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The Fiscal Balance in Canada - August 2000

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The Fiscal Balance in Canada

The provinces and territories recorded an aggregate surplus last year

• The provincial-territorial government sector recorded a surplus of $1.4 billion in 1999-2000, the first aggregate surplus in at least 30 years.

• According to the most recent estimates, six provinces and one territory are expected to record a balanced budget or a surplus in 1999-2000.

The provincial-territorial outlook for 2000-01 is very good

• Based on the 2000 budgets, seven jurisdictions are forecasting a balanced budget or a surplus in 2000-01.

• Given the level of prudence included in these forecasts and the continued strength of the Canadian economy, it is very likely that outcomes for 2000-01 will be better than forecast.

The provincial debt burden is much smaller than the federal debt burden

• The provincial-territorial debt burden is much smaller than at the federal government level. Therefore, the federal government remains more vulnerable than the provinces to increases in interest rates.

• Because of its higher debt load, debt charges consume a much higher proportion of federal revenues than is the case with the provinces and territories.

The provinces and territories have diversified revenue bases

• Combined provincial-territorial revenues have exceeded federal revenues for almost 25 years – since 1975.

• Historically, provincial-territorial revenues have kept pace with the growth in their program spending.

• The fact that provinces are choosing to reduce taxes suggests that they have the revenue base to meet their spending needs.

• The tax bases from which both the federal and the provincial governments derive revenues are essentially the same, providing the provinces with virtually the same diversity of revenue sources on which to draw, if deemed necessary, to meet their spending priorities. The option of moving to a tax-on-income system will provide the provinces and territories with even greater tax flexibility.

• Provincial-territorial own-source revenues have grown faster than federal revenues over the past 24 years. In fact, the provinces have unique access to fast growing categories, such as gaming profits. In contrast, some uniquely federal revenue categories, such as import duties and employment insurance revenues, are not growing and are even declining.

Spending pressures from an ageing population are not unique to the provinces and territories

• The spending pressures associated with an ageing population will not become significant until 10 to 15 years from now.

• At that time, both levels of government will be affected: provincial-territorial governments will face higher spending pressures for health care, partially offset by lower spending for primary and secondary education, whereas the federal government will face increased old-age security spending pressures.

• For both levels of government, the cost pressures associated with an ageing population should be manageable, particularly if governments continue to take action now to bring down debt loads, thus freeing up resources now devoted to servicing the debt.

The provinces and territories recorded an aggregate surplus in 1999-2000

Provincial-territorial budgetary balance
Public Accounts basis

Source: Public Accounts and 2000 budgets.
Note: See the annex for supporting data.

• The provincial-territorial sector recorded a surplus of $1.4 billion in 1999-2000, an improvement of more than $3 billion from the previous year's deficit.

• More importantly, this represents the first aggregate surplus in at least 30 years.

• This constitutes an historical milestone that testifies to the continued improvement of the financial health of provincial and territorial governments.

• Based on current budget forecasts and the strong economic outlook, it seems very likely that another aggregate surplus will be recorded in 2000-01.

A majority of provinces and territories have achieved a balanced budget or surplus

Provincial and territorial budget balances for 1999-2000
Public Accounts basis

Source: Public Accounts and 2000 budgets.
Note: See the annex for supporting data.

• According to the most recent provincial data, seven jurisdictions recorded a balanced budget or surplus in 1999-2000.

• Three provinces, Manitoba, Saskatchewan and Alberta, have recorded five or more consecutive surpluses.

• This situation is a major improvement compared to 1991-92, when every province and territory was in a deficit position.

A majority of provinces are forecasting a balanced budget or a surplus in 2000-01

Provincial and territorial budget balances forecast for 2000-01
Public Accounts basis

Source: 2000 budgets.
Note: See the annex for supporting data.

• Based on the 2000 budgets, seven jurisdictions are forecasting a balanced budget or a surplus in 2000-01.

• These budget forecasts are based on prudent assumptions and include various reserves.

• In light of the continued strength of the economy, the actual outcomes are very likely to be better than forecast.

The federal debt burden is much larger than the provincial-territorial debt burden

Federal and provincial-territorial net debt
Public Accounts basis

Source: Public Accounts and 2000 budgets.
Note: See the annex for supporting data.

• The debt burden of both levels of government has increased substantially during the last 20 years.

• However, the federal government's debt burden is over twice as large as the aggregate provincial-territorial debt burden.

• Reducing the debt burden must continue to be a major priority for the federal government.

Debt charges are significantly higher at the federal level

Federal and provincial-territorial debt charges
Public Accounts basis

Source: Public Accounts and 2000 budgets.
Note: See the annex for supporting data.

• Because of its higher debt load, the federal government has consistently faced a higher debt service burden than the provinces and territories.

• In 1995-96, the federal government spent 36 per cent of its revenues on debt charges. Although significant progress in moderating this burden has been made, federal debt charges still consume more than a quarter of all federal revenues, compared to about 12 per cent at the provincial-territorial level.

• Because its debt charges are so large, the federal government has considerably less fiscal room-to-manoeuvre than the provinces and is more vulnerable to volatility in global interest rates.

• A further reduction in the federal debt burden is critical to reduce the share of revenues going to servicing the debt, and thereby free more funds to reduce taxes and invest in key priorities.

