to cut personal income taxes to “starve the beast” then he could have at least claimed that he was undertaking good tax policy.
The Conservative government cut the GST by one point in 2006 and one point in 2007. This cost the government $14 billion annually. As a result of the GST cuts, the government recorded a “structural deficit” of $5.8 in 2008-09 down from a “structural surplus” of $9.6 billion in the previous rear, a change in one year of $15.4 billion, and before the 2008-09 recession had even started.
With the onset of the 2008-09 recession and the subsequent G20 agreement for countries to introduce temporary stimulus spending equivalent to 2 percent of GDP, the federal deficit ballooned to $55.6 billion in 2009-10; $33.0 billion in 2010-11; $26.3 in 2011-12; $18.4 billion in 2012-13 and $5.2 billion in 2013.14.
Prime Minister Harper could not have been happier. He hadn’t planned on a recession and in fact both he and his Minister of Finance had said Canada wouldn’t be affected by the global meltdown (so much for their forecasting skills). But that didn’t matter because he now had his “deficit problem” thanks to the GST cuts and the recession. He could now turn his attention to establishing his “fiscal bona fides” by cutting government programs and services and developing his brand under the slogan “Canada’s Economic Action Plan”.
This strategy delivered him a majority government in 2011.
Under the Canada Economic Action Plan the deficit will be eliminated by 2015-16; although total net public debt will have increased by $150 billion, the debt ratio will have declined to 33.0 per cent in 2015-16 and reach the government’s target of 25 percent by 2019-20; program spending will fall to below 13 percent of GDP and will continue to fall thereafter; public sector jobs have been eliminated; and income and corporate taxes have been cut.
By this record Prime Minister Harper has proven his “fiscal bona fides”.
But was it all really necessary”?
Suppose Prime Minister Harper woke up from a deep fiscal sleep and decided he wouldn’t cut the GST by two points.
If the GST had not been cut by almost $14 billion annually then the deficit would have been much smaller. For example, simply adding back the $14 billion would give a deficit of $41.6 billion in 2009-10; $19.4 billion in 2010-11; $12.3 billion in 2011-12; and, $4.4 billion in 2012-13. There could even have been a surplus in in 2013-14 of $9.2 billion, two years earlier than the commitment by the Conservative government. Net debt would have increased by under $80 billion by 2015-16 compared to the increase of $150 billion that will likely occur.
And there would have been no need to cut government programs and services the way the government did, since there was no structural deficit that would require such actions. The level of the net federal debt would be lower in 2015-16 by about $70 billion and the level of the debt to GDP ratio would also be lower. Economic growth and job creation would also have been stronger and unemployment lower.
For Stephen Harper this was a “bad dream”.
This was never his plan from the very beginning. He needed a deficit problem, which he could deal with. From the very beginning his fiscal strategy has been driven by a commitment to his Conservative base and ideology and by a desire to show that he had “what it takes”. He desperately wanted to be seen in history as a better fiscal manager than his predecessors.
Prime Minister Harper and the late Jim Flaherty both believed, as do most conservatives, that smaller government would lead to stronger economic growth. Unfortunately for them “economic reality” has been unwilling to cooperate with their “economic theory”.
The evidence is clear: cutting deficits does not by itself generate economic growth. The Conservative “growth friendly austerity” strategy has failed consistently, whenever and wherever it has been applied: whether in the U.S. under Republican administrations; in the EURO area in recent years; by the G20 after 2010; and, definitely in Canada since 2010.
Cutting the GST by two points will go down in Canadian fiscal history as one of the worst public finance decisions in Canadian public policy. It served no useful purpose other than to give Prime Minster Harper the “deficit problem” he needed to impose a Neo Liberal fiscal orthodoxy that diminished the federal government unnecessarily, and failed to generate economic growth and job creation.
All Canadians have paid the price for this and will continue to do so for some time.