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Fiscal-consolidation strategies for Canadian governments.

Although Canada remains in an advantageous fiscal position relative to many other OECD countries as the global economy recovers from the 2008/09 recession, the deterioration in the country's public finances has been substantial. Years of spending increases above trend economic growth have led to high structural levels of expenditure, and some Canadian governments are now on unsustainable fiscal paths, a diagnosis made starker when taking an even longer-term view that considers the fiscal implications of demographic change. Evidence shows that successful fiscal consolidations tend to rely on spending restraint rather than tax increases. When focused on restraining less productive expenditure, they can also boost economic growth. Fiscal rules can be useful tools in achieving budgetary consolidation, but also as part of the general fiscal framework to limit deficit bias and counteract the tendency shown by some Canadian governments over the past two decades to run pro-cyclical fiscal policies. Canadian governments with large deficits should announce deficit targets on the way to fiscal balance and should consider supporting these targets with spending-growth limits. Other governments should also limit spending growth and target reductions in debt-to-GDP ratios, perhaps supported by budget-surplus targets. Temporary fiscal-stimulus measures should be allowed to expire as planned. To date, the federal and almost all provincial/territorial governments have committed to return to budget balance over the medium term and outlined plans to do so that focus primarily on expenditure restraint. These plans are broadly in line with the recommendations set forth in this Survey and should allow Canada to return to budget balance over the medium term. Of crucial importance for the long-term success of fiscal-consolidation and debt-reduction strategies are public backing and transparency. The federal government should continue to support the Parliamentary Budget Office, and provinces should consider establishing similar independent fiscal agencies that can assess compliance relative to objectives and reinforce accountability.

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In view of the significant deterioration in the fiscal positions of virtually every OECD country, including Canada, the need for credible fiscal consolidation plans has mounted. To address these near-term challenges, the federal government, along with almost all provincial and territorial governments, have committed to return to budget balance over the medium term and have begun to elaborate specific plans to meet their commitments. These plans focus primarily on expenditure restraint, including limits to public-sector wage growth. No doubt they will firm up and be adjusted as uncertainties surrounding the post-crisis economic setting dissipate. They are broadly in-line with the recommendations set forth in this Survey and should allow Canada to return to budget balance over the medium term. This chapter examines the sustainability of current fiscal positions, projecting their likely evolution over the medium term, and studies fiscal-consolidation strategies under various economic scenarios. These exercises serve as the basis for jurisdiction-specific recommendations on fiscal-consolidation paths to 2020. The chapter also discusses the conduct of fiscal policy across the country in recent years and how it could be improved, notably through the use of new or improved fiscal rules.

Most Canadian governments need fiscal consolidation, soon, ideally through spending restraint

The recent reversal in fiscal positions has been substantial

Before the recent global economic crisis, Canada had a total government surplus and the lowest net debt-to-GDP ratio among G7 countries, thanks in part to an important fiscal-consolidation effort in the mid-1990s at the federal level and to structural reforms to public pension plans during the same period. These reforms brought Canada's gross and net debt-to-GDP ratios from levels much higher than G7 and OECD averages in 1995 to, respectively, below G7 averages and closer to OECD averages in 2008 (Figure 2.1, Panels A and B).

Entering the crisis with a relatively large budgetary margin for manoeuvre, the fiscal authorities implemented measures to support the economy during the recession. Now, in the aftermath of the crisis, and of Canada's first significant recession since the early 1990s, the cyclical decline in tax revenue and the concurrent extraordinary spending measures have provoked a sharp turnaround in the country's fiscal situation, from a total government surplus of 1.6% of GDP in 2007 to a deficit of 5.1% in 2009 and an expected deficit of 3.4% in 2010 (Figure 2.1, Panel C). Despite a substantial fiscal stimulus, the size of this turnaround is about average compared to other OECD countries, thanks to a relatively shallow recession. Together with a better starting point, this average turnaround means that Canada is expected to come out of the cyclical downturn with still the lowest net debt-to-GDP ratio in the G7, and one of the strongest fiscal balances among OECD countries.

While such international comparisons may be comforting, a medium-term fiscal-consolidation effort is nevertheless necessary. Naturally, if the economic recovery that has started is sustained, government revenue will pick up and spending on automatic fiscal stabilisers will recede. But even if the level of output returns to its pre-crisis trend within a few years, which is doubtful (see Chapter 1), cyclical effects will not be sufficient to restore a sustainable fiscal position at the total government level. That is partly because of the discretionary fiscal easing of recent years, partly because of the permanent loss in potential output due to the crisis and partly because instead of being saved (i.e. used to reduce public debt), some of the cyclical revenue strength associated with the long pre-crisis upswing was used to permanently increase spending and lower taxes. The result of these developments is a structural deficit, as shown by the projected negative cyclically adjusted fiscal balance in 2010 (Figure 2.2). (1)

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While relatively small at the national level, this total government structural deficit hides significant variation at the sub-national level, with some provinces facing large structural deficits and others being in much better condition. Official government projections, on a public-accounts basis, show that almost all provinces/territories are expected to be in deficit in 2010, which was not the case only a few years ago (Table 2.1). The largest province, Ontario, which was particularly hard hit by the crisis because of the importance of its manufacturing sector (autos in particular), is expected to have one of the largest deficits in relation to the size of its economy.

[FIGURE 2.2 OMITTED]

Baseline projections for the next decade show that the recent fiscal path is unsustainable

To determine how much of a fiscal-consolidation effort would be necessary to eliminate the general government deficit, the medium-term baseline projection to 2025 in OECD Economic Outlook 87 assumes that, starting in 2012, Canada undertakes five years of fiscal consolidation whereby the underlying primary balance is strengthened by 1/2 percentage point of GDP in each year. This effort, along with the natural elimination of the cyclical part of the deficit as the economy returns to its potential production level by 2015, is sufficient to generate a positive fiscal balance of 0.3% of GDP in 2016. To carry out a similar assessment for each province/territory and separately for the federal government, and to simulate fiscal outcomes by jurisdiction under a variety of economic scenarios, a new medium-term fiscal-simulation model was developed specifically for this Survey. It is summarised in Annex 2.A1. Using this model, baseline fiscal projections are produced with what can roughly be described as business-as-usual or extrapolation-of-recent-trends assumptions, whereby most non-cyclically sensitive expenditures are assumed to keep growing at their 1997-2007 average growth rates from 2011 on except for extraordinary stimulus outlays on fixed capital (Table 2A1.1 in Annex 2.A1). Of course, 1997-2007 was a period of generally high GDP and revenue growth. The average spending-growth rates extrapolated from this decade are of course not in line with future spending trends outlined in the latest federal and provincial/territorial budgets. But given that the objective of the simulations is to illustrate the extent to which spending growth must be restrained in the various jurisdictions to achieve fiscal-consolidation objectives, the expenditure growth rates from recent history are the natural benchmarks. (2) The simulation results are compared with the latest plans and projections from governments in the discussion below.

Unfortunately, economic theory does not provide a fiscal sustainability definition that is widely accepted without reservations. Different theoretical definitions and sustainability conditions have been proposed, while in practice, various indicators--not always grounded in economic theory--have been applied. (3) One common condition derived from the government's inter-temporal budget constraint says that fiscal policy is sustainable if the present discounted value of all future primary surpluses is at least equal to the initial value of debt. Sustainability defined in this way is ensured even if the government debt-to-GDP ratio diverges from its initial level, as long as its growth rate is lower than the difference between the real interest rate on government debt (r) and the trend real GDP growth rate (g), in other words, if the debt-to-GDP ratio expands at a pace lower than r - g. The condition can be expressed in terms of a target primary balance ([pb.sup.*]), the long-term primary balance as a ratio of output consistent with stabilising the long-term debt ratio at a given level, say the current level ([b.sub.0]). A primary gap (pg) can then be defined as the difference between the estimated or projected primary balance (pb) and the target primary balance. If this gap is negative, the debt ratio would be expected to rise without bound, causing deleterious economic effects (Box 2.1), and fiscal policy can be qualified as unsustainable. This condition is necessary but not sufficient for fiscal sustainability as it allows an arbitrarily large initial debt ratio. It is therefore a weak test of fiscal sustainability.

This weak test is sufficient for the present exercise, because no jurisdiction has a very large net debt-to-GDP ratio. Also, even with this weak test, and using the fiscal-simulation model and baseline economic and fiscal assumptions described in Annex 2.A1, primary gaps are estimated to be significantly negative in 2010 in all jurisdictions except the federal level, Nova Scotia, Saskatchewan and British Columbia (Table 2.2). (4) Both Saskatchewan and British Columbia are projected to have negative primary gaps within a few years, however. Although most jurisdictions are projected to see an improvement in their primary gaps in 2011, when stimulus spending on capital expenditure is assumed to be withdrawn, projected gaps grow again under baseline assumptions as the projection horizon lengthens. Only the federal government and Nova Scotia remain near their target primary balance over the entire projection period.
Box 2.1. The undesirable economic effects of rising debt

High deficits and debt may lower the growth rate of GDP, and thus
lower the economy's capacity to service a given amount of debt, for
two main reasons. The first reason is that deficits lower overall
saving. To the extent that households are non-Ricardian--that is,
they do not perfectly offset a decline in public saving with higher
private saving, for example because of finite planning horizons, a
hypothesis supported by empirical evidence (Rohn, 2010)--higher
fiscal deficits lead to lower overall saving. The resulting
increase in the real interest rate crowds out investment in
physical capital and therefore real output. The second reason is
the existence of distortionary taxes. In the long run, unless
higher debt-service costs crowd out other expenditure in government
budgets, servicing a larger stock of public debt that carries a
higher real interest rate means that taxes must eventually rise to
maintain the same level of programme spending. The disincentive
effects of higher taxes reduce the rate of output growth, with the
size of the loss depending on the distortionary effects of the
fiscal instrument used. Nations typically see growth slow when
gross public debt reaches 90% of GDP (Reinhart and Rogoff, 2010).
The median growth rate falls by one percentage point and average
growth falls even more.


Implicit demographic liabilities beyond 2020 add to the urgency of consolidation

Even a zero or a small positive primary gap does not necessarily signify that fiscal policy is sustainable without any need for future adjustment. After 2020, government spending as a percentage of GDP is set to increase, and trend growth to decline, as a result of ageing. Maintaining the primary deficit at the sustainable level ([pb.sup.*]) would then require further adjustments to revenue or expenditure. Implicit demographic liabilities, which take into account health care, education, transfers to the elderly and children's benefits, amount to close to 100% of 2007 GDP for the country as a whole (Robson, 2009) (Table 2.3). (5) They are particularly large for provinces, as they have the main responsibility for the delivery of health-care services, even more so for the Atlantic Provinces and Quebec, where population ageing is expected to be particularly pronounced (Belanger, Martel and Caron-Malenfant, 2005). Unfortunately, most provinces already show wide primary gaps, underscoring the urgency of attending to fiscal consolidation. Even for other jurisdictions, significant implicit demographic liabilities call for running budget surpluses and paying down debt over the next decade, thus helping to free up fiscal room, which is equivalent to pre-funding future obligations. For resource-rich Alberta and other provinces with relatively little debt, these liabilities call for building up a net asset position.

Fiscal consolidation should occur soon and mainly through spending restraint

The recent empirical evidence from OECD countries, reviewed in Box 2.2, quite clearly demonstrates that fiscal consolidation based upon selective spending cuts is more likely to durably reduce deficits and debt ratios than revenue increases. Spending restraint is also less likely to provoke recessions or jeopardise recoveries, and, when anticipated, it can enhance the effectiveness of short-term fiscal stimulus. For these reasons, the fiscal-consolidation simulations in this chapter focus on spending restraint. Furthermore, to the extent that fiscal consolidation based on spending restraint can accelerate an economic expansion, the empirical evidence just reviewed suggests that the reductions in deficits and debt ratios to be simulated below should be considered worst cases, because the model used here does not build in positive effects of fiscal consolidation on the economy.
Box 2.2. Fiscal consolidation: Spending restraint or revenue
enhancement?

A number of theoretical and empirical studies suggest that spending
restraint, notably with respect to government consumption and
transfers, is more likely to generate lasting fiscal consolidation
and better economic performance than measures to raise more
revenue. For instance, OECD research shows that an emphasis on
cutting current expenditure has been associated with larger
consolidation results in the past than strategies based on
increasing revenue (Guichard et al. 2007):

* The higher the initial primary deficit, the larger was the
overall consolidation that was achieved over a consolidation
episode. This finding likely means that jurisdictions facing a
bigger fiscal problem are able to garner more public support for
their fiscal-consolidation efforts. It underlines the importance of
being fully transparent about the size and negative consequences of
future deficits, thereby bolstering public support.

* Large fiscal adjustments are associated with restraint in primary
current expenditures (public consumption and social transfers).
This finding argues for concentrating fiscal-consolidation efforts
on reducing the growth of public consumption and transfers, rather
than of other types of expenditure (e.g. capital expenditure) or on
tax increases.

* The probability of a consolidation period lasting longer was
higher if it was initiated at the time of a large negative output
gap. This finding argues for not waiting for normal economic
conditions before beginning fiscal consolidation. Like the first
finding, it suggests that it is easier to convince the public of
the necessity of acting before the fiscal balance starts partially
recovering on its own during the cyclical upturn. Furthermore, it
supports the idea of pre-emptive adjustment; that is, of minimising
the risk that financial markets will eventually force a hesitant
government to bring in unpopular measures. A consolidation period
triggered by a loss of confidence of financial-market participants
is generally much more chaotic. Waiting also increases the severity
of the adjustment necessary to reach a given sustainability target
by a given date, as the snowballing of debt and interest payments
digs a deeper structural deficit.

