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Jim Flaherty’s record: Lucky - and good

Ever since the 2008 crisis and slump, Canada's relatively good economic performance has inspired the question: were we lucky, or were we smart? Tuesday's announcement that Jim Flaherty is stepping down as federal Finance Minister is an apt time to ask the question again.

There's no denying that Mr. Flaherty caught some breaks – his predecessors left him a surplus, and credit for our relatively robust financial sector and strong natural resource prices belongs elsewhere. Yet Canada's fiscal record since he donned his first new pair of shoes to deliver a budget – eight years ago – shows plenty of smarts as well; a strong legacy for his successor, Joe Oliver.

Mr. Flaherty's tenure as Finance Minister, to be sure, included many specific tax and spending initiatives – and the record there is mixed. The move to tax income trusts like regular corporations – however justified by fears of revenue leakage and the tax-driven drive to a potentially unsustainable business model – broke a clear promise.

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Putting federal-provincial transfers on an escalating path kicked down the road a needed revamp of taxing and spending powers. The decision to cut the GST, like the decision to load the tax system up with spending gimmicks disguised as tax credits, was a triumph of poll-driven politics over sound economics.

On the plus side of the ledger, though, are some key achievements. Mr. Flaherty served as a bulwark against the regulatory excesses that spread elsewhere after the financial crisis. Moreover, after 2007, he oversaw key reductions in uncompetitive business tax rates. The Working Income Tax Benefit helps get low-income families past the "welfare wall" of clawbacks that discourages work. And the Tax Free Saving Account will, over time, let far more Canadians escape double taxation of their saving – indeed, in years to come, many may judge it Jim Flaherty's most important innovation.

Those initiatives got a lot of the headlines. Mr. Flaherty, meanwhile, oversaw a profound shift in Ottawa's approach to budgeting.

He came to the position after a steady string of low-ball revenue forecasts. Those were initially excusable as a tool for former finance minister Paul Martin to restore Ottawa's credibility after coming close to a debt crisis in the mid-1990s. But the chronically pessimistic forecasts became a problem – especially when each year's in-year positive revenue "surprise"generated an in-year spending surprise that, over time, made the federal government grow far faster than budgets anticipated. Spending overshot the budget plan in the seven years up to Ottawa's 2005 fiscal year, helping boost federal spending almost one-third over the period.

That pattern of consistent positive revenue and spending surprises was problematic politically – it made a mockery of budget votes. It was also economically destabilizing. If governments react to unexpected economic strength by letting revenue rise and spending fall, and react to unexpected weakness by letting revenue fall and spending rise, the budget balance will move toward surplus in booms and toward deficit in busts, helping to smooth the cycle. Spending unexpected revenue has the opposite effect – boosting demand when it is already strong, as it did during the early 2000s.

Mr. Flaherty inherited that pattern of revenue and spending overshoots, and his first full year on the job looked the same: another revenue surprise thanks to a strong economy, and another spending overrun. But then things changed. During the seven years after Ottawa's 2007 fiscal year, revenue and spending surprises in each direction have been about the same. The bias toward overshoots has disappeared. Notwithstanding a 15-per-cent hike in the depths of the slump, federal spending grew by only about one quarter during those years.

In short, the federal fiscal balance responded to the crisis in a stabilizing way, with revenue coming in lower than forecast, and spending coming in higher than forecast. And it has responded to the recovery with revenue higher than forecast and spending lower than forecast. Good stabilization policy: a deficit during a slump, and a return to surplus afterwards.

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So Canadians have not only been lucky while Jim Flaherty has been finance minister – we have also been smart. Mr. Oliver inherits a budget that is all but balanced and, with it, restored fiscal credibility. As a result, the shoes Mr. Oliver wears for his first budget will be comfortable, if a bit hard to fill.

William Robson is president and CEO of the C.D. Howe Institute

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