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How to fix Alberta’s $10-billion budget hole

When it comes to tackling Alberta’s fiscal problems, everything should be on the table in the provincial budget on April 14


 
Alberta Finance Minister Joe Ceci, centre, receives a round of appause after delivering the 2015 provincial budget at the Legislative Assembly in Edmonton on Tuesday, Oct. 27, 2015. (Topher Seguin/CP)

Alberta Finance Minister Joe Ceci, centre, receives a round of appause after delivering the 2015 provincial budget at the Legislative Assembly in Edmonton on Tuesday, Oct. 27, 2015. (Topher Seguin/CP)

How big is $10 billion? “It’s a lot. It’s a hell of a lot of money.” That’s how Alberta’s Finance Minister Joe Ceci described the potential size of Alberta’s upcoming deficit. He’s right.

It’s roughly as much as all personal income taxes in Alberta. It’s more than any ministry spends, except Health. It means 20 cents of every dollar spent by the government will be borrowed. And at 3.2 per cent of GDP, this deficit fits right in with those of Don Getty. The seven budgets between 1986-87 and 1992-93 averaged deficits of 3.7 per cent of GDP.

Of course there is much (much) more to a government’s budget than just the headline deficit number. To put it all in perspective, here’s a simple Sankey diagram. (I used SankeyMATIC and the third-quarter update data.)

fig1

Billions of dollars flow into government on one end, then flow out the other. The inflows are various taxes, investment income, resource royalties, transfers from the federal government, a wide variety of fees, tuition, and so on. On the spending side, health, followed by education, makes up the vast majority of government spending. In fact, more than 80 per cent of operating spending is in the top four ministries.

Borrowing is simply the difference between what flows in and what flows out. Unfortunately, the “Resource Revenue” inflow is much smaller than it used to be. Hence, the deficit. And if you want to do something about that, then you’ll need to either increase revenues, decrease spending, or some combination of the two.

Many will say “it’s a revenue problem,” while others say “it’s a spending problem.” Those positions each provide some perspective, and both have truth behind them, but the problem is more general: Alberta has a budget problem.

The deficit as a choice

As energy prices rise and fall, so does Alberta’s provincial revenues. Up under Lougheed, down under Getty. Up under Klein, down under Prentice and again under Notley.

We’re on the royalty roller coaster, folks. Having fun? Or getting sick?

Past PC governments were having fun, so made no attempt to get off this wild ride. Premier Notley does say she wants off. But actions speak louder than words, so hopefully we will see a plan in the next budget.

What is required? Simple: save more (even all) of our royalty revenues. Or balance the books at low oil prices—and save any surpluses.

What won’t work are government subsidies to favoured businesses. They were a staple of past PC governments, and have found new life in the NDP. Whatever you may think of the merits of such projects or other “diversification” initiatives, such measures will do nothing to help the government’s bottom line. They have nothing to do with the rollercoaster that counts.

The budget is the real problem, and tinkering along the economy’s periphery is a mere sideshow.

Of course, there’s no need for sudden or drastic changes to fill our budget’s hole. Knee-jerk reactions to Alberta’s deficit are as unnecessary as they are unwise. Alberta’s fiscal situation remains strong. With a lower net debt per person than any other province by far (see below), we have time to make sensible choices.

fig2

The challenge will be to put forward a credible plan to get out of deficit. Gradually, realistically, and sustainably.

But if we forgo resource revenues, how will we fill the gap? Perhaps new revenues, such as an HST, or perhaps spending controls. Ideally the compromise solution is a package that includes both.

Let’s explore some options.

Option 1: Raise revenue

Alberta brings in far less revenue from its massive tax base than any other province. Nothing demonstrates that our deficit is a policy choice better than this graphic from the October budget:

fig3

It shows that Alberta could raise roughly $8.5 billion in additional revenue if Alberta adopted B.C.’s taxes, or more than $9 billion if we adopted Saskatchewan’s.

As a quick side note, this is like the “fiscal capacity” behind the “have” or “have-not” provinces in the equalization formula. Alberta is not—and is nowhere close to becoming—a have-not province. Our ability to raise revenue (whether we choose to do so or not) is massive. We are very (very, very) far from being a have-not province—even today.

But we shouldn’t raise revenue from just any source. We should use stable and efficient taxes. A sales tax is the answer (specifically, an HST…. not a PST). According to recent research by Jack Mintz and Philip Bazel—of the University of Calgary—royalty revenues are nearly four times more volatile than sales tax revenues. A sales tax also beats income taxes. In terms of efficiency, sales taxes are also far less damaging to the economy (see Table 2 of this paper by Bev Dhalby and Ergete Ferede).