Another recent study largely confirms the findings of the OECD
study. Alesina and Ardagna (2009) look at major
fiscal-consolidation periods in 21 OECD countries over the period
1970 to 2007 and evaluate them according to two criteria: whether
they were successful in significantly reducing deficits and
debt-to-GDP ratios; and whether they were associated with a
reduction in growth. On the first criterion, they define a
fiscal-consolidation period as successful if the cumulative
reduction of the debt-to-GDP ratio three years after the beginning
of a fiscal adjustment is greater than 4.5 percentage points, which
selects 17 successes among 107 fiscal-consolidation episodes. They
find that in successful episodes total primary spending as a
percentage of GDP falls by about two percentage points. Total
revenue, for its part, declines by about half a percentage point of
GDP. Thus, successful fiscal-consolidation episodes are completely
based on spending cuts, accompanied by modest tax cuts (as a share
of GDP). On the contrary, in unsuccessful adjustments, total
revenue goes up by almost 1.5 percentage points of GDP and primary
spending is cut by about 0.8 percentage points of GDP. On the
second criterion, looking at all 107 fiscalconsolidation episodes,
they find that the expansionary episodes are mostly characterised
by spending cuts, a result consistent with theory and found in
other empirical studies (e.g. Briotti, 2005). In those expansions,
primary spending falls by more than two percentage points of GDP.
Total revenue instead increases slightly, by about 0.3 percentage
point of GDP. On the other hand, during contractionary
fiscal-consolidation episodes, primary spending falls by about 0.7
percentage point of GDP, while revenue increases by about 1.2
percentage points of GDP. Thus, fiscal consolidations occurring on
the spending side have superior effects on growth than those based
upon increases in revenue.

Using different and multiple empirical methods--including case
studies, panel regressions and simulations with a multi-country
dynamic general equilibrium model--to study the effects of fiscal
consolidation on economic activity in OECD countries, Kumar, Leigh
and Plekhanov (2007) arrive at similar conclusions: while
fiscal-consolidation episodes have tended to have short-run
contractionary effects, some have had expansionary effects. The key
to having long-run expansionary effects seems to reside in not
relying excessively on cuts in productive government expenditure.
Furthermore, there is evidence that even before fiscal
consolidation begins, the anticipation of medium-term spending cuts
generally enhances the expansionary effect of short-run fiscal
stimulus, a conclusion that still applies when monetary policy is
constrained by the zero lower bound on policy rates (Corsetti et
al., 2010).


The 1990s federal government fiscal-consolidation experience points the way forward (6)

The fiscal-consolidation experience of Canada, or more precisely of the federal government, in the second half of the 1990s is often presented in international case studies as one of the most successful examples of fiscal consolidation in recent history. It is thus worth reviewing the lessons learned then that could be applied now and in the coming years.

As it entered the 1990s, Canada had to contend with a recession that threw the country's fiscal position into sharp relief. In 1992, general government gross debt exceeded 90% of GDP, higher than any other G7 country bar Italy, with the federal government accounting for just over half the total. The level of public spending appeared unsustainable in a setting of flaccid growth and high interest rates. The general government deficit was slightly above 9% of GDP in 1992, higher than any other G7 country except Italy, with the federal government accounting for about 60% of the deficit. Canadians and governments could see the link between persistently high deficits, the level of interest rates and an inevitable increase in the tax burden in the near future. Financial markets were becoming nervous as well--spreads on federal government short- and long-term debts had been rising steadily since the mid-1980s (Figure 2.3), and there was downward pressure on the Canadian currency. In response, the federal government introduced extensive reforms starting in 1993. The reforms were centred on three main strategic priorities: setting deficit targets, controlling expenditures and ensuring public buy-in.

[FIGURE 2.3 OMITTED]

* Deficit targets. A reasonable but firm medium-term target for the federal government deficit was set, an approach deemed more effective than aiming for a zero deficit further out. In 1994, the government began setting two-year rolling deficit targets, with an ultimate goal of balancing the budget.

* Expenditure control. The federal government began enforcing the Federal Spending Control Act of 1991, which set limits on all programme spending with the exception of that under major self-financing programmes, such as Unemployment Insurance (later renamed Employment Insurance). Except in 1992-93 (when part of under-spending in the previous year was allocated to cover the excess spending) actual expenditures met the requirements of the Act until 1996 when it became no longer needed as subsequent budgets became more restrictive than the legislation. In 1995, the government introduced a contingency reserve in its budget planning to protect against adverse changes in the economy or forecasting errors. If not needed, the reserve was applied to debt reduction. Legislated and non-legislated fiscal rules were supported by budget cuts, expenditure reviews, workforce reductions, wage freezes, labour-market reforms and other structural reforms. Budget cuts affected all spending categories, particularly transfers to provinces and social benefits. With the help of robust post-recession growth, federal government programme expenses (all budgetary expenses except debt service) fell from 17.4% of GDP in 1992-93 (on a public-accounts basis) to 13% of GDP five years later (programme expenses actually decreased in nominal terms over this period), at which time the federal deficit had been completely eliminated.

* Public buy-in. The third priority was to get economic stakeholders behind the reforms. Indeed, a key factor in the success of the fiscal-consolidation effort during this period appears to have been strong public support for the strategy. Media stories around government debt downgrades contributed to making the public aware of the perils of runaway deficits and debt. The government also contributed by explaining to the public that if it continued to accumulate debt, an ever-diminishing share of expenditure could be assigned to priorities such as education and health, and that the fiscal-consolidation steps taken were justified and consistent with efforts to restore growth and employment in the medium term. Large-scale pre-budget consultations helped garner support for specific budget measures. Public understanding and buy-in eventually became so strong that even after the deficit was eliminated, a defacto no-deficit rule prevailed as it became politically extremely difficult to run deficits. Even without a legislated fiscal rule, the federal government did not run another deficit until 2008/09 when the global economic crisis caused a recession in Canada. This episode demonstrates that public understanding and support is the most effective compliance/enforcement mechanism available. Judging by the political debate in Canada over the last several months, the public appears to favour a return to zero deficits again as long as it does not hurt growth prospects.

After eliminating the deficit, the federal government complemented the de facto no-deficit rule with a debt-reduction strategy. While the deficit was being reduced between 1992 and 1995, the federal government's debt continued to increase. In 1995/96 federal net debt reached a high of 68.4% of GDP. So in 1998, the federal government committed to follow the non-legislated debt-repayment plan that had prevailed since 1995, under which the contingency reserve set aside each year was devoted to debt reduction if not needed. Other commitments to accelerate debt repayment followed. As a result of these commitments and the growing economy, the ratio of net public debt to GDP was reduced to below 60% by 1999/2000. In the 2004 budget, the federal government announced an objective to reduce the debt due to accumulated deficits to 25% of GDP by 2014/15. At the time--in the spring of 2004--this ratio stood at 40%. The target year was brought forward in subsequent budgets, and in the 2008 budget the government planned to reach the 25% debt-to-GDP ratio by 2011/12. While this target was seen by some as arbitrary, the government argued that achieving it would flee up funds for priorities such as health care, education or tax cuts. It also argued that such funds would be all the more needed as the population aged and put increasing demands on the health-care system. These arguments, of course, remain just as valid today. And with less time remaining before the acceleration in retirements, the urgency of reducing the debt burden has only increased.

Today, the federal government does not have a legislated fiscal rule. But since 2006, it has had the Federal Accountability Act. Among its many provisions, the Act aims to increase transparency in government spending and establish clearer links between approved expenditure and outcomes (previous legislation required linkage between expenditure and "purpose", rather than outcomes). The Act created the Office of the Parliamentary Budget Officer (PBO), which is intended to provide Parliament with objective analysis about the estimates and projections of the government, the state of the nation's finances and trends in the national economy. The PBO has proved useful at providing an independent, sometimes discordant, opinion on the federal government's fiscal forecasts, which can only improve the transparency and debate around federal fiscal policy.

Budget agencies are missing at the provincial level

By contrast, one particularly glaring feature of provincial fiscal frameworks is that no external/independent bodies exist to monitor the fiscal health of provinces and the application of rules. Provincial Auditors General audit official financial statements and can give opinions on the general framework, but audits are only carried out ex post. The advantage of bodies like the PBO and the Congressional Budget Office in the United States is their independence, which improves transparency and credibility. Provinces should consider the creation of such provincial/territorial agencies tasked with monitoring more stringent fiscal rules as part of their strategies to update their fiscal frameworks and institutions. Concurrently or alternatively, because small provinces may not feel they have the resources needed for such an office, one agency reporting to the Council of the Federation and tasked with providing independent analysis on provincial fiscal matters could be established.

The lessons that can be drawn from the federal government's experience of fiscal consolidation since the 1990s is that the following features can achieve significant improvement in a short period of time: i) rolling deficit targets toward a no-deficit objective, ii) legislated or de facto rules on spending supported by expenditure reviews and structural reforms, and iii) a good communication strategy to ensure strong public buy-in. Over a longer time frame, once consolidation has been achieved, a medium-term debt target seems useful to guide fiscal policy. These results from the Canadian federal experience align well with theoretical and empirical lessons from the economic literature on fiscal consolidation. Consequently, an approach based on these principles is recommended for the federal government as well as the provinces and territories in need of fiscal consolidation in the coming years.

This time, however, interest rates on government bonds are near historical lows, spreads are much lower than they were in the early 1990s (see Figure 2.3), and there is no downward pressure on the Canadian dollar. In Canada at least, there is not the same impetus and sense of urgency from capital markets to concentrate the minds of politicians and public alike on the need for fiscal restraint, making it less likely perhaps that the consolidation effort will be vigorous and sustained. Rather, the impetus must come from a collective realisation of the urgency of preparing fiscally for the spending pressures associated with demographic change, as demonstrated in Table 2.3 above and in other studies (e.g. Parliamentary Budget Office, 2010). Enshrining the fiscal plan in legislated rules and institutions may be useful this time around to ensure that consolidation efforts do not falter. Also, as noted above, a significant share of the federal consolidation effort in the 1990s was achieved by cutting transfers to the provinces. In a context where both the federal and sub-national governments are planning to consolidate at the same time, such a federal strategy this time would only increase the difficulty of consolidating at the provincial/territorial level and would be fraught with political difficulties, given delicate intergovernmental relations on this issue. Indeed this strategy has been rejected by the current federal government. The trade-off between federal consolidation through reductions in provincial transfers and sub-national consolidation is examined further in the simulations below.

Deriving jurisdiction-specific fiscal-consolidation recommendations

Over the short term, the recommended fiscal-consolidation approach is the same for all jurisdictions currently in a significant deficit position: announce a series of deficit targets on the way to a balanced budget. The precise strategies used to reach a balanced budget will of course vary by jurisdiction, but efforts should concentrate on curbing the growth of spending, possibly by introducing spending ceilings. Once the budget has been balanced, and for provinces/territories already near fiscal balance, the fiscal strategy should focus on lowering debt-to-GDP ratios. For this purpose, a balanced-budget target, or in some jurisdictions surplus targets, consistent with achieving medium-term debt-ratio targets should be used, keeping spending-growth limits in place. A surplus target has the advantage of providing a fiscal cushion for unexpected fiscal developments, in the absence of which surpluses should be allocated to debt reduction. While not absolutely necessary, setting surplus and debt-ratio targets in law as well would make them better able to stand up to changes of government, political disputes and pressure from social groups that refuse to give up their advantages or benefits. This overall strategy would provide clear yardsticks for accountability and transparency. It should be accompanied with a public-relations campaign to explain to the public the fiscal objectives of the government and their rationale. Public buy-in would serve as the enforcement mechanism. Transparency at the provincial/territorial level should be strengthened by establishing independent fiscal agencies, which would provide similar information to legislatures as the federal PBO. With these qualitative general recommendations in mind, the next section seeks to offer quantitative suggestions for fiscal-consolidation targets tailored to each jurisdiction.

Fiscal targets should depend on the need and capacity for fiscal consolidation

What should the fiscal-consolidation targets be in the different jurisdictions? While this decision is political and depends on many factors, not all of them economic, it should be duly informed by a fiscal-sustainability assessment of the sort presented above (see Table 2.2). Jurisdictions with a large cyclically adjusted deficit, which thus cannot rely on the cyclical upturn to balance their budgets, need policy action to restrain the growth of spending and in some cases maybe even new revenue measures. Short- to medium-term deficit targets are suggested here and used for the rest of the analysis (Table 2.4). These targets take four factors into account. First, the greater the degree of consolidation needed, the more time is generally allowed to eliminate a deficit. Second, already-announced official fiscal-consolidation objectives are kept when they seem ambitious but achievable. Third, target consolidation paths all eliminate deficits in or before 2015, because planning to eliminate a deficit over a period longer than five years runs several risks. Economic developments, such as another recession or sharply higher interest rates, could derail the plan, public support for the fiscal-consolidation effort could falter, the government could change once or more, etc. For these reasons, distant objectives, such as Ontario's commitment to eliminate its deficit by 2017/18, lack credibility. And, fourth, the later the output gap in a given jurisdiction is projected to close in the baseline projections, the more time is generally allowed for consolidation. This last factor reflects the undesirability of rushing to eliminate deficits faster than the economy is expected to return to its potential productive level and in so doing remove fiscal support to the economy. The baseline provincial economic projections are made to be roughly consistent with the OECD Economic Outlook 87 medium-term baseline, in which the Canada-wide output gap closes in 2015. (7) For jurisdictions already near fiscal balance, the proposals are instead for debt-to-GDP-ratio targets for 2020 that take into account current debt levels. All things considered, the targets remain somewhat arbitrary, but any target is bound to be, and these are intended only as guides.

One important factor to bear in mind when comparing official fiscal-consolidation objectives (as shown in Table 2.1) and plans with the model-based simulations is the different accounting systems used. Official plans are based on public accounts systems, which differ between jurisdictions and with the national accounts system used in the simulations (see Annex 2.A1). Consequently, differences between official and simulated fiscal consolidation plans and their discussion should be interpreted with caution

How much spending restraint would be necessary to meet these objectives?

