Highlights

Management action and support from senior levels of government will support municipalities' ability to match spending with revenues amid rising operating and capital pressures.   The institutional framework for Canadian municipalities remains stable, even amid inflation-driven cost escalation and rising operating and capital requirements stemming from a rapidly growing population and, in some cases transit system imbalances.

S&P Global Ratings sees municipal governments approving above-inflation property tax increases and deferring lower-priority capital to manage budgetary pressures. These, coupled with ongoing transfers from provincial governments and, in some instances, one-off financial deals with individual municipalities, mean budgetary results should remain healthy and largely stable in the next two years. In addition, while we expect borrowing will increase, stronger revenue will keep the debt burden stable at 70% of operating revenue, on average.

Chart 1

Chart 2

Generally, the federal government does not provide operating funds for municipalities.   It provides grants directly to municipalities in lieu of property taxes, and some federal funds are channeled through federal-provincial agreements, targeting specific priorities such as increasing housing supply as home construction struggles to keep up with the pace of population growth. A notable example is the Housing Accelerator Fund initiated in 2022, designed to remove barriers to building more homes and support development of affordable communities through agreements between the federal government and municipalities. This program expedites processes such as planning approvals, zoning amendments, community improvement plans, and stormwater management.

S&P Global Ratings does not expect major municipal reforms to be implemented in the medium term.   Overall, key municipal responsibilities have not eased, and municipal fiscal policy frameworks have not changed, despite some fine-tuning at the provincial level. In addition, historically healthy liquidity levels and relatively low debt burdens remain key credit strengths for Canadian municipalities in general.

Trend: Stable

The trend is stable. We expect budgetary balances will remain strong, despite potential modest weakening in the next two years due to increasing costs and additional service and capital requirements to support an expanding population. We believe strong support from the federal and provincial governments will continue, as observed during and after the COVID-19 pandemic. As a result, we expect any increase in debt will be modest.

S&P Global Ratings does not foresee any significant reform initiatives in the sector that could alter the supportive and predictable framework.

Downside:

We could revise our institutional framework assessment downward if we observe a sustained weakening in the sector's ability to balance revenues and expenditures, such that balances after-capital accounts approach a deficit position and the pace of debt accumulation accelerates. This could stem from changes in the municipal fiscal frameworks limiting municipalities' ability to effectively raise revenues to meet increasing cost requirements or an alternation in the provincial funding formulae, such that transfers to municipalities are notably reduced.

Revenue/Expenditure Balance

Municipalities have sufficient revenue flexibility to meet expenditure needs

Canadian municipalities have strong revenue and expenditure autonomy to manage their budgets. The primary municipal revenue sources are property taxes, water and sewer fees, investment income, provincial and federal grants, licenses and permits, and dividends from government business entities. The main expenditures are protective services (policing, firefighting, etc.), environmental services (water, sewer, and solid waste), transportation services, and social services. Municipal councils can set tax rates and water and sewer fees and authorize expenditures.

Chart 3

Chart 4

Provinces have the power to set restrictions on municipalities, including influencing property tax rates. Despite this hierarchical control, provinces have not used it in ways that affected municipalities' financial performance or long-term credit quality. Tax competitiveness and political factors, however, have been the most effective long-term constraints on municipalities' ability to increase their revenue beyond gains resulting from economic growth.

In the past two years, municipal governments have been meeting rising operating and capital requirements, in part due to persistent high inflation, with above-inflation property tax increases, on average, and cost management. Some municipalities exposed to transit systems also face shortfalls related to lagged recovery in ridership revenue following the pandemic. Operating expenditures are typically less flexible, as personnel costs represent a large proportion of the total. Moreover, some municipalities have incorporated capital levies into their budget or have kept raising utility rates as a funding source for capital to further mitigate debt issuance.

Ongoing fiscal support to municipalities from the provinces is generally strong, in our view, but varies among provincial jurisdictions. In addition, the federal government provides grants to the municipalities, such as sharing a portion of gasoline tax revenue, or sharing the cost of approved infrastructure projects equally between itself and the respective provinces and municipalities.

