This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.

Abstract

This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.

IX. Provincial Fiscal Developments 1/

This chapter briefly reviews the longer term trends in the fiscal situation of the provinces, discusses the more recent developments, and examines in more detail the fiscal situation of the four largest provinces.

1. Recent trends 2/

Chart IX-1 illustrates the aggregate trends in revenues, expenditures, and balances of the provinces since 1970. As can be seen, the budgets of the provinces (on a national accounts basis) have tended to move from a near-balance during the 1970s to deficits during the 1980s and 1990s, particularly during economic downturns. For example, the recession experienced in the early 1980s was followed by an increase in the aggregate deficit to 1.5 percent of GDP in 1982 and 1983 and a subsequent retrenchment to a balanced position in 1988. Following the 1990-91 recession, the deficit of the provincial sector rose sharply and reached 3.4 percent of GDP in 1992, the largest deficit experienced during the past twenty years. Since that time the deficit has narrowed appreciably, but in 1995 it was still high, at about 1 percent of GDP.

CHART IX-1
CHART IX-1

CANADA PROVINCIAL FISCAL DEVELOPMENTS

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 038; 10.5089/9781451806830.002.A009

Source: Statistics Canada (supplied by DRI).1/ National accounts basis.

Provincial revenue/GDP and expenditure/GDP ratios have been on an upward trend since 1970. However, the rate of increase in the revenue/GDP ratio appears to have slowed since the mid-1980s, mainly owing to a slowdown in the growth of investment income--in turn related to the decline in interest rates--and the weakness in natural resource revenues following the decline in energy prices that took place in 1985. By contrast, direct personal income and sales tax receipts have grown rapidly as a share of GDP (except during economic downturns), partly owing to increases in tax rates. Federal transfers to the provinces have remained a roughly constant share of GDP during the past 25 years, despite the adoption of federal limits on the size of transfers since the late 1980s.

An important factor underlying the growth in the provinces’ expenditure/GDP ratio during the past 25 years has been the rise in interest payments as a share of GDP from about 1 percent in 1970 to nearly 3 1/2 percent in 1995. Provincial consumption of goods and services and transfers to persons also have grown rapidly as a share of GDP, and appear to have been particularly sensitive to the business cycle. Transfers to lower levels of government and business subsidies have shown a relatively more modest upward trend, but also appear to be correlated with the economic cycle.

2. Recent budgetary initiatives 1/

In response to the widening fiscal deficits and rising levels of debt that followed the 1990-91 recession, most provinces put in place adjustment programs. These programs concentrated for the most part on expenditure cuts, particularly in administrative costs, government employment, and other nonpriority areas. As a result, seven of the 10 provinces are projected to have either a balanced budget or to be in surplus as of 1995/96. However, owing to the continued large deficits in Ontario and Quebec (which account for roughly two thirds of Canada’s GDP) the aggregate provincial deficit is expected to remain relatively high at about just over 1 1/2 percent of GDP (public accounts basis). This compares to aggregate deficits of 0.7 percent of GDP in 1989/90 and 3.6 percent of GDP in 1992/93.

The provinces have adopted medium-term balanced budget commitments in order to assist in their deficit reduction efforts. All but Ontario, Nova Scotia, and Quebec have targeted a balanced budget by 1996/97; Nova Scotia plans to balance its budget by 1997/98, and Ontario has targeted a balanced budget by 2000/01; Quebec’s fiscal commitment is to balance its current account by 1997/98. 2/

A number of the provinces whose fiscal consolidation efforts are most advanced have moved to adopt explicit debt-reduction targets. 3/ In particular, Manitoba’s Balanced Budget, Debt Retirement and Taxpayer Protection Legislation requires at least a balanced budget from 1995/96 and targets the elimination of Manitoba’s net debt over a 30-year period. Alberta’s Balanced Budget and Debt Retirement Act also requires balanced budgets after 1995/96 and mandates a $8.3 billion reduction in net debt over 25 years (the debt reduction is roughly equivalent to 10 percent of 1995 provincial GDP; Alberta’s net debt ratio is currently just over 15 percent). British Columbia has adopted a Debt Management Plan that calls for a cut in provincial net debt by $10.2 billion (roughly 10 percent provincial GDP; the current debt ratio is around 11 percent) over 20 years.

Further details of fiscal developments in Ontario, Quebec, British Columbia, and Alberta--which together account for nearly 90 percent of Canada’s GDP--are presented below.

a. Ontario

Ontario’s budget deficit rose sharply from near zero in 1989/90 to 4.4 percent of provincial GDP in 1992/93, mainly owing to similar increases in outlays related to increased spending on social programs and debt servicing. Despite the economic recovery and cuts in spending, the deficit ratio was reduced only modestly thereafter to 3.3 percent by 1994/95, and the net debt ratio reached 29 percent of GDP by the end of the year.

