Provinces follow Ottawa's pattern of rosy revenue forecasts and unrealistic spending projections

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Appeared in the Financial Post
When Finance Minister Jim Flaherty announced last week that the Conservative government will miss its target for balancing the budget, he confirmed something that should be obvious to all students of recent Canadian economic history: Crossed-finger revenue forecasts and unrealistic spending growth projections are no basis for sound economic policy.

Ottawa's delay in balancing its budget will result in additional government debt and a much larger bill for the next generation to pay back. So why are virtually all provincial governments poised to follow this same failed strategy?

All provinces (save Saskatchewan) expect to run deficits over the next several years. Provinces such as British Columbia and Manitoba currently have the smallest deficits among the provinces (0.4% and 0.6% of GDP). At the other end of the spectrum is Ontario, with a $16.3-billion deficit (2.6 % of provincial GDP), a number so large it makes up more than 64% of the total deficits recorded by all the provinces in 2011-12, even though the province represents only 38% of total Canadian GDP.

More important than the size of their deficits is when each province plans to eliminate them. For the most aggressive deficit slayers of the bunch - B.C., Alberta, Quebec and Nova Scotia - it will take three years of red ink.

But here's the rub: Nearly all provinces are using optimistic revenue projections with annual average growth ranging from 3.2% in Manitoba to 7.3% in Alberta. Ontario, where the deficit problem is most severe, is assuming very rosy revenue projections of 4.3% per year for the next seven years.

On the other side of the ledger, the provinces plan to significantly restrain their expenditures by holding the growth of program spending (total spending minus interest costs) to between 1.4% in Ontario and 1.9% in Quebec.

Given the recent spending history of many provincial governments (even before the 2008 downturn) and the fiscal pressures put on various programs from an aging population, it is almost unimaginable that the provinces will be able to restrain spending to these rates over the medium term.

Consider that in the five years before the recession (2003-04 to 2008-09), Quebec increased program spending at an average rate of 5%, the lowest average among all provinces. The most prolific spender, Alberta, increased spending at an average rate of more than 11%. The balanced budget plans of all provinces are currently built on promises to constrain spending to under 2%. That hardly seems likely.

Combine optimistic revenue projections and unrealistic low rates of program spending, and you get balanced budget plans that contain substantial risks - especially in light of the following scenarios.

First, revenues may not materialize as expected due to slower economic growth. Lower than forecast commodity prices would batter provinces that depend on natural resource royalties. For instance, Alberta is expecting average revenue growth of 7.3% over the next three years. That might be attainable if commodity prices remain strong, but a minor dip in the province's revenue expectations might delay the balanced budget plan.

Second, program spending may increase faster than planned for a number of reasons. Indeed, this is what happened in the 1980s and 1990s, when Canadian governments tried to tackle their deficits using the same strategy.

Finally, interest costs may also turn out to be higher than expected, putting upward pressure on government spending.

By relying on strong future revenue growth, most provincial governments are dealing with their fiscal problems using a passive approach. Think about what would happen if the economic outlook worsens, and like the federal government, the provinces miss their balanced budget targets. Canada will be left with larger deficits for a much longer time period and significantly more government debt - all of which are a significant drag on the economy.

Total provincial debt is already expected to reach $487-billion this year. Add this to the federal debt that's currently at $586-billion and Canadians are leaving over a trillion dollars ($111,000 per Canadian family) in debt for the next generation to pay. With the federal government and nearly all provinces expecting deficits into the foreseeable future, the total level of debt will increase significantly.

Politicians from all political parties need to realize the seriousness of the inherent risks in their fiscal plans. Rather than rely on the failed policies of the past, of trying to slow spending growth while hoping revenues rebound sufficiently, provincial governments should be proactive and enact immediate program spending reductions and reforms.

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