Provinces set and revise municipal service delivery standards in several areas, which constrains municipal spending autonomy. Some of the most common municipal service standards are for potable water and wastewater quality, protection levels (such as the number of police officers or firefighters per 1,000 inhabitants), building standards, and solid waste disposal.

Labor costs (salaries and benefits) represent the largest share of municipal operating expenditures. Multiyear collective agreements govern these costs and will tend to limit spending flexibility in the next one-three years. Expenditure management is often limited to temporary staff and service level reductions, where feasible, and operating efficiencies.

A broad fiscal policy framework is imposed

Canadian provinces impose extensive fiscal policy frameworks on their municipalities. All 10 provinces require that their municipalities prepare balanced budgets and independently audited financial statements. The provinces place restrictions on the use of derivatives (for genuine hedging purposes only, such as interest- or exchange-rate risks) and on the type of investments municipalities can make. Debt limits are established by statute or through regulation, and all municipalities must issue amortizing debt or establish sinking funds. All frameworks provide supervisory powers over municipalities to the provincial ministry or department responsible for municipalities.

An established track record of extraordinary support

In Canada, there are no formalized procedures for municipal bailouts. However, in the past, provincial governments have undertaken numerous initiatives to assist distressed municipalities. These efforts include providing support through grants and financial resources, akin to assistance offered in response to natural disasters.

The pandemic prompted a federal-provincial collaboration through the Safe Restart Agreement, a multiphase C$19 billion funding agreement. The financial aid facilitated the continued provision of essential services at the local level, mitigating the impact of the pandemic on municipal operations.

The federal government also provided a historic level of support throughout the pandemic (almost C$200 billion in 2020 and 2021) directly to individuals and businesses. As a result, the collection of property taxes, a municipality's largest revenue source, generally remained stable, while grants mitigated the impact of a drop in user fees for transit, parking, and recreation.

More recently, recognizing the problems of a growing population and the need for affordable housing, the federal government launched the Housing Accelerator Fund in 2022 with an allocation of C$4 billion. Operating until 2026-2027, this initiative aims to expedite housing development through agreements between the federal government and municipalities. These agreements are anticipated to streamline various processes, leading to the fast-tracking of permits and the construction of more than 750,000 homes in the next decade.

Another example of extraordinary support occurred in 2000 when the town of Tumbler Ridge, B.C., was in financial difficulty following the closure of a coal mine that was a major employer and taxpayer. British Columbia assumed the municipality's debt and dedicated funding for services. And during the 2008-2009 recession, the provinces, in conjunction with the federal government, boosted their infrastructure grants to provide fiscal stimulus.

Predictability Of The Framework

Frequency of reforms is limited and subject to extensive public consultation

In our opinion, the Canadian municipal institutional framework is very predictable and stable overall. According to the Canadian Constitution, provinces are responsible for municipal governance and oversight, with principal statute powers and responsibilities. While municipal powers are not defined in the constitution, they are outlined in statutes, such as municipal acts, which are amended infrequently.

Provinces exercise control by delegating authority and defining the scope of municipal government action. The governing statutes delineate revenue-raising powers, service responsibilities, and expenditures for all municipalities within their jurisdictions. These statutes cover various aspects, including the role of the mayor and council, municipal organization, financial administration, debt and investment policies, and taxation and collection. Several major municipalities in Canada, such as Calgary, Edmonton, Toronto, and Vancouver, operate under separate city charters established through provincial statutes. These charters acknowledge the distinctive needs of larger cities, offering tools to tailor municipal laws more effectively to their requirements.

In our opinion, the provinces' municipal acts are largely similar, especially the provisions that govern municipal financial administration and debt and investment practices. The main shift in delegating powers to municipalities occurred in the 1990s, marked by a surge of reforms. In 1994-1995, Alberta became the first province to provide municipalities with natural person power, empowering municipalities and transforming restrictive authorizations into general ones.

