Canada’s new fiscal reality: Ottawa has the money and the provinces need it – desperately

Posted on October 1, 2013 in Governance Debates – FullComment
27/09/13.   Andrew Coyne

Wait a minute, wait a minute, wait a minute. You mean we’re supposed to like the PBO now? Time was when a report from the Parliamentary Budget Officer was the occasion for a full-on two minute hate from Tory central command: biased, off-base, can’t add, etc.

But it seems all it takes is a positive review — specifically, the PBO’s annual Fiscal Sustainability Report, rating the long-term outlook for federal finances as stable — to brighten the mood in Ottawa. “We are pleased to see that the PBO continues to believe that our government’s finances are on a fiscally sustainable path,” read the statement from the Finance Minister’s press secretary. I imagine her beaming, benevolently.

This has the added advantage, as they say, of being true. On the basis of current data, the PBO projects the federal government is “on track to achieve [its] G20 commitment to a debt-to-GDP ratio of 25 per cent by 2021.” Indeed, it suggests Ottawa could eliminate its net debt altogether by 2044. A lot could happen between now and then, of course. But the trend line is obviously good.

This despite an aging population and slowing economic growth: just 1.7% per annum, the PBO projects, over the next 75 years, versus the 2.6% it averaged over the last 30. Can it be that it was just two years ago that the PBO was warning federal finances were on an unsustainable path?

Well yes: but much has changed since then. Notably, the beginnings of some restraint in federal spending, after several years of some unrestraint. It isn’t so much the unwinding of the “stimulus” spending that is responsible for the improved outlook: that was always intended to be short-term. It’s the result, rather, of structural changes in federal spending, limiting Ottawa’s exposure over the long run on the budget items that are set to expand, inexorably, as the population ages.

Two stand out in particular: postponing the age of eligibility for Old Age Security from 65 to 67, and limiting the growth in health care transfers to the provinces to no more than the rate of growth in the economy.

Ah yes, the provinces. Unlike the Finance department, the PBO also takes into account the sustainability of provincial finances (also territorial, local and aboriginal, collectively referred to as the “other levels of government”) since, as we are sometimes gravely warned, there is only one taxpayer. And that sole, solitary taxpayer, unfortunate wretch that he is, is ultimately responsible for all of the debts our governments ring up in his name, not just some of them. “Our” government’s finances may be sustainable, if you mean “our” in the way the Finance Minister’s press secretary carefully means it. But our governments’, plural? Not so much.

The provinces, that is to say, are doomed. Currently, they spend about 18% of GDP between them every year. Of this about 14 percentage points is financed out of their own revenues; the other 4% comes out of federal transfers. Over the next several decades, provincial spending will increase to roughly 24% of GDP. That’s an increase of more than six percentage points of GDP, virtually all of it due to the growth in spending on health care. Health care is already costing the provinces half of every dollar they raise themselves. In the future it will cost them just about all of it.

Unless, of course, they raise taxes. As it happens, six percentage points is also about as much as the provinces raise every year in personal and corporate income taxes, combined. So think of it as another income tax, on top of the one you already pay. That might not go over well.

The provinces, that is to say, are doomed

Couldn’t they just cut spending? Yes, but that won’t save them, either. Even if you strip out “excess cost growth” — growth in health care spending in excess of that explained by population aging and rising incomes — the provinces “will continue to have an unsustainable debt position.”

Is this all the feds’ fault? No. Though federal transfers for health will not grow quite as fast as the provinces spend it, they’ll still rise in line with GDP. Even if they paid the same 20% share of health care costs, 75 years hence, as they do now, that would only knock two or three percentage points of GDP off the provincial bill.

But certainly we’re looking at a significant reshaping of fiscal federalism. A generation ago, the feds spent very nearly as much as the provinces, combined; a generation from now, it will be roughly half their size. On the surface, this looks like marking a sharp decline in Ottawa’s relative strength in the federation. But looks can be deceiving.

It’s the balance between spending and revenues, not just the totals, that matters. The federal government, as the PBO numbers show, will have substantial fiscal “room,” revenues in excess of what it needs to pay its bills, while the provinces will be in substantial structural deficit. Ottawa has the money, in other words, and the provinces need it — desperately.

This puts the feds in a very strong bargaining position. Rather than simply hand over the loot, as the provinces will inevitably demand, they can use it as leverage: a transfer of x number of GST points, say, in exchange for dismantling provincial trade barriers.

Ottawa will have the fiscal clout to bring some order at last to this chaotic economic union. It should begin thinking how to use it.

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