When provincial Finance Minister Siobhán Coady tabled Newfoundland and Labrador’s 2020/21 budget two weeks ago, she painted a picture of a province in fiscal peril. The Furey government projects a budget deficit of $1.84 billion. While all provinces are struggling with the effects of the COVID-19 recession, Newfoundland and Labrador has the second-largest deficit relative to the size of its economy.

Clearly, this budget was developed under challenging circumstances. COVID and the collapse in oil prices have hurt government revenues. However, the Furey government controls spending, and this will be key in the recovery. This year’s budget deficit (where the government will spend more money than it receives in revenue) will be the province’s eighth in 10 years.

Indeed, spending is projected to increase by $542 million, although according to the government, much of that increase is pandemic-related. Going forward, the government can’t simply hold the line on spending if it wants to repair the province’s fiscal situation.

For example, consider interest on the government’s debt. Although there was only a marginal increase in the dollar value of debt interest charges between 2019/20 and 2020/21, they now consume a greater share of provincial revenues—15.1 per cent, up from 10.9 per cent last year. And this situation will likely get worse in the coming years because the province currently enjoys historically low interest rates and assistance from the Bank of Canada. If revenues remain constrained and debt levels continue to spike, the amount the province pays to service its debt will increase. And of course, any increase to interest rates would put even more pressure on provincial finances.

While much of the Furey government’s rhetoric has focused on financial assistance from Ottawa, the fiscal woes will continue until the province brings its own finances under control. Newfoundland and Labrador’s net debt-to-GDP ratio, a measure of debt relative to the size of the economy, has more than doubled in less than a decade due to persistent deficits. Further, research has shown that government occupies nearly half of the province’s economy and the province has the largest share of government workers in the country. All of these factors underscore the need for reductions in the size of government.

Policymakers in St. John's can learn from other jurisdictions. Late Harvard economist Alberto Alesina examined large fiscal changes (i.e. efforts to reduce large deficits and other measures to recover from recessions) in OECD countries and found that decreasing spending is an important part of reducing the deficit and has less adverse effects on the economy than tax increases.

Closer to home, Canada’s federal government and many other provincial governments faced similar situations in the 1990s. Large deficits, rising debt, and high interest costs wreaked havoc on government budgets. By and large, the federal government and provinces such as Saskatchewan successfully recovered by containing and reducing spending, balancing the budget and establishing a competitive tax mix.

Provinces across Canada have increased government spending in response to COVID-19 and the associated recession. Some of this spending has been necessary to contain the virus and stabilize incomes in a fragile economy. However, maintaining a large government footprint over the long-term can have negative effects including stunting badly-needed economic growth. While the 2020/21 budget effectively held the line on non-pandemic spending, if the Furey government wants a successful economic recovery in Newfoundland and Labrador, it should reduce the size of government and rein in spending.