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(The Canadian Press)
(The Canadian Press)

With Ottawa's finances looking up, provinces still feel the crunch Add to ...

On Tuesday, Finance Minister Jim Flaherty's budget will show Ottawa is quashing its recession-fuelled deficit more quickly and painlessly than many had dreamed possible, thanks to better-than-expected economic growth in North America and the stronger revenue that comes with it.

But that sunnier outlook will mask a colder reality felt in several provincial capitals.

Gut-wrenching tradeoffs about what areas can absorb the deepest cuts, or what type of tax increases voters might tolerate to keep services ranging from health to transportation more or less intact, could be just around the corner.

Most prominently, a major national accord on health funding, which sucks up more than 40 per cent of provincial budgets, is set to expire in 2014. Despite Ottawa's assurances that its contribution won't shrink, it is questionable whether the Harper government can maintain, let alone increase, its current 6-per-cent annual health transfer and still eliminate its own deficit by 2015-16, as it has promised.

"They are all faced with a health spending problem," David Dodge, the former governor of the Bank of Canada who was deputy minister at the Finance Department during the deficit-slashing mid-1990s, said of the provinces. "Expenditures are likely to be growing faster - potentially, significantly faster - than revenues will grow from current revenue sources."

Ontario and most provinces east of it face debt trouble, Mr. Dodge said, but how Ontario tackles its problem "matters to the country as a whole" because of its sheer size. Same goes for Quebec, to a lesser degree.

No province's spending crunch is as dire as in the most cash-strapped U.S. states, such as California and Illinois, and none is in immediate danger of a bond-market rout like the ones that forced Greece and Ireland into humiliating bailouts and an era of brutal austerity. Still, as Ottawa learned the hard way in the 1990s when markets started to lose patience with federal profligacy, those annual shortfalls that seem manageable while borrowing costs are low pile up and, eventually, the cost of servicing the accumulated debt can cripple a government's capacity to do much else.

The federal budget is expected to announce that Canada's 2010-11 deficit will have been less than the $45.4-billion forecast in October, and could point to a faster-than-expected track back to balance. But provincial deficits for the same period add up to just under $30-billion, so the federal fiscal picture dramatically understates the collective red ink across the country.

Already, the average amount of debt carried by provinces equals about a quarter of gross domestic product. Those with the biggest liabilities, like Ontario and Quebec, suffered disproportionately when the U.S. economy tanked in 2008, and still face the daunting challenge of trying to control spending and trim debt without the benefit of a stronger U.S. market, or the natural resources enjoyed by provinces like Alberta and Saskatchewan.

Adding another twist, the coming year could feature as many as seven provincial elections, pointing to an unprecedented pace of generational change among the premiers.

It's possible that the potential lurch to the right in many provinces will make deficit-and-debt-control a defining issue that pushes existing finance ministers to hurry up and get their books in order. At the same time, analysts worry governments will bet that the key to staying in office is pushing the toughest medicine farther down the road.

Regardless of when they go to the polls, the race is on for governments to tackle their finances before interest rates rise, as economies around the world recover from the downturn, making those seemingly manageable debt loads more volatile. That could bring the issue to the front burner, which, as Bob Rae found out in Ontario in the 1990s, can be lethal for an incumbent.

Debt-rating agencies are watching three provinces closely.

Quebec won praise last year with a plan to tackle the debt and deficit, including through higher hydro rates. Last Thursday it won praise again for a budget that maintained a timeline of returning to balance by 2014, in part by increasing the province's notoriously low tuition fees and lifting contribution rates to its pension plan. But the latest budget also pencilled in a wider-than-expected deficit next fiscal year, and showed that Quebec's debt-to-GDP ratio - already the highest in the country - is now 54 per cent if you include pension-related obligations.

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