Discretionary-spending-growth limits consistent with achieving the fiscal-consolidation targets set out in Table 2.4 are derived using the fiscal-simulation model described in Annex 2.A1. The spending categories considered discretionary include the bulk of government spending. They are "net current expenditure on goods and services", "transfers to businesses", "transfers to provincial/local governments" and "investment in fixed capital and inventories". Spending in these categories is assumed to grow at the same rate starting in 2011, unlike in the baseline scenario where different, historically based growth rates, were applied to the various expenditure categories. There are two exceptions to this rule where baseline assumptions are preserved. The first is for the growth rate of "investment in fixed capital and inventories" in 2011 when, as in the baseline scenario, stimulus spending on fixed capital is assumed to be withdrawn. The second is for federal transfers to provinces/territories. For 2011 and beyond, they are assumed to grow at 4.8% per year based on a weighted average of the size of major transfers and their expected growth rates (see Annex 2.A1). The focus on discretionary expenditure is not meant to suggest that reforms to programmes that affect non-discretionary expenditure categories (e.g. transfers to persons) should not be envisaged, or that revenue-increasing measures are unnecessary. But discretionary expenditures had been growing at a fast rate before the recession (Table 2.5), certainly much faster than projected trend GDP growth over the coming decade. Therefore, restraint of such spending is undoubtedly necessary in many jurisdictions. In the first instance, discretionary expenditure growth limits that achieve the fiscal targets set out in Table 2.4 in the deterministic approach are derived (Table 2.5).

Unsurprisingly, jurisdictions where most or all the deficit is estimated to be cyclical, such as the federal government, need less spending restraint than those where most of the deficit is estimated to be structural, such as Quebec. Likewise, jurisdictions that can expect faster economic growth, because of stronger population growth or more depressed starting conditions, have an easier time consolidating. Indeed, because the stylised deterministic approach assumes that provincial/territorial output gaps close linearly from 2012 to 2015 and remain closed afterwards, jurisdictions with larger projected output gaps in 2011 are implicitly assumed to grow faster than other jurisdictions over the following years to 2015 relative to their potential rates of growth, thus making fiscal consolidation appear somewhat easier. While it is likely that jurisdictions that have suffered the most during the recession will also bounce back the most during the recovery, it is by no means certain. The great uncertainty around how provincial/territorial economies will evolve over the decade makes it useful to also offer guidance on how much fiscal consolidation would be necessary to reach the targets set out in Table 2.4 under a wide range of plausible growth paths in a probabilistic framework. To this end, a stochastic projection approach is used (see Annex 2.A1) to trace out mean net lending paths from 2010 to 2020 across 1 000 simulations using baseline assumptions compared to consolidation scenarios where discretionary expenditure grows at 5%, 4%, 3% and 2%, respectively (Figure 2.4).

On the basis of these simulations, discretionary-expenditure-growth limits that, on average, achieve the fiscal targets set out in Table 2.4 are derived (Table 2.5). They are broadly similar to those derived using the deterministic approach. Using these to guide fiscal policy would far from guarantee that consolidation objectives would be attained, however. In fact, governments could only be about 50% certain of achieving these objectives. Many jurisdictions, especially those concerned about debt-rating downgrades, will want to be more certain of achieving objectives in the time span promised. To illustrate the difference in the required stringency of spending-growth paths to raise the likelihood of achieving fiscal-consolidation objectives, discretionary-expenditure-growth guidelines consistent with an 80% probability of reaching the deficit and/or debt-ratio targets under the stochastic projection approach are also derived (Table 2.5). In most cases, an extra 0.5 percentage point of restraint in the growth of discretionary spending is necessary. The simulation exercises demonstrate that jurisdictions starting from large cyclically adjusted deficits, such as Ontario, need more stringent consolidation strategies over a longer time span than those in better fiscal health.

[FIGURE 2.4 OMITTED]

Curbing federal transfers to provinces would make provincial fiscal consolidation significantly tougher

Current legislation on federal-provincial transfers expires in 2013/14. In all simulations reported so far, transfers to provinces are assumed to grow at a rate of 4.8% per year until 2020. The federal government has promised not to cut provincial transfers to eliminate its deficit, as it did in the mid-1990s. But if it were merely to lower the growth rate of these transfers starting in 2014, most provinces would find it substantially more difficult to meet their own consolidation objectives. For each percentage point fall in the growth rate of federal transfers to provinces from 2014 on, the probabilities that provinces will be able to meet the fiscal-consolidation objectives in Table 2.4 by following the spendinggrowth rules in the final column of Table 2.5 fall significantly (Table 2.6). The territories are not shown because they depend on a federal transfer called Territorial Formula Financing, which is not subject to the same negotiation as the three major transfers to provinces. Two factors must be kept in mind when interpreting the results. First, the more distant in time the fiscal-consolidation objective, the greater the cumulative impact of changes in federal transfers on the probability of meeting this objective. Of course, only fiscal outcomes in 2014 and beyond are affected, which explains why the probabilities for Prince Edward Island, whose fiscal-consolidation objective is prior to this date, do not vary. Second, jurisdictions which are dependent on federal transfers for a large share of their revenue, such as the Atlantic Provinces, would of course be more affected than jurisdictions that depend more on their own revenue, such as Alberta.

To curb spending growth, start with withdrawing fiscal stimulus and restrain public-sector wage growth

For all governments, an important first step to restrain spending is to keep temporary economic stimulus measures temporary. Failure to let them expire, and notably to reduce capital expenditure to pre-crisis levels as assumed in the simulations, would only make fiscal consolidation more difficult to achieve. At the federal level, temporary measures include the Canadian Skills and Transition Strategy (worth about CAD 8 billion), including enhancements to Employment Insurance and new funding for skills and training, and special infrastructure investment funds (about CAD 12 billion). Some measures have already expired, most notably the Home Renovation Tax Credit. At the provincial level, fiscal stimulus has mostly taken the form of accelerated infrastructure spending, taking advantage of federal co-financing.

The promise to focus on curbing the growth of programme spending raises the issue of public-sector compensation. Apart from Saskatchewan and Alberta, all governments in Canada have seen average weekly earnings in public administration grow faster on average than in the rest of the economy over the past two decades (Figure 2.5). While there may be good reasons for a higher average level of pay in the public sector, such as differences in the educational/skill composition of the workforce, these should not give rise to large differences in the growth rate of compensation unless that composition is also changing over time. Also, careful studies that look at comparable occupations in both the public and private sectors find a significant public-sector pay premium. Indeed, the federal government's own studies show that with the exception of executives and trades people, federal public-sector employees are paid a premium over their private-sector counterparts (Treasury Board of Canada Secretariat, 2006). Whereas the premium was smaller historically, the rate of increase in salaries in the federal public service since 1998 has exceeded what the private sector has experienced on average. The public-sector pay premium is even more marked when considering the generosity of public-sector pension plans. Only a small and shrinking fraction of private-sector workers enjoys pension plans with parameters comparable to those found in the public sector. The result is that the lump-sum value of a middle-income public-sector retiree's pension, not including private retirement wealth, is roughly five times that of a typical private-sector worker, including the latter's pension plan, if any, and all private retirement accounts (Pierlot, 2008). With a view to restraining government spending growth to eliminate deficits, but also to reduce income inequality and reinforce the social contract between citizens and their public servants, governments should devise strategies to limit wage increases in their public sectors. Indeed, Prince Edward Island, Nova Scotia, New Brunswick, Ontario, Manitoba, Alberta and British Columbia have all signalled their intent to limit public-sector pay increases.

If new revenue-raising measures cannot be avoided, start with broadening tax bases and green levies

Although spending restraint is the most effective and economically stimulative way to achieve fiscal consolidation, it might also be necessary to consider new revenue measures. Within existing tax systems and without introducing any new tax, one strategy to raise more revenue would be to scale back the large number and relative importance of tax expenditures in the federal and provincial/territorial tax bases. (8) In 2004, the federal government reported 143 tax expenditures under the income tax system (personal and corporate), accounting for a revenue shortfall relative to a benchmark tax system of 5.4% of GDP (OECD, 2010a). (9) General business incentives, not including sector- and region-specific tax relief, accounted for about half this amount. Personal exemptions include an age credit for seniors, a mineral exploration tax credit for investors and a first-time home buyers' tax credit. The federal government also reported 32 tax expenditures under the Goods and Services Tax (GST) in 2004, equal to 1.2% of GDP. Goods and services that are exempted or zero-rated under the GST include basic groceries, prescription drugs, health and dental services, financial services, long-term residential accommodation, child-care services and educational services All together, tax expenditures subtracted an amount equal to 6.6% of GDP from federal revenue in that year, or roughly 55% of the relevant tax revenue (Figure 2.6). Relative to some other OECD countries, such as Germany, Korea and the Netherlands, these proportions are large. It should be noted that the reporting of tax expenditures varies by country, and Canada is recognised as having a comprehensive approach relative to other countries. Even so, high proportions of tax expenditure to GDP imply that broadening tax bases without increasing tax rates would yield new revenue and at the same time potentially remove some economic distortions. This conclusion also goes for provinces/territories. Though tax-expenditure evaluations are not available for all of them, provinces/territories use tax bases that are very similar to those of the federal government, so the intensity of tax expenditures in their own tax bases would be comparable, as would be the possible broadening and proportionate revenue increase.

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If new taxes are needed, environmental levies that correct negative externalities stand out as the most promising options. For instance, the federal government has announced a target of reducing carbon emissions by 17% from 2005 levels by 2020. An analysis based on reducing emissions by 20% from 2006 levels by 2020 found that a carbon price starting at CAD 40 per tonne in 2011 and rising to CAD 100 per tonne by 2020 would be needed, along with other policies (Pembina Institute and David Suzuki Foundation, 2009). This analysis found that gradually phasing in such carbon charges would yield about CAD 45 billion per year in extra revenue to the government by 2020, enough to completely eliminate the federal deficit in the baseline scenario. (See Box 1.3 in Chapter 1 for more on climate change policies.)

Finally, new revenue should be raised through instruments that introduce the least possible economic distortions. Taxes on immoveable property and value-added taxes have been shown to be the most economically efficient and growth-friendly taxes (Johansson et al., 2008; Arnold, 2008). At the federal level, the two recent successive onepoint cuts in the GST could be reversed. Failing that, provinces could decide to occupy the value-added tax room opened up by the GST cuts and raise their own sales (or preferably value-added) tax rates, as Nova Scotia has done.

Discussion by jurisdiction

The subsections below discuss consolidation strategies in a more tailored way for each jurisdiction and offer some thoughts on related fiscal issues.

Federal government

According to the 2010 federal budget, released in March, the deficit will be virtually eliminated by 2014/15 through a combination of cyclical increases in revenue and spending restraint. The federal strategy aligns well with the general recommendations made above: letting temporary fiscal-stimulus measures expire and focusing on restraining the growth of discretionary spending. On the revenue side, besides the general improvement in cyclical revenue, the only significant discretionary revenue measures planned are an increase in employment insurance (EI) premiums (10) and a move to close certain tax loopholes. On the spending side, besides the lapsing of temporary fiscal-stimulus measures after 2010/11, the federal government's fiscal-consolidation strategy focuses on restraining the growth of direct programme spending. This excludes transfers to persons and governments, leaving only about half of total programme spending subject to restraint (Figure 2.7). (11) Announced measures include restraining national defence spending growth, capping the international assistance envelope, containing public-administration costs by freezing operational budgets and identifying savings through strategic programme reviews. These measures are expected to help contain total direct programme-spending growth to about 1.3% per annum starting in fiscal 2011/12 when temporary stimulus measures will have expired. The simulation exercises above suggest that this spending-growth target would be sufficient to eliminate the deficit by 2014 with a high probability and, if maintained thereafter, would generate persistent surpluses and allow a rapid rate of debt reduction.

In recent years, federal transfers to provinces have increased much more than initially planned, partly because provinces have successfully put pressure on federal politicians to solve a perceived vertical fiscal imbalance. A case in point: from 1997 to 2005, federal budgets repeatedly announced plans for stable or even declining transfers under the Canada Health and Social Transfer (CHST, now split into the CHT and CST) over the medium term, only to have those commitments overturned and replaced by higher spending tracks in the next fiscal update or budget (Smart, 2005). Frequently, transfer increases have been the result of negotiations among the premiers and the prime minister at their annual meetings--as was notably the case in 2000, 2003, and 2004. The result is a transfer system with unpredictable federal spending commitments, one where provinces are conceivably able to extract more transfers from the federal government by manufacturing political crises, for instance around waiting times in hospitals, thus creating perverse incentives. There is empirical evidence that, in a federal system (in this case Germany), sub-national jurisdictions with softer budget constraints (those with more political influence in the upper chamber of the German parliament) exhibit higher deficits and debts, and receive more "bailouts" from the federal government (Fink and Stratmann, 2009). Furthermore, these jurisdictions are less efficient in spending public funds and are more prone to respond to rent seeking by interest groups. In the last few years the federal government in Canada has taken steps to put transfers to provinces, notably Equalization, on more predictable paths. An even more stable, rules-based transfer system could limit the growth of federal transfers, sharpen incentives for provincial governments and help them plan their fiscal-consolidation strategies by providing them with more certainty than they have had over the last two decades. Well in advance of the expiration of the current accord in 2013/14, the federal government should announce a "growth cap" under which federal-provincial negotiations would take place. For instance, the growth of transfers other than Equalization, which has already been capped at a three-year moving average of nominal GDP growth, could be similarly limited by GDP or federal revenue growth. (12) Such a cap would help enforce "hard" budget constraints on provinces and send a signal to both government negotiators and provincial public-sector unions regarding the wage increases they can hope for as new work contracts are negotiated over the next few years.

