The United States is not the first advanced modern economy to face a serious federal budget challenge. A number of countries have seen their debt rise to unacceptable levels in recent decades, and they have taken steps to rein it in. We explore the approaches that Canada and the United Kingdom have used. Though there are important differences in approaches and countries, we draw five useful lessons for the reforms that may be proposed in the U.S. as it addresses its fiscal challenges.Debts, Public - Canada ; Deficit financing ; Debt - United States ; Debts, Public - United Kingdom

Daniel Carroll

John Lindner

English

Research Papers in Economics

ECONOMIC COMMENTARY
Number 2011-22
October 18, 2011
Reducing the Federal Deﬁ  cit:
Approaches in Some Other Countries
Daniel Carroll and John Lindner
The United States is not the ﬁ  rst advanced modern economy to face a serious federal budget challenge. A number of 
countries have seen their debt rise to unacceptable levels in recent decades, and they have taken steps to rein it in. 
We explore the approaches that Canada and the United Kingdom have used. Though there are important differences in 
approaches and countries, we draw ﬁ  ve useful lessons for the reforms that may be proposed in the U.S. as it addresses 
its ﬁ  scal challenges.
  ISSN 0428-1276
As highlighted in current public discussions, the United 
States faces a federal budget challenge over the long term. 
The ﬁ  nancial crisis produced large deﬁ  cits due both to the 
rescue of the ﬁ  nancial industry and to decreases in taxes 
and increases in social welfare beneﬁ  ts, which are standard 
in recessions. These deﬁ  cits caused the federal debt held 
by the public to increase by 79 percent from 2007 to 2010. 
Projections of the path for the debt show it continuing to 
rise over the next decade. When the Congressional Bud-
get Ofﬁ  ce takes into account historical tax and spending 
behavior, the debt skyrockets to unsustainable levels within 
25 years (ﬁ  gure 1).
It is now widely recognized that the United States will have 
to ﬁ  nd some combination of revenue increases and govern-
ment spending reductions in order to bring projected debt 
under control. (In August 2011, Standard and Poor’s down-
graded the U.S. long-term credit rating from AAA to AA+, 
citing the need for a credible plan to rein in projections.) 
During his ﬁ  rst post-FOMC press conference, Federal Re-
serve Chairman Ben Bernanke expressed his concern over 
future budget shortfalls, calling them “the most important 
economic problem … in the longer term that the United 
States faces.”
The United States is not alone in facing large ﬁ  scal imbal-
ances and a need for large corrections. The economic crisis 
wreaked havoc on the ﬁ  nances of governments worldwide. 
Several countries such as Greece, Portugal, and Ireland 
have sought help from the European Union (EU) after 
rating agencies downgraded assessments of their debt, 
leading to higher borrowing costs. Many countries in the 
EU, responding to a stipulation in the Maastricht treaty that 
members have deﬁ  cits no greater than 3 percent of GDP, 
passed austerity measures to rein in their budgets. The 
United Kingdom (UK), noting the downgrades in the public 
debt ratings of some EU countries, has taken aggressive 
steps to reduce its deﬁ  cit to 1 percent of GDP by 2015. 
In order to inform some of the choices the United States 
faces, this Commentary examines the structures of the auster-
ity measures that some other nations have adopted. Speciﬁ  -
cally, this article focuses on the experience of two devel-
oped countries: Canada in 1995 and the UK in 2011. The 
outcomes (or projected outcomes in the case of the UK) are 
discussed, and potential guidelines for a U.S. budget reform 
based on applicable plans from other nations are laid out.
Canada, 1995
Canada’s austerity program began in 1995, on the heels of a 
three-year recession. Despite the recession, the government 
had been returning a primary surplus (that is, revenues 
exceeded expenditures excluding interest on accumulated 
debt) for the six previous years; however, these surpluses 
were not sufﬁ  cient to offset debt service payments, and so 
the debt continued to mount (ﬁ  gure 2). After more than a 
decade of running deﬁ  cits greater than 4 percent of GDP, 
Canada’s debt had climbed from below 30 percent of GDP 
in 1980 to 67 percent.
In response, Canada embarked upon a widespread ﬁ  scal 
