Will Jim Flaherty cut as deeply as Paul Martin?

When Finance Minister Jim Flaherty rises in the House of Commons on March 29 to present the federal budget, Canadians will finally learn how deep the Stephen Harper government is prepared to cut.

Will the cuts be as sharp as some cabinet ministers were hinting at until a month or so ago? Or has the government had second thoughts?

The Harper government began preparing the public for a big dose of austerity in the summer and, in January, Jason Fekete of Postmedia News wrote that Flaherty's next offering would be "arguably the most important federal budget in a political generation."

By that he probably had in mind Paul Martin's 1995 deficit-busting budget, the one that curtailed transfers to the provinces and other programs and set the stage for over a decade of federal surpluses.

Expect the Flaherty-Martin comparison to be frequently made on the afternoon on the 29th. So it may be worth reminding ourselves what is similar and what is different about the two times.

In 1995, an international financial crisis loomed over the Liberal government's budget preparations, not unlike the situation today in Europe.

In 1995, it was Mexico's peso crisis (brought on by a sudden devaluation of the currency in December 1994) and the negotiations of a rescue package for Mexico that followed.

But probably the more important element here has been the international view of the Canadian economy, which was dramatically different in 1995 compared to today.

Debt servicing then and now

In 1995, Martin faced a federal government debt of over $500 billion, with annual deficits running about $40 billion.

With a 72 per cent debt-to-GDP ratio, Canada had the second highest in the G7 group of elite economies at the time, second only to Italy.

Today's Europe is in much worse shape, with an average debt burden for the euro area of 88 to 90 per cent of GDP.

But back then, as now, it was relative performance that mattered most.

International investors were shunning Canada, which helped keep Canadian interest rates high and made debt servicing more costly.

According to Martin, 36 cents of every dollar of federal spending went to servicing the debt. And 46 per cent of that debt was held abroad

Today, federal debt is again over $500 billion but servicing the debt costs only 11 cents of every tax dollar. What's more, just 22 per cent is now in foreign hands, according to the Department of Finance.

Perception

Perception is everything in politics and back in January 1995, the influential Wall Street Journal ran an editorial under the headline "Bankrupt Canada?"

"Mexico isn't the only U.S. neighbour flirting with the financial abyss," the editorial said. "Turn around and check out Canada, which has now become an honorary member of the Third World in the unmanageability of its debt problem."

The Globe and Mail reprinted the article, which infuriated most Liberals, Edward Greenspon and Anthony Wilson-Smith wrote in their book Double Vision: the Inside Story of the Liberals in Power.

However, it helped Paul Martin make his "come hell or high water" case for cuts to his cabinet colleagues.

Interestingly, Ontario Finance Minister Dwight Duncan employed that same phrase on March 5 when telling reporters about the need for the province to tackle its deficit.

Jim Flaherty also spoke to reporters that day, when he described Ottawa's fiscal situation as "in relatively good shape," from a global perspective but noted some provinces have "serious deficit and debt problems."

Flaherty also faces a different political situation than the Jean Chretien-Paul Martin Liberals did back in 1995.

The Liberals had won a landslide victory in 1993 and were still enjoying majority support in the polls two years later.

Today's Conservatives eked out a smaller 12-seat majority in 2011 after five years of minority government, and have fallen a bit since then in public opinion polls.

However, Flaherty has both a mandate and public support for reducing the deficit.

Plus, unlike Martin, he does not have a party to his right in the House of Commons that will call him "cowardly" if he doesn't cut deeply enough, as the Reform Party did when describing Martin's 1995 budget.

'Pre-condition' the public

The Liberals had promised to reduce the deficit to three per cent of GDP from six per cent.

But what Martin wanted to do in his 1995 budget went against much of the Liberal platform, the famous Red Book.

So Martin had "to prepare the public for what was going to be a very tough budget," as he wrote in his memoirs, Hell or High Water: My Life in and out of Politics. He added that he "also needed to reassure the markets."

Elly Alboim of Earnscliffe Strategy Group was an adviser to Martin in 1993. He had previously headed CBC News' Ottawa bureau.

Alboim said the communications strategy for the 1995 budget was "much more extensive than the ones that preceded it" and that it was Martin who pushed for it.

Martin's strategy, Alboim said in an interview, was to "pre-condition the environment for the budget."

But "the Canadian people arrived at that point ahead of governments, anyway," he added.

Alboim also thinks the Conservatives began a similar strategy to prepare Canadians for cutbacks following their election win. 

Talk of a $4 billion cut grew to $8 billion and five per cent cuts to ministry budgets grew to 10 per cent over the summer and fall. Then, while attending the Davos economic forum in January, Prime Minister Harper mused about making changes to Canada's Old Age Security program.

By February, however, the yardsticks seemed to be shifting back. Both the federal and global economic situations were changing in ways that the government did not appear to have anticipated in the fall.

The "European crisis" still hangs in the air but does not appear as bad as it once did. And talk of a U.S. recession has receded as the American economy begins to add jobs.

Canada's economy is growing as well. After his March 5 meeting with economists, Flaherty reported that "the economists noted that the Canadian economy has been resilient over the last year and Canada will continue to see modest growth going forward."

On the fiscal front, things are also looking better than Flaherty anticipated in his autumn economic statement.

The latest figures from the finance department, released in February's Fiscal Monitor, suggest the deficit will be around $24 billion rather than the $31 billion Flaherty had earlier projected. Tax revenues in December increased 6.8 per cent.

'This is not austerity'

In recent weeks, Flaherty seems to be trying to shift expectations. After the most recent numbers were released, he said his budget would show "some moderation" in the increase in government spending (which had been ramped up to address the global recession of 2008-09) but that "this is not austerity, this is not draconian."

For his part, Alboim argues that delaying the budget until March 29, nearly the last minute in a normal budget season, is undoubtedly a result of the current economic uncertainty.

In this regard, March 20 is a key date. That's when Greece is supposed to meet a key debt repayment, which seems likely at the moment but which would send the markets reeling if it doesn't.

Another reason for the apparent backpedalling of the past few weeks, Alboim suggests, is that the government is "sensing the public's accepting of a severe austerity budget might not be as deep or as welcoming as was originally thought."

Deep cuts could slow or even stall economic growth, especially if the Ontario government also opts for severe austerity in its budget, which is expected to be unveiled around the same time.

Contrast today's economy with 1995's, which Martin described as "stronger than it has been for years."

For the Chretien government, he said, that meant it was the time to reduce the deficit. "Relative to the size of our economy, program spending will be lower in 1996-97 than at any time since 1951."

Martin also warned that with high interest rates and the government's huge debt, "the quicksand of compound interest is real."

Martin announced that, "The budgets of government departments are being reduced dramatically, in several cases halved over the next three years." He projected the federal public service would shrink by 45,000 positions.

Three years later, the government of Canada was no longer running a deficit and total net expenditures had fallen by $11 billion (not adjusted for inflation).

In drafting his budget, Flaherty does not have the benefit of a strong economy but rather one that many economists say has yet to turn the corner following the recession.

He does, however, have the luxury of historically low interest rates.

The risk with an austerity budget is that it can set back economic growth by taking government spending and the jobs that it supports out of the economy.

In a February research note, Bank of Montreal economist Douglas Porter mused about all the talk that Flaherty would cut aggressively and wondered why such cuts were required.

"The current plan seems to be working quite well all by itself," he concluded.

Porter was one of the economists Flaherty met with on March 5. After the meeting he told reporters, "there is not a push from the financial markets for the federal government to do any more than what's already scheduled."