The 1998 Alternative Federal Budget - What Happened?
Canadian Centre for Policy Alternatives
CHO!CES: A Social Justice Coalition
by Jim StanfordEconomist, Canadian Auto Workers and Co-Chair, Macro Policy Committee, Alternative Federal Budget
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OVER THE RAINBOW: The Balanced Budget, How We Got It, And How to Hang Onto It
Glinda: "She brings you good news, or havent you heard.
When she fell out of Kansas, a miracle occurred."
Dorothy: "It really was no miracle, what happened was just this."
According to national accounts data, the federal government deficit declined from over $31 billion in the second quarter of 1995 (immediately following Paul Martins historic budget, and prior to the implementation of his announced cutbacks) to almost zero just two years later, during the second quarter of 1997. A number of factors contributed to the rapid erosion of the deficit, including the program spending cutbacks, some announced tax increases (and the unannounced tax increases that result from "bracket creep"the failure to index the tax system to inflation), higher tax revenues that automatically accompany economic growth, and the post-1995 decline in interest rates.
The overall improvement in the deficit can initially be decomposed into three broad components:
These latter two components can be further decomposed. Some of the growth in taxes results automatically from economic growthwhich generates more income against which existing taxes are levied. But some of the growth results from tax increases: either explicit tax increases (which have been very rare in the Liberals deficit-reduction scheme), or the implicit tax increases that result from the less-than-full indexing of the tax system to inflation and other factors (often referred to as "bracket creep"). Similarly, the net reduction in the governments interest payments can be decomposed into two portions: the savings resulting from the decline in interest rates, less the increase in interest payments resulting from the continued growth of the federal debt. In summary, then, we can identify five mutually exclusive fiscal changes that together produced the sum change in the total federal deficit over the two-year period being considered:
The first four components all contributed toward the reduction of the deficit; the last term offset some of this improvement.
It has been the historic and painful reductions in federal program spending that have received top billing in the federal war on the deficitand won the most plaudits for the Finance Minister from the business and financial communities. But do the spending cutbacks indeed deserve most of the credit for the subsequent balancing of the governments books? Based on the preceding decomposition of the overall change in the federal deficit over the past two years, the relative importance of the various factors contributing to that reduction can be estimated, as illustrated in Table 1.
Paul Martins cuts to federal program spending, deep as they have been, account for just 45% of the total $30 billion improvement in the federal deficit attained over the two-year period. More important have been the favourable macroeconomic conditionslower interest rates and subsequent economic growththat have prevailed since late 1995. These two factors account for close to 60% of the total deficit reduction. Tax increases and "bracket creep" (under which federal taxes have increased as a share of GDP from 19.0% to 19.4% over the two years) account for another $3 billion (or 10%) of deficit reduction. Finally, the negative impact of the higher federal debt load has offset overall deficit reduction by about $4 billion (or some 14% of the total net fiscal improvement).
If there is a lesson to be learned from the surprisingly rapid turnaround of federal government finances since Paul Martins historic 1995 budget speech, therefore, it is not the conventional wisdom that "getting tough" on spending is the only way to effectively reduce a fiscal imbalance. Instead, a more accurate conclusion would be that the governments fiscal position is improved strongly and relatively painlessly when Canadas macroeconomic engines are pointing in the right direction. Compared to the ultimate effects of discretionary, pro-active spending and taxation decisions, the fiscal impacts that arise automatically from macroeconomic trends are actually the more important determinants of the governments bottom line. If those macroeconomic trends had not been so favourable over the past two years, the federal governments fiscal position would not be in its present sunny state, despite the deep spending cuts that Canadians have endured.
1. Similar calculations to those reported here can also be conducted using Public Accounts data, instead of National Accounts data. See Appendix for discussion.
2. See Appendix for a complete algebraic description of this disaggregation.