Option 2: Lower spending

Raising revenues isn’t the only solution. Large resource revenues probably create a political incentive for inefficient spending. After all, why worry about costs when it’s raining money? (That, I suspect, is why everyone loves premier Lougheed—he had it easy.)

Let’s compare Alberta’s spending to other large provinces. Recently, Ron Kneebone and Margarita Wilkins—also of the University of Calgary—did just that. (See their published paper here, and the data here.)

fig4

Looking at this graph, a certain song comes to mind. (Note: these numbers are different than the RBC Fiscal Tables. I use the Kneebone and Wilkins (2016) data because they break down spending categories in a consistent and comparable way across provinces. Also, this comparison critically depends on whether you look at spending per capita, or spending as a share of GDP.)

These differences in per-capita spending are large. If Alberta had the same per-capita spending as Ontario, for example, our deficit would shrink by $7 billion. Though there may be many good reasons why our costs are higher—our wages are higher than elsewhere, for example. So saving the full $7 billion isn’t likely feasible. (For more spending comparisons, this report is helpful.)

The elephant in the room is health. Not only is it the largest ministry of government—by far—but it’s also one of the costliest health care systems in the country. I’ve plotted a comparison below of the four largest provinces, and also included the two other Prairie provinces to show there’s something different happening in Alberta.

fig5

This is very odd. Our population is years younger than others, and the fraction of people over 65 is far lower than other provinces. This should lower health care costs, not raise them.

The government knows all this, and they are hoping to “bend the curve” on health care costs. Will they announce changes to physician compensation? Or consolidations of our aging and under-utilized rural hospitals? Or changes to procurement policies, or any number of other necessary reforms? Hopefully we will find out in the budget.

Option 3: Restrained spending growth and patience

Revenue tends to grow with the province’s economy, which is typically faster than the rate of population growth and inflation. If the province holds its spending growth below this level, then eventually the deficit will be eliminated. The critical question is: how much debt will we accumulate in the meantime and how much will interest costs rise? This matters. Every dollar spent on interest payments is a dollar unavailable for more valuable uses.

To explore this, I’ve very roughly guesstimated interest costs under a few scenarios. Let’s say revenues grow by one per cent between 2016-17 and 2017-18, then by five per cent thereafter. (For comparison, the government’s October budget had six per cent average revenue growth to 2020, but was based on some optimistic oil price assumptions.)

On the spending side, the government’s last budget had an average spending growth to 2020 of 2.3 per cent. I’ll make this one scenario. Another is for spending to grow with population and inflation. Finally, consider a rough approximation for two opposition alternatives. For the Alberta Party, I’ll illustrate growth of zero per cent, 0.5 per cent, then one per cent until the budget is balanced. For the Wildrose Party, Brian Jean announced he’d like to lower spending four per cent over two years. I’ll presume a spending freeze after that. For all scenarios, I’ll stop once the deficit is eliminated. (Obviously, this is just an illustration and oversimplifies the various plans.)

fig6

Unless revenues grow faster than five per cent, the government’s 2.3 per cent spending growth trajectory will balance the books in 10 years or so. No wonder they abandoned plans to stick to their 2019-20 goal.

How well do opposition parties do? The Alberta Party plan will balance a few years earlier, and the Wildrose plan two years before that. Roughly speaking, no one has a plan that would balance the books by the end of the decade—absent faster revenue growth than the five per cent assumed.

Importantly, no scenario increases the debt service costs beyond six cents for each dollar of government revenue. Ontario, for perspective, currently spends nine. We’re in a strong position, and will continue to be.

Final thought

Which options do you prefer? It’s a question where full, frank, and fair debate is essential. When those on the left claim the opposition parties would “slash and burn” their way to balance, they are wrong. When those on the right claim the government is setting Alberta on a course to financial ruin, they are also wrong.

Reasonable people can disagree without being alarmist. How to fix the budget is a debate we need to have. Everything should be on the table.

I cannot help but mention one final item sure to receive much attention in the budget: The carbon tax. How large will the revenues be over time? How much will be used to increase spending versus lowering future deficits? How large will any new “clean” infrastructure and technology investments be? How large will the household rebates be to lower- and middle-income families? Will rural areas receive additional rebates? Will the roughly $3 billion in output subsidies to large emitters be explicitly recorded in the budget? The list of questions is long.

For so many reasons, and to so many people, next week’s budget is going to be significant. There are critical questions that the government must, and hopefully will, answer.

