Demographic shifts, Ottawa’s debt-reduction drive will hit provinces' bottom line, PBO warns

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Provinces are facing soaring debt loads over the coming decades as demographic shifts – and a new federal plan for health transfers – will force governments across the country to make hard decisions about taxes and spending, according to the Parliamentary Budget Office.

The PBO report issued Thursday echoed a warning from a year ago – but some see little evidence that premiers are tackling the problem. Alberta, New Brunswick and Ontario are taking early steps to address the cost of public pensions, and provincial governments point to the fact that they are all scheduled to be out of deficit by 2017-18. But larger questions around long-term spending trends remain.

As the ratio of working-age citizens to retirees shifts dramatically, governments will face a shrinking proportion of taxpayers and a growing percentage of citizens using health-care services and government pensions.

"As an economist, I would say always control your debt," said Jean-Denis Fréchette, the Parliamentary Budget Officer. "The big problem for the provinces in the upcoming years will be to control the debt and see what kind of transfers they can get from the federal government."

It is not a new warning. Growing health costs and changing demographics were concerns even before governments began piling on debt in recent years during the deep recession that ensued from the 2008 financial crisis. Moody's Investors Service has said the debt levels of Ontario and Quebec "stand apart" from other provinces in terms of their size, though all provinces currently have high credit ratings.

Moody's analyst Jennifer Wong said health care is a challenge for provinces, but she notes they have slowed the rate of growth in health spending recently and have room to cut other spending or raise taxes if they need more money for health down the road.

"They have the ability to adjust on the revenue and the spending side, which is something we note as a credit strength for provinces," she said. "But health-care spending is a pressure."

Philip Cross, a former chief economic analyst with Statistics Canada who is now research co-ordinator with the Macdonald-Laurier Institute, said he sees no evidence that provinces are taking serious steps to avoid the problems ahead.

Mr. Cross, who has warned that provinces face significant risks of defaulting on debt over the coming decades, said he was pleased to see the PBO report also identified municipal debt as a growing problem.

"The municipalities are really forgotten in all this, but they are running record deficits," he said. "It's very hard to see progress [at the provincial level]. There's been no substantive action done."

The PBO's annual Fiscal Sustainability Report looks at public finances with a 75-year horizon to assess how policy decisions and demographics will impact government finances over the medium and long term.

As it also warned in last year's report, the PBO says Ottawa's decision to move away from annual 6-per-cent increases in provincial health transfers toward a new formula where increases are tied to economic growth will force hard decisions in provincial capitals.

"The federal fiscal structure has been transformed from unsustainable in 2011 to sustainable – with substantial fiscal room – largely through spending restraint and reform of the Canada Health Transfer Escalator," the report states. "However, the federal fiscal room created by the change in the CHT escalator has transferred the fiscal burden to provinces and territories."

The report does not comment on the fiscal situation of individual provinces.

Federal transfers to the provinces for health spending have been growing at 6 per cent a year since about 2004. The Conservative government is promising to continue this practice until 2016-17. After that, total health transfers will grow in line with nominal Gross Domestic Product, with a guaranteed minimum increase of 3 per cent.

Kathleen Perchaluk, a spokesperson for federal Finance Minister Jim Flaherty, said the government is "pleased" that the PBO report shows Ottawa's finances are sustainable.

"We are staying on that path while still increasing record health transfers to the provinces each and every year," she said in a statement.