Newfoundland and Labrador

On a public-accounts basis, Newfoundland and Labrador registered four consecutive surpluses from 2005/06 to 2008/09. As noted by the province's Auditor General, the surpluses in recent years were due in large part to increased oil and gas revenue. Buoyant revenue from natural resources also allowed the province to increase spending at a fast pace over the last decade. In fiscal 2009/10 the province is estimated to have realised a deficit, however, and additional deficits are projected for the current and the next two fiscal years. A cut in programme spending is planned in 2012/13, but this will be insufficient to balance the budget. To do so by 2015, the simulations above suggest that discretionary spending would have to be frozen. Such a large downward adjustment in the growth rate of spending will require considerable discipline. Once the zero deficit is achieved, debt-reduction objectives should be announced and continue to be supported by spending-growth limits and surplus targets. Newfoundland and Labrador being one of the jurisdictions which face the direst demographic outlooks, reducing the level of debt takes on added urgency. After eliminating its debt, Newfoundland and Labrador should implement a savings policy for its substantial natural resource revenues along the lines recommended for Alberta (see below).

Prince Edward Island

The economic downturn and the high rates of growth of discretionary spending over the past few years have caused the fiscal position of Prince Edward Island to deteriorate significantly from a balanced position only a few years ago. In its 2010 budget the government has chosen to balance the budget over a term of four years by holding the pace of growth in expenditure below the rate of increase in revenue. The simulations imply that rates of discretionary-spending growth should come down significantly and be limited to between 0.5% and 1% per year to balance the budget by 2013, after which debt-reduction targets should be adopted.

Nova Scotia

After its election in June 2009, the new government commissioned an independent review of the province's finances, which found that the deficit was set to increase to CAD 1.3 billion (on a public-accounts basis) by 2012/13, with net debt continuing to grow (Deloitte and Touche, 2009). Another report commissioned by the government to study longer-term fiscal issues demonstrated that without permanent changes in the revenue or spending paths relative to recent trends Nova Scotia would face a structural deficit (Nova Scotia Economic Advisory Panel, 2009). As a result, first in its September 2009 budget and then in its April 2010 budget, the new government presented fiscal projections to 2013/14 that include new revenue measures and significant expenditure cuts, with the objective of achieving a small surplus in 2013/14. Most notably, the province is increasing its Harmonised Sales Tax (HST) rate by two percentage points to 10%, effective 1 July 2010. The spending cuts are to be made via an expenditure management initiative, starting in 2010/11, that is projected to identify CAD 772 million in yearly savings by its fourth year, which implies that programme expenditures would be lower in 2013/14 than in 2009/10. The simulations presented above are somewhat more optimistic regarding the medium-term fiscal outlook than the two reports commissioned by the government. Taking the tax-rate change into account, they show that on a national-accounts basis, the budget is expected to be balanced in 2010 after a small deficit in 2009. But they also show that the province faces longer-term fiscal pressure. Without a reduction in the recent rate of expenditure growth, the province would return to a negative net lending position before the end of the decade. On the other hand, by reducing discretionary-expenditure growth to between 3% and 4% per year, Nova Scotia could generate fiscal surpluses over the coming decade and lower its net debt-to-GDP ratio from about 30% now to zero by 2020.

New Brunswick

In its December 2009 budget the government presented a six-year plan that, it argued, would put the province on the path to a balanced budget by 2014/15, two years later than the original four-year plan presented in March 2009. It also stated that the objective after attaining a balanced budget would be to reduce the province's net debt. In the new plan, total-spending growth is assumed to be 0.5% on average over the period 2009/10 to 2014/15. The simulations suggest that holding discretionary-spending growth to between 3% and 3.5% per year would be sufficient to eliminate the deficit by 2014.

Though details are lacking in the government's plan as to how the ambitious reduction in spending growth is to be achieved, part of it relies on containing wage growth in the public sector. To do so, the government took the unusual step of announcing in its March 2009 budget:

* a wage freeze on base salaries for all management and non-unionised employees from 1 April 2009 to 31 March 2011;

* that effective 17 March 2009, all expiring collective bargaining agreements for which no replacement agreement has been signed would be re-negotiated for a two-year term with no wage increases during that period;

* a wage freeze for Members of the Legislative Assembly extending to 2010/11;

* that all crown corporations would be directed to institute a similar wage-restraint policy.

The government signalled its intent to implement the wage-restraint policy through negotiations, but also stated that it was prepared to legislate it if necessary. Wage costs being a very significant share of public expenditure, constraining their growth sends a strong signal to markets that governments are serious about curbing spending growth.

Quebec

Given its high level of debt--it is the most indebted province in relation to the size of its economy--Quebec's fiscal-consolidation effort needs to be especially vigorous. The province's long-term debt has persistently carried the highest spread over federal government debt of the four large provinces. The government intends to limit programme-spending growth to 2.9% in 2010/11 and to 2.2% thereafter until 2013/14, at which time the budget would be balanced, but not without new revenue-raising measures. Among such measures is a one percentage point increase (from 7.5% to 8.5%) in the Quebec Sales Tax (QST) effective 1 January 2011 and a further one percentage point increase effective 1 January 2012. Quebec is also introducing an annual health contribution, for each adult, of CAD 25 in 2010, CAD 100 in 2011 and CAD 200 as of 2012. Taking these new revenue measures into account, the simulations suggest that even greater efforts at restraining spending and/or other revenue-raising measures are needed. Assuming an objective of balancing the budget one year later than the government's, by 2014, the simulations imply that discretionary-spending growth should be limited to between 1.5% and 2% from 2011 on to achieve this objective.

Fiscal competition with other provinces and countries constrains the scope for tax increases. Thus, Quebec is now examining options to collect more revenue through user charges, of which it now makes relatively little use. A 2008 report estimated that Quebec could raise about CAD 5 billion, or about 8% of current budgetary revenue, by closing the gap with other jurisdictions (Government of Quebec, 2008). Electricity tariffs are especially low, hiding large natural-resource rents. Economic efficiency dictates that the price of electricity should match its marginal opportunity cost, determined by the price at which Quebec can sell electricity on inter-provincial or international markets, or at a minimum it should match its marginal production costs (Boyer, 2005 and 2007). (13) Despite having been unfrozen a few years ago, tuition fees for colleges (CEGEPs) and universities remain especially low and could be increased substantially while remaining competitive with other North American jurisdictions (Laberge, 2008). Rather than raising further revenue, a more significant effort at reducing expenditure growth could be made, which would almost certainly require substantial structural reforms in areas like health care (see Chapter 3).

In the past, Quebec had a balanced-budget rule targeting only the operating balance (the so-called "golden rule"). This fiscal rule created two problems. First, because it excluded capital expenditure, it provided an incentive to minimise maintenance expenditure (part of operating expense) relative to new capital formation. Second, whereas the rule required budget balance, Quebec should instead have run large surpluses during the pre-crisis period to pay down debt, the equivalent of pre-funding future obligations associated with demographic change. The fiscal rule had the perverse effect of limiting efforts to close the operating deficit, because merely achieving a balanced operating budget was enough to declare success and reap political dividends. Given its need to reduce debt quickly, once the deficit has been eliminated, surplus targets combined with debt-reduction objectives would focus attention on the right measures. A similar approach was recommended some years ago by Joanis and Montmarquette (2004).

The Government of Quebec should consider winding down the Generations Fund, an asset-accumulation fund created in 2006 and applying the proceeds to debt repayment. The idea behind the fund was that the province could earn a greater financial rate of return on assets in the fund than it pays on its debt, thereby eventually allowing for greater debt reduction. But such a possibility exists only if there is a spread between the cost of the province's liabilities and the return on assets the fund invests in, and the risk difference corresponding to this spread effectively falls on taxpayers. The existence of such a risk became obvious during the economic crisis as the fund's value collapsed. The average rate of return on the fund was -22.4% in 2008 (a loss of CAD 326 million). Amounts diverted to the fund over the past years would have been better applied directly to debt reduction, as they would in the future as well.

Ontario

On a public-accounts basis, Ontario programme spending increased at a trend rate of 7.3% between fiscal 2000/01 and 2007/08. If the province had kept spending to the amounts legislated in spring budgets, it would now be in a much better fiscal position, but additional expenditure was voted on the back of strong cyclical revenue increases for several years in a row, creating large structural obligations. The province now faces a deep structural deficit (see Table 2.2). As required by Ontario's Fiscal Transparency and Accountability Act 2004, the government has tabled a recovery plan to balance its books by 2017/18. The plan assumes that revenue growth averages 4.2% annually over the next seven years, while annual increases in programme outlays are held to 1.9% per year on average beyond 2012/13. The government's goal is to hold annual health-sector spending increases to 3% by 2012/13, significantly lower than recent growth, and this goal is the key to the fiscal-consolidation plan. The simulations assume that the budget should be balanced by 2015, two years prior to the government's objective. They imply that to do so would require freezing discretionary expenditure from 2011 on. Other simulations (not shown in the tables above) reveal that even holding discretionary-spending growth to 2% from 2011 on would not be sufficient to balance the budget by the government's target year of 2017. These results suggest two broad choices. Ontario could seek to constrain discretionary spending more than currently planned, a strategy which undoubtedly would need to be supported by extensive structural reforms to be credible, or it needs to raise more revenue. Given the very large increases in public expenditure in recent years, which were not justified either by inflation or population growth, a strategy of expenditure consolidation appears feasible and preferable.

On the topic of fiscal rules, Ontario provides an example of the potentially counterproductive effects of rules that are too strict. Starting in 1999, the government had a no-deficit rule with financial penalties for cabinet members. The rules may have led to a lack of transparency in budgeting. Since then, Ontario has abandoned strict rules, a flexibility that is proving useful in the current context, but which also did not prevent the emergence of a large structural deficit. This 10-year history suggests that while the rules may have been too strict in the past, they now seem to have shifted too close to discretion. If anything, it highlights the need for independent fiscal agencies so that the true fiscal situation can be assessed, and political incentives brought to bear, in real time.

Ontario has decided to harmonise its provincial sales tax with the federal GST, a value-added tax, as of 1 July 2010. Both the province and the federal government, which worked with Ontario on the new policy and supported harmonisation with transitory financial compensation to the province, are commended on this development, long advocated by the OECD. Unfortunately, Ontario has decided to provide point-of-sale rebates for a number of goods or services categories from the new Harmonised Sales Tax (HST) (e.g. some prepared food and beverages and print newspapers) in addition to those already exempt under the GST, thus going against advice to have as broad a base as possible to minimise distortions. Removing these provincial point-of-sale rebates, while keeping the same tax rate (8% for the provincial component), should be the first step taken if fiscal consolidation requires raising more revenue. As it stands, the tax package that introduces the HST is expected to be broadly revenue neutral for the province, as higher revenue from the broader sales tax base will be offset with a package of temporary and permanent business and personal income tax cuts and grants, the latter designed to offset the regressivity of higher spending-based taxation.

Manitoba

Manitoba's Budget 2010 projects a deficit in 2010/11 followed by three further years of deficits before balance is achieved in 2014/15. These deficits are not large, but the province has chosen to keep overall expenditure growing at an annual average rate of 1.8% over the four-year period and to balance the budget gradually. As this plan means five consecutive years of red ink when including the 2009/10 deficit, the government will amend the current legislated fiscal rule requiting budget balance over a four-year period. The new legislation will require the current budget shortfall to be eliminated over four years and a return to surplus in year five of the plan. It will also keep the legal requirement to have balanced budgets into the future. On a national-accounts basis, the simulations project that the province will show a small surplus in 2011 after a deficit the previous year. Furthermore, they suggest that by maintaining growth in discretionary expenditure between 3.5% and 4% per year from 2011 on, the province can reduce its net debt-to-GDP ratio to below 10% by 2020.

Saskatchewan

Saskatchewan's public-accounts deficit in 2009/10 was funded by drawing down the Growth and Fiscal Security Fund (GFSF). Without a downward adjustment to spending growth relative to recent history, deficits would likely continue and would soon cumulatively dwarf the amount left in the GFSF, estimated at about CAD 705 million at the end of fiscal 2009/10. The government would then have to suspend the application of its existing fiscal rules, which require fully offsetting a deficit the following fiscal year. Saskatchewan started this necessary adjustment by cutting total operating expense in 2009/10. The 2010 budget projects that operating spending will be held constant in 2010/11 and then rise by 1% in 2011/12 and by 2% in the following two fiscal years, for an annual average growth rate of 1.3% from 2010/11 to 2013/14. The budget is projected to be balanced without recourse to the GFSF in 2012/13. The simulations show that, on a national-accounts basis, the province will likely realise a surplus in 2010 after a small deficit in 2009. Therefore, the simulations assume an objective of reducing the net debt-to-GDP ratio to zero by the end of the decade. They show that Saskatchewan could attain this objective by limiting growth in discretionary expenditure to between 4.5% and 5% per year.

Alberta

In Alberta, the rapid deterioration in public finances in recent years involves a downturn in the global energy market as much as the recession. Some of this turnaround in energy prices may prove to be only temporary in nature - for instance the oil price has rebounded from its recent low. But some of it may well be permanent. In particular, revenue from natural gas royalties have collapsed over the past two years along with the international price for natural gas, partly reflecting shale gas discoveries in the central-eastern United States, which have resulted in a structural change in the market for gas and in traditional pricing models. In 2007, the government raised the royalty rates on natural resource extraction but it recently backtracked on that policy. Given these developments, the government estimates a CAD 3.6 billion deficit for the 2009/10 fiscal year. The deficit was fully funded by transferring CAD 3.6 billion out of the Alberta Sustainability Fund (ASF), (14) which has already declined from CAD 16.8 billion at the end of the 2007/08 fiscal year to a projected 15 billion at end-2009/10. The government expects to continue drawing down the fund for the current (2010/11) and the next fiscal years, at which point its value is expected to have fallen to about CAD 4.7 billion. In 2012/13, the government expects to have eliminated its deficit, mainly by severely constraining spending growth over the next few years while revenue recovers.

