Canada's provinces are caught in a fiscal vise and there is no easy way out. They face similar demographic forces, with slowing labour force growth. As a consequence, economic growth of 2 per cent or less is the "new normal."
Provinces in Atlantic Canada and Quebec in particular will be hard pressed to reach that level, and slower growth is putting the brake on growth in government revenues. Simultaneously, health care costs (which represent more than 40 per cent of provincial spending) are mounting, due to an increased prevalence of chronic diseases, higher usage of the health care system and more expensive treatment.
Yet provinces have sharply different revenue bases, deficits and debt, as well as differences in overarching philosophy, strategy and innovation. For example, only a few provinces – Quebec, Nova Scotia and, most recently, New Brunswick – have taken full advantage of the sales tax space created by the federal GST cut of two percentage points. For others, this may prove to be a missed revenue-generating opportunity. All are still hoping the federal government will help out with more fiscal transfers, but the feds are themselves facing the same forces.
Federal Finance Minister Bill Morneau is now busy preparing his first federal budget. The previous government made a commitment to increase health and social transfers to the provinces after 2017 in line with expected growth in the nominal economy (real growth plus inflation), which should be around 4 per cent annually. This commitment may well define the limits of sustainable federal fiscal transfers to the provinces, unless broader federal spending and revenue-generation priorities are redefined.
There is significant divergence in fiscal performance among the provinces today. B.C. and Saskatchewan are in the strongest overall positions, with a pattern of balanced budgets and low and declining debt ratios. Manitoba's economy has seen relatively healthy growth in recent years and its debt-to-GDP ratio has been declining, although the province is still in a deficit position. Quebec has taken hard decisions to rebalance its books in 2016-17, driven by its relatively high debt-to-GDP ratio and concerns about credit downgrades.
Alberta and Newfoundland and Labrador have seen their budgets quickly shift into large fiscal deficits. Heavy reliance on resource royalties to fund current program spending explains much of the issue – royalties recently represented nearly a quarter of overall revenue for Alberta, and a third of revenue for Newfoundland and Labrador. Fiscal deficits are understandable in the near term, given the sharp drop in oil prices, but public debt will inevitably mount if large deficits continue. Newfoundland and Labrador is particularly exposed due to spending on debt financing and health care – two budget items that are difficult to manage in the short term.
Both provinces will need to define a medium-term plan to regain control of their public finances; reducing reliance on royalties should be a centrepiece. Such a shift would inevitably mean finding other sources of revenue by taxing current economic activity to pay for current government programs. This change in fiscal philosophy will hardly be politically popular, but it would be the right thing to do.
Elsewhere, Ontario is still in deficit, seven years after the global recession. Its public debt ratio has been rising and will exceed 40 per cent of GDP. Plans are in place to restore a balanced budget by 2018, but delay is not making the inevitable adjustment any easier.
Of all the provinces, those in Atlantic Canada are caught most tightly in the demographic vise of aging population, slowing economic growth and rising spending pressures. Newly elected governments have the unenviable mandate to ensure deficits and public debt are brought under control. More favourable local economic conditions in the next two years will help, but the fiscal and debt management task will hardly be easy.
All provinces are grappling with how to constrain growth in health care spending, both by improving the design and operations of their health care systems, and by promoting better population health. There is further room for fiscal innovation by the provinces – if they are prepared to be bold and creative. For example, introducing a basic or guaranteed income for provincial residents, administered through the income tax system, could produce fiscal savings in both the administration of the existing social welfare system and in health care spending, while improving work force attachment. We believe it's time for pilot projects in various provinces to try it out, with the engagement of the other two levels of government.
In sum, the current and prospective fiscal situation is not dire for Canada's provinces, but slower economic and revenue growth will not make future fiscal decision making any easier. Decisions deferred only get larger down the road.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.