Fiscal Sustainability Report 2023

Summary

To assess whether a government’s fiscal policy is sustainable requires projecting current policy beyond a budget’s medium-term planning horizon. Fiscal sustainability means that government debt does not grow continuously as a share of the economy.

Across all provinces and territories, the ageing of the population will move an increasing share of Canadians out of their prime working-age years and into their retirement years, resulting in slower growth in the Canadian economy.

Slower economic growth will put downward pressure on government revenues as growth in the tax base slows. At the same time, population ageing will put upward pressure on government programs such as health care, Old Age Security and pension benefits. Programs targeted to younger age groups will face reduced pressure as the population ages.

The objective of this report is to identify if changes to current fiscal policy are required to avoid unsustainable government debt accumulation and to estimate the magnitude of these changes.

Assessment

Total general government sector

From the perspective of the general government sector as a whole, that is federal and subnational governments and public pension plans combined, current fiscal policy in Canada is sustainable over the long term. Relative to the size of the Canadian economy, total general government net debt is projected to decline steadily over the long term due to fiscal room at the federal level and to rising net asset positions in the public pension plans (Summary Figure 1).

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

The projection period covers 2023 to 2097.

Federal government

Current fiscal policy at the federal level is sustainable over the long term. We estimate that the federal government could permanently increase spending or reduce taxes by 1.7 per cent of GDP ($49.5 billion in current dollars, growing in line with GDP thereafter) while stabilizing net debt at its initial level of 30.5 per cent of GDP over the long term.

Our assessment reflects all Budget 2023 measures. These measures include, for example, funding for health and dental care and investment tax credits in green technologies, which permanently raise the level of federal program spending over the long term, even after accounting for savings from spending reviews. Revenue-raising measures such as the taxation of dividends financial institutions receive on Canadian shares, as well as international tax reform, permanently raise federal revenues over the long term.

Our estimate of 1.7 per cent of GDP in federal fiscal room is marginally lower relative to our previous assessment (1.8 per cent of GDP). Despite an upward revision to our medium-term outlook for revenues that more than offsets increased program spending, the upward revision to the federal effective interest rate reduces the amount of fiscal room.

PBO assesses fiscal sustainability using the fiscal gap—the difference between current fiscal policy and a policy that is sustainable over the long term.

The fiscal gap represents the immediate and permanent change in revenues, program spending, or combination of both, expressed as a share of GDP, that is required to stabilize a government’s net debt-to-GDP ratio at its initial level over the long term.

A negative gap indicates that net debt is projected to decline as a share of GDP and that there is room available to increase spending or reduce taxes while maintaining fiscal sustainability.

For each public pension plan, the fiscal gap represents the immediate and permanent change in contributions or benefits that returns the net asset-to-GDP ratio to its initial level over the long term.

Subnational governments

Current fiscal policy is sustainable over the long term for the subnational government sector as a whole, which includes provincial-territorial, local and Indigenous governments. Our assessment reflects provincial and territorial government budgets from spring 2023.

Over the long term, relative to the size of their economies, subnational governments will face rising health care expenses due to population ageing. In addition, all subnational governments will face a less favourable effective interest-GDP growth rate differential compared to the federal government. Some subnational governments will also face significant budgetary pressures owing to reduced federal transfers (relative to the size of their economies).

That said, for the subnational sector as a whole, their own-source revenues, combined with federal transfers, are sufficient to keep the subnational government net debt-to-GDP ratio below its 2022 level over the 75-year projection horizon.

• Our assessment indicates that current fiscal policy in five provinces is sustainable: Quebec, Saskatchewan, Nova Scotia, New Brunswick and Alberta (Summary Figure 2).

• We estimate that governments in fiscally sustainable provinces have fiscal room to increase spending or reduce taxes, ranging from 1.8 per cent of provincial GDP in Quebec to 0.1 per cent of GDP in Alberta.

• Current fiscal policy is not sustainable in the remaining provinces and the territories. The amount of policy action required to achieve fiscal sustainability in these jurisdictions ranges from 0.2 per cent of provincial GDP in Ontario to 6.4 per cent of territorial GDP for the territories.

• We estimate that subnational governments in Quebec and Saskatchewan combined contribute 0.35 percentage points to subnational fiscal room while subnational governments in British Columbia, Manitoba and Ontario combined contribute 0.32 percentage points to the subnational fiscal gap (Summary Figure 3).

Office of the Parliamentary Budget Officer

Office of the Parliamentary Budget Officer

Fiscal gaps for each province and the territories are expressed relative to their corresponding provincial and territorial GDP. SUB refers to the consolidated subnational government sector.