Indeed, spending is being squeezed in typical boom-bust fashion. As shown in Guillemette (2010), the province exhibits a clear pattern of pro-cyclical fiscal policy whereby spending is ramped up or non-resource revenue slashed (e.g. by using higher royalties to cut tax rates or give rebates) in good years followed by spending contraction in bad ones. Instead of stabilising the economy, the government has thus frequently exacerbated macroeconomic volatility. Once again, after growing at a pace of 10% per year as revenue was growing at 8% per year from fiscal 2002/03 to 2008/09 (on a public-accounts basis), the government now projects total spending to grow at an average of only 2% per year from 2008/09 to 2012/13, and to actually fall in 2011/12. These projections rely on rising prices for energy commodities and real GDP growth of around 3% per year, which result in nominal GDP growth of 6.5% to 8% per year. The simulations suggest that restraining discretionary-spending growth to roughly 1.5% to 2% per year would at best balance the budget two years later than the government objective, in 2014. A legislated spending-growth rule, rather than the current in-year spending rule, would help anchor fiscal policy and, if respected, would avoid another acceleration of spending when the budget is finally balanced. The rule should also be consistent with a new saving policy.

Enacting a new policy on saving is indeed a crucial issue for Alberta. The province is comparable to Norway and Chile in that it benefits from large natural resource reserves and derives a large part of its revenue from royalties. Unlike Norway, which saves all of its oil and gas revenue in a stabilisation fund and draws only 4% of the fund's value each year, Alberta has not had a consistent and disciplined approach to saving. In the 1970s, the government had a policy of saving 30% of its resource revenue in a fund to provide resources for the future. In the face of falling resource prices and rising public expenditures during the 1980s, the province stopped saving. In the early 1990s, with large deficits, rising debt levels and high per capita spending, Alberta went through a painful experience of cutting spending to restore its fiscal strength. The government then set its sights on paying down its debt in full, which it achieved while accumulating upward of CAD 36 billion in net financial assets, thanks in part to rising natural resource prices from 2000 to 2008. Now, with a high level of structural spending, the province has returned to deficit and taken to drawing down its Sustainability Fund to fill the budget gap.

The result of this ad hoc saving approach is that Alberta's resource wealth is unlikely to benefit current and future generations equitably. Even current generations lose out if too-rapid short-term spending growth in response to rising cyclical royalties is dissipated in inflation. To improve intergenerational fairness and help achieve long-term fiscal sustainability, a much higher percentage of resource revenue should be saved (Shiell and Busby, 2008). To this end, a government-commissioned report recommended that Alberta legislate a fiscal rule that requires the government to set aside a fixed share of the province's total revenue in a new consolidated savings fund with a target of building up a CAD 100 billion net asset position by 2030 (Alberta Financial Investment and Planning Advisory Commission, 2007). In addition, the Commission recommended that any yearend surpluses be used first to top up a CAD 3.5 billion macroeconomic stability fund (a re-purposed ASF), as required, and that at least 75% of the rest be allocated to the new consolidated savings fund. Only 4.5% of the value of the fund could be disbursed annually. Such a saving policy, when combined with a spending-growth rule, would have the major advantage of building up more savings in good times, rather than using revenue windfalls to ramp up spending. Savings could be used in bad times to avoid cutting back on public services. That would no longer amplify the business cycle.

British Columbia

Due to the effects of the economic crisis on provincial finances, the government amended its Balanced Budget and Ministerial Accountability Act in 2009 to permit temporary deficits until 2012/13. The official fiscal-consolidation plan thus states that the budget must be balanced in 2013/14 and that the debt-to-GDP ratio will decline thereafter. The government's projections are for total expenses to rise by about 2.4% per year until balance is achieved. The simulations project no deficits in 2011 and 2012 even under baseline assumptions, but a return to deficit starting in 2013 unless some effort at reducing spending growth relative to recent trends is made. Limiting discretionary-spending growth to about 2.5% per year would reduce the net debt-to-GDP ratio to zero by the end of the decade. The government hopes to achieve most of the savings required in its consolidation plan by attrition in the public sector, taking advantage of upcoming baby-boom retirements, and by tight expenditure controls, notably the "zero cost" mandate under which renegotiated collective agreements must result in no new cost to government. Penalties on Ministers' salaries will be imposed if targets are not met. On the revenue side, the health-care premium (a fixed head tax which must be paid in order to qualify for Medicare benefits) is being raised as of 2011. (15) On the other hand, the government has said that health-care spending, which continues to increase, would not be affected by the effort to restrain spending growth, a promise it might have to reconsider in light of the savings potential of structural reform in the health sector (see Chapter 3). Like Ontario, British Columbia is harmonising its provincial retail sales tax with the federal GST, effective 1 July 2010, however, it too should reduce the too-numerous exemptions to improve the tax's efficiency. (16)

Territories

The Yukon projects a balanced budget in 2010/11 after a deficit in the previous fiscal year. The simulations suggest, however, that on a national-accounts basis the territory is in a deficit position and should limit discretionary-spending growth to 1.5% over the next few years to balance its budget by 2014. Spending growth could increase thereafter and the objective switch to maintaining balance, given that it is already in a net asset position. As to the Northwest Territories and Nunavut, both expect a small budgetary surplus in 2010/11. after deficits in 2009/10. They are analysed as a single unit in the simulations, which suggest that, on a national-accounts basis, their combined deficit could be eliminated by 2015 by limiting discretionary-expenditure growth to between 0.5% and 1%.

Consolidation plans announced to date are broadly consistent with these recommendations

To date, the federal government and virtually all provincial and territorial governments have committed to return to budget balance over the medium term and have begun to elaborate specific plans to meet their commitments. These plans focus primarily on expenditure-restraint measures, including for example limits to public-sector wage growth, although some provinces have also introduced revenue-raising measures such as increases to consumption taxes. The plans are broadly consistent with the recommendations made in this Survey and should allow Canada to return to budget balance over the medium term.

Well-designed fiscal rules can help fiscal consolidation and strengthen fiscal frameworks

Fiscal rules can potentially be useful in achieving consolidation, particularly in avoiding "consolidation fatigue" when multi-year plans are required, as they are in many Canadian jurisdictions. A fiscal rule can be defined in general terms as a constraint on fiscal policy expressed in terms of an indicator of overall fiscal performance. In the study on fiscal-consolidation episodes cited in Box 2.2, the size of fiscal consolidation was significantly larger and the consolidation efforts sustained for longer when such rules were present. On the basis of a detailed analysis of 12 fiscal-consolidation episodes, however, Lilico, Holmes and Sameen (2009) argue that in periods of significant consolidation, self-imposed fiscal rules seem to have had limited, if any, role compared to a "just do it" culture. (17) They have rather tended to be used after successful consolidations, in an attempt to "lock in" success and as an expression of cultural change, not as substitutes for it. What is clear is that the rationale for fiscal rules goes beyond possibly helping to achieve fiscal consolidation. Perhaps most importantly, rules can strengthen fiscal frameworks for the post-consolidation period when the impetus for fiscal discipline is likely to fade.

Fiscal rules help counteract perverse government incentives

The main rationale for the introduction of a fiscal rule, whether a government needs to embark on fiscal consolidation or not, is to improve the credibility of government policy over time; in other words, to improve the time consistency of fiscal policy. The time-consistency problem stems from the existence of a deficit bias in the conduct of fiscal policy, which in turn originates from a common-pool resource problem, as argued by Hagen (1992). In this view, politicians and constituencies benefit from specific spending programmes, while imposing the costs on a common pool. Due to this negative externality, the individually rational strategies generate budgets that are sub-optimal from the perspective of the group. The equilibrium outcome is an inefficient excess appropriation of the common pool of revenue. In an intertemporal version of the model, short-run political expediency and a lack of understanding of the government inter-temporal budget constraint by the electorate leads to spending that is too high and financed by deficits, with all the ensuing economic and distributional effects of public-debt accumulation, including redistribution from the unborn to the present generations. (18) The results of this dynamic can be seen across OECD countries, almost all of which have tended to run budget deficits year after year in recent history. Fiscal institutions in general, including formal and informal rules, can potentially enhance fiscal discipline and thus counteract the deficit bias.

Another rationale for fiscal rules is to support macroeconomic stability. A lack of fiscal discipline by governments can reduce the natural counter-cyclical role of fiscal policy to the point of rendering it pro-cyclical. By helping to restore counter-cyclicality, fiscal rules can lessen the burden on monetary policy to damp output fluctuations. Fiscal policy has indeed tended to be pro-cyclical in many Canadian jurisdictions over the past quarter century, particularly in Alberta, Ontario and Manitoba (Guillemette, 2010).

The design of fiscal rules matters

The specifics of the rule or rules chosen to guide budgeting are important determinants of its efficacy. Inappropriate fiscal rules can be destabilising, such as balanced-budget rules that may force governments to cut spending when revenue falls during a downturn (as occurred recently in many US states). Fiscal rules may also lead to behaviour aimed at respecting the letter but not the spirit of the rule (Koen and van den Noord, 2005). Box 2.3 outlines a list of criteria that a good fiscal rule should meet.
Box 2.3. Criteria for evaluating a fiscal rule

The characteristics of the fiscal rule determine its credibility with
the capital markets and the electorate and its efficacy in reaching
the government's fiscal targets. Following Kopits and Symansky (1998),
a good fiscal rule would: **

* Have a track record of satisfactory compliance. For instance,
while it did not involve fiscal rules per se, the approach taken
in the mid-1990s by the federal government worked well for several
years in that it achieved the objective of eliminating the federal
deficit and reducing the level of debt. These objectives may have
been achieved at the expense of creating other problems with the
fiscal framework, such as too much caution in forecasting
(O'Neill, 2005), but the success achieved with respect to the
main objectives argues for using a similar approach in the coming
years.

* Be supported by well-specified policy measures. For instance, a
fiscal rule that limits the growth rate of expenditure should be
accompanied by specific explanations of how the reduction in
spending growth is to be achieved, including, if necessary,
structural reform (e.g. reforms to social entitlement programmes).
In the case of provinces, health-sector reforms are especially
important to limit expenditure growth, given this sector's
relative size in provincial budgets (see Chapter 3).

* Be well defined and transparent. The indicator to be constrained,
the institutional coverage, the specific escape clauses and the
accounting and forecasting concepts used should all be clearly
spelled out to improve transparency and avoid ambiguities and
ineffective enforcement.

* Target the objective. The rule specified should correspond directly
to the objective sought. For instance, sustainability of the public
debt-to-GDP ratio would require a rule expressed as a maximum and
non-increasing debt ratio, perhaps in conjunction with other rules
on expenditure growth, etc, that support this objective.

* Be consistent with other rules and objectives of the government.
For instance, price stability being an objective of the central
bank, a fiscal rule should support price stability by avoiding
pro-cyclical fiscal policy.

* Be simple. The simplicity of a fiscal rule enhances its appeal
and understanding, to politicians and members of the public alike,
making it more likely to be followed.

* Be flexible. A fiscal rule should be flexible enough to
accommodate exogenous shocks beyond the control of the authorities,
but there can be tradeoffs between flexibility and other
objectives. Fiscal rules defined over the medium term, or in terms
of cyclically adjusted balances, can allow flexibility over a
strict year-to-year budget-balance rule, but at the cost of
diminished simplicity, transparency and possibly credibility. A
highly flexible rule can even border on discretion.

* Be enforceable. The consequences for non-compliance, whether in
the form of financial, judicial or reputational sanctions, should
be clearly spelled out. The likelihood of enforcement, both by the
capital markets and from self-imposed mechanisms, is increased if
an independent authority is responsible for monitoring compliance.

** See also Anderson and Minarik (2007).


Conclusions and recommendations

Box 2.4 gathers the chapter's principal recommendations on the fiscal strategies and processes that should support the fiscal-consolidation drive in the years to come, many of which echo the recommendations of the OECD Working Party of Senior Budget Officials (OECD, 2010b). In the end, however, commitments and institutional rules cannot achieve fiscal consolidation on their own, and laws are simply laws; they can be altered and abolished at any time, as indeed many have been in response to the latest recession. Immediate action to address long-term structural issues that threaten fiscal sustainability is what is needed, both to achieve targets and to reassure markets. In many countries, reforming public pension plans are the principal challenge when it comes to fiscal sustainability. In Canada, the principal challenge is to reform provincial health-care systems. Redesigning these systems to reduce the pace of spending increases without sacrificing service quality is the topic of the next chapter.
Box 2.4. Fiscal policy recommendations

Recommendations for all jurisdictions:

* For jurisdictions with large deficits: maintain ambitious but
achievable deficit targets on the way to a balanced budget. Then,
and for jurisdictions not in deficit but with a significant debt
burden, announce medium-term debt-to-GDP-ratio targets accompanied
by fiscal-balance or surplus targets consistent with meeting these
debt targets. Allocate realised surpluses automatically to debt
reduction.

* Begin fiscal consolidation in 2011 by allowing temporary stimulus
measures to expire as planned. Make restraining the growth of
expenditure the cornerstone of fiscal-consolidation strategies, and
consider supporting this approach by legislating spending-growth
caps for which governments can be directly held to account.

* To enhance credibility, flesh out existing fiscal-consolidation
plans including, where necessary, plans for structural reforms.
Implement these plans starting in 2011. Adopt or implement existing
public-sector wage-restraint policies.

* If raising new revenue is necessary, use instruments that reduce
or minimise distortions to economic efficiency. Start with
broadening tax bases by eliminating tax expenditures that do not
have a compelling economic rationale. Then use measures that
correct negative externalities (e.g. carbon tax or emission permit
auctions) or relatively efficient taxes (e.g. value-added taxes and
property taxes at the local level).