consolidation. Although the reform contained some tax 
increases, income taxes were not changed. Instead, increased 
revenue was secured with very modest changes to business 
taxes and higher taxes on tobacco and gasoline. Making 
up only $1 for every $7 of government spending reduction, tions is unclear. Nevertheless, although Canada’s economic 
prosperity during this period cannot be directly attributed to 
its ﬁ  scal reforms, Canada’s ﬁ  scal consolidation did translate 
that growth into massive reductions in deﬁ  cits and eventually 
public debt. By 2007, the debt-to-GDP ratio was below 30 
percent. By making hard choices about the size of federal gov-
ernment, Canada was well-positioned to take full advantage 
of the years of economic growth to restore its ﬁ  scal house.
United Kingdom, 2011
The ﬁ  nancial crisis that began in 2008 put the ﬁ  scal situa-
tion in the UK into public view. Primary deﬁ  cits had been 
run since early in the decade (2003) but had only recently 
topped 4 percent of GDP in any one year. Since the onset 
of the crisis, the annual deﬁ  cit has averaged 9.3 percent of 
GDP. Meanwhile, the level of debt as a percentage of GDP 
has risen from 31.5 percent at the end of 2002 to over 60 
percent in 2010 (ﬁ  gure 3).
Anticipating that without reform its debt-to-GDP ratio 
would continue to rise over the next ﬁ  ve years, the UK de-
veloped a plan to rebalance its ﬁ  scal situation and encourage 
growth. As in Canada, the UK structured the bulk of the 
response on spending reductions.
According to Her Majesty’s Treasury’s 2011 budget, cor-
porate tax decreases, drops in some land tax rates, and an 
increase in the personal tax allowance are expected to help 
boost GDP back up to a 2.9 percent growth rate by 2013. 
These changes would be more than offset by reforms to the 
personal tax system, as well as increases in the VAT (value 
added tax), environmental taxes, and the supervision of tax 
avoidance. At a ratio of $3 in government spending reduc-
tion to $1 of tax revenue increase, however, the tax changes 
compose a minority of the total reform package.
Figure 1.  U.S. Gross Debt and 
Budget Balance
Figure 2.  Canadian Gross Debt and 
Budget Balance
30
40
50
60
70
80
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
–12
–10
–8
–6
–4
–2
0
2
4
Percent
OMB projections
OMB projections
Percent
Budget balance, 
as a percent of GDP
Debt, as a 
percent of GDP
20
30
40
50
60
70
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
–8
–6
–4
–2
0
2
Percent Percent
Budget balance, 
as a percent of GDP
Debt, as a percent of GDP
changes to tax revenue collection composed a very small 
portion of the total reform package. The lion’s share of the 
consolidation came from cutting expenditures. 
The cuts were broad and deep, averaging roughly 23 per-
cent over three years, with some departments facing cuts of 
over 50 percent to their budgets. Large savings, particularly 
in transportation and resource management, came from 
consolidating department roles and from either privatizing 
some federal operations or transferring them to provincial 
government.
In line with a greater decentralization of government 
administration, the federal government converted many 
cost-sharing programs into block grants, forcing localized 
governments to also make difﬁ  cult choices about how much 
public service to provide. Federal cash transfers to provinces 
had exceeded 4 percent of GDP for over 20 years; from 
1995 to 1999 they averaged 3.3 percent. 
Over the same period, provincial expenditures on programs 
declined by 11.8 percent. Federal, provincial, and local gov-
ernment employment fell by roughly 15 percent, 9 percent, 
and 6.5 percent, respectively, from 1995 to 1999. Overall, 
total government spending as a fraction of GDP declined 
from 48.5 percent in 1995 to 42.7 percent in 1999.
The late-1990s were a time of strong economic conditions in 
Canada, with steady output growth and a near 3 percentage 
point decline in the unemployment rate. Within only three 
years, Canada began producing surpluses and continued to 
do so for the next 10 years. Canadian economist Stephen 
Gordon has reported that the recovery period was largely 
due to the concurrent growth of Canada’s largest trading 
partner, the United States, which boosted Canadian exports. 
At this time, the marginal impact of Canada’s ﬁ  scal reform 
on its subsequent GDP growth and unemployment reduc-
