July 3 2013

Smaller Government, Bigger Economy

Vicki E. Alger

Less than two decades ago the Wall Street Journal dubbed Canada an “honorary member of the Third World.” It has come a long way since then—especially in terms of cutting deficit spending and government restraint (for more check out the award-winning book The Canadian Century).

As the CATO Institute’s Chris Edwards explains, we could learn a lot from our neighbors to the north. Beginning in the mid-1990s, Canadians cut government spending (actual spending, that is, not the spending “light" we do here by cutting spending growth). As Edwards explains:

Canada's fiscal reforms undermine the Keynesian notion that cutting government spending harms economic growth. Canada's cuts were coincident with the beginning of a 15-year boom that only ended when the United States dragged Canada into recession in 2009. The Canadian unemployment rate plunged from more than 11 percent in the early 1990s to less than 7 percent by the end of that decade as the government shrank in size. After the 2009 recession, Canada has resumed solid growth and its unemployment rate today is about a percentage point lower than the U.S. rate.

But the cutting didn’t stop there. An array of tax reforms lowered taxes for individuals and businesses that resulted in and government surpluses thanks to a more robust economy. Edwards continues:

As the new millennium dawned, a slimmed-down Canadian government under the Liberals enjoyed large budget surpluses and pursued an array of tax cuts. The Conservatives continued cutting after they assumed power in 2006. During the 2000s the top capital gains tax rate was cut to 14.5 percent, special "capital taxes" on businesses were mainly abolished, income taxes were trimmed, and income tax brackets were fully indexed for inflation. Another reform was the creation of Tax-Free Savings Accounts, which are like Roth IRAs in the United States, except more flexible.

The most dramatic cuts were to corporate taxes. …the overall average rate in Canada is just 27 percent today. By contrast, the average U.S. federal-state rate is 40 percent. …

Canada's federal corporate tax rate has been cut from 38 percent in the early 1980s to just 15 percent today. Despite the much lower rate, tax revenues have not declined. Indeed, corporate tax revenues averaged 2.1 percent of GDP during the 1980s and a slightly higher 2.3 percent during the 2000s.

Now compare Canada with the United States. In 2012, Canada is expecting to collect 1.9 percent of GDP in federal corporate income taxes with a 15 percent corporate tax rate. The United States is expecting to collect 1.6 percent of GDP at a 35 percent corporate tax rate. Thus, the high U.S. rate is not only bad for the economy, but it also doesn't help the government collect any added revenue.

Smaller government, bigger economy. That appears to be the Canadian Way. It can and should be the American Way, too.

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