A new government took office in June 1995 and announced immediate spending cuts in the area of social welfare, capital spending, and departmental operating budgets. Further cuts in spending were announced in November 1995 and specific measures included: across-the-board cuts in spending (e.g., a 33 percent cut in internal program spending over two years); cuts in transfers to businesses and other organizations; higher user charges for provincial health plans; conversion of existing transfers to municipalities to block grants at lower levels of funding; a 3 percent reduction in funding for public schools; and cuts in transfers to hospitals. The Government also adopted a balanced budget target for 2000/01. However, detailed fiscal projections beyond 1995/96 have not yet been released, and there may be difficulties in making the balanced budget commitment consistent with the Government’s campaign promise to sharply reduce personal income tax rates.

b. Quebec

Quebec’s deficit rose steadily in relation to provincial GDP from 1.1 percent in 1989/90 to 3.4 percent in 1994/95; during most of this period the widening deficit was due to marked increases in spending on social services, which more than offset increases in the revenue ratio. During the last two years, though, the increase in the deficit ratio has resulted from weaknesses in tax revenues (particularly sales tax receipts) as well as cuts in federal transfers, which more than offset a slowdown in the growth of spending in the areas of health, social services, and education. By the end of 1994/95, the net debt ratio had reached 33.5 percent of provincial GDP. 1/

Quebec’s May 1995 budget contained measures aimed at further deficit reduction and ultimately at achieving a balanced current account by 1997/98. Measures included increases in cigarette taxes, fuel taxes, and capital taxes. In addition, a one percentage point increase in the provincial sales tax, effective July 1996, was proposed. Overall spending in 1995/96 was frozen at the previous year’s level, but cuts in the areas of business subsidies and capital spending are expected to provide further savings. The deficit for 1995/96 is projected to fall to 2.3 percent of provincial GDP.

c. British Columbia

British Columbia’s deficit rose to 3.1 percent of provincial GDP in 1991/92, compared to a surplus of 1.1 percent of GDP in 1988/89. The deterioration in the province’s fiscal situation occurred despite the fact that provincial growth was less affected by the recession than elsewhere in Canada. The deficit was mainly the result of rapid growth in almost all spending categories. With the election of a new government in 1991, efforts to restrain spending were adopted and, together with a sharp increase in the revenue ratio (related to buoyant corporate and natural resource revenues), the deficit declined steadily, reaching 0.4 percent of GDP in 1994/95. Provincial net debt was 11.9 percent of GDP at end-1994/95, compared with a recent peak of 12.4 percent in 1993/94.

In 1995, British Columbia’s government adopted a 20-year plan in order to: reduce provincial net debt by $10.2 billion; cut total “taxpayer-supported debt”--gross debt held by the public--from its current level of about 19 percent of GDP to 10 percent of GDP within 20 years; and cap interest payments on taxpayer-supported debt to no more than 8.5 percent of provincial revenues in any given year during the next 20 years. The 1995 budget also introduced a number of measures--including continued civil service salary freezes and other spending reductions--aimed at achieving these longer term objectives and ensuring a balanced annual budget. British Columbia’s deficit is projected to be in modest surplus in 1995/96 and net provincial debt is expected to decline as a share of GDP to 11.3 percent. 1/

d. Alberta

Unlike many of the other provinces, Alberta entered the 1990-91 recession with a relatively large deficit, a legacy of the sharp decline in natural resource revenues following the fall in energy prices in 1985. In particular, Alberta’s deficit was 3.1 percent in 1989/90, still significantly lower than the 7.1 percent deficit/GDP ratio in 1986/87. With the economic downturn and the decline in the revenue ratio, the deficit widened to reach 4.6 percent by 1992/93. The province’s fiscal situation has improved markedly since 1992/93, owing to an improved provincial economic situation that increased corporate tax receipts and natural resource revenues, as well as the adoption in 1993 of spending cuts in social services. A surplus of 1.2 percent of provincial GDP was recorded in 1994/95 and the net provincial debt was 15.4 percent of GDP at end-1994/95 compared to zero in 1990/91.

Alberta’s government introduced the Balanced Budget and Debt Retirement Act in 1995, which requires elimination of the province’s net debt by the year 2021 and a balanced budget every year after 1995/96. The 1995 budget also adopted additional spending cuts, including the elimination of over 2,000 government positions, cuts in education spending, reorganization in the area of health care spending, and the privatization and elimination of government agencies. The surplus is expected to fall somewhat in 1995/96, due to a decline in corporate tax receipts and natural resource revenues.

1/

Prepared by Christopher Towe.

2/

In order to provide a consistent time series, this section uses data on a national income accounts basis.

1/

This section relies heavily on summaries provided by Canada’s Department of Finance. The data described below are presented on a public accounts basis to be consistent with the provincial budget presentations. However, since public accounting methodologies differ between the provinces, the data are not strictly comparable. Some of the major differences between the public accounts and national accounts presentations are that: (i) the public accounts are generally on a modified-cash basis and the national accounts are on an accrual basis; (ii) the national accounts treat government employee pension plans as part of the government; (iii) the sale (purchase) of land and used assets is included as revenue (expenditure) in the public accounts but is treated as a balance sheet adjustment in the national accounts.

2/

Following the 1996 Federal budget, Quebec announced its intention to balance its budget by 1999/00.

3/

See Chapter VIII for a detailed discussion of provincial debt developments.

1/

Note that this excludes the unfunded liabilities of the Quebec Retirement Plan.

1/

The surplus may be lower than previously expected because of a recent decision by the federal government to withhold part of the province’s transfer for social programs.