Office of the Parliamentary Budget Officer

Office of the Parliamentary Budget Officer

Contributions are expressed relative to Canadian GDP. SUB refers to the consolidated subnational government sector.

Compared to our previous assessment, the subnational fiscal gap has been revised down from 0.1 per cent of GDP. Our current assessment reflects the budgets of provincial governments from spring 2023. Based on these recent budget plans, the medium-term outlook for provincial and territorial government own-source revenues has been revised up in most provinces and, consistent with our methodology, we assume that the revision carries through to the long term. The upward revision to subnational own-source revenues is partially offset by upward revisions to program spending.

Public pension plans

The current structure of the Canada Pension Plan (CPP) and Quebec Pension Plan (QPP) is sustainable over the long term. We estimate the fiscal gaps for the CPP and QPP to be, respectively, -0.1 per cent of GDP (in Canada) and ‑0.5 per cent of GDP (in Quebec).

Under the current structure of the CPP, contributions could be reduced, or benefits increased by 0.1 per cent of GDP while ensuring that the net asset-to-GDP position is at its initial value after 75 years. In the case of the QPP, contributions could be reduced, or benefits increased, by 0.5 per cent of GDP, while maintaining fiscal sustainability.

In comparison to our previous assessment, the fiscal gap estimate has improved by 0.04 percentage points of GDP for the CPP and by 0.11 percentage points of GDP for the QPP. This revision reflects a higher rate of return assumed over the long term that more than offsets downward revisions to projected net cash flows (relative to GDP).

Sensitivity of results

To help gauge the sensitivity of our baseline fiscal gap estimates, we consider alternative demographic, economic and fiscal policy scenarios.

We find that our qualitative assessment of fiscal sustainability for the federal government is unchanged across all the scenarios considered.

Our qualitative sustainability assessments for most provinces and the territories are essentially unchanged across the alternative demographic, economic and fiscal policy scenarios considered. However, our sustainability assessment is reversed under some alternative scenarios for subnational governments, mostly in cases where their baseline fiscal gap estimates are close to zero.

1. Introduction

Fiscal sustainability means that government debt does not grow continuously as a share of the economy. Assessing whether—and the degree to which—fiscal policy is sustainable involves projecting government net debt relative to the size of the economy over the long term under the assumption that current fiscal policy is maintained throughout that period.

Recall that these long-term fiscal projections are not forecasts or predictions of the most likely outcomes. They are illustrative scenarios that show the consequences of maintaining a government’s current fiscal policy over the long term, after accounting for the economic and fiscal implications of population ageing.

We produce these projections to motivate discussion about the adequacy of current fiscal policy to deal with expected long-term demographic and economic challenges; the earlier that a required policy intervention can be identified, the lower will be the cost of its implementation.

A government’s primary balance is defined as revenues less non-interest spending. It represents the contribution to debt accumulation that is directly influenced by fiscal policy.  Subtracting public debt charges from the primary balance yields the more familiar budgetary balance or “net lending”.

In the case of the public pension plans, we refer to the primary balance as the net cash flow, which represents plan contributions less benefits and administrative expenses.

The degree to which current fiscal policy needs to be adjusted to achieve sustainability can be quantified by the fiscal gap.[^1] PBO’s baseline fiscal gap is calculated as the immediate and permanent change in the primary balance (that is, revenues less program spending) required to return the net debt-to-GDP ratio to its initial level over a 75-year horizon.

The fiscal gap estimate reflects both policy and structural factors:

• Policy factor: The primary balance reflects the policy driver of sustainability. Permanent changes in the primary balance can be achieved by adjusting revenues and/or spending on programs.

• Structural factor: When interest rates exceed the rate of GDP growth, interest charges on government debt outpace growth in the overall economy. This can lead to excessive debt accumulation unless a government runs primary surpluses. However, for the federal government and some provinces, we project a favourable interest-growth rate differential over the long term, that is, GDP growth exceeding their effective interest rate.

