Major Factors

Recent Developments

Federal support during the pandemic tempered weaker fiscal results for provinces

Since S&P Global Ratings' last review of the institutional framework for the Canadian provinces, developments have been positive overall, most notably those associated with the ongoing COVID-19 pandemic. Twice in the past dozen years, the federal government has provided support to the provinces in a time of stress. During the 2008-2009 financial crisis, it supported provincial economic recoveries with increased infrastructure investment.

More recently, during the pandemic, the federal government chose to allocate the vast majority of its support (almost C$200 billion in fiscal years 2021 and 2022) directly to individuals and businesses in the form of income support to individuals and wage subsidies to business. At the provincial level, grants, via the C$19 billion Safe Restart Agreement and other ad hoc funding (for personal protective equipment and testing), were allocated to help fund the rising costs related to the pandemic, a portion of which was passed down to the municipal level. Notably, at the immediate onset of the pandemic, in spring 2020, the Bank of Canada stepped in with two temporary programs to support the liquidity and efficiency of provincial funding markets by purchasing bonds and short-term paper through the short-term money market and long-term bond purchase programs. These programs were both wound down in 2021.

Social distancing requirements established by the provinces to mitigate the spread of COVID-19 greatly reduced economic activity and resulted in a significant decline in own-source revenues in fiscal 2021 and led to substantial after-capital deficits. As the economy recovered, provincial financial performance improved, most notably in fiscal 2022, owing to strong growth in nominal GDP and taxes, which offset a moderate decline in federal transfers. The extent of provincial fiscal deterioration was limited by the initiatives of the federal government, which did most of the heavy lifting in the country's financial response. The pandemic response is another noteworthy example in the long history of extraordinary support from the federal government to the provinces.

Predictability: Visibility Of Reforms Is High

Frequency and extent of reforms

The provincial institutional framework is stable and we view predictability as high. The Canadian constitution is the cornerstone of federal-provincial intergovernmental arrangements. While changes to the constitution have been rare historically, they have happened. The constitution was amended in 1982 when the Canadian government repatriated it from the U.K. and added the Charter of Rights and Freedoms, as well as a constitutional amending formula. An effort to amend the constitution in 1990 failed. The formulas used to determine the amounts transferred to the provinces under the three main transfer programs (Equalization, Canada Health transfer, and Canada Social transfer) were amended in 2014 as part of the renewal of the 10-year transfer agreements. The agreements are set to renew in 2024 and negotiations will start in earnest in the near term. The visibility of future reforms is high: The main transfer agreements are renegotiated every 10 years and potential changes to the constitution are prefaced by extensive and lengthy public consultation.

Ability of provinces to influence or oppose reform

The provinces are not directly represented in the House of Commons or Senate, nor do they have the power to veto unfavorable federal decisions. Rather, they must rely instead on the force of public opinion to oppose unwanted changes.

Revenue And Expenditure Balance: Full Autonomy Has Effective Limits

Overall adequacy of revenues to cover expenditures needs

The provinces have almost full revenue and expenditure autonomy for the powers and responsibilities granted to them under the constitution. In theory, revenues should always be adequate to cover expenditures. Autonomy, however, has effective limits. Political considerations and tax competitiveness with other provinces and U.S. states constrain the ability to increase revenues beyond those gains resulting from economic growth--whether by raising existing tax rates or imposing new taxes. Furthermore, the nature of the provinces' key spending responsibilities effectively constrains expenditure autonomy. Health care, which has been claiming a progressively larger share of provincial budgets, is the best example. Moreover, labor costs (salaries and benefits) represent the largest share of provincial operating expenditures, and multiyear collective agreements govern these costs, which can limit short- and medium-term spending flexibility.