While subsequent reforms have been infrequent, they are more common than at the federal-provincial level and are often fine-tuning adjustments rather than comprehensive overhauls. In other instances, although reforms may be unfavorable, they are typically preceded by extensive public consultation between a province and its municipalities, making them predictable. For example, Ontario has recently adopted policies that could affect municipalities' ability to collect revenue for growth-related investment and their responsibility for ensuring adequate housing supply. Still, we believe municipalities have some power to influence such reforms, and we consider the overall fiscal framework for municipalities to remain balanced and predictable.

Likewise, the levels of fiscal sustainability in institutional frameworks are also predictable and similar among provinces. Municipalities across the country have largely the same degree of tax- and fee-setting autonomy and have very similar service responsibilities. The greatest variance between provincial frameworks might lie in differences in the levels of funding. Nevertheless, the provincial institutional frameworks are generally far more alike than different. In our opinion, the high predictability of diverse municipal frameworks persists due to the infrequency of substantial reforms by provinces. For example, the Prince Edward Island Municipal Act, implemented in December 2017, replaced a patchwork of legislation from the 1980s. It is noteworthy that the groundwork for updating these laws commenced in 2004. Nevertheless, provincial-municipal relationships exhibit greater dynamism than federal-provincial relationships, primarily because municipal governments are established through provincial statutes.

Although a number of provinces have implemented reforms to their systems, these have been infrequent and often don't result in major changes. Ontario undertook a major reform of its municipal taxation and transfer of responsibilities in 1998 and a review of its Municipal Act in 2008; however, the process resulted in only marginal changes after public consultation. Quebec unilaterally amalgamated municipalities in the largest urban centers and many smaller centers in 2002, abolishing more than 200 former municipalities. Past reforms with significant impacts on municipalities have involved involuntary amalgamation, property assessment, property taxation, provincial transfers, environmental standards, and uploading or downloading of responsibilities.

There are no provincial-municipal transfer programs under the constitution. Provinces have established some municipal grant programs in their own statutes; however, a provincial legislature can readily amend or repeal its statutes. For example, in 2018, as a result of increasing fiscal pressures related to revenue exposure to commodity prices, Saskatchewan amended its municipal grant structure to share 1% of of its provincial sales tax with municipalities, down from 2% previously. While the change was meant to be temporary, the government has yet to create a new formula. Accordingly, we believe that provincial statutes are not as enduring as the constitution, which we view as highly stable.

Municipalities have limited ability to formally influence or oppose reforms

Municipalities operate within the exclusive powers granted to provinces by the Constitution Act of 1867. The division of powers between municipalities and provinces is at the latter's discretion, with provinces holding the authority to determine and delegate municipal powers as they see fit within their jurisdiction.

In addition, Canadian municipalities are not directly represented in their respective provincial legislatures and do not have the power to veto unfavorable provincial decisions. Instead, they must rely on the force of public opinion to oppose unwanted changes. Their resilience arises from the effective collaboration between provinces and municipalities rather than municipalities possessing inherent strength on their own to oppose reforms.

Transparency And Accountability

Roles and responsibilities are clearly defined

At the municipal level, the separation of roles and responsibilities between administrative staff and politicians is what we consider high. As at other levels of government, staff implement the policies set by politicians; their ability to block political decisions is limited.

Robust public sector accounting standards and disclosure, despite some variability in reporting

There is no national standard for budgets, and the comprehensiveness, level of detail, and span (current year only versus multiyear) vary substantially, usually depending on the municipality's size and sophistication. Budgeting practices are very prudent, in our opinion, and are another reason for the strong credit quality of Canadian municipalities. Of note, municipal budgeting processes are evolving and improving as many municipalities have begun or are planning to undertake multiyear operating budgets and 10-year capital budgets. In addition, monitoring systems identify negative expenditure variances efficiently and capital budgets are evolving to better reflect annual cash outlays rather than total project procurement costs.

Reporting standards are generally high, but there can be some exceptions (especially with respect to timeliness) among small and rural municipalities. Financial information is usually timely, accurate, and comprehensive. Strong, in our view, national accounting standards for all governments' financial statements are in place and are based on Canadian public sector generally accepted accounting principles (full accrual) accounting. All municipalities must