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Running a provincial government is never easy. Most Canadians expect their governments to deliver core services like health and education, but also to rebalance the budget following the deficits induced by the 2008-09 recession. All provinces have stated that they want to meet that goal, and Saskatchewan and British Columbia are already there. However, a variety of pressures are making it hard to build a sustainable fiscal plan, and these pressures are not going away. In short, there is no Santa Claus; real action will be needed.

Three forces are causing the never-ending squeeze on provincial government finances. First, the provinces are stuck in a health care spending trap. Provincial spending on health care has grown faster that nominal gross domestic product for more than a generation, with average growth exceeding 5 per cent annually. Spending on health care now absorbs up to 45 per cent of provincial budgets, yet the public appetite for health care seems insatiable. Health care spending has slowly crowded out other long-term priorities, notably infrastructure – essential for a well-functioning economy and society.

Second, slower population growth and aging work forces are placing unrelenting downward pressure on the long-term growth potential for provincial economies. Slower growth quickly translates into weaker personal and business revenue growth for governments, making it even harder to keep feeding the insatiable health care beast. The Conference Board of Canada expects potential economic growth to decline for all provinces. For Central and Eastern Canadian provinces, potential growth is expected to dip to 2 per cent or less, so growing out of deficit is unlikely.

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Moreover, a few provinces have made themselves heavily dependent on royalty revenues, rather than the local tax base, to fund their current spending. Royalties have represented up to 30 per cent of Newfoundland and Labrador's revenues, and one quarter of revenues for Saskatchewan and Alberta. Falling global commodity prices are quickly translating into lower provincial royalties. Relying heavily on royalties to fund current spending (essentially having someone else pay your taxes) is ultimately a risky and likely unsustainable fiscal strategy. With less oil royalty revenue, Alberta and Newfoundland now face some unappealing choices in the short term: increase taxes, cut spending, or run deficits.

What can be done to address the structural forces? There are essentially three options available to provincial governments. Option One is to seek more money from the federal government. One of the central issues in fiscal federalism is the federal government's role in funding programs under provincial jurisdiction, and under what conditions. Nearly a decade ago, the Martin government increased health transfers to the provinces by $41-billion, with annual increases of 6 per cent until 2014. The federal government subsequently committed to increase future health transfers in line with the economy (likely around 4 per cent annually). But a lasting solution remains evasive on this highly politicized file, and more federal money is not guaranteed to buy better provincial health care.

Option Two is to find more provincial revenues. The cuts to certain federal taxes like the GST created space for provinces to raise their own taxes without adding to residents' overall tax burden. However, only a few have chosen to occupy that space, notably with higher sales taxes in Quebec and Manitoba.

More fundamentally, provincial tax reform could strengthen the revenue base by simplifying, broadening and restructuring the tax base while eliminating loopholes and exceptions. Using provincial tax systems to put a price on carbon and other greenhouse gases deserves to be examined. Admittedly, while tax reform makes good economic sense, it is often hard politics. So provinces have some options that could increase their own revenues, but none are likely to be popular.

Option Three is to address the fundamentals of how provincial governments operate and spend. The ultimate goal would be to transform the design and functioning of provincial government operations and spending, drawing upon analysis of best practices and guided by the willingness to innovate, one program at a time. Health care delivery absorbs such a large share of overall provincial spending that it must be at the top of the list, but everything from the design of social welfare programs to funding for necessary infrastructure could be evaluated through an innovation lens. The risk is that a thoughtful reassessment of program design and delivery will take time; slashing budgets could become the short-term budget fix.

In short, there is no simple solution to establishing a sustainable fiscal position for each province; there is no Santa Claus. But doing nothing is probably not a realistic option either. Better to get on with the task of creatively rethinking how governments tax and spend, evaluating the options, and taking the necessary decisions.

Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.

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