By Charles Lammam
and Milagros Palacios
The Fraser Institute
On the easternmost part of the country, a fiscal storm is brewing.
Newfoundland & Labrador’s provincial finances are in a dire state. The government’s latest projections have the province facing a nearly $2 billion operating deficit, equivalent to almost a third of its total annual revenue. After adjusting for the size of its economy and population, Newfoundland & Labrador will have by the far the largest deficit among the provinces in 2015/16.
It gets worse. The government currently projects deficits averaging approximately $2 billion from now until 2020/21. Meanwhile, provincial net debt (a measure that adjusts for financial assets) is set to almost triple in nominal terms from the recent low of $7.8 billion in 2011/12 to $22.9 billion in 2020/21.
As a share of the economy, net debt is projected to increase from a recent low of 23.4 percent in 2011/12 to 35.9 percent in 2015/16. Over the same period, net debt per person will grow from $14,875 to $23,564. On this latter measure, Newfoundland & Labrador already has the highest debt burden among all the provinces.
Rising government debt has real costs. Today, almost 14 cents of every revenue dollar in the province goes to debt interest and not to public programs that Newfoundlanders value such healthcare and education, or tax relief.
So why are provincial finances in such bad shape? A popular narrative holds that falling revenues are to blame, particularly as the energy sector and consequent government revenues have been hit by depressed commodity prices. And there is no doubt revenues have taken a big hit in recent years, declining by 31 percent since 2011/2012 and placing considerable pressure on government finances. Nevertheless, the view that declining revenues alone are responsible for the province’s fiscal problems ignores the important role that provincial spending growth has played in creating the current crisis.
Government spending in Newfoundland & Labrador took off after 2004/05, coinciding with the commodity boom when energy prices and development began to rise. Subsequently, the provincial government continued to aggressively increase spending as revenues quickly poured into the provincial coffers.
In fact, program spending is now almost 80 percent higher in nominal terms than in 2004/05. From 2005/06 to 2011/12, the government increased program spending by a whopping 8.4 percent each year on average – much faster than the rate needed to keep pace with increasing overall prices (inflation) and a slightly growing population (2.3 percent).
Had the government restricted program spending increases since 2004/05 to the combined rate of inflation and population growth, Newfoundland & Labrador would now have a small surplus, not a large deficit.
In recent years, the province managed to largely stabilize its level of program spending, but it has not reduced spending from the historically high levels observed in 2011/12.
The fundamental problem with Newfoundland and Labrador’s approach to public finances over the last decade is that the government increased spending during the good times as though they would never end. When resource prices ultimately fell, the province found itself at an unsustainable spending level.
As the government prepares its 2016 budget, it must recognize the role that spending growth has played in producing its current fiscal predicament, and work to reduce and reform spending.
Some warn that spending restraint will harm an already weak economy. But the evidence points in another direction. In fact, economic research shows that successful attempts at slaying deficits focus on spending, which impose less economic damage than those which rely on tax hikes.
Unfortunately, the Newfoundland & Labrador government has shown a penchant for increasing taxes in recent years. For instance, it has created higher personal tax rates on upper earners in the hopes of closing the budget deficit. Yet the province’s tax system is already uncompetitive, and measures like this will only make matters worse, with harmful consequences for the economy and little revenue in return as people change their behaviour in ways that mitigate their tax liability.
Sustained spending growth helped create Newfoundland & Labrador’s fiscal problems and the government should not try to tax its way out. Getting the fiscal situation under control will require bold and decisive action to rein in spending.
Charles Lammam, Ben Eisen, and Milagros Palacios are analysts with the Fraser Institute.