The effective constraints on revenue autonomy are most evident in periods of stress, such as during the financial crisis and the pandemic. Governments are generally very reluctant to impose new taxes to backfill revenue shortfalls, preferring instead to focus their efforts on the often-slow process of managing down expenditures. Consequently, they have little choice but to issue additional debt to cover the shortfalls. This was evident for Canadian provinces as debt burdens rose more rapidly following the financial crisis and in 2020-2021. As social distancing measures were lifted, provincial economies recovered faster than expected, leading to stronger fiscal outcomes, which has tempered debt issuance. Nevertheless, provincial debt burdens are already high generally; tax-supported debt ratios ranged from about 142% to 300% in fiscal 2021.

The federal government's equalization program is relatively small; in fiscal 2022-2023, about C$22 billion is expected to be distributed to five provinces. The other two transfers are more important; the health and social transfers to the provinces will total about C$61 billion in 2022-2023. The total of the three transfer programs will represent about 18% of total provincial revenues of about C$465 billion in fiscal 2022-2023. Despite their relatively small size, transfer programs are important to all provinces and vital to some, representing as much as approximately 25% of operating revenues.

Chart 1

Chart 2

Chart 3

Chart 4

Fiscal Policy Framework

The constitution does not permit the federal government to impose any fiscal policy framework or penalties on the provinces. Instead, many provinces voluntarily enacted their own frameworks, such as balanced budget and debt-reduction legislation. The self-imposed frameworks were not adequate safeguards, as most of the balanced budget legislation from before 2008-2009 was relaxed when the recession sideswiped provincial revenues and deficits swelled.

Extraordinary Support

There are no formalized procedures for provincial bailouts. Nevertheless, there is a long history of extraordinary support to the provinces from the federal government. The federal government has regularly provided extraordinary support for natural disasters, typically floods or wildfires. It has also provided extraordinary support to provinces in financial distress, both individually and to the sector as a whole. It provided sectorwide support in the aftermath of the financial crisis when it significantly increased infrastructure grants to the provinces and their municipalities to stimulate their economies. It more recently provided a historic level of support through the pandemic directly to individuals and businesses and has supported provinces indirectly, as individuals and businesses (to a lesser degree) were able to pay taxes and stay employed. In addition, the Bank of Canada established two provincial debt-buying programs to support provincial debt issuance (short- and long-term) during the pandemic.

Transparency And Accountability

Transparency and institutionalization of budgetary process

There is no national standard for budgets, and the comprehensiveness, level of detail, and span (current year only versus multiyear) can vary substantially among the provinces. Nevertheless, we believe budgeting practices are prudent, and monitoring systems are in place to identify overspending compared to budget on a timely basis. Generally, long-term financial planning is weak, in our view. The roles and responsibilities of administration staff and politicians are separate: Staff implement policies that politicians set.

Disclosure and accounting standards

Strong national accounting standards for financial statements exist for all governments based on Canadian public sector generally accepted accounting principles (full-accrual). Each province has an auditor general who is independent of the government and whose role is to report on annual financial statements to the legislature. Although no national standards exist for disclosure, provincial financial administration statutes do have some disclosure requirements (for budgets, quarterly reports, and annual financial statements). Provincial budgets and financial statements are available to the public in a variety of ways. No national standards exist concerning governance, controls, or planning, although provincial practices are typically advanced, in our view.

Control levels and reliability of information

We believe reporting standards are high, and annual financial information is timely, accurate, and comprehensive. The restatement of financial information is relatively infrequent and tends to have a minor impact on results. Expenditure control systems are sophisticated and timely, allowing politicians and administrators to implement spending measures within the current year.

Trend: Stable

Through the pandemic, effective, albeit temporary support was provided by the federal government via different measures including direct support to individuals and business, and, to a lesser degree, ad hoc provincial grants and the Bank of Canada's two bond purchase programs. We do not foresee any changes to the framework in the next two to three years that would cause us to revise our assessment.

Related Criteria

• Guidance: Methodology For Rating Local And Regional Governments Outside Of The U.S., July 15, 2019

Related Research

• Institutional Framework Assessments For International Local And Regional Governments, Feb. 10, 2022