COVID-19, Fiscal Federalism and Provincial Debt: Have We Reached a Critical Juncture?

Kyle Hanniman

doi:10.1017/s0008423920000621

Abstract

In 2019, Canada's gross subnational debt to GDP was well over 40 per cent, easily the highest in the world (see Figure 1). This level will only grow as the provinces grapple with the pandemic and its fiscal effects. Some believe surging provincial debts have brought Canadian federalism to a critical juncture: they have greatly increased the odds of federal measures to stabilize provincial finances. This article assesses this claim. The cleanest and most balanced path to fiscal sustainability is a combination of enhanced federal transfers, which would bolster provincial fiscal capacity, and national fiscal rules, which would constrain provincial borrowing. But the former is unlikely to restore sustainability on its own, and the latter would require a severe provincial debt crisis, which Canada's existing fiscal federal structures can avoid. COVID-19 has increased the odds of certain reforms, and it is difficult to predict their long-run effects. But any obvious paths to fiscal sustainability remain hidden.

Highlights

In 2019, Canada’s gross subnational debt to GDP was well over 40 per cent, the highest in the world.1 This level will only grow as the provinces grapple with the pandemic and its fiscal effects
Prior to the pandemic, there was an immediate threat to provincial borrowing, it was this: markets were generally happy to lend to provinces but would occasionally recoil or demand higher spreads in the face of global liquidity shocks
Changes to basic transfer programs seem increasingly likely, suggesting we have reached a critical juncture in this narrow sense

Summary

Introduction

In 2019, Canada’s gross subnational debt to GDP was well over 40 per cent, the highest in the world (see Figure 1).1 This level will only grow as the provinces grapple with the pandemic and its fiscal effects. If provincial debts are so high, do provinces manage to borrow so cheaply? If bailout expectations are high, do provinces not borrow on federal terms? Provinces can borrow as long as they pay a premium over unreliable spread indications from secondary markets.

Results

Conclusion