 

Trevor Tombe is an assistant professor in the department of economics at the University of Calgary. Follow him on Twitter: @trevortombe


 

How to fix Alberta’s $10-billion budget hole

  1. Any discussion of our fiscal problem in Alberta that does not include wage and benefit cuts to the public sector is simply an exercise in futility. For example, a simple change from a defined benefit pension to a 5% matching contribution pension would save over $2 billion per year. Across the board pay cuts of no less than 10% would be next in line. There is probably room for at solid 15-20% pay cut within Alberta’s public sector work force, which would solve the fiscal problem in its entirety.
    Governments have a long tradition of spending themselves into trouble, with little or no encouragement from the tax paying sector of the populace. In fact, it could easily be argued that those who comprise the portion of the population that actually pay taxes have a pretty solid track record of suggesting, demanding even, serious spending restraint by government. In Alberta, you’ll even find a pretty solid group who believe that government spending should be restricted by law, and that any increases in spending or debt must be approved by referendum. That’s because there is another part of that tradition. Having spent themselves into trouble, governments invariably come after people’s money, and the only money they ever- EVER- come after belongs to that shrinking portion of the population who actually pay taxes.
    Absent of any willingness to discuss wage and benefit cuts in the public sector- payroll costs are some 75% of the Alberta budget- any discussion of how to balance the Alberta budget is a pointless exercise and utter waste of energy.
    As usual, the question will come up. “Well then, how much do you think a teacher is worth?” My answer to that is “We’ve never actually tried to find out, but all market indicators tell us we’re paying more than we should be.” This spring, in Alberta, some 30% of those who graduate university with an education degree (Why would you need a university degree to teach kids how to read and write?), will be unable to find jobs in the field of education, yet this fall, an even larger group of young people will enter university seeking a degree in that field, hoping to become teachers. The only real way to find out what a teacher should earn is to reduce salaries in that field until we see a serious reduction in university applications for that particular degree. Then we hold those salaries down until we begin to see an actual teacher shortage. At that point, we’ll have a pretty good idea of what a teacher should earn. However, right now in Alberta, that figure is about 40% higher in inflation adjusted dollars than it was in 1970. From that alone, we can extrapolate that there is a very large sum to be gained simply by applying market economics to Alberta’s public sector.
    When you consider that every one who pays into the system is governed by market economics, why would we expect market economics to be absent from the governance of public sector pay?

    • An addendum- I would begin by applying this process from the top down. The median personal income in Alberta is about $61,000 per year. I would apply a cap of 3x the average income on all individuals who earn a publicly funded paycheque, with a gradual reduction pay package benefits starting at 2x the average personal income. I believe in leadership by example.
      If you seek employment within any government agency or ministry, then it’s safe to say that you believe in the concept of socialism, ergo you should expect to be paid as a socialist. If you feel you are worth m,ore than 2.5-3x what the average Albertan earns, then we would encourage you to seek employment within that tax paying private sector. Given the track record of one agency, Alberta Health Services, it’s safe to say we have been paying $300-400K per year for individuals who would struggle to make six figures in any private sector arena.

      • I think you’re taking a flawed approach. You’re conflating the issues of compensation and employee performance. I think your problem is a lack of performance and a poor mechanism to correct it. Restricting compensation at the level you’re proposing will probably compound the issue by filtering out the talent.

        Let’s take your median income number: 3 x the median would give you $183,000/year. According to the Association of Professional Engineers and Geoscientists of Alberta, that’s less than average base salary for a senior engineering manager. That’s less than average total compensation for an engineering manager (the next level down.) I do not think you’ll be doing yourself a favour if the Alberta government managers responsible for regulating the oil & gas industry are the dregs who can’t compete at the comparable level of their industry counterparts.

        Limiting pay for government employees makes for good populist politics, but usually founders on the fact that it’s a simplistic solution to a complicated problem. It’d be far better to try to solve the tougher problem of managing performance in a government organization and benefiting from the results.

        • You have a valid point. My observation is that, in spite of paying above market salaries, there’s no indication we’re getting what we pay for. Obviously another component needs to be added, and that is adding a greater emphasis on the concept of public service and de-emphasizing careerism within the publi service.
          I honestly believe there are successful and wealthy individuals who would be happy to retire early from private work and take modest pay to manage some of our social enterprises for a few years. We simply need government to ask them, and the NDP to shut up (i.e. Gwyn Morgan). At the same time, we need to inject dynamism into the public sector by encouraging managers to move on if they want to make so-called “real money”. There was a time when a public sector stint was a stepping stone in a career. Now it’s the pinnacle. Remove some of the financial incentive for careerism, and make public sector success merely a resume highlight, and we’ll at least be stepping in the right direction of getting a handle on out of control payroll costs.

      • I agree with you. you can not compare public and private salaries as the public sector is meant to be run inefficient and anybody working in government positions knows this. The only item I take issue with is the average wage. You should look at average wages excluding the oil and gas sector as this industry will need a huge restructuring if it wants to be competitive and in the future. Things will need to change in Alberta whether people like it or not.

