The Fraser Institute Backgrounder - 1999 Federal Budget

Contact:

Joel Emes, Research Economist
The Fraser Institute, (604) 714-4542 Email: joele@fraserinstitute.ca

Release Date: 11 February 1999

VANCOUVER, BC>>>  Most of the pre-budget discussion has been about the size of the budget surplus and how many billions of dollars will be spent on health care. In addition, there have been many calls to cut taxes or reduce debt which are answered with claims that such a policy would put the hard-won budget balance back into a deficit. Unfortunately, several key ideas have been glossed over in these discussions.

First, the level of taxes depends on the level of spending—tax cuts will never be significant if the bulk of the surplus is spent every year. Second, total spending by the federal government will be about 18.3 percent of GDP in 1999—3.7 percentage points higher than the spending rate that would maximize economic growth. Third, there is a way to provide significant tax and debt relief and shrink federal government spending without risking a deficit.

• Taxes depend on the level of spending - tax cuts will never be significant if the bulk of the surplus is spent every year

Last year’s budget surplus was mainly pledged to new spending: the Millennium Foundation, a civil service pay raise, the aboriginal "healing" fund and higher federal cash transfers to provinces. "The Budget Plan 1998" shows that the federal government plans, from 1997/98 to 1999/00, to accumulate $14 billion in new spending or tax expenditures and only $4 billion in general tax relief. Judging from the pre budget discussion and comments made by MPs, the priority of the 1999 budget plan will also be spending – with between $1 and $3.5 billion going to health care alone. True to the 1997/98 to 1999/00 plan there may be a small cut in taxes – such as the complete elimination of the 3 percent surtax or a raise in the basic personal exemption – but likely not any significant cuts.

• Total spending by the federal government will be about 18.3 percent of GDP in 1999 – 3.7 percentage points higher than is optimal

Many economists have looked into the size of government and its effect on general and specific aspects of economic performance and found that governments are much larger than they need to be. In fact, one paper done by the International Monetary Fund which looked at 17 industrialized countries including Canada notes that "…most of the important social and economic gains can be achieved with a drastically lower level of public spending than what prevails today." The authors observe that up until about 1960 increased public sector spending led to measurable improvements in social indicators such as education and health.

After 1960 however, big governments, whose spending increased to more than 50 percent of GDP, did not perform better in economic and social indicators than small governments, whose spending increased but stayed below 40 percent of GDP. In fact, countries with small governments have equal or better real GDP growth and capital formation, lower unemployment rates, smaller underground economies, and more patents per person than countries with medium or large governments (see Table 1).

Related research posits that there is an optimal size of government based on the simple idea that up to a certain level, government spending does more good than harm but after the optimum level is reached, further increases in spending actually harm the countries’ economy and people. A Fraser Institute estimate puts the optimal size of the total government sector at 34 percent of GDP and the optimal size of the federal government at 14.6 percent.

• There is a way to provide significant tax and debt relief and shrink the federal government without risking a deficit

The Fraser Institute Public Policy Source, Using Cash Rebates for Tax Relief Without Risk, released on February 4th details a plan to cut taxes and debt without a renewed deficit risk.

Paul Martin is hampered in his efforts to enact tax reductions by the understandable concern that if, in his forthcoming budgets, he announces plans for tax cuts equal to the expected year’s surplus, an unexpected recession or increase in interest on the debt will create a deficit. His commitment to balanced budgets would be questioned, and he would lose the public credibility he has developed.

Returning fiscal surpluses to taxpayers as cash rebates at the end of the year in which they are realized and continuing the practice of using the $3 billion contingency reserve (if it is not needed) to pay down debt would eliminate the risk of deficits. The plan calls for a decision about what the size of the federal government should be and no spending increases until this optimal size is reached. A spending freeze coupled with the current revenue structure should lead to large surpluses. At the end of the first fiscal year of the plan, the surplus would be returned to taxpayers.

The surplus would again be returned at the end of the second fiscal year, but tax rates would be cut to ensure that revenue in the third year was smaller by the portion that was returned at the end of the first year. This process would continue until the target for the size of the federal government is reached—the optimal size of 14.6 percent could be reached by 2008. The plan could be modified or put on hold if there is no surplus in any given year.

Taxes and debt can be reduced without the risk of a deficit. The real worry is that the federal government is larger than it should be and if we continue to spend most of the surplus, significant tax cuts will never be realized.

Table 1

Chart 1 - The Size of Government and Real GDP Growth

Source: statistics Canada and calculations by The Fraser Institute

Note: 5-year real GDP Growth rate.

Established in 1974, The Fraser Institute is an independent public policy organization based in Vancouver.

For further information contact:

Suzanne Walters, Director of Communications,
The Fraser Institute, (604) 714-4582,
Email suzannew@fraserinstitute.ca

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