THE FEDERAL-PROVINCIAL FISCAL DIVIDE
Canadians have developed an almost pathological fear of deficits and debt. Perhaps this is a result of the fiscal crisis in the mid-1990s and the tough actions that were taken by both federal and provincial governments to restore fiscal credibility.
The federal Conservative government inherited a surplus of almost $14 billion in 2006 and then took actions almost immediately to wipe it out. The deficit situation was then worsened by the 2008-2009 recession and the temporary stimulus program. Since then, the elimination of the deficit has been the priority of every federal budget.
In his November 2012 Economic and Fiscal Update, Mr. Flaherty forecast that the deficit would not be eliminated until 2016-17, one year later than forecast in his March 2012 Budget. A day later, the Prime Minister contradicted him and said the government would still eliminate the deficit in 2015-16. All of this is, of course, dependent on two very important assumptions: that the US avoids the “fiscal cliff” and the EURO countries continue to avoid collapse.
But why should Canadians care if the federal deficit is eliminated two years from now or three years or even within four years? The fact is the federal government does not have a deficit, debt, or spending problem, let alone a crisis. Mr. Flaherty is right when he says that we have the best financial situation in the G-7 and he could well be able to announce the elimination of the deficit before the next election barring unfortunate international economic circumstances. After all if the election were in the autumn of 2015, Canadians won’t even know the final deficit results for the year until the fall of 2016. No doubt the 2015 budget will forecast its elimination that year.
The November Update forecast a deficit of $26 billion this year almost $5 billion higher than forecast in the March 2012 budget. This may look like a big number but it is only 1.4 per cent of GDP. There is also a good possibility that the deficit good still come in closer to the budget forecast. By 2014-15, the deficit is forecast to fall to $8.6 billion, or only 0.4 per cent of GDP. A deficit of $3.4 billion or 0.2 per cent of GDP is forecast for 2016-17.
These numbers include, however, a “risk adjustment” of $3 billion. Removing this adjustment and allowing for statistical error, the underlying budget would be in balance by 2015-16. In other words, what the November Update, and for that matter the March budget, said is that deficit is small and inconsequential and could easily disappear in a couple of years.
Nor does the federal government have a debt problem. In 2011-12, the federal debt/GDP ratio was 33.0 per cent and is forecast to fall to under 30 per cent by 2016-17. Compare this with the levels reached in the mid 1990s of almost 70 per cent.
As a share of GDP, program spending for the federal government is at a very low level compared to previous years, dating from the middle of the last century. It was 13.8 per cent in 2011-12 and is forecast to fall to12.5 percent by 2017-18, only slightly higher than the historical low of 12.1 per cent recorded in 1995-96. With the cut in the growth of the CHT that will take effect in 2017-18, it will fall even further in the following decade.
We now have a federal government that is smaller in size than at any time since the middle of the last decade and is on track to become even smaller in the coming decade much at the expense of the provinces.
Although the federal government is not facing a serious fiscal problem, the same cannot be said for Canada Inc. Provincial governments are facing serious fiscal problems. According to the Parliamentary Budget Officer (PBO), the fiscal structure of the provincial-territorial government sector is not sustainable (Fiscal Sustainability Report 2012 page 2-3), given their current debt structures and the pressures that they will face from an ageing population. Provincial governments are now facing the choice of cutting services and/or raising taxes.
What is emerging is a widening “fiscal divide” between a federal government with its diminished size and sound finances, and provincial governments with growing fiscal imbalances resulting from growing spending pressures (e.g., for health, education, infrastructure) and slowing economic growth and revenue growth.
This federal-provincial “fiscal divide” is not sustainable.
One of the benefits of having a sustainable fiscal structure is that it provides a government with the fiscal flexibility to respond to critical policy issues. The federal government now has that flexibility, and the provinces don’t. The federal government needs to start using its fiscal flexibility to refocus its policy priorities to help narrow the federal-provincial “fiscal divide”.
Too bad ideology won’t let this happen.