Sources: Canadian Department of Finance. Sources: Congressional Budget Ofﬁ  ce; Ofﬁ  ce of Management and Budget.By far, the largest spending reductions come as a result 
of a new indexation process for public pensions, public 
beneﬁ  ts, and tax credits. This change will index these 
public expenditures to the Consumer Price Index (CPI) 
and is expected make up over a third of the £75 billion 
announced savings. Previously, these items were tied to 
the Retail Price Index (RPI), which has tended to increase 
more quickly than the CPI. 
The CPI differs from the RPI in several respects. The RPI’s 
basket of goods and services is constructed differently than 
the CPI’s basket. Not only do the two baskets contain dif-
ferent items (most notably, unlike the CPI, the RPI contains 
mortgage interest payments and house purchase costs), but 
also the weights assigned to items in the basket are calcu-
lated differently. Furthermore, the RPI uses an arithmetic 
mean to average price changes within the basket while the 
CPI uses a geometric mean. This causes the CPI to respond 
more to a downward movement in the price of an item than 
to an equivalent upward movement in the price of the same 
item. Put another way, even if the CPI and RPI baskets 
were constructed with exactly the same method, the CPI 
would never be greater than the RPI because of the aver-
ages used.
The UK plan also trims deﬁ  cits by reducing tax credits 
(thereby increasing tax revenue), shrinking local capital 
expenditures, and loosening carbon reduction commitments. 
The government’s share of contributions to the national 
safety net will be reduced by increasing both employee and 
employer contributions over the next ﬁ  ve years. Despite 
these changes, current expenditures are still expected to rise 
over the medium term to meet obligations for social security 
beneﬁ  ts and debt interest payments, as well as to increase 
investment in education and infrastructure.
Projections estimate that the debt-to-GDP ratio will continue 
to rise into ﬁ  scal year 2014, peaking at 70.9 percent. By 
2015, it is expected that a current surplus of 0.4 percent of 
GDP will be achieved, which will allow the debt-to-GDP 
ratio to fall back to 69.1 percent by the end of 2015. The 
marginal impact of ﬁ  scal consolidation is to reduce net pub-
lic debt by 4 percent of GDP within four years.
Some of this recovery is expected to result from increased 
economic growth, as forecasts project that growth will 
return to a 3 percent trend by 2013. Under this scenario, 
growth is boosted by increases in business ﬁ  xed investment 
and exports, two targets of expanded investment spending. 
Higher growth in turn improves overall economic condi-
tions, including reducing unemployment from 8.2 percent 
down to 6.4 percent in 2015.
Implications for the United States
The United States shares some characteristics with both 
Canada and the UK. All three countries have solidly estab-
lished democratic governments as well as well-developed, 
modern economies. As in Canada and the UK, debt has 
accumulated from a history of consistent deﬁ  cits (1998–2001 
notwithstanding), and the accumulation has been escalated 
because of an economic recession.
At the same time, the United States is unique in some 
regards. One difference working in the United States’ favor 
is the standing of the U.S. dollar as the leading exchange 
currency. The demand for U.S. dollars from abroad reduces 
exchange rate risk and helps keep the nation’s interest rates 
low. On the other hand, a difference that works against the 
United States is that it has yet to see the largest contributor 
to its long-term future deﬁ  cits fully realized—the entry of the 
baby boom generation into entitlement programs. This sets 
the bar for restoring ﬁ  scal balance much higher. Not only 
must the U.S. ﬁ  nd a way to take action on revenues and 
spending to address near-term imbalances, it must also ﬁ  nd 
a way to address even larger future transfers.
The two cases discussed above offer some takeaways for the 
reforms that may be proposed in the U.S. as it addresses its 
ﬁ  scal challenges. First, it should be noted that there is no 
one-size-ﬁ  ts-all ratio of government spending reductions to 
tax increases. Canada, with the higher spending-to-tax ratio, 
decided that its tax code was mostly adequate and identi-
ﬁ  ed overspending at the federal and provincial levels as the 
primary cause of deterioration in its federal budget. In con-
trast, the UK recognized that very low income taxes and an 
