Provincial Spending - Downloading the Responsibility

As consumers, particularly Canadian consumers, we are constantly being warned (usually by Mark Carney) that the current level of consumer debt accumulation is well into the danger zone.  Other than occasional musings about Ontario's debt level, we rarely hear anything about the dangers and sustainability of provincial debt accumulation.  In a recently released Fiscal Sustainability Report by the Parliamentary Budget Officer, Randall Bartlett, Scott Cameron, Helen Lao and Christ Matier examine the levels of provincial-territorial-local government debt and look at whether or not these levels are sustainable.

Let's open by looking at a graph that shows the past and projected levels of government sector net debt-to-GDP from 1991 to 2086:

The blue line shows the rapidly growing level of provincial-territorial-local (PTL) debt after 2032 with growth in debt far outstripping economic growth over the long-term.  By 2086, PTL debt will reach 350 percent of GDP.  To put this number into context, Japan, the world's most indebted nation when measured against GDP has a debt-to-GDP level somewhere around 200 percent.   As shown on the following graph, part of the problem with PTL debt can be laid at the feet of the federal government; beyond 2016 - 2017 as its most recent budget incarnation reduced growth levels in the Canada Health Transfer, Canada Social Transfer and other federal transfers:

This will put the onus on the provincial and territorial governments to cover the shortfalls (aka fiscal gap) which will increase as Canada's population ages.  

Here is a graph showing the dropping federal Canada Health Transfer relative to PTL health spending as a percentage of GDP:

Here is a similar graph showing the dropping federal Canada Social Transfer relative to PTL health spending as a percentage of GDP:

You can quite quickly see why the provinces and territories will end up with ever-rising debt-to-GDP levels.  On the upside, these cuts will help balance the books of the federal government which will end up with a fiscal gap (surplus) of -1.4 percent of GDP compared to the PTL gap of +2.0 percent as shown here:

As a result, provincial governments will be forced to take the following actions:

1.) Raise taxes.

2.) Reduce program spending.

3.) A combination of the two.

Starting in 2012, to cover the looming fiscal gap, provinces as a whole will have to implement $36 billion in tax increases or program spending cuts.  This amount will increase over time following growth in GDP.  Delaying these actions by a mere five years means that the fiscal gap grows from 2.0 percent to 2.3 percent, delaying by ten years to 2.6 percent, by twenty years to 3.4 percent and by thirty years to 4.7 percent of GDP.

Here is a bar graph showing PTL internally sourced revenue as a percentage of GDP from 1961 to 2086 assuming that the tax burden remains constant:

Here is a bar graph showing total PTL program spending as a percentage of GDP from 1961 to 2086:

Most critically, here is a bar graph showing PTL health spending as a percentage of GDP from 1975 to 2086:

As Canadians age, the PTL spending on health care is expected to rise from 7.6 percent in 2011 to 12.1 percent of GDP in 2050 and 14. 6 percent in 2086.  Over the period between 2011 and 2032, the authors project that PTL spending on health care will grow at an average annual rate of 5.1 percent.

I think that you can see where this is heading.  Keeping all of this data in mind, here is a graph showing what will happen to the provincial debt picture as the decades pass:

As the years pass, more and more of PTL revenue will be required to repay mounting levels of interest owing on the ever-increasing debt.  In all likelihood, the interest rate spread between federal government and provincial government will also rise as bond raters look less favourably on the ability of provinces to service their debts; this will be particularly apparent in provinces with low levels of economic growth (most of Atlantic Canada) and those with high debt levels (Ontario and Quebec).

It is quite obvious that the current scenario is unsustainable over the long-term.  Unfortunately, one way or another, Canadian taxpayers will feel the pain.  Even though the federal government may (and that's a big "may") achieve some sort of semblance of fiscal balance, it will likely be done by downshifting the deficit load to the provinces and, since all Canadians pay provincial income taxes, that  means that we are the ones that will ultimately pay.