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A Chill Wind Hits Canada: Newtnomics

For weeks, the pressure kept building in Canada. Investors worried about massive government debt drove the Canadian dollar to a nine-year low of just above 70 U.S. cents--and dubbed it the "northern peso." Moody's Investors Service Inc. threatened to strip the country of its coveted AAA credit rating. And as the government prepared its fiscal 1996 budget, investors seemed ready to hammer the Canadian dollar even more.

But on Feb. 27, Prime Minister Jean Chretien answered back with a vengeance. In a bold bid to rebuild international confidence, his government presented the most draconian budget Canada has seen in four decades. With a planned $18 billion in cuts over the next three years, the budget calls for reducing federal spending to 13.1% of Canada's gross domestic product--lower than at any time since 1951. Grumbles Bob White, president of the Canadian Labor Congress: "It may make Wall Street happy, but this budget sounds an awful lot like Newt Gingrich to me."

RAIL SALE. The budget marks a watershed for Canada, which has long taken pride in providing European-style social programs. And it's an abrupt about-face for Chretien's Liberal Party, which created many of the big government programs. Spending is being slashed on everything from farm subsidies to unemployment insurance and could lead to the elimination of 45,000 government jobs. While Canada will retain its renowned nationalized health insurance, Ottawa's payments to the provinces for social programs will be cut by 12% over the next three years.

As presented by Finance Minister Paul Martin, the budget lays out a credible plan for nearly halving the budget deficit from its 1994 level, to $17.5 billion--or 3% of GDP in the fiscal year ending in March, 1997. But over the same period, net federal debt will balloon by 19%, to $434 billion, and the annual interest tab alone will soar 33%. Canada's "balance sheet has deteriorated so much, it will take years" of cuts to lower government debt, warns Brian I. Neysmith, president of Canadian Bond Rating Service, a private agency.

That was probably why the market rallied only modestly after the budget announcement. On Feb. 28, the Canadian dollar rose about one-sixth of a cent to close at 72 cents, while big banks cut the prime a quarter-point, to 9.25%.

In any event, the budget cuts signal a new era for Canadian citizens. Unemployment insurance payouts will be cut 10% on top of the 12% cut in last year's budget. Aid to dairy farmers will fall 30%, and subsidies to business will be slashed more than 60%. Furthermore, Ottawa plans to privatize the Canadian National Railway Co. and unload its 70% stake in Petro-Canada.

With foreigners now holding much of Canada's debt, "we have lost control of our economy and are being forced to harmonize our social programs down to U.S. standards," complains Maude Barlow, head of the Council of Canadians, a group against free trade. In another echo of the Republican revolution in the U.S., the budget makes a "major move to transfer powers back to the provinces," says John McCallum, chief economist at Royal Bank of Canada. Provinces will have far more freedom to design social programs.

GREENER GRASS. In the end, though, Canadians may be getting what they are willing to pay for. Earlier this winter, angry taxpayers staged rallies across the country insisting on "no new taxes." The reason: "Canadians are becoming more and more alarmed" about the growing disparity between U.S. and Canadian taxes, explains David Perry, an executive at the Canadian Tax Foundation, a national tax research group.

Fifteen years ago, the tax burden was about equal on both sides of the border. But now, marginal income tax rates are some 25% higher in Canada. So Martin resisted raising personal income taxes--a big change from previous Canadian budgets. Instead, he imposed modest hikes in gas and corporate income taxes.

For all the anger over taxes, it will be a long time before Canada can afford to narrow its tax disparity with the U.S. Canada's debt problem is bringing its era of a European-style social welfare system to a gradual end. The days of tighter budgets and tax fatigue are just getting under way.

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