Tax and Fiscal Policy

What Britain can learn from Canada and Australia

As Britain’s short term growth prospects improve, pressure for further economic reforms recedes. Over the past two years Parliament has enacted few structural reforms, and the pace is likely to slow even further up until the next election. Perhaps it is time to draw inspiration from two other Anglo‑Saxon nations, which have succeeded thanks to a more long-term commitment to growth.

In contrast to the UK, neither Australia nor Canada has the benefit of being a major financial hub. Yet Canada’s GDP per capita is 18 per cent higher than the UK’s and Australia’s fully 24 per cent higher. Even before the financial downturn both countries had surpassed the UK in terms of per capita wealth. Australia and Canada also successfully integrate a large foreign born population into their labour markets. The key for prosperity and an inclusive economy has been a long‑term commitment to growth-oriented policies.

Canada was in very bad shape when Paul Martin, minister of finance in the newly elected left‑liberal government, took office in 1993. The government chose to introduce wide‑ranging market reforms, tearing down barriers to competition and reducing public spending. Although the changes were unpopular in the short term, they gained public support over time. Campaigning on the promise to reduce taxation as well as the federal deficit, the party gained a second term in 1997. The liberals won two further re‑elections on market oriented policies. Conservative governments have since moved in the same direction.

Thanks to these changes Canada has today been transformed into North America’s new free-market role model. The country has become a global magnet for investment and talent, and has withstood the recent global downturns better than most developed economies. In Australia, a set of Labor governments began introducing far-ranging market reforms during the 1980s. Both conservative and left governments in the country have since continued to foster a competitive business climate. Australia is rather unique in the developed world in having experienced more than two decades of continuous growth.

In a number of fields, Australia and Canada can inspire structural changes in the UK. One example is to further strengthen the incentives to work. The OECD calculates the extent to which taxes and benefits reduce the financial gain of going from ‘half-time’ work to full-time work. In Australia a single parent with two children will keep 42 per cent of this income increase, compared with 37 per cent in Canada. The incentives to work more are relatively small, but not negligible in these two nations. In the UK, the single parent would on average only keep 18 per cent of the income increase. The current policies of the UK are not only economically, but also socially, irresponsible. When the returns to working diminish due to taxes and benefits, families risk being trapped in low incomes and public dependency.

Government spending is overall lower in Canada and Australia compared to the UK. At the same time, investments in infrastructure are considerably higher. As a share of GDP, Canada spends some 50 per cent more on inland transport infrastructure than the UK. In Australia, the level is twice as high. Given Britain’s tradition of academic excellence, it is somewhat surprising that Australia and Canada have also begun to catch up to the UK in metrics such as research publications per citizen. One reason is that public spending on scientific research in the UK is low compared to other modern economies. To encourage future prosperity, not only the scope of public spending, but also how it is utilised could be altered. Australia and Canada have also come a long way in opening up to external investments in infrastructure, including both direct private investments and investments through pension funds.

The difference between the UK on the one hand and Australia and Canada on the other seem to relate to the long-term trajectory of political culture. In the latter two countries, successful structural reforms have over time reduced the threshold for new reforms. British policies have focused more on distributing existing wealth. The result is a GDP per capita level close to tax‑ridden France. Taking a bolder approach to growth might in the long term prove successful in the UK. After all, recent history suggests that British governments that have increased the level of economic freedom have also promoted their own chances of re‑election.

Nima Sanandaji and Stefan Fölster are the authors of Renaissance for Reforms.