We use Statistics Canada’s Provincial and Territorial Economic Accounts and Government Finance Statistics (GFS) as the basis for our fiscal projections.[^2] The GFS measure and analyze the economic dimensions of the public sector of Canada, consistent with Canada’s System of National Accounts and the International Monetary Fund’s global guidelines Government Finance Statistics Manual 2014.[^3] The scope of our analytical framework is limited to the general government sector.[^4]

Our medium-term economic and federal fiscal projections are based on PBO’s March 2023 Economic and Fiscal Outlook, adjusted to incorporate Budget 2023 measures.[^5] Our medium-term fiscal projections for subnational governments are aligned with the Public Accounts-based budget forecasts prepared by provincial governments in spring 2023. Detailed data for all our Fiscal Sustainability Report (FSR) projections are available electronically on our website.[^6] Additional methodological and technical details are provided in our 2017 FSR.[^7]

2. Demographic projection

The evolving demographic profile of the Canadian population is one of the key drivers of PBO’s long-term economic and fiscal projection. Across all provinces and territories, the ageing of the population will move an increasing share of Canadians out of their prime working-age years and into their retirement years, resulting in slower growth in employment and GDP.

PBO’s baseline demographic assumptions reflect Statistics Canada’s latest population projections which include upward revisions to mortality rates and changes to projections of interprovincial migration.[^8] The baseline demographic assumptions also include the Government’s 2021 immigration targets.[^9] While Canada’s population growth rebounded in 2022, changes to demographic assumptions lower the projected level of the population compared to our 2022 assessment by 3.5 per cent in 2097, the last year of our projection.[^10] Population growth at the national level is projected to slow from 1.8 per cent in 2022 to 0.7 per cent in 2097 (Figure 2-1).

There continue to be meaningful disparities in population projections at the subnational level. Alberta and Saskatchewan will see the highest population growth, although projected to slow from current levels. In contrast, the population of Newfoundland and Labrador is projected to decline over the projection period.

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

The average age of Canada’s population is projected to increase from 41.7 years in 2021 to 45.1 in 2068.[^11] The senior dependency ratio—the ratio of individuals 65 years and older relative to the population between 15 to 64 years of age—is projected to increase at the national level from 28.7 per cent in 2022 to 42.6 per cent in 2097 (Figure 2-2). The most acute period of population ageing is projected to occur over the next 13 years.

At the subnational level, the senior dependency ratio in the Atlantic provinces is projected to remain well above the national average over the long term. The higher senior dependency ratio in these provinces reflects lower fertility and net migration rates compared to other provinces.

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

In contrast, the senior dependency ratio in the prairie provinces and the territories is projected to remain well below the national average over the long term. The lower senior dependency ratio in these provinces reflects higher fertility and net migration rates compared to other provinces. That said, their senior dependency ratios are projected to rise well above current levels, particularly over the next 13 years.

3. Economic projection

Over the long term, the Canadian economy is assumed to operate at its productive capacity, or potential GDP, which is determined by trends in labour input (that is, total hours worked) and labour productivity (that is, GDP per hour worked).[^12] PBO’s methodology for projecting GDP at the provincial and territorial level is detailed in our 2017 FSR.[^13]

As a greater proportion of the population shifts into older age groups that are less likely to work, or work fewer hours, this will put downward pressure on growth in total hours worked in the economy. Consequently, growth in real GDP and real GDP per capita—a commonly used measure of average living standards—is expected to be slower.

Labour input measures the total number of hours worked and is determined by the size of the working-age population, the employment rate and the average number of hours worked.

Labour productivity measures the amount of output produced per hour worked.

Real GDP is equal to labour input multiplied by labour productivity. Potential GDP is the amount of output that the economy can produce when capital, labour and technology are at their respective trends.

Growth in real GDP per capita is typically used to measure increases in living standards.

Compared to our 2022 assessment—both domestically and globally—monetary policy has been tighter; near-term inflation has been higher and economic growth has been weaker than we projected.[^14] While the projected level of real GDP in 2027 (the last year of our medium-term projection) is 1.3 per cent lower than projected in our 2022 FSR, the level of nominal GDP in 2027 is now 1.5 per cent higher.

PBO’s long-term baseline projection of real GDP now incorporates estimates of the impact of future changes in weather patterns due to climate change. Based on previous PBO estimates, we project that future changes in weather patterns will decrease the level of real GDP by 3.4 per cent in 2097 relative to what our baseline projection would have been in the absence of future changes in weather patterns (Figure 3-1).[^15]

Office of the Parliamentary Budget Officer.

Office of the Parliamentary Budget Officer.

Beyond the medium term, nominal GDP growth across provinces and territories is, on balance, slightly lower compared to our 2022 assessment.

Population ageing will contribute to slower growth in total hours worked at the national level, but the magnitude of such changes varies across provinces and territories. For example, Alberta will see relatively less drag on economic growth from population ageing (Figure 3-2). In contrast, Newfoundland and Labrador, Nova Scotia and New Brunswick will experience significantly more drag on economic growth from population ageing.