The federal government needs to maintain a prudent fiscal approach

Federal and provincial-territorial surplus/deficit (-)
Public Accounts basis

Source: Public Accounts and 2000 budgets.
Note: See the annex for supporting data.

• Historically, the federal government has incurred significantly larger deficits, as a per cent of GDP, than the provinces and territories.

• After years of fiscal restraint and favourable economic conditions, the federal government has recorded budget surpluses for three consecutive years, from 1997-98 to 1999-2000.

• Continued fiscal prudence is vital for the restoration of fiscal room-to-manoeuvre in the future.

Provincial-territorial revenues have been larger than federal revenues for more than two decades

Federal and provincial-territorial total revenues
National Accounts basis

Source: National Income and Expenditure Accounts.
Note: See the annex for supporting data.

• Since 1975, total provincial and territorial revenues have exceeded federal revenues. In 1999, provincial-territorial revenues exceeded federal revenues by $36.5 billion, or 3.8 per cent of GDP.

• During this period, provincial-territorial revenues increased by 3.5 percentage points from 18.5 per cent of GDP in 1975 to 22.0 per cent in 1999. In comparison, federal revenues rose by a mere 0.4 percentage points from 17.8 per cent of GDP in 1975 to 18.2 per cent in 1999.

• This rise in revenues testifies to the ongoing capacity of provincial-territorial administrations to use their revenue bases to finance their spending.

Contribution of federal cash transfers to provincial revenues

Government revenues before and after federal cash transfers to provinces and territories

Source: National Income and Expenditure Accounts.
Note: See the annex for supporting data.

• In 1999, the federal government transferred $32 billion in cash to the provinces and territories.

• This amount is a $32-billion expenditure out of federal revenues.

• In 1999, the effect of transfers was to increase provincial-territorial revenues from $178 billion to $210 billion.

Provincial-territorial revenues have kept pace with program spending

Provincial-territorial revenues and program spending
National Accounts basis

Source: National Income and Expenditure Accounts.
Note: See the annex for supporting data.

• Over the last four decades, provincial-territorial program spending as a share of GDP has more than doubled, rising by 9.0 percentage points. This reflects the creation of new social programs and increased spending under existing programs.

• At the same time, total provincial-territorial revenues as a share of GDP increased even faster, rising by 11.9 percentage points.

• Thus, the increase in provincial spending has not led to a fundamental imbalance in provincial finances.

Provincial tax cuts suggest that current and future spending pressures are manageable

Tax cuts announced in recent budgets¹

• All provinces have announced tax cuts over the last five years.

• The fact that provinces are choosing to implement tax reductions strongly suggests that their spending pressures are manageable and that they are able to respond to them with existing resources.

The provinces and territories have a very diversified revenue base

Breakdown of provincial-territorial revenue, excluding federal cash transfers – 1999
National Accounts basis

Source: National Income and Expenditure Accounts.
Note: See the annex for supporting data.

• In Canada, provinces and territories can draw their revenues from a very wide variety of sources. With the exception of import duties and taxes on non-residents, which are exclusive to the federal jurisdiction, provinces have access to the same revenue sources as the federal government.

• In addition, provinces benefit from some revenue sources that fall under their exclusive jurisdiction, such as natural resource royalties, liquor and gaming profits, property taxes and specific licenses and permits.

• Beginning in the 2001 taxation year, the provinces and territories will have the freedom to adopt a tax-on-income system for personal income taxes, without having to create separate income tax forms. Provincial and territorial income taxes will no longer have to be calculated as a percentage of Basic Federal Tax. This will provide provincial and territorial governments with increased flexibility to design their tax systems according to their policy objectives and financial needs.

Provincial-territorial own-source revenues have grown faster than federal revenues over the last 24 years

Growth in revenues and revenue sources from 1975 to 1999 and shares of revenue sources as of 1999

• During the past 24 years, provincial-territorial own-source revenues grew faster than federal revenues by some 1.2 per cent per year, on average.

• Provinces have access to essentially the same tax bases as the federal government.

• For personal and corporate income taxes, provinces have the ability to set their own tax rates.

• Some components of federal revenue, such as custom import duties, employment insurance and tobacco receipts are not growing, and are even declining.

• Provinces have unique access to fast growing categories such as gaming profits.

Both levels of government will face increased future spending pressures as a result of population ageing

Canadian demographic trends

Source: Statistics Canada

• The number of older persons will increase dramatically over the next 50 years because the baby boom generation is growing older and Canadians are living longer as a result of lifestyle changes and medical advances.

• Over the next five years, there will be relatively little change in the demographic composition of the Canadian population. It is only in about 10 to 15 years – when the eldest of the baby boomers will have reached the age of 65 – that demographic changes will start having a significant impact on government expenditures.

• At that time, the provinces and territories will face increased spending pressures, particularly in the health care sector. The federal government will also face increased spending pressures, especially for old-age security.

• Population ageing should also reduce some spending pressures for the provinces. As the number of younger people declines relative to the total population, less spending will be required for education and some social services.

• For both the federal and provincial governments, the emerging cost pressures should be manageable, particularly if all governments continue to take action now to increase their fiscal manoeuvring room by reducing the debt burden. This will reduce the proportion of revenues that go to debt servicing, thereby freeing up revenues to meet Canadians' needs for public services.

- Annex (supporting data).