P.E.I. government should reduce spending to avoid fiscal risks

Recently, the Parliamentary Budget Officer (PBO) published its annual report on the health of government finances across Canada including a worrying analysis of Prince Edward Island’s fiscal situation.

The purpose of the PBO’s annual report is to assess the sustainability of government finances using a technical definition of the term. Under the PBO’s definition, a government’s finances are unsustainable if, under current policies and reasonable economic assumptions, government debt is on track to grow faster than the overall economy over the long-term.

Simply put, according to the report, P.E.I.’s finances are unsustainable. This means if the provincial government fails to take any policy action, the province’s net debt-to-GDP ratio, a key indicator of the sustainability of debt levels, will rise over time.

The PBO is not alone in this key finding. Leading experts at the Finances of the Nation project concur with this basic assessment. Their calculations suggest that P.E.I. requires significant spending reductions to make the province’s finances sustainable without tax increases. To achieve sustainability in one year, their analysis suggests the government must reduce program spending (all spending other than debt interest costs) by approximately $140 million or 5.8 per cent. In June, P.E.I.’s auditor general raised similar concerns.

Of course, the government could take a gradual approach to reduce spending from the current trajectory. However, there are meaningful advantages to moving quickly, including reducing the likelihood of deficits in the years ahead, which would mean more debt and (all else equal) higher interest costs borne by taxpayers.

And the need for fiscal reform in P.E.I. and Atlantic Canada more broadly is even greater than headline numbers suggest because government finances in the region are subject to a number of region-specific risks that could make the fiscal situation more precarious.

For example, the region’s heavy dependence on transfer payments from Ottawa to fund provincial activities. The Maritime provinces specifically receive a larger share of their revenue from federal transfers than any other province in Canada. This makes the region uniquely vulnerable to changes in federal transfer policy. Bringing spending closer in line with own-source revenues (revenue generated within the province) would help mitigate this risk.

Of course, the future effects of interest rates on government debt remains another source of risk for P.E.I. Partly due to lower credit ratings, the Maritime governments generally pay higher interest rates than many other provinces. That’s why one recent report showed that in 2021 the four Atlantic provinces were among the five highest spenders in Canada when it comes to interest payments relative to own-source revenue.

With interest rates rising, these factors make it all the more important for the King government to manage money frugally to prevent the province from starting to accumulate debt that’s more expensive than it has been in years, which could contribute to long-run sustainability challenges.

The recent PBO report made it clear that P.E.I. requires a change in fiscal direction. Spending restraint is needed to restore sustainability and help make the provinces more resilient in the face of fiscal risks in the years ahead.