Statistics Canada and Office of the Parliamentary Budget Officer.

Statistics Canada and Office of the Parliamentary Budget Officer.

Nationally, we project labour productivity growth to converge to its steady-state rate of 1.07 per cent over the long term, which is slightly lower than historical average annual growth in labour productivity of 1.12 per cent observed over 1982 to 2019 (Figure 3-3). The difference in labour productivity growth projected over the long term primarily reflects the impact of future changes in weather patterns due to climate change.

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

For the provinces, we project growth in labour productivity based on their respective historical average growth rates (over 1982 to 2019) but make adjustments to ensure consistency with our national projection. Newfoundland and Labrador and Saskatchewan are projected to have the fastest labour productivity growth over the next 75 years while British Columbia and Quebec are projected to have the slowest growth.

We project that real GDP growth in Canada will slow to 1.7 per cent annually, on average, over the long term (Figure 3-4).[^16] The relative profile of real GDP growth across provinces and territories over the long term primarily reflects differences in growth in total hours worked. By 2072, we project real GDP growth to range from 1.0 per cent in New Brunswick to 2.2 per cent in Alberta.

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

Growth in real GDP per capita—typically used to measure increases in living standards—is projected to average 0.9 per cent annually from 2023 to 2097, which is 0.3 percentage points lower than the average growth observed over 1982 to 2019. This projected slowdown reflects slower growth in total hours worked. With total hours worked projected to ultimately grow in line with the population over the long term, growth in real GDP per capita will ultimately be driven by labour productivity.

To illustrate the impact on real GDP per capita of slower growth in hours worked, we compare our baseline projection to a counterfactual scenario in which growth in total hours worked relative to the population grows at its historical average (1982 to 2019) of 0.1 per cent annually, instead of ‑0.2 per cent projected over 2025 to 2047 under the baseline (Figure 3-‑5). We project that real GDP per capita in 2047 would be $5,700 or 8.3 per cent higher in this no-ageing scenario.

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

The projection period covers 2023 to 2047. The counterfactual scenario starts in 2025, where growth in total hours worked relative to the population is maintained at its 1982 to 2019 historical average. Growth in labour productivity is the same under both projections.

Reflecting the length of the projection period and despite relatively small differences in growth rates, real GDP per capita levels are projected to diverge significantly across provinces and territories. Alberta, Newfoundland and Labrador, Saskatchewan and the territories are projected to enjoy the highest living standards over the long term while New Brunswick, British Columbia and Prince Edward Island are projected to have the lowest (Figure 3-6).

For provinces, real GDP per capita is an important contributor to their fiscal capacity (which is closely linked to income per capita) that determines their eligibility for Equalization payments from the federal government. Provinces with fiscal capacity below the national standard are eligible to receive Equalization.

Consistent with the economic developments over the past year, our medium-term projection of inflation and interest rates is higher compared to our 2022 assessment.

However, our long-term assumption for inflation is unchanged from our 2022 assessment. Beyond the medium term, we assume that inflation will settle at 2.0 per cent. In nominal terms, we assume that the 3-month treasury bill rate will be 2.45 per cent over the long term. The 10-year Government of Canada benchmark and long-term (maximum 30-year maturity) bond rates are assumed to be 3.25 per cent and 3.50 per cent—both are 25 basis points higher compared to our 2022 assessment.[^17]

The federal effective interest rate is projected to settle at 3.1 per cent. Provincial and territorial effective interest rate spreads (that is, the difference relative to the federal effective rate) are unchanged from our previous assessment.[^18] Over the long term, effective interest rate spreads range from a low of 82 basis points for British Columbia to 108 basis points for Newfoundland and Labrador.

For some jurisdictions (the federal government and subnational governments in Saskatchewan and Alberta), their effective interest rate is lower than their nominal GDP growth rate, on average, over the long term.[^19]

4. Federal government

Current fiscal policy at the federal level is sustainable over the long term. Our assessment reflects Budget 2023 measures, including funding for health and dental care, investment tax credits for clean energy and revenue raising measures such as international tax reform, as well as the taxation of dividends financial institutions receive on Canadian shares, in addition to savings from spending reviews.

Over the long term, federal program spending declines in our projection (relative to the size of the economy prior to the pandemic) for elderly benefits, children’s benefits, and transfers to other governments, under status quo policies (Figure 4-1).

