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PBO report warns of dire implications for Health Transfers fiscal sustainability

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A new report was released by the Parliamentary Budget Office. The mandate of the PMO is to provide an independent analysis to Parliament on the state of the nation’s finances, the government’s estimates, and trends in the Canadian economy: and upon request from a committee or parliamentarian, to estimate the financial cost of any proposal for matters over which Parliament has jurisdiction.

The title of the report is “Renewing the Canada Health Transfer“. The report notes that provincial debt loads are on track to soar over the long term in the wake of Ottawa’s decision to curb the rate of growth in health transfers. It warns that by scaling back the rate of growth in health transfers, the debt burden will test the resolve of provincial governments that already have looming deficits they must reign in. The long term debt-to-GDP projections in the 2011 Fiscal Sustainability Report (FSR) are based on the assumption that once the economy has fully recovered, both federal and provincial-territorial revenues will grow in line with nominal GDP thereafter.

In their FSR report released back in September 2011, the PBO’s analysis suggested that the fiscal structure at the federal and provincial-territorial level was not sustainable over the long term. In the baseline projection, PBO estimated that addressing this fiscal gap and restoring sustainability to public finances would require permanent policy actions of 2.7% of GDP, either to raise taxes, reduce overall program spending, or some combination of both.

But this FSR report also had a few caveats that should be noted as well. Quoted from the report: PBO’s long-term projections are best viewed as illustrative ‘what if’ scenarios that attempt to quantify the implications of leaving a government’s current fiscal structure unchanged over long periods of time…these scenarios should not be interpreted as predictions of the most likely outcomes. The report also does not consider the outlooks for individual provinces or territories, or include local government, or the Canada and Quebec public pension plans (CPP and QPP).

It also does not capture any interaction between government debt levels and economic activity

From the new reports (Renewing Canada’s Health Transfer), the PBO’s updated baseline consolidated federal and provincial-territorial government debt-to-gdp projection indicates that the overall fiscal structure is not sustainable over the long term if we are to look at the projected demographic and economic trends. The report finds that consolidated federal and provincial-territorial government net debt, over the long term, is projected to ultimately grow faster than the economy, resulting in ever-increasing debt-to-GDP ratio. Fiscal sustainability requires that government debt cannot grow faster than the economy.

The degree to which this structure is not sustainable, can be estimated by the fiscal gap which is the difference between the current fiscal structure and a structure that is sustainable over the long term. On a consolidated basis, the updated baseline federal and provincial-territorial government fiscal gap is estimated at 2.4% of GDP when calculated over a 75 year horizon.

The report goes on to state that provincial-territorial net debt relative to GDP “is projected to increase substantially over the long term.” While the ratio stood at 20% of GDP in 2010-11, the PBO expects that will now climb to over 125% in 2050-51 and to over 480% by 2085-86.

Bottom Line:  To close the fiscal gap, the PBO recommends measures that would require provinces and territories to take a combination of actions such as higher taxes or lower spending that would amount to $49-billion in 2011-12 – an amount that will grow over time in line with nominal GDP – for Canada’s finances to be sustainable.

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