* Consider establishing provincial budget agencies similar to the
federal Parliamentary Budget Office that provide independent
analysis of fiscal forecast and cost estimates for policy
proposals; and/or an agency reporting to the Council of the
Federation and tasked with providing independent analysis on
provincial fiscal matters.

Some jurisdiction-specific recommendations:

* Federal government. Continue working toward a more stable,
permanent, rules-based system for determining transfers to
provincial governments so as to enhance planning certainty and at
the same time place "harder" budget constraints on provinces.

* Quebec. Wind up the Generations Fund and apply the remaining
assets to debt reduction.

* Ontario. Bring forward the target date for balancing the budget
and be more ambitious in restraining non-health-spending growth.

* Alberta. Implement the recommendations of the Alberta Financial
Investment and Planning Advisory Commission. In particular,
legislate a fiscal rule that directs a fixed share of total revenue
into a long-term investment fund and allows a maximum share of the
fund to be spent each year.


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Notes

(1.) The cyclically adjusted budget balance shows the estimated budget balance if the economy were operating at its potential level. A deficit on this indicator suggests that even when the cyclical downturn is over and the economy has returned to its potential productive level, deficits will continue, i.e. that some part of the total deficit is structural.

(2.) An alternative baseline would be to hold the ratio of discretionary expenditure to GDP constant over the projection period, but this approach would for most jurisdictions already imply a significant slowdown in spending growth compared to recent history.

(3.) For a discussion of various fiscal sustainability definitions and concepts, see Krejdl (2006).

(4.) The long-term real interest rates used for these calculations are the predicted nominal interest rates in 2020 by jurisdiction (which are based on OECD Economic Outlook 87 projections but also depend on projected debt and deficit levels in 2020), minus the assumed long-term inflation rate (2.1%). The trend output growth rate is equal to the average predicted real growth rate of potential output from 2010 to 2020. See Guillemette (2010) for more details.

(5.) The demographic health-care liability alone accounts for some 120% of GDP according to Robson (2009), but other programmes lower the total as they amount to an implicit demographic asset of roughly 20% of GDP. See Chapter 3 for more health-care liability estimates and discussion.

(6.) This section draws on Kennedy and Robbins (2001) and Bouthevillain, Paul and Pavot (2007). Other reviews of the federal fiscal-consolidation experience of the 1990s include Bourgon (2009) and Lilico, Holmes and Sameen (2009).

(7.) See Guillemette (2010) for the baseline output-gap projections by province and territory.

(8.) Tax expenditures are provisions of tax law, regulation or practices that reduce the tax liability of a comparatively narrow population of taxpayers (physical or moral) relative to a benchmark tax system.

(9.) There are many conceptual and measurement difficulties involved in accounting for tax expenditures and in making international comparisons. For a thorough discussion of caveats, see OECD (2010a).

(10.) After having been frozen in 2009 and 2010 as part of temporary stimulus measures, EI premiums will rise from their current CAD 1.73 (per CAD 100 of insurable income) by the cap of 15 cents per year to a projected CAD 2.33 by fiscal 2014/15 in order to return the EI account to balance. The increase in premiums is projected to raise an extra CAD 15.5 billion in revenue cumulatively over the 2011/12 to 2014/15 period. Starting in 2011, an independent board--the Canada Employment Insurance Financing Board- will set contribution rates in a manner that balances the EI programme from 2009 forward. Annual changes in the EI premium rate are limited to 15 cents. See Orr (2009) for more details.

(11.) Programme spending corresponds to total current expenditure minus public debt charges. Direct programme spending excludes transfers to other levels of government and to persons from total programme spending.

(12.) Nominal CDP growth over the 2014-to-2020 period is projected to average 3.8% in the baseline scenario.

(13.) One problem with raising electricity prices that does not apply to some other revenue-increasing measures is that roughly 38% of the new revenue generated and distributed by Hydro-Quebec to the provincial government in dividends is clawed back by the federal government in lower Equalization payments to Quebec (Belanger and Bernard, 2009).

(14.) The Alberta Sustainability Fund is a cyclical stabilisation fund. It differs from the Alberta Heritage Savings Trust Fund from which only income earned from investments, minus the amount kept in the Fund for inflation-proofing, is transferred to the provincial government's operating fund.

(15.) Maximum monthly premium rates will increase by CAD 3.50 per month to CAD 60.50 for single persons, by CAD 7 per month to CAD 115 for two person families and by CAD 7 per month to CAD 121 for families of three or more persons.

(16.) On top of exemptions and zero ratings already provided under the GST, point-of-sale rebates for the provincial portion of the harmonised sales tax (HST) will be provided in British Columbia for motor fuels, books, children's clothing and footwear, children's car seats and car booster seats, children's diapers and feminine hygiene products. In addition, a provincially administered credit equal to the provincial portion of the HST will be provided for residential energy purchases.

(17.) Studies of the influence of fiscal rules on budget outcomes that focus on the Canadian experience include Millar (1997), Bird and Tassonyi (2003) and Tellier and Imbeau (2004).

(18.) See Corsetti and Roubini (1992) and Alesina and Perotti (1996).

ANNEX 2.A1

Summary description of the medium-term fiscal-simulation model.

The basic idea behind the model is to estimate output gaps for each of the provinces and territories on the basis of simple aggregate supply and demand concepts, and then use these output gaps as cyclical indicators to examine the influence of economic conditions on fiscal variables. Below is a summary of the methodology, which is detailed in Guillemette (2010).

Estimation of output gaps over history and projections

A first estimate of potential output is obtained using a production function on the basis of the working-age population, the trend labour force participation rate, the natural rate of unemployment, trend hours worked, the capital stock and trend labour-augmenting technical progress. This methodology is similar to that of the OECD Economic Outlook which is described in Belly et al. (2006). A second estimate of potential output is obtained by simply filtering historical GDP estimates using the Hodrick-Prescott filter. The final potential-output estimate used is the average of the production-function and HP-filter estimates. Historical output gaps from 1981 to 2008 are calculated as percentage deviations of official real GDP estimates from these potential-output estimates.

For the projection period 2009 to 2020, potential-output estimates are extended using population projections, projections of trend labour force participation rates on the basis of recent averages of age- and sex-specific participation rates, projections of hours worked and technical efficiency assuming continuation of historical trends, and assuming that the natural rate of unemployment remains near recent estimates. The capital stock is projected on the basis of historical accumulation and scrapping rates, but adjusted slightly so that once aggregated for the country as a whole, projections of potential output match the projection made for Canada in OECD Economic Outlook 87. Demand-side projections are then needed in order to derive output-gap projections. First, near-term GDP growth forecasts for 2010 and 2011 by province are taken from a private-sector forecaster and adjusted so that the Canada-wide projections match those of OECD Economic Outlook 87. An external source is necessary because the OECD does not produce projections at the provincial/territorial level. Then, for the years 2012 to 2020, two different approaches are used.

Under the first approach, similar to that used to produce the OECD Economic Outlook medium-term baseline, projected output gaps in 2011 are simply assumed to close linearly over a chosen number of years. For consistency and comparability with the OECD Economic Outlook 87 medium-term baseline, output gaps are assumed to close over a four-year period, so that they are completely closed in 2015. Thereafter, output grows at its potential rate, so output gaps remain closed. A second approach, based on stochastic methods, allows the simulation of a large number of plausible paths for output gaps and the construction of probability densities for economic (and eventually fiscal) variables. Under this approach, GDP growth rates by province/territory for each year from 2012 to 2020 are drawn from a multivariate normal distribution. The vectors of means and standard deviations are based on historical GDP growth rates from 1981 to 2008, and the full cross-correlation matrix of provincial growth rates based on the historical period is used to take into account contemporaneous correlation between provincial/territorial economic conditions. GDP deflators by province are projected using a simple relationship in which GDP inflation depends on the size of the provincial and national output gaps.

Influence of economic conditions on fiscal variables

The fiscal-accounting framework used is that of Statistics Canada's Provincial Economic Accounts (PEA), which is consistent with the national-accounts framework. The most recent historical figures available are for 2007. Other data sources, including Statistics Canada's Financial Management System, as well as official fiscal documents from the various jurisdictions, are used to extend PEA figures to today and for near-term fiscal projections. Balance-sheet figures are from Statistics Canada's Government Financial Statistics, which are also consistent with the national accounts. Some revenue categories are assumed to be cyclical, or non-discretionary, namely personal and business income taxes, social insurance contributions, indirect taxes and the share of investment income due to royalties from natural resources. Non-cyclical revenue categories are assumed to grow at the rate of nominal potential output, while the cyclical ones are assumed to depend on output gaps according to estimated elasticities (see below). The exception is royalties from natural resources. In provinces where such royalties account for a large share of investment income, cyclical royalties are assumed to be influenced by "commodity price gaps". These are similar in spirit to output gaps, but they are computed as differences between current real energy and non-energy commodity prices relative to equilibrium values, which are assumed to be 10-year moving averages of Bank of Canada commodity price indices. One spending category, transfers to persons, is assumed to be cyclical. Others are considered discretionary variables--transfers to other levels of government, net expenditure on goods and services, transfers to businesses and investment in fixed capital and inventories- and the rest are assumed to be non-cyclical and to grow along with nominal potential output.

The sensitivity of cyclical revenue and expenditure categories with respect to their respective cyclical indicators are estimated separately for each jurisdiction using mainly regression analysis but also other techniques following the general approach described in Girouard and Andre (2005) and used for cyclical fiscal adjustments in the OECD Economic Outlook.

Other model features and outputs

The sensitivity estimates allow the calculation of historical cyclically adjusted budget balances for each jurisdiction. Cyclically adjusted primary balances are also computed. These cyclically adjusted balances can be used along with output-gap estimates to study the historical stance of fiscal policy in each jurisdiction. Sensitivity estimates are also used to project cyclical government revenue and expenditure over the medium term by applying them to projected output gaps under either the deterministic or the stochastic approaches. To obtain a full set of fiscal projections, a few other model features are needed. First, noncyclical revenue and expenditure are projected by making them grow at the rate of growth of nominal potential output. Second, investment income due to natural-resource royalties is projected by assuming that real commodity prices stay constant at the last historical observation over the projection period, so that "commodity price gaps" are closed by the end of the projection period. Third, investment income not due to royalties is assumed to depend on the level of financial assets (which grow at the rate of potential output except if gross debt reaches zero in which case surpluses add to financial assets) and on long-term interest rates as projected in OECD Economic Outlook 87, with the recent historical spread over the long-term interest rate remaining constant over the projection period. As for stocks, net debt changes along with net lending. Market debt is obtained by identity and non-market debt grows at the rate of potential output. Interest on the public debt is assumed to depend on the level of market debt, on a blended interest rate and on the term structure of market debt. The blended interest rate on market debt is modelled using a dynamic equation with interest-rate inertia. To take into account the reaction of capital markets to fiscal positions, market interest rates are adjusted using a spread that depends on fiscal balances and debt, using estimates from the empirical literature.

Assumptions then have to be made for discretionary fiscal variables, which are all spending and transfer variables. These can be varied to construct different scenarios, in either the deterministic or the stochastic approaches, to study the influence of government decisions on future fiscal outcomes and on the likelihood of reaching certain targets. The baseline assumptions derived by extrapolating recent trends are described below.

Baseline fiscal assumptions

For the federal government, actual fiscal results for all budget categories are available for 2008 and 2009 in the regular quarterly national-accounts releases. Assumptions for discretionary variables for 2008, 2009 and 2010 for the provinces and territories and for 2010 for the federal government are derived from official budget documents. They are as follows:

* "Net current expenditure on goods and services" and "current transfers to businesses" are assumed to grow at the budgeted rate of growth of programme/operating expenditure. The reason for applying this assumption to transfers to businesses is that there is typically no budget line that corresponds closely to transfers to businesses, and, in any case, these are invariably a small share of current expenditures.

* "Investment in fixed capital and inventories" is assumed to grow at the budgeted rate of growth of capital expenditure, or, when available in the statement of change in net debt, of acquisition of tangible capital assets. This category does not include depreciation allowances (which are assumed to grow at the rate of nominal potential output) and net capital transfers (which are set to zero).

* The rates of growth of federal transfers to provinces are obtained from provincial and territorial budget documents.

* The rates of growth of provincial transfers to local governments are assumed to remain at their 1997-2007 average growth rates.

For 2011 and beyond, the baseline assumptions for federal and provincial discretionary fiscal variables are as follows:

* The rate of growth of federal "current transfers to provincial governments" is assumed to be 4.8%, based on a weighted average of the size of major transfers and their expected growth rates. The Canada Health Transfer (CHT) and the Canada Social Transfer (CST) are currently legislated to grow at 6% and 3%, respectively, and Equalization grows at a three-year moving average of nominal GDP growth. * After the current legislation expires in 2013/14, the overall rate of growth of federal transfers remains at 4.8% on a business-as-usual basis.

* The growth rates of "net current expenditure on goods and services" and "current transfers to businesses" are set equal to the average rate of growth of "net current expenditure on goods and services" over the 1997-to-2007 period. The reason why historical growth rates of "current transfers to businesses" are not used is that there is too much year-to-year variation in this expenditure category historically, especially in small provinces, so the growth rate would depend too much on the particular start and end years. The 1997-to-2007 period is chosen because 2007 is the last year for which data are available from the PEA, and it avoids the more recent period where fiscal stimulus temporarily increased the rate of growth of expenditure.

* The level of "investment in fixed capital and inventories" in 2011 is assumed to fall back to its 2008 level as stimulus spending is withdrawn. Almost all jurisdictions saw large cumulative increases in this spending category in 2009 and 2010 because a significant portion of stimulus spending in provinces was targeted on infrastructure, with the help of federal transfers earmarked for infrastructure. Post 2011, "investment in fixed capital and inventories" grows at its average rate of growth over the 1997-to-2007 period (1999 to 2009 for the federal government).

