As Canada’s federal and provincial budgets swell, sales-tax increases may follow

Canada’s provincial and federal government debt has ballooned during the COVID-19 pandemic, as it has for governments around the world, as they cope with both the costs of a health emergency and the need to use taxpayer dollars to prop up their economies.

But in Canada, some of the new public spending will settle at a permanently higher level or resume an upward trend once life goes back to normal, some economists say.

In Ottawa, the 2021 federal budget is eyeing a slew of new measures — from a national childcare system to revamping the outdated Employment Insurance program and a bump in Old Age Security benefits — that go far beyond a temporary increase in federal outlays to carry the country through the last months of the pandemic and restart the economy.

“Budget 2021’s ambition goes far beyond these targeted efforts to boost the recovery,” RBC economist Josh Nye writes in a recent report. “The government is significantly increasing transfers to older Canadians and lower-income workers.” And that, he notes, would mean permanently higher spending.”

And at the provincial level, healthcare costs were ballooning even before the pandemic — a trend that economists say will likely continue even after the battle against COVID-19 is over.

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So does that mean Canadians should expect tax increases once the economy is back on solid enough footing?

That depends on who you ask.

For Bill Robson, CEO of the C.D. Howe Institute, higher taxes are “implicit” in the 2021 federal budget.

A first analysis by the Institute of Ottawa’s latest spending roadmap suggests “we’re really on a knife’s edge here,” Robson says.

“If they’re lucky with interest rates, if they’re lucky with economic growth rates, then (we’ll) probably have a stable debt ratio,” he adds.

With federal deficits of $354 billion for 2020-21 and expected at $155 billion for 2021-22, and more than $50 billion for the following two years, the size of the federal debt is set to hover around 50 per cent of GDP until at least 2025-26, according to current budget projections.

But that ratio could creep higher if borrowing costs increase or the economy hits a rough patch, Robson says.

The few revenue-raising measures introduced by the budget — such as a new luxury tax on high-end cars, yachts and private aircraft —  won’t count for much in the federal government’s balance sheet, Robson predicts.

And there was no mention in Ottawa’s 739-page budget of increasing the goods and services tax (GST), a move the C.D. Howe Institute has been advocating for.

A hike in the GST rate, which has been sitting at five per cent since 2008, would be an effective way to boost revenues, Robson argues.

“A lot of economists would like to see higher GST instead of other taxes because it is such a broad and robust tax base that doesn’t discourage people from working as badly as personal income taxes do,” Robson says.

And higher sales taxes also don’t tend to drive business out of Canada to the same degree that corporate tax hikes do, he adds.

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Still, if Ottawa was pondering raising the GST, the right time to do it would likely be sometime in 2023, when the economy is back on its feet and Canadians who’ve been benefitting from the government’s COVID-19 emergency income supports will be in a better financial position to pay, Robson says.

Mostafa Askari, chief economist at the University of Ottawa’s Institute of Fiscal Studies and Democracy (IFSD), on the other hand, doesn’t see federal tax hikes as inevitable based on the latest spending patterns laid out by Ottawa.

Askari’s analysis of the latest federal budget shows that, barring significant interest rate increases or a long-term slowdown in economic growth, “what you will see is that the debt-to-GDP ratio actually starts to decline gradually over time.” And that, he adds, “is what we call a sustainable fiscal structure or fiscal policy.”

That’s because about 60 per cent of the federal government’s spending is currently based on formulas that ensure those outlays grow as fast or slower than GDP. Social transfer to other levels of government, for example, are capped at three per cent a year, while Canada’s long-run GDP growth trend (including inflation) is around four per cent per year, Askari says. The Canada Health Transfer and equalization payments are also linked to GDP growth, which ensures they won’t expand faster than the economy.

While the budget presented by Finance Minister Chrystia Freeland would dial up permanent spending, it stops short of setting Canada on an inevitable path of expenses growing faster than GDP, Askari says. Notably, Ottawa resisted provincial calls to boost health transfers, he adds.

Still, the federal government’s fiscal position is becoming more vulnerable to changes in underlying conditions like interest rates, Askari says. Interest rates rising by two percentage points or more over the next four or five years, for example, could mean that Canada’s debt-to-GDP ratio may not actually shrink over time, he warns.

But it’s in some of the provincial government coffers that Askari sees the most serious fiscal strains. Healthcare spending, which makes up about 40 per cent of provincial budgets on average, will keep growing fast even after the pandemic is in the rearview mirror, due in large part to the ever-rising costs of new drugs and treatments as well as the needs of Canada’s aging population, he says.

That’s why Askari sees room for sales tax increases at the provincial level.

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For example, a provincial sales tax — however, unsavoury politically — would “significantly” help in Alberta, where provincial debt remains relatively small compared to the size of the provincial economy but the debt-to-GDP ratio keeps rising.

An increase in net debt to $82 billion this year will leave Alberta’s net debt to GDP ratio at 24.5 per cent. But continued deficits are set to push that to 26.6 per cent by 2023-2024, according to the province’s 2021 budget projections.

But both Askari and Robson singled out Newfoundland and Labrador as facing an especially daunting fiscal picture. Like Alberta, the province has been facing the twin challenges of COVID-19 coupled with uncertainty in the oil market. But the province’s greatest fiscal woe comes from its demographic makeup, Askari and Robson say.

“They have a huge problem and the aging population,” with healthcare costs set to balloon, Askari says.

Higher sales taxes would be an easy-to-implement and effective way to beef up government revenues, Askari says. But they are considered a somewhat regressive form of taxation, one that hits low-income households harder than higher-income ones, he notes.

Still, without an increase in revenues or a boost to economic growth, there’s a risk one or more of Canada’s provinces may need Ottawa to come to the financial rescue, Robson warns.

“I would much prefer to see the federal government leave more fiscal room for the provinces by not getting so big itself,” he says.