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Alberta’s Fiscal Model Needs a Fresh Re-think

January 22, 2013
Glen Hodgson
Senior Vice-President and Chief Economist
Forecasting and Analysis

Alberta is arguably the most blessed jurisdiction in North America. Despite the continued- bumpy global economic environment, prospects are better in Alberta than in every other state and province in North America. The Conference Board of Canada forecasts average growth of 3.0 per cent in 2013. The unemployment rate has already dipped to 4.8 per cent, and we expect private investment growth to remain robust. Alberta has closed the output gap caused by the 2008-09 recession and is moving back to its full growth potential.

Real GDP Growth, Alberta

So why is Alberta in such a muddle when it comes to fiscal policy? Why are fiscal deficits growing again, toward $3 billion annually, rather than shrinking back to a balanced budget as planned? The simple answer is that raising revenue for the provincial government in an energy export-driven economy has seemed too easy for too long. The apparent ease of generating revenue has created the false impression that spending growth could proceed with few constraints. And now, fiscal reality is biting.

Like it or not, Alberta remains a boom-bust economy, driven to a great degree by the global commodity cycle. When global (i.e. Chinese and American) demand for energy and other resources is growing strongly, the revenues pour into Alberta’s coffers from rising incomes and growing energy royalties. But when there are hiccups in the global economy—as occurred repeatedly during 2011 and 2012—that revenue growth stream is interrupted, and government finances can quickly shift into larger fiscal deficits. Moreover, current transportation bottlenecks are proving costly for the provincial treasury—Alberta’s producers are taking heavy price discounts on oil and bitumen production and the problem will not be resolved quickly.

With this reality as a backdrop, Alberta’s approach to fiscal policy needs a fresh re-think. Public finances are heavily exposed to global commodity prices and can exacerbate the boom-bust cycle. Not having a provincial consumption or sales tax is highly popular and has been great politics, but it denies the provincial government a steady and stable source of revenue through the business cycle. It also feeds the illusion of Albertans being richer than they really are—and governments are de facto pressured to use royalty earnings from non-renewal energy and other resources to pay for current government spending on health care, education and other highly-valued public services. This builds the illusion that Albertans can get something they value (hospitals, schools and public infrastructure) without having to pay the full price. Low rates of taxation on personal and corporate income, while popular, add to the wealth illusion and increase the pressure to find revenues from other sources.

What’s the right solution? Alberta’s policies and practices should be re-designed to strengthen the fiscal base and dampen the impact of external market forces. Specifically, within a plan to maintain a balanced budget over time, the province should be banking a growing portion of its expanding energy royalties (like Norway), rather than spending them today. This means expanding the tax base and specifically taxing current consumption to pay for current government services. It means a more measured expansion in public services, recognizing that Alberta can probably still grow spending on health and education faster than almost anyone else in the industrial world. And it means steady growth in private investment, while being careful to avoid excessive exuberance through regular dialogue among the key players.

This kind of advice was offered two years ago by David Emerson and his fellow commissioners in their report Shaping Alberta’s Future. The advice was solid and correct—even if it was generally ignored. It remains the right fiscal advice today.

Moreover, Alberta (and Canada) is facing the major structural challenge of an aging population and workforce, which is making it increasingly difficult for Alberta-based firms to find the talent they need to sustain their planned business path. The days of very tight labour markets and rapidly rising wages in Alberta, as experienced in 2005-07, have returned. Indeed, these labour market pressures will be even more acute this time, due to aging demographics across the country and much slower projected growth in the available labour force.

There are many ways for Alberta to mitigate the impact of aging demographics. Options include: sustained investment in advanced and applied education; active and employment-focused immigration policies; encouraging older workers to stay engaged longer; better integrating Aboriginals into the workforce; continuing to attract other Canadians to Alberta; and private and public organizations transforming their business operations, concentrating on their core functions within the province while shifting non-core operations outside the province wherever possible. All of these options will be needed if Alberta’s firms hope to sustain their growth curve.

The time has come for Alberta to modernize its tax revenue base and chart a more sustainable economic path. The current renewed fiscal pressures reinforce the need to re-think Alberta’s approach to fiscal policy.

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