* Provincial/territorial "current transfers to local governments" are assumed to grow at their 1997-2007 average growth rates until the end of the projection period.

The fiscal assumptions are summarised in Table 2.A1.1.

Differences between projections based on national accounts versus public accounts

The projections given by the model, based on national-accounts concepts, can differ substantially from official government projections, based on public-accounts concepts. For instance, some jurisdictions exclude certain government entities from their headline fiscal projections that would be included in the national accounts system. Also, fiscal targets based on national-accounts concepts are implicitly more stringent than targets based on public-accounts concepts as net lending balances are currently more negative than public-accounts balances. This is because net lending is a cash-based concept and therefore includes the full cash outlay associated with capital purchases rather than just the amortised amount, as in the public-accounts. For example, the net lending balance averaged almost a full percentage point of GDP less than the corresponding public-accounts figure for provinces and territories between 2000/01 and 2009/10. As a result, returning to balance on a net lending basis is equivalent to targeting a surplus of about 1% of GDP on a public-accounts basis. Another difference is that public accounts use fiscal years (which end on 31 March) whereas national accounts and therefore the simulations use calendar years.

* In November 2008, the federal government announced changes to the Equalization formula to limit increases in payments that would have otherwise occurred given buoyant resource revenue in Alberta. It put a limit on the total amount that would be paid out--the limit is set to grow at a three-year moving average of nominal GDP.
Table 2.A1.1. Short- and medium-term fiscal assumptions in the
baseline scenario

Growth rate of ...

                              NL      PE      NS      NB      QC

                                Variables that change after 2010
                                   depending on the scenario

... current       2009        -38.1    13.5   10.5      4.3     8.6
transfers from    2010         15.1    -0.2   -1.7      0.5     0.6
federal           2011-13       4.8     4.8    4.8      4.8     4.8
government        2014-20       4.8     4.8    4.8      4.8     4.8

... net current   2009         15.7     9.8    6.3      6.7     3.8
expenditure on    2010          3.5     5.9   -0.3      1.6     2.9
goads and         2011          8.7     5.9    5.1      5.1     5.4
services and
transfers to      Post-2011     8.7     5.9    5.1      5.1     5.4
businesses        2009         24.4    50.1   18.1     42.7    56.9

... investment    2010         79.6    -2.8   -9.2     45.0     3.8
in fixed          2011        -55.2   -31.5   -6.8    -51.7   -38.6
capital and       Post-2011     7.0     6.8    8.7      2.8    10.6
inventories

                                    Variable that do not change

current           2009          2.8     5.2    2.9      1.0     4.4
transfers to      2010          2.8     5.2    2.9      1.0     4.4
local             2011          2.8     5.2    2.9      1.0     4.4
governments       Post-2011     2.8     5.2    2.9      1.0     4.4

                              ON      MB      SK      AB      BC

                                  Variables that change after 2010
                                      depending on the scenario

... current       2009         11.9     5.3    -6.8   18.8     14.1
transfers from    2010         27.6     1.3     5.8    2.4     12.5
federal           2011-13       4.8     4.8     4.8    4.8      4.8
government        2014-20       4.8     4.8     4.8    4.8      4.8

... net current   2009         14.8     6.9    -1.9    0.3      6.7
expenditure on    2010          6.5     1.5     0.6    3.9      2.0
goads and         2011          6.5     6.4     5.9    8.5      4.4
services and
transfers to      Post-2011     6.5     6.4     5.9    8.5      4.4
businesses        2009         37.1    30.9    14.8   -1.3      6.2

... investment    2010         15.3    39.2   -17.3    5.9     34.9
in fixed          2011        -36.7   -45.1     5.3   -4.3    -30.2
capital and       Post-2011     9.3     7.0     7.0   20.0     10.6
inventories

                                     Variable that do not change

current           2009          5.8     1.7     5.3    8.0      2.0
transfers to      2010          5.8     1.7     5.3    8.0      2.0
local             2011          5.8     1.7     5.3    8.0      2.0
governments       Post-2011     5.8     1.7     5.3    8.0      2.0

                              YT      NT&NU   Federal

                               Variables that change
                               after 2010 depending
                                  on the scenario

... current       2009          3.9     2.3
transfers from    2010          5.2     6.4
federal           2011-13       4.8     4.8      n.a.
government        2014-20       4.8     4.8

... net current   2009         11.5     1.3     Actual
expenditure on    2010         -3.8     1.2      3.1
goads and         2011          6.1     6.5      5.3
services and
transfers to      Post-2011     6.1     6.5      5.3
businesses        2009         54.2     5.1     Actual

... investment    2010        -13.8   -33.3      9.1
in fixed          2011        -24.8    42.6    -15.9
capital and       Post-2011     7.0     7.0      3.7
inventories
                              Variable that do not
                                     change

current           2009         -0.4     6.1
transfers to      2010         -0.4     6.1
local             2011         -0.4     6.1       n.a.
governments       Post-2011    -0.4     6.1

Table 2.1. Federal and provincial/territorial fiscal situations
and projections

                       % of          Budget balance (CAD million)
                      Canada
                     real GDP   2008/09   20009/10   2010/11   2011/12
                     in 2008

Newfoundland and       1.5         2434       -295      -194      -157
  Labrador
Prince Edward          0.3          -41        -84       -55
Island
Nova Scotia            2.2           20       -489      -222      -370
New Brunswick          1.8         -265       -754      -749      -681
Quebec                20.4            0     -4 257     -4506     -2900
Ontario               40.3       -6 409    -21 330   -19 690   -17 300
Manitoba               3.2          470       -555      -545      -448
Saskatchewan           3.1        2 389        425        20        50
Alberta               14.1         -852     -3 624    -4 748    -1 135
British Columbia      12.5           78     -2 775    -1 715      -945
Yukon                  0.1            1        -23         3         7
Northwest
  Territories          0.4         -165       -153        35
  and Nunavut
Federal government   100.0        -5755     -46956    -49200    -27600

                           Budget balance (% of GDP) (1)

                      2008/09    20009/10   2010/11    2011/12

Newfoundland and          7.8       -1.3       -0.7       -0.5
  Labrador
Prince Edward            -0.9       -1.8       -1.1
Island
Nova Scotia               0.1       -1.4       -0.6       -1.0
New Brunswick            -1.0       -2.8       -2.7       -2.3
Quebec                    0.0       -1.4       -1.4       -0.9
Ontario                  -1.1       -3.7       -3.2       -2.7
Manitoba                  0.9       -1.1       -1.0       -0.8
Saskatchewan              3.8        0.7        0.0        0.1
Alberta                  -0.3       -1.4       -1.6       -0.4
British Columbia          0.0       -1.5       -0.8       -0.4
Yukon                     0.1       -1.3        0.1        0.3
Northwest
  Territories            -2.5       -2.5        0.5
  and Nunavut
Federal government       -0.4       -3.1       -3.0       -1.6

                     Net debt in 2008/09   Target year
                                            for budget
                       CAD        % of       balance
                     million      GDP       or surplus

Newfoundland and        7 896       25.2          None
  Labrador
Prince Edward           1 409       30.5       2013/14
Island
Nova Scotia            12 324       36.0       2013/14
New Brunswick           7 388       27.0       2014/15
Quebec                128 793       42.6       2013/14
Ontario               165 864       28.2       2017/18
Manitoba               11 498       22.6       2014/15
Saskatchewan            3 848        6.1          n.a.
Alberta               -26 769       -9.2       2012/13
British Columbia       24 540       12.4       2013/14
Yukon                    -151       -7.9       2010/11
Northwest
  Territories             221        3.3       2010/11
  and Nunavut
Federal government    525 213       32.8          None

(1.) Provincial/territorial GDP used for the provinces and
territories and national GDP used for the federal government.

Source: RBC Economics Provincial Fiscal Tables (on the basis of
Department of Finance Canada Fiscal Reference Tables, provincial
budgets and public accounts), territorial budgets and OECD
calculations. Current as of 31 May 2010.

Table 2.2. Current fiscal positions and fiscal-sustainability
assessment in the baseline scenario

                                              NL       PE       NS

Current fiscal positions (% of GDP)

                               2010
                            estimates

Total budget balance                          -6.0    -4.6      0.9
(net lending)

Cyclically adjusted                           -4.9    -4.9      0.8
(% of potential GDP)

Primary budget                                -5.1    -3.2      2.5
balance

Cyclically adjusted                           -4.1    -3.5      2.4
(% of potential GDP)

Government                                    30.8    35.4     29.7
net-debt-to-GDP ratio

Assumptions for fiscal sustainability
assessment

Trend real output       Projected average
growth rate (g) (%)        for 2010-20         1.0     0.8      0.5

Real interest rate      Projected for 2020     3.4     3.2      2.7
on government
debt (r) (%)

Target government       Stabilise at 2010
net debt-to-GDP          level for every
ratio ([b.sub.0])          jurisdiction

Fiscal sustainability indicators

Primary balance                                0.7     0.9      0.7
required to reach
target debt ratio
(pb *) (% of GDP)

Primary gap (pg)               2010           -5.8    -4.1      1.8
(% of GDP)                     2011           -4.4    -2.4      2.4
                               2012           -5.1    -3.2      2.3
                               2013           -5.9    -4.0      1.9
                               2014           -6.8    -4.8      1.4
                               2015           -7.8    -5.7      1.0
                               2016           -8.9    -&.4      0.7
                               2017          -10.1    -7.2      0.4
                               2018          -11.4    -8.0      0.1
                               2019          -12.8    -8.8     -0.2
                               2020          -14.3    -9.7     -0.6

                                              NB       QC       ON

Current fiscal positions (% of GDP)

                               2010
                            estimates

Total budget balance                         -1.8     -4.9     -3.7
(net lending)

Cyclically adjusted                          -1.5     -4.6     -3.0
(% of potential GDP)

Primary budget                               -1.1     -3.7     -2.7
balance

Cyclically adjusted                          -0.8     -3.5     -2.1
(% of potential GDP)

Government                                   24.5     41.9     25.0
net-debt-to-GDP ratio

Assumptions for fiscal sustainability
assessment

Trend real output       Projected average
growth rate (g) (%)        for 2010-20        0.8      0.6      1.6

Real interest rate      Projected for 2020    2.8      3.1      3.0
on government
debt (r) (%)

Target government
net debt-to-GDP
ratio ([b.sub.0])

Fiscal sustainability indicators

Primary balance                               0.5      1.1      0.3
required to reach
target debt ratio
(pb *) (% of GDP)

Primary gap (pg)               2010          -1.6     -4.8     -3.1
(% of GDP)                     2011          -0.9     -2.5     -2.4
                               2012          -1.2     -2.3     -2.8
                               2013          -1.5     -3.0     -3.1
                               2014          -1.8     -3.7     -3.4
                               2015          -2.1     -4.5     -3.8
                               2016          -2.4     -5.2     -4.2
                               2017          -2.8     -6.0     -4.7
                               2018          -3.1     -6.7     -5.2
                               2019          -3.5     -7.6     -5.7
                               2020          -3.9     -8.4     -6.3

                                              MB       SK       AB

Current fiscal positions (% of GDP)

                               2010
                            estimates

Total budget balance                         -1.5      1.1      -1.9
(net lending)

Cyclically adjusted                          -1.5      1.7      -0.5
(% of potential GDP)

Primary budget                               -1.6      0.6      -3.0
balance

Cyclically adjusted                          -1.7      1.2      -1.5
(% of potential GDP)

Government                                   23.6      9.4     -10.3
net-debt-to-GDP ratio

Assumptions for fiscal sustainability
assessment

Trend real output       Projected average
growth rate (g) (%)        for 2010-20        1.3      1.5       3.2

Real interest rate      Projected for 2020    2.9      2.6       2.7
on government
debt (r) (%)

Target government
net debt-to-GDP
ratio ([b.sub.0])

Fiscal sustainability indicators

Primary balance                               0.4      0.1       0.1
required to reach
target debt ratio
(pb *) (% of GDP)

Primary gap (pg)               2010          -2.0      0.5      -3.1
(% of GDP)                     2011          -0.1      0.2      -3.2
                               2012          -0.4     -0.1      -3.6
                               2013          -0.9     -0.4      -3.9
                               2014          -1.3     -0.7      -4.3
                               2015          -1.7     -0.8      -4.5
                               2016          -2.2     -1.0      -5.1
                               2017          -2.6     -1.3      -5.8
                               2018          -3.0     -1.4      -6.4
                               2019          -3.5     -1.8      -7.3
                               2020          -4.0     -2.1      -8.3

                                              BC       YT       NT&NU

Current fiscal positions (% of GDP)

                               2010
                            estimates

Total budget balance                         -0.9      -7.3      -5.3
(net lending)

Cyclically adjusted                          -0.7      -7.8      -4.3
(% of potential GDP)

Primary budget                               -0.5      -8.2      -4.9
balance

Cyclically adjusted                          -0.4      -8.7      -4.0
(% of potential GDP)

Government                                    8.1      -2.5      13.8
net-debt-to-GDP ratio

Assumptions for fiscal sustainability
assessment

Trend real output       Projected average
growth rate (g) (%)        for 2010-20        1.1       3.0       4.0

Real interest rate      Projected for 2020    1.8       3.3       3.4
on government
debt (r) (%)

Target government
net debt-to-GDP
ratio ([b.sub.0])

Fiscal sustainability indicators

Primary balance                               0.1       0.0      -0.1
required to reach
target debt ratio
(pb *) (% of GDP)

