Federal and provincial fiscal responsibilities are increasingly misaligned, and policymakers need to account for this imbalance when making spending and revenue decisions, say Desjardins economists.
“At a time when the federal government is pursuing an ambitious spending and investment agenda, it should not lose sight of the mounting structural pressures facing provincial finances,” Desjardins Deputy Chief Economist Randall Bartlett and Senior Economist Laura Gu, wrote in an analysis, Do Canadian Governments Have a Revenue Problem?
“With federal fiscal room potentially more constrained than budget projections suggest, there is a risk that Ottawa’s ability to respond to these pressures will become even more limited.”
The warning comes as Canadian governments grapple with near-record deficits, with the exception of some oil-producing provinces.
However, Bartlett and Gu argue the financial challenges facing federal and provincial governments are fundamentally different.
“With revenues near their highest share of GDP in two decades — a time when the Government of Canada was running significant and sustained budget surpluses — ongoing large federal deficits today point more to a spending problem than a revenue one,” they wrote.
Provincial governments, meanwhile, face a more challenging revenue outlook.
Provincial revenues reached 20.9% of nominal GDP in the 2024-25 fiscal year but are projected to decline to 20.1% in 2026-27. By 2027-28, revenues could approach their pre-pandemic decade average of 19.7.
At the same time, federal transfers have failed to keep pace with the rising cost of public services, particularly health care.
The Canada Health Transfer's share of provincial health spending has declined from an average of 23% in the three years before the pandemic to approximately 20%, forcing provinces to devote more of their own resources to health care.
Resource-producing provinces face additional uncertainty because of their reliance on commodity prices. In Alberta, higher oil royalties accounted for $9.3 billion of an $11.7-billion upward revenue revision in the province's first-quarter update. Oil royalties now represent 29.2% of Alberta's own-source revenues, compared with a pre-pandemic average of 13.5%.
“As revenue growth faces mounting headwinds, provinces lack a durable revenue base to support their expanding spending commitments,” they wrote.
Desjardins estimates provinces collectively would need additional revenues approaching 1% of nominal GDP to sustainably balance their budgets over the next three years, assuming spending remains as planned.
“Additional federal funding could narrow the gap, while raising provincial own-source revenues through higher taxes and fees is another option,” they said. “Spending cuts and/or often hard-to-find efficiencies are of course another option.”
They pointed to the federal Productivity Mega Deduction as an example of how federal policy can affect provincial finances, noting that the measure reduced revenues for both levels of government without additional federal transfers to compensate provinces.
While provinces remain responsible for managing their finances, Bartlett and Gu called for greater consideration of these pressures in federal fiscal policy.
“Ultimately, Canadians fund both levels of government and rely on the services they collectively provide. There is just one taxpayer in Canada after all,” they wrote.