    • The problem of course, Bill, is that while you are absolutely correct in your assesment, the unions have a contract. We can’t break it.

      All we can do, is remove this at the next round of negotiations (also called “Blackmail meetings) with the unions. Gotta play hardball. Tell them, you either renogitiate the pensions, or we lay off 30% of your members to pay for the other 70%.

  2. Well,

    when you are in a hole, the adage says the best solution is to stop digging.

    Not much can be done about alberta’s trouble now, but the best way to ensure it doesnt’ get worsein the future is to turf the marxists currently running the place at the first opportunity.

    • (Replies in best Leonid Brezhnev accent) But in socialist republic of Alberta, NDP vote for you!

    • James – you DO realize that the current mess in AB was created by a right-wing government, right? And What’s with the “marxist” crap? Why do you right-wing types always throw around words like that, if the party is anywhere to the left of your fascist beliefs? (No, I don’t really think you’re all fascists; I’m just making a point about the idiocy of the overblown rhetoric.)

      I’m not at all convinced that the best way to improve employment and the overall economic health of AB is to turn off the taps. That just puts even more people out of work. Is Notley’s approach the best one? Debatable. The article does a good job of setting out the alternatives, and there are quite a range of them.

      Discuss away – but try not to let your slavish adherence to one political viewpoint completely blind you.

      • “And What’s with the “marxist” crap?”

        Premier is fond of wearing a Che watch. Environment Minister named her roller derby character after Noam Chomesky. Other ND MLAs publicly extol virtues of Hugo Chavez. What name would you suggest be used to describe them?

      • Ed Stelmach was a CINO, and Alison Wonderland was actually our first NDP premier. Just because they called themselves conservative, it doesn’t take a rocket scientist to see that our last ten years of Alberta government were tax and spend liberals. Every year for a decade, they ramped up spending at a rate double that of inflation coupled with population growth, leading to the current problem.
        We had a decade where our surpluses actually exceeded what the province earned in provincial income taxes, yet the opportunity to go income tax-free was squandered at the altar of big government.
        As I pointed out earlier, though, the main driver of spending growth was in the wages and benefits. Public sector workers were granted large raises, ostensibly to keep up with the private sector even though there was no evidence that we were losing public sector workers to the private sector. As a result, we have bloated government spending, and every a–hole and his dog in Edmonton claiming we can balance the budget by taking on more debt, and trying to plug a $10 billion shortfall by making a few million dollars in spending adjustments.
        It’s like losing your $10k per month paycheque, looking at your $1600 in EI benefits, and claiming that you’ll economize by cutting back to single ply toilet paper, ordering your Quarter Pounders without cheese, and only buying DVD’s from the $5 rack at Walmart, but refusing to think about selling the Escalade, the boat, or the Viper.
        Unless there is a willingness to discuss wage rollbacks in the public sector, discussions about Alberta’s budget problems are strictly academic.

      • Keith asked about my use of the descriptive “marxist” to describe the NDP.

        “Why do you right-wing types always throw around words like that, if the party is anywhere to the left of your fascist beliefs?

        Couple points:

        1st – Keith, clearly you don’t truly know what a fascist is, but don’t fret, most of those on the left use it frequently; without actually getting the irony that they are in fact describing themselves.

        2nd Point: LEAP MANIFESTO

        This piece of weak-minded claptrap came from the weak-minded pairing of Avi Lewis and Naomi Klein. Just a couple of champagne socialists who have never really had an actual job, but who whole-heartedly believe that only THEY know all of the correct answers, and will use whatever means necessary to ensure you COMPLY.

        Frankly, Keith, if you want to know what a modern facist looks like, one could simply look at Avi and his wife, or anyone in a good portion of the NDP who supported LEAP.

        That is the end of today’s lesson, Keith. You are welcome.

  3. It is stunning to find out that Alberta spends way more per capita than Quebec. So much for the rhetoric about socialist s versus free market economies. Obviously the problem is that th cheap oil is running out and they have to adjust to that.

    • the PC’s in Alberta were the pigs of Animal Farm. They were so used to being in charge, and thinking they were entitled to their entitlements…..they turned into a Western Version of the LIberal Party and forgot what Conservative values truly are.

      That is the problem with long serving parties. The first win or two is by folks who want to make a difference, but if you are continually succesful, you start attracting folks who just want to be in power for other reasons; usually personal enrichment. (ie. sponsorship, public works, etc.)

      That is why the Liberals are so corrupt so often. They are too succesful, and they attract shady characters. They all need the boot after two terms.

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