ever-narrowing income tax base played a critical role in the 
rapid surge in its deﬁ  cits. In both cases, spending reductions 
made up a signiﬁ  cantly greater proportion of the overall 
deﬁ  cit reduction plan, but the degree to which tax revenue 
played a role differed.
Second, substantial curtailment of government spending 
tends to involve cutbacks in public employment and com-
pensation. Some combination of wage freezes, staff reduc-
tions, and beneﬁ  t reduction was common to both reforms.
Figure 3.  United Kingdom Gross Debt and 
Budget Balance
30
40
50
60
70
80
1999 2001 2003 2005 2007 2009 2011 2013 2015
–12
–10
–8
–6
–4
–2
0
2
Percent Percent
Budget balance, as a percent 
of GDP
Debt, as a percent of GDP
Sources: Ofﬁ  ce of National Statistics.Daniel Carroll is a research economist at the Federal Reserve Bank of Cleveland, and John Lindner is a research analyst at the Bank. The 
views they express here are theirs and not necessarily those of the Federal Reserve Bank of Cleveland, the Board of Governors of the 
Federal Reserve System, or Board staff.
Economic Commentary is published by the Research Department of the Federal Reserve Bank of Cleveland. To receive copies or be placed 
on the mailing list, e-mail your request to 4d.subscriptions@clev.frb.org or fax it to 216.579.3050. Economic Commentary is also available 
on the Cleveland Fed’s Web site at www.clevelandfed.org/research. 
PRSRT STD
U.S. Postage Paid
Cleveland, OH
Permit No. 385
  Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
Return Service Requested:
Please send corrected mailing label to the 
above address.
Material may be reprinted if the source is 
credited. Please send copies of reprinted 
material to the editor at the address above.
The spending-focused Canadian plan, however, made much 
larger cuts to public employment compared to the more balanced 
UK plan, which only increased contributions to public insurance. 
Third, reformers may be more hesitant today to increase taxes 
on business than in the past. In contrast to 1990s Canada, 
where the only tax reforms were increases to business taxes, 
the modern UK is very determined to not raise corporate tax 
rates and, in fact, prefers to offer some subsidies to encourage 
business growth by either cutting corporate taxes or increasing 
government spending to invest in business. The hope is to use 
slower government spending to allow the UK to grow back to 
ﬁ  scal health. These differing views between the modern UK and 
1990s Canada may reﬂ  ect the increase in global competition over 
the last two decades. 
Fourth, reform may be focused on the short term. Both Canada’s 
and the UK’s programs aim to achieve their budget balance goals 
in three to ﬁ  ve years. A short timetable forces a nation to rely 
heavily on the commitment of the current government and less 
on the faith that future governments will make the hardest cuts. 
In this regard, front-loading the reform so that the bulk of tax 
and spending changes comes early on may better ensure that the 
program is completed. It should be strongly cautioned, how-
ever, that such a strategy can be signiﬁ  cantly contractionary. An 
ill-timed, front-loaded reform might be counterproductive if it de-
rails recovery, as a recession invariably increases budget deﬁ  cits. 
Finally, taking reforms on as soon as possible permits countries to 
take full advantage of eventual recoveries. Expansions follow reces-
sions. When an expansion arrives, a country should be ready to 
harness the increase in tax revenue to restore its ﬁ  scal position.
References and Suggested Reading
“On the Lessons to Be Learned from the Elimination of the 
Canadian Federal Deﬁ  cit in the 1990s,” Stephen Gordon, 2010. 
Worthwhile Canadian Initiative (web blog). Available at <http:// 
worthwhile.typepad.com/worthwhile_canadian_initi/2010/06/ 
on-the-lessons-to-be-learned-from-the-elimination-of-the-canadian-
federal- deﬁ  cit-in-the-1990s.html>
“What Promotes Fiscal Consolidation: OECD Country Experi-
ences,” Stephanie Guichard, Mike Kennedy, Eckhard Wurzel, 
and Christophe André, 2007. OECD, Economics Department 
working papers, no. 553.
“Budget 2011.” Her Majesty’s Treasury. HC 836. March 2011.

Reducing the federal deficit: approaches in some other countries

http://www.clevelandfed.org/research/Commentary/2011/2011-22.pdf

Reducing the federal deficit: approaches in some other countries

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics