Provincial Debt Crises Looming, Say Economists

January 6, 2021 Updated: January 6, 2021

News Analysis

Economic forecasters say that Canada’s provinces and other levels of government below the federal level are spending unsustainably and will face a debt crisis unless they change course.

The Parliamentary Budget Officer (PBO) provided this finding in a recent fiscal sustainability report updating the assessment it made in February 2020. The report projected the debt levels of the federal, provincial, territorial, local, and indigenous governments over a 75-year period from 2020 to 2094.

Fiscal sustainability means that government debt doesn’t grow continuously relative to the size of the economy, or the gross domestic product (GDP). This assessment involves projecting government net debt relative to the GDP over the long term while assuming that the government maintains its current fiscal policy.

The report found that, collectively, the subnational governments must permanently raise taxes or cut spending—or do some combination of both—by an amount equal to 0.5 percent of GDP in order to stabilize their net debt to the pre-pandemic level of 24.1 percent of GDP. This fiscal gap of 0.5 percent of GDP amounts to $12 billion in current dollars.

The report estimates that the current fiscal policy is sustainable over the long term only in Quebec, Nova Scotia, and Ontario, and says the current fiscal policy is unsustainable in the remaining provinces and the territories. The territories, with a fiscal gap of 11.3 percent of territorial GDP, require the most drastic policy actions in order to achieve fiscal sustainability. B.C., with a much smaller fiscal gap of 0.2 percent of provincial GDP, requires the least drastic policy actions.

However, a 70-year forecast by Trevor Tombe, associate professor of economics at the University of Calgary, found that none of the provinces’ finances are sustainable aside from Quebec’s.

“Quebec’s fiscal situation is sustainable, owing largely to their higher than average taxes,” said Tombe in his analysis. “Alberta and Saskatchewan are not sustainable, with relatively large fiscal gaps of 4.8 and 3.4 percent of GDP, respectively. Both are accounted for by far lower than average taxes, as projected health expenditures are lower in these provinces than any other.”

Tombe told The Epoch Times that Newfoundland and Labrador is “in a uniquely difficult situation” because its population is both shrinking and aging as young people leave.

“The tax base is leaving with those young people, but the expenditure pressures remain because of the health-care needs of the elderly individuals that remain … [and] the offshore levels of oil production are going to be declining,” he said.

Provincial health-care costs will rise as the boomer generation ages. The Canada Health Transfer—the largest transfer payment to the provinces and territories—rises based on a three-year moving average of nominal GDP but is guaranteed to increase by at least 3 percent per year.

“We have this funny situation where COVID is going to lead health transfers in the future to be higher than they otherwise would have been … because we will be recovering from this big negative dip,” Tombe said.

He said the provinces must rein in health spending because “the [deficit] problem is twofold—health expenditure growth being above average and provincial revenue lagging behind economic growth.”

A 2012 study by the Macdonald-Laurier Institute (MLI) on provincial solvency and federal obligations had estimated that Quebec and Saskatchewan had the lowest probabilities of defaulting at the end of a 30-year projection horizon.

Philip Cross, a senior fellow at the MLI and a former chief economic analyst at Statistics Canada, says the provinces have worse problems than Ottawa.

“Most of the discussion about debt tends to focus on the federal level, and that’s the one that’s the best off,” he said in an interview. “People should really be paying attention to what’s going on at the provincial level. That’s where the trouble really lies.”

The PBO report also projected that the current fiscal policy at the federal level is sustainable over the long term, despite the pandemic spending.

Tombe’s report, based on Statistics Canada data, placed federal gross debt at 35 percent of GDP in 2018, compared with a total provincial gross debt of 42 percent. The debt ratio was highest in Manitoba, at 74 percent of GDP, and lowest in B.C., at 22 percent.

Reining In Spending

A future return to balanced budgets is important, though politically tricky, said Cross.

“In Québec, there were two Liberal governments, first under Jean Charest [2003–2012] and then [Philippe] Couillard [2014–2018]. They probably lost elections because of the actions they took to reign in deficits, so it’s not popular,” he said. “You’ve really got to build a consensus that it really is necessary.”

The math is more straightforward than the politics involved, Cross notes.

“The only way you can deal with deficits [is] you’ve got to restrain spending and maximize revenues. I think most studies say that it’s best for growth if you restrain spending and not increase taxes, but that’s the only way the math in this situation works. It’s pretty simple,” he said.

Cross also believes pension reform is crucial. He supports an increase in the age of eligibility for Old Age Security from 65 to 67, a move proposed by the Harper Conservative government but reversed by the Trudeau Liberals. He said the defined benefit pension plans enjoyed by much of the public service must change.

“Either taxpayers are going to be stuck with the bill or pensioned public sector employees are simply going to have to accept lower benefits,” Cross said. “Most taxpayers don’t have a pension plan, so the idea that their taxes [will] go up to support lavish pension plans of the public sector—that’s not going to fly.”

Jake Fuss, an economist at the Fraser Institute, agrees the provinces must limit their spending.

“Smaller government is where you start,” he said in an interview. “And one of our recommendations is to bring public sector compensation more in line with the private sector. Depending on what province you are in, there’s a pretty big gap.”

Fuss said governments should look for efficiencies, not tax hikes.

“A lot of provinces right now don’t have competitive tax rates with a lot of countries around the world and a lot of American jurisdictions. And we certainly know that decreasing personal income tax rates and corporate tax rates are beneficial on the whole for the economy.”