Primary gap (pg)               2010          -0.6      -8.2      -4.8
(% of GDP)                     2011           0.2      -6.1      -7.2
                               2012           0.1      -6.7      -7.5
                               2013          -0.1      -7.3      -7.8
                               2014          -0.3      -7.9      -8.0
                               2015          -0.5      -8.6      -8.2
                               2016          -0.6      -9.2      -8.7
                               2017          -0.8      -9.7      -9.2
                               2018          -1.1     -10.3      -9.7
                               2019          -1.3     -10.8     -10.2
                               2020          -1.6     -11.4     -10.7

                                              Federal

Current fiscal positions (% of GDP)

                               2010
                            estimates

Total budget balance                            -0.9
(net lending)

Cyclically adjusted                             -0.2
(% of potential GDP)

Primary budget                                   0.3
balance

Cyclically adjusted                              0.9
(% of potential GDP)

Government                                      31.7
net-debt-to-GDP ratio

Assumptions for fiscal sustainability
assessment

Trend real output       Projected average
growth rate (g) (%)        for 2010-20           1.5

Real interest rate      Projected for 2020       2.8
on government
debt (r) (%)

Target government
net debt-to-GDP
ratio ([b.sub.0])

Fiscal sustainability indicators

Primary balance                                  0.4
required to reach
target debt ratio
(pb *) (% of GDP)

Primary gap (pg)               2010             -0.1
(% of GDP)                     2011              0.2
                               2012              0.4
                               2013              0.5
                               2014              0.6
                               2015              0.6
                               2016              0.5
                               2017              0.4
                               2018              0.3
                               2019              0.2
                               2020              0.0

Table 2.3. Demographically driven implicit assets and liabilities

CAD billion except as noted

                    Health    Education   Elderly     Child/family
                                          benefits      benefits

Newfoundland         -40.9         1.9       -0.1            0.1
  and Labrador
Prince Edward         -6.9         0.4       n.a.           n.a.
  Island
Nova Scotia          -55.7         3.3       n.a.            0.2
New Brunswick        -44.8         2.1       -0.1            0.1
Quebec              -431.5       -17.4       n.a.           n.a.
Ontario             -726.3        67.5        0.1            5.3
Manitoba             -44.4        -2.1        0.0            0.1
Saskatchewan         -31.7        -0.9        0.0           n.a.
Alberta             -222.2       -16.1        0.8            0.9
British Columbia    -234.5        13.6        0.0            0.4
Yukon                 -5.4         0.0       n.a.           n.a.
Northwest            -14.3         0.6       n.a.           n.a.
  Territories
  and Nunavut
Provincial/        -1858.6        53.0        0.8            7.1
  territorial
  total
Federal               n.a.        14.6       64.0          222.9
  government
Canada total       -1858.6        67.6       64.8          229.9

                        All              All
                     programmes       programmes
                                       as % of
                                       2007 GDP

Newfoundland            -39.0             -131
  and Labrador
Prince Edward            -6.6             -140
  Island
Nova Scotia             -52.2             -152
New Brunswick           -42.6             -156
Quebec                 -448.9             -145
Ontario                -653.3             -107
Manitoba                -46.3              -92
Saskatchewan            -32.6              -61
Alberta                -236.7              -86
British Columbia       -220.5             -111
Yukon                    -5.4             -307
Northwest               -13.6             -220
  Territories
  and Nunavut
Provincial/         -1 797.8              -112
  territorial
  total
Federal                 301.5               19
  government
Canada total        -1 496.3               -94

Source: Robson, W.B.P. (2009), "Boomer Bulge: Dealing with the
Stress of Demographic Change on Government Budgets  in Canada",
C.D. Howe Institute e-brief, No. 71, C.D. Howe Institute,
Toronto, www.cdhowe.org/pdf/ebrief_71.pdf.

Table 2.4. Suggested fiscal-consolidation objectives and consistent
fiscal-balance targets

CAD billion or per cent of GDP

                        Objective

Federal government      Zero net lending by   Baseline projections
                        2014                  Targets

Newfoundland and        Zero net lending by   Baseline projections
Labrador                2015                  Targets

Prince Edward Island    Zero net lending by   Baseline projections
                        2013                  Targets

Nova Scotia             Reduce net debt to    Baseline projections (1)
                        zero by 2020          Targets (1)

New Brunswick           Zero net lending by   Baseline projections
                        2014 Zero net         Targets
                        lending by 2014
Quebec                                        Baseline projections
                                              Targets

Ontario                 Zero net lending by   Baseline projections
                        2015                  Targets

Manitoba                Reduce net debt to
                        <10% of GDP by 2020   Baseline projections (1)
                                              Targets (1)

Saskatchewan            Reduce net debt to    Baseline projections (1)
                        zero by 2020          Targets (1)

Alberta                 Zero net lending by   Baseline projections
                        2014                  Targets

British Columbia        Reduce net debt to    Baseline projections (1)
                        zero by 2020          Targets (1)

Yukon                   Zero net lending by   Baseline projections
                        2014                  Targets

Northwest Territories   Zero net lending by   Baseline projections
and Nunavut             2015                  Targets

CAD billion or per cent of GDP

                           2010      2011      2012

Federal government      -14 281    -8 999    -7 289
                           n.a.    -8 000    -6 000

Newfoundland and         -1 157    -1 359    -1 682
Labrador                   n.a.      -900      -700

Prince Edward Island      -223      -146       -190
                          n.a.       -80        -40

Nova Scotia                29.7      27.7      25.5
                           n.a.      28.0      25.5

New Brunswick              -505      -199      -258
                           n.a.      -100       -50

Quebec                  -15 462    -8 021    -7 500
                           n.a.    -6 000    -2 000

Ontario                 -22 294   -19 392   -22 815
                          n.a.    -15 000   -11 000

Manitoba
                           23.6      23.9      22.6
                           n.a.      24.0      22.0

Saskatchewan                9.4       7.9       6.6
                           n.a.       9.0       8.0

Alberta                  -5 402    -5 922    -7 722
                          n. a.    -4 000    -2 500

British Columbia            8.1       8.6       8.1
                           n.a.       9.0       8.0

Yukon                      -146      -114      -136
                           n.a.       -80       -50

Northwest Territories      -359      -562      -654
and Nunavut                n.a.      -400      -300

CAD billion or per cent of GDP

                           2013      2014      2015

Federal government       -6 146    -2 773    -1 679
                         -3 000         0

Newfoundland and         -2 112    -2 600    -3 154
Labrador                   -500      -200         0

Prince Edward Island       -245      -305      -374
                              0

Nova Scotia                23.4      21.8      20.4
                           23.0      20.0      17.0

New Brunswick              -365      -482      -613
                            -25         0

Quebec                  -10 137   -13 228   -16 758
                           -800         0

Ontario                 -26 963   -31 494   -36 471
                         -8 000   -4 000          0

Manitoba
                           21.6      21.1      21.1
                           20.0      19.0      17.0

Saskatchewan                5.6       5.0       4.6
                            7.0       6.0       5.0

Alberta                 -10 051   -12 669   -15 338
                         -1 500         0

British Columbia            7.8       7.7       7.9
                            7.0       6.0       5.0

Yukon                      -162      -192      -226
                            -25         0

Northwest Territories      -762      -883    -1 016
and Nunavut                -200      -100         0

CAD billion or per cent of GDP

                           2016      2017      2018      2019     2020

Federal government       -3 497    -5 538    -7 828   -10 378  -13 244
                               Adopt debt reduction target

Newfoundland and         -3 820    -4 583    -5 455    -6 448   -7 582
Labrador                             Adopt debt reduction target

Prince Edward Island      -444      -522      -611      -710      -820
                           Adopt debt reduction target

Nova Scotia                19.4      18.5      18.0      17.7     17.7
                           14.0      10.0       7.0       3.0      0.0

New Brunswick              -769      -945    -1 145    -1 370   -1 620

                                  Adopt debt reduction target
Quebec                  -20 664   -24 989   -29 904   -35 472  -41 745
                                  Adopt debt reduction target

Ontario                 -43 008   -50 257   -58 420   -67 578  -77 841
                                    Adopt debt reduction target

Manitoba
                           21.5      22.4      23.7      25.4     27.8
                           15.0      13.0      12.0      10.0    <10.0

Saskatchewan                4.4       4.4       4.7       5.1      5.9
                            4.0       3.0       2.0       1.0      0.0

Alberta                 -19 547   -24 611   -29 985   -37 666  -46 566
                              Save a fixed share of revenue

British Columbia            8.3       9.0       9.9      11.1     12.7
                            4.0       3.0       2.0       1.0      0.0

Yukon                     -263      -305      -352      -404      -462
                                 Maintain budget balance

Northwest Territories    -1 175    -1 355    -1 556    -1 782   -2 033
and Nunavut                       Debt reduction target

(1.) Per cent of GDP.

Table 2.5. Spending restraint necessary to achieve
fiscal-consolidation targets

                        Nominal rate of growth of overall
                        discretionary expenditure (1) (%)

                                        Estimates (3)

                           Average
                        1997-2007 (2)
                                         2008     2009

Federal governments          4.5          9.6      6.5
Newfoundland and             7.4          5.7     14.5
  Labrador
Prince Edward Island         6.0          9.3     15.0
Nova Scotia                  4.9          3.7      6.5
New Brunswick                5.0          2.5      7.9
Quebec                       6.0         11.4     10.8
Ontario                      6.6          4.2     14.7
Manitoba                     5.8          7.1      9.3
Saskatchewan                 5.9         20.2      0.3
Alberta                      9.3         13.7      1.8
British Columbia             4.3          3.5      5.8
Yukon                        6.4          7.0     16.8
Northwest Territories        6.6         20.4      2.4

                        Nominal rate of growth of overall
                        discretionary expenditure (1) (%)

                        Required over the 2010-to-2020
                        consolidation obejctives (4)

                        In deterministic   In stochastic
                           approach         approach on
                                              average

Federal governments           4.5               4.0
Newfoundland and              0.5               0.5
  Labrador
Prince Edward Island          0.5               1.0
Nova Scotia                   3.0               4.0
New Brunswick                 3.5               3.5
Quebec                        1.5               2.0
Ontario                       0.5               0.0
Manitoba                      3.5               4.0
Saskatchewan                  5.0               4.5
Alberta                       2.5               1.5
British Columbia              2.5               3.0
Yukon                         1.5               1.5
Northwest Territories         1.0               0.5

                        Nominal rate of growth of overall
                        discretionary expenditure (1) (%)

                        Required over the 2010-to-2020
                        consolidation obejctives (4)

                                  In stochastic
                                    approach
                                     with 80
                                   probability

Federal governments                    1.5
Newfoundland and                       0.0
  Labrador
Prince Edward Island                   0.5
Nova Scotia                            3.5
New Brunswick                          3.0
Quebec                                 1.5
Ontario                               -0.5
Manitoba                               3.5
Saskatchewan                           4.5
Alberta                                1.0
British Columbia                       2.5
Yukon                                  1.0
Northwest Territories                  0.5
and Nunavut

(1). Discretionary expenditure is defined to include net
expenditure on goods and services, provincial transfers to local
governments, transfers to businesses and acquisition of
non-financial capital.

(2). Based on Provincial Economic Accounts.

(3). Based on official budget documents for provinces/territories
(direct programme spending or operating expenditure) and on
National Accounts for the federal government.

(4). The simulations are done in 0.5 percentage point increments.

(5). Federal transfers to provincial/territorial governments are
not considered discretionary expenditure.

Source: Statistics Canada and OECD calculations.

Table 2.6. Probabilities of provinces meeting their fiscal-
consolidation objectives

                           Per cent

                           Memo.: Share of       Nominal rate of growth
                           revenue attributable  in federal transfers
                           to federal transfers  to provinces from 2014
                                 in 2007                 to 2020

                                                       4.8%      4%

Federal government                  n.a.               79.5     81.1
Newfoundland and Labrador           51.3               90.0     77.1
Prince Edward Island (2)            41.7               92.7     92.7
Nova Scotia                         39.5               97.3     91.1
New Brunswick                       36.5               97.7     96.5
Quebec                              17.6               90.7     89.9
Ontario                             16.0               81.1     77.9
Manitoba                            32.0               83.4     78.2
Saskatchewan                        20.9               79.0     70.0
Alberta                              8.7               77.6     76.3
British Columbia                    15.8               86.3     80.8

                                   Nominal rate of growth
                                    in federal transfers
                                   to provinces from 2014
                                          to 2020

                                 3%      2%      1%      0%

Federal government              83.0    84.8    86.5    89.1
Newfoundland and Labrador       59.4    42.7    27.2    13.9
Prince Edward Island (2)        92.7    92.7    92.7    92.7
Nova Scotia                     67.5    33.1    13.1     3.2
New Brunswick                   93.5    90.3    85.3    78.2
Quebec                          88.1    85.9    83.2    79.6
Ontario                         73.5    71.0    67.7    64.3
Manitoba                        71.1    63.7    56.5    47.9
Saskatchewan                    58.6    48.9    40.0    32.2
Alberta                         73.7    71.9    69.8    68.3
British Columbia                73.3    64.2    56.3    47.0

(1.) The territories are not shown as they do not receive the three
major transfers considered here (Equalization, CHT and CST) but
they instead receive Territorial Formula Financing, which is
subject to a different agreement.

(2.) The probabilities are constant because the consolidation
objective is anterior to 2014.

Source: Statistics Canada and OECD calculations.

Figure 2.7. Federal programme spending
2008/09

Other departments and agencies                   20.6%
National Defence                                  9.0%
Crown corporation expenses                        3.9%
Other transfers                                  14.5%
Major transfers to other levels of government    22.4%
Major transfers to persons                       29.6%

Source: Department of Finance Canada, Fiscal Reference
Tables, www.fin.gc.ca/pub/frt-trf/index-eng.asp.

Note: Table made from pie chart.
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Title Annotation:Chapter 2
Publication:OECD Economic Surveys - Canada
Geographic Code:1CANA
Date:Sep 1, 2010
Words:21870
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