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Compared to Canada, It's a Fiscal Dip, Not Cliff

12/29/2012 02:32 pm ET | Updated Feb 28, 2013

Co-authored with Robert P. Murphy

As the prospect for a last-minute deal seems ever bleaker, the politicians and pundits are warning Americans to brace themselves for a plunge off the so-called fiscal cliff to disaster. Yet even if the much dreaded spending cuts and tax hikes go through as scheduled, they will be a drop in the bucket compared to the amazing fiscal reform that Canada achieved in the 1990s. Americans might like to know that Canada proves you can balance the budget without wrecking your economy.

First the background: By the mid-1990s the Canadian federal government had been running deficits for two decades, with a third of federal revenue being absorbed by interest payments. The international economic situation was dire. Fresh on the heels of the Mexican peso crisis, a Wall Street Journal editorial from January 12, 1995 viewed Canada as similarly vulnerable and declared that the U.S.'s neighbor to the north "...has now become an honorary member of the Third World in the unmanageability of its debt problem...it has lost its triple-A credit rating and can't assume that lenders will be willing to refinance its growing debt."

The Canadians retreated from the abyss when the center-left Liberal government tabled their historic budget in February, 1995. Total federal government spending fell by more than 7 percent over two years, while the budget deficit of $32 billion (4 percent of GDP) was transformed into a $2.5 billion surplus. By January 1998, federal employment was down by 14 percent or 51,000 people. Ottawa ran 11 consecutive budget surpluses beginning in the 1997/98 budget year, causing the total public debt to plummet as a share of GDP. They tightened welfare and fixed their version of social security.

Far from wrecking the economy, in the decade after reform Canada out-performed all the other G7 nations on economic growth, investment, and job creation. In the recent worldwide recession Canada's economic robustness allowed it to weather the downturn better than any other G7 nation. Even in the short-term, the dramatic fiscal austerity in the 1990s was mild in its side effects, merely causing a temporary uptick in the unemployment rate that was quickly reversed.

It is instructive to compare Canada's experience with what is known as America's fiscal cliff, as projected by the Congressional Budget Office (CBO) in its August update. It is far more modest than what Canada achieved.

The Canadians balanced their budget in just two years. In contrast, the United States -- starting with a deficit of 7.3 percent of GDP in 2012 -- will never balance its budget through 2022, even after the "cliff." Canadians cut actual, total federal spending by more than 7 percent in the first two years. In contrast, the fiscal cliff has U.S. government spending falling a mere $9 billion in 2013, a reduction of 0.3 percent. Then total spending will rise again in 2014, so that it ends up higher than in 2012. The public commentary has largely focused on the cuts to "discretionary" spending, but few people know that by the second year, these cuts will be more than offset by increased spending on "mandatory" programs and interest payments. A drop in federal spending of 0.3 percent in 2013 and higher spending forever after is hardly the vertigo-inducing "cliff" of so much breathless media commentary.

Yes, the CBO projection says tax receipts will rise, by $478 billion (20 percent) in 2013. Yet this too runs counter to Canada's austerity plan, where spending cuts outweighed revenue increases by 5 to 1. Both economic theory and historical evidence suggest that it is much more conducive to economic growth if the government reduces its budget deficit through spending cuts and restraint, rather than taxing more from the citizens. In Canada, once the fiscal situation was righted and growth restored, new spending on social programs and lower taxes both became possible.

In order to make sound policy decisions, Americans must know the facts. Canadians decisively willingly took on a much more dire fiscal situation and discovered that it was no cliff, but the beginning of fiscal sanity and restored confidence and growth. In particular, the U.S. government needs to push through much more aggressive cuts in its expenditures if it really wishes to solve its fiscal woes. The metaphor of going over a cliff is alarmist and wrong. It should be replaced by the image of an athlete getting back into training after a period of self-indulgence and lost discipline. Americans have the chance, not to fall off a fiscal cliff, but to climb out of the fiscal hole they have dug for themselves.

Brian Lee Crowley is Managing Director of the Macdonald-Laurier Institute, a public policy think tank in Ottawa. Robert P. Murphy is principal at Consulting by RPM, in Nashville, TN. They are co- authors of Northern Light: Lessons for America from Canada's Fiscal Fix.

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