Spending Less, Gaining More: Lessons from Canadian Debt Reduction

The national debt has (finally!) received more attention in recent months, particularly due to debates surrounding the One Big Beautiful Bill Act. Long-time deficit hawks like the Cato Institute (and R Street, of course) weighed in, but the issue also surfaced in many liberal spaces, such as in The Ezra Klein Show at The New York Times. And then, there was Elon Musk, who called the debt “crushingly unsustainable” in a widely shared tweet.

This attention is deserved. The consequences of an ever-rising national debt are well documented. It crowds out private investment, puts upward pressure on interest rates, has negative effects on employment and wage rates, and ultimately slows long-term economic growth (just to name a few).

But here’s the part that gets missed too often: Tackling the debt doesn’t have to be seen as painful or punitive, like a medicine we know we need but hate to take. What if we stopped treating spending cuts as a necessary evil and recognized them as opportunities to strengthen our economy instead?

This isn’t just wishful thinking. According to the International Monetary Fund (IMF), every 10-point drop in the debt-to-gross domestic product (GDP) ratio is associated with a 1.4 percent increase in long-run real GDP growth. Deficit reduction doesn’t just prevent future economic problems—it can also unlock stronger performance over time.

We’ve seen this play out in the real world. Let’s take some notes from our neighbor to the north.

In the early 1990s, Canada’s fiscal outlook was dire. Its debt-to-GDP ratio was climbing, interest payments were consuming over a third of government revenue, and investor confidence was plummeting. In 1995, The Wall Street Journal called Canada “an honorary member of the Third World.”

That same year marked a sharp turning point. Prime Minister Jean Chrétien and Finance Minister Paul Martin launched an ambitious reform effort. Over three years, Canada drastically reduced total federal program spending, cutting spending on defense, welfare, provincial government aid, business subsidies, and many other things. Importantly, spending cuts outweighed tax increases by a ratio of roughly seven to one in the 1995 budget.

The effects were dramatic:

• The federal deficit turned into a surplus by FY 1996-97.
• Debt-to-GDP fell 30 percentage points in just a decade.
• Unemployment fell from over 11 percent in the early 1990s to under 7 percent by the end of the decade.
• Real GDP growth accelerated, averaging over 3 percent annually from the late 1990s through the mid-2000s.

To be clear, not all of this growth was due to fiscal consolidation alone. Trade expansion under the North American Free Trade Agreement played a role as higher GDP growth shrinks the relative burden of debt. Smart fiscal policy should be paired with pro-growth open trade policies rather than protectionism.

Canada’s turnaround worked because well-designed spending cuts can do more than just balance the books—they also ease pressure on capital markets. Economists call it the “crowding out effect”—when governments borrow heavily, they compete with private borrowers for funds, driving up interest rates and discouraging investment. By bringing its deficit under control, Canada gave its private sector more room to grow. Spending restraint also restored credibility. Investor confidence, which had flagged sharply, rebounded as markets recognized the government’s commitment to fiscal discipline. This helped stabilize borrowing costs and freed more public funds for investment rather than debt service. Moreover, spending discipline forced prioritization. Programs and departments were evaluated more critically, bureaucracies were streamlined, and resources were directed toward what worked.

These dynamics aren’t unique to Canada. The IMF has found that deficit reduction achieved through spending cuts tends to produce better growth outcomes than tax increases, particularly in advanced economies. Spending cuts tend to be more credible and less distortionary, fostering healthier long-term economic environments.

The United States now faces a fiscal outlook that mirrors the urgency of Canada’s 1990s situation. Debt-to-GDP has surpassed 120 percent. Interest payments have exceeded both defense and Medicare spending. There’s a growing recognition, even across ideological lines, that our current fiscal path is unsustainable.

Canada’s example shows us that course correction is not only possible through budget cuts, but comes with added benefit, too. With political will, disciplined spending cuts can restore fiscal balance and spur long-term growth. While Americans may not agree on exactly where to cut, the sheer amount the U.S. government spends—over $6 trillion annually—means there is no shortage of options. If we shift the conversation away from austerity as punishment and toward reform as opportunity, we can turn a looming crisis into a generational turning point.