The wolf is really at the door

Provincial debt default a very real possibility

At some point in the next 20 to 30 years, on current trends, one or more of the provinces is likely to default on its debts. That is the inescapable message in the Parliamentary Budget Officer’s latest annual “Fiscal Sustainability” report.

It is by no means a certainty: these sorts of extrapolatory exercises necessarily involve holding constant certain policy variables that are unlikely to be held constant. That phrase “on current trends” is there for a reason. But it is more than a possibility. The PBO’s bland phrasing, to the effect that the provinces’ fiscal position, collectively, is “not sustainable over the long term,” conceals much worse news about individual provinces.

The key table is the one labelled Net Debt: Subnational Governments, on page 24 of the report. As of 2017, the provinces’ net debts average about 26 per cent of GDP — five points better than the federal government, at 31 per cent — ranging from a high of 43 per cent in Quebec to a low of 1.6 per cent in Alberta.

Now flash forward 25 years. While average provincial debt, the PBO projects, will increase modestly, to 36 per cent of GDP, the deterioration in the position of some provinces is quite startling: New Brunswick’s debt, now at 34 per cent of GDP, leaps to 115 per cent; Manitoba’s, from 37 per cent to 105 per cent; Newfoundland’s, from 32 per cent to 76 per cent.

IT’S TRUE THAT FISCAL POLICY IN MANYOFTHE PROVINCES HAS BEEN IRRESPONSIBLE, GUSTING TO RECKLESS.

It only gets grimmer from there: by 2067, New Brunswick, Manitoba and Newfoundland’s debts are projected to balloon to 262, 246, and 229 per cent of GDP respectively. By 2092, they are roughly five times GDP, on average. For comparison, when Saskatchewan famously “hit the wall” in the early 1990s, its debtto-GDP ratio was less than 60 per cent.

Of course, the further you push out such projections, the less reliable they become. All sorts of things could change in the next 75 years to throw these figures off. (Mind you, things could change for the worse as well as better.) But the figures for 2042 are alarming enough — these are subnational governments, remember, without access to the printing press to bail them out.

And while the federal government, in the course of extricating itself from its own debt crisis a generation ago, acquired a fair degree of fiscal wiggle room — notably by imposing caps of various severity on transfers to the provinces — much provincial spending is more or less locked-in, driven less by discretionary policy than by the remorseless arithmetic of demography.

It’s true that fiscal policy in many of the provinces has been irresponsible, gusting to reckless. It is unforgivable that, 10 years into a recovery, six of the 10 should still be running deficits, even modest ones — as if the business cycle, and the likelihood of a recession that would plunge them all back heavily into the red, had been abolished.

Likewise, that nearly half of the average province’s tax revenues now go to fund one department, health care, is not something that simply “can’t be helped.” It reflects the failure of most of them to think seriously about health care reform, still less to implement it.

Still, even the most efficient provincial health care system would be under severe pressure in the decades to come, thanks to population aging. We have, to be blunt, never seen a society like the one we are about to become. By 2035, more than 25 per cent of the population will be over the age of 65 (in the early 1970s, it was seven per cent), with historically high numbers of them over the age of 70, 80, 90, and 100. Where not so long ago there were five people of working age for every retiree, that ratio will soon fall to just over 2 to 1.

That’s nationally: the picture in some provinces, notably in Atlantic Canada, is gloomier still, the pace of aging accelerated by the flight of young people. Escalating spending — health costs rise from $2,000 per capita at age 50 to $20,000 at age 90 — and declining numbers of workers to pay for it is a recipe for fiscal disaster. The PBO estimates that Manitoba, for example, would require some combination of permanent spending cuts and/or tax increases equal to 4.5 per cent of GDP to stabilize its debt position. That’s about half as much as the province currently spends on health care.

At the very least, this is going to require a massive overhaul of the terms of fiscal federalism. The provinces have cried wolf a few times too often about an alleged “fiscal imbalance,” but now the wolf is genuinely at the door it is time to consider systematic reform: rather than Ottawa forking over ever-higher piles of cash, as in the past, it might cede an equivalent amount of tax “room,” lowering its taxes at the same time as the provinces raised theirs.

And yet this is unlikely to be enough to avert a provincial default somewhere down the road — again, on current trends. If we are lucky, it will only be a relatively small province like New Brunswick. If we are not, it could be, say, Alberta (projected debt-to-GDP ratio, 2067: 100 per cent).

So we had better start thinking about what we are going to do in that event, or better yet how to prevent it. In particular, we should think hard about how the failure to plan for such a disaster may be hastening it. Is any part of the provinces’ apparent inertia, not to say complacency, in the face of this admittedly distant prospect informed by the belief that, in extremis, the feds will bail them out? And if so, what can be done to disabuse them of this?