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The Peace Tower, shown through the gates of Parliament Hi

Justin T/THE CANADIAN PR

Parliamentary Budget Officer Jean-Denis Fréchette is warning that provinces are unprepared for the ballooning health care costs they will face as Canada's baby boomers enter their final years.

The PBO's latest report on the health of federal and provincial finances comes as Ottawa and the provinces are negotiating the terms of a new health care accord. Those negotiations will put pressure on the federal government to share some of Ottawa's fiscal toom.

The federal spending watchdog assesses whether or not government finances are "fiscally sustainable," based on whether current spending levels can continue without adding more debt as a share of the economy. Tuesday's report projects federal and provincial spending out to the year 2090 in an effort to provide a general guide to whether governments are prepared for longer-term demographic issues. These projections are highly sensitive to assumptions related to future economic growth, interest rates, immigration levels and fertility rates.

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The PBO report concludes that federal finances are sustainable and the federal debt is on track to be eliminated entirely in 50 years.

Alternatively, the PBO says Ottawa could choose to maintain its current debt level at 33.7 per cent of GDP and devote 0.9 per cent of GDP a year to a mix of new spending or tax cuts. That's $19.2-billion in current dollars.

The provinces and municipalities are not so fortunate. Simply stabilizing their current combined debt level of 32.5 per cent would require a mix of spending cuts and tax hikes worth 1.5 per cent of GDP, or at least $30.2-billion annually.

That contrast of fiscal fortunes is sure to figure prominently in the discussions among Canada's provincial and territorial ministers, who are scheduled to meet in Whitehorse for a July 20-22 summit of the Council of the Federation.

"Subnational government debt is unsustainable," states the PBO report, adopting a term used to describe the provinces and municipalities. Addressing this problem would require higher revenues, increased federal transfers, cuts to program spending or some combination of the three, according to the PBO.

"However, the longer this adjustment is delayed, the greater the required adjustment," the report states.

Government spending on the baby boom generation will be felt first by the federal government but will have much larger costs over time for the provinces.

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The main cost for the federal government is through federal seniors benefits such as Old Age Security and the Guaranteed Income Supplement. These costs are expected to peak in 2031, when the largest number of boomers are in retirement age. After that, federal spending on seniors benefits is expected to decline. However provinces face a different spending forecast. The PBO notes that because of the higher health care costs associated with the final years of life – as well as the accumulated increases in health care spending above the rate of economic growth – provincial spending and debt will rise dramatically after 2040.

"The primary driver of subnational spending growth as a share of GDP is health care, which is in turn driven by aging demographics and excess cost growth," the PBO report states. The cost of health care spending is projected to rise from 7.3 per cent of GDP in 2015 to 12.5 per cent by 2090.

The PBO report notes that federal measures announced by the new Liberal government have reduced Ottawa's fiscal room. Last year, the PBO pegged Ottawa's fiscal room at 1.4 per cent of GDP. That has since been reduced to 0.9 per cent of GDP. One of the main factors for the change was the Liberal government's decision to cancel plans that would have raised the age of eligibility for OAS from 65 to 67 by 2029. Tuesday's PBO report does not assess the impact of last week's announced change to the CPP as the PBO said it is still gathering information on that measure.

Major demographic changes are expected to have broad implications for public policy. According to the PBO, there were 4.2 people between the working ages of 15 and 64 for every individual aged 65 and over in 2015. By 2040, the ratio is projected to be fall to 2.5 and decline to 2.1 by 2090.

Conservative Party finance critic Lisa Raitt said the PBO's warning of a dramatic spike in provincial spending requires an immediate focus on how to manage the future costs of health care.

"There's a health care crisis coming and the PBO literally said it's better to deal with it now than later," she said. "I don't know if it means more federal transfers, but it certainly means that the provinces have to take a serious look at their costs and the federal government has to take a serious look at how they can offset what's happening in health care."

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Daniel Lauzon, a spokesperson for Finance Minister Bill Morneau, said the government is pleased with the PBO's finding that federal finances are sustainable over the long term. Finance Canada is promising to release its own report in the fall that will outline the direction of federal spending and revenues over the coming decades.

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