Now the hard work begins: Keeping provincial budgets balanced

Posted on December 18, 2013 in Governance Policy Context – ROB/Economy/Economy Lab
Dec. 18 2013.   Glen Hodgson

Over the past three years, the federal government and all provincial governments have made commitments – to varying degrees – to restore balanced budgets. This first phase was actually the easy part. The next phase will be much harder: To maintain balanced budgets.

Provinces are facing much slower economic growth in the years to come. At the same time, pressures for spending on valued social goods, such as health care, education and infrastructure, continue to mount.

Following the 2008 financial crisis, governments in many countries and across Canada introduced aggressive fiscal stimulus to kick-start the economy. It worked in the short term. The stimulus boosted public investment and private consumption, helping to break thepsychology of recession and recreate a path back toward economic growth.

As a general principle, once growth is restored, fiscal stimulus ought to be progressively withdrawn and replaced with plans to rebalance the books in a reasonable time frame. Canadians and their governments – federal and provincial – appear to have understood that some sacrifices would be necessary to re-establish a sustainable fiscal position. Since early 2011, our governments have been steadily withdrawing the net fiscal stimulus from 2009-10. Tighter controls on program spending and public sector compensation have been applied in some cases, and Quebec imposed tax increases.

This fiscal readjustment has had a negative but unavoidable impact on Canadian economic growth. The government sector is now the lagging edge of the economy. It is projected to grow by 1 per cent in 2013 and just 0.4 per cent in 2014, and is a major reason why the Canadian economy is growing at an annual rate of less than 2 per cent over all.

The next phase will be harder; simply squeezing budgets and compensation increases will not be enough. Two factors will constrain the ability of most provincial governments to maintain a balanced fiscal path.

First, Canada’s growth potential will wane after 2016, due to the impact of aging demographics, lower fertility rates and the resulting slowdown in labour force growth. While growth potential will slow in all provinces, Quebec and Atlantic Canada are forecast to grow much more slowly than the West and Ontario. Slower economic growth means government revenues will also grow much more slowly.

Second, the pressure for public expenditure on valued services, notably health care, education and infrastructure, will not abate. Provincial governments are the principal delivery point for health and educational services, so they will feel the squeeze most acutely.

Quebec provides a useful case in point. The government just reported that its target date for restoring fiscal balance has slipped by two years, to 2015-16. Fiscal deficits of $2.5-billion in 2013-14 and $1.75-billion in 2014-15 are now projected, adding another $4.25-billion to Quebec’s public debt.

The fiscal slippage is due in part to slower nominal economic growth (i.e. real growth plus inflation), in part to new spending measures designed to stimulate job creation and economic growth (in advance of an expected provincial election in 2014), and in part to an apparent desire to not further increase taxes. The Conference Board of Canada expects Quebec’s sustainable real growth rate to dip to 1.5 per cent annually after 2017, which will only increase the pressure on government tax revenues.

What, if anything, can be done to change the outlook? All governments have similar policy tools available. They can transform how priority public services such as health care are delivered. They can implement an array of measures to support the labour force – such as investing in skills and postsecondary education, and implementing more integrated and targeted immigration policies.

Governments can foster the conditions for business innovation and can improve the operating environment for business by reducing barriers to trade and labour mobility between provinces, thereby giving a boost to Canadian productivity and overall growth. They can expand and simplify their revenue base through tax reform. And governments can review program effectiveness, streamline the delivery of public services and work together more effectively.

Few of these measures are easy to design and implement in the short term. The danger, of course, is that governments will avoid the hard policy choices and instead opt for short-term measures that are easier to implement and politically popular, but ultimately unsustainable.

But let there be no doubt: Thanks to slower growth ahead and unrelenting cost pressures, the hard part is just beginning.

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

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