Statistics Canada

Office of the Parliamentary Budget Officer

Statistics Canada

Office of the Parliamentary Budget Officer

The projection period covers 2023 to 2097. Employment Insurance includes the Canada Emergency Response Benefits and Canada Recovery Benefits. Major transfers to other governments include Equalization, the Canada Health Transfer, the Canada Social Transfer, the Territorial Formula Financing, and other transfers.

Federal spending on elderly benefits amounted to 2.4 per cent of GDP in 2022. As the last of the baby-boom cohort reaches 65 years of age, we project that spending on elderly benefits will continue to increase, peaking at 2.7 per cent of GDP in 2030. However, given that benefit payments are indexed to inflation only, spending on elderly benefits is ultimately projected to decline as these cohorts age and pass on.

Children’s benefits reached a peak of 1.2 per cent of GDP in 2020 mainly due to the additional children’s benefits allocated during the pandemic. However, given that the under-18 age group will comprise a smaller share of the total population over the coming decades and that benefit payments are indexed only to inflation, children’s benefits will decline relative to the size of the economy. By the end of our projection, children’s benefits are projected to amount to 0.4 per cent of GDP.

Federal major transfers to other levels of government are also projected to decline slightly between 2022 and 2097, from 4.7 per cent of GDP to 4.5 per cent of GDP. The Canada Health Transfer (CHT) and Equalization are legislatively linked to growth in nominal GDP. However, the Canada Social Transfer (CST) is legislated to increase by 3 per cent per year, which is 0.7 percentage points lower, on average, than projected GDP growth.

Given projected declines in transfers to individuals and other governments, we project that revenues will exceed program spending over much of the projection period, resulting in sizable primary surpluses by the end of our long-term projection (Figure 4-2).

Statistics Canada

Office of the Parliamentary Budget Officer.

Statistics Canada

Office of the Parliamentary Budget Officer.

The projection period covers 2023 to 2097.

In addition, we project that the federal effective interest rate will remain below the growth rate of nominal GDP, further contributing to the sustainability of current federal fiscal policy. Based on our projection, the federal government’s net debt of 30.5 per cent of GDP in 2022 would be eliminated in 2054 in the absence of policy changes.

Fiscal sustainability assessment

Current fiscal policy at the federal level is sustainable over the long term. To stabilize its net debt at 30.5 per cent of GDP over the long term, we estimate that the federal government could permanently increase spending or reduce taxes by 1.7 per cent of GDP ($49.5 billion in current dollars, growing in line with GDP thereafter).

Our assessment reflects all Budget 2023 measures. These measures include, for example, funding for health and dental care and investment tax credits in green technologies, which permanently raise the level of federal program spending over the long term, even after accounting for savings from spending reviews.[^20] Revenue-raising measures such as the taxation of dividends financial institutions receive on Canadian shares, as well as international tax reform, permanently raise federal revenues over the long term.

Our estimate of 1.7 per cent of GDP in federal fiscal room is marginally lower relative to our previous assessment (1.8 per cent of GDP). Despite an upward revision to our medium-term outlook for revenues that more than offsets increased program spending, the upward revision to the federal effective interest rate reduces the amount of fiscal room.

Our qualitative assessment that current federal fiscal policy is sustainable over the long term is unchanged across all the alternative demographic, economic and fiscal policy assumptions considered (see Tables A-1 to A-3 in Appendix A).

5. Subnational governments

Current fiscal policy is sustainable over the long term for the subnational government sector as a whole, which includes provincial-territorial, local and Indigenous governments. Our assessment reflects provincial and territorial government budgets from spring 2023.

Over the long term, relative to the size of their economies, subnational governments will face rising health care expenses due to population ageing. In addition, all subnational governments will face a less favourable effective interest-GDP growth rate differential compared to the federal government. Some subnational governments will also face significant budgetary pressures owing to reduced federal transfers (relative to the size of their economies).

That said, for the subnational sector as a whole, their own-source revenues, combined with federal transfers, are sufficient to keep the subnational government net debt-to-GDP ratio below its 2022 level over the 75-year projection horizon (Figure 5-1).

Statistics Canada

Office of the Parliamentary Budget Officer.

Statistics Canada

Office of the Parliamentary Budget Officer.

The projection period covers 2023 to 2097.

Subnational governments derive most of their revenues from own-sources—most notably taxes on income, consumption, and property. We assume that these revenues grow in line with provincial nominal GDP over the long term. Consequently, total revenues rise or fall as a share of provincial GDP in our projection because of changes in federal transfers, such as Equalization, CHT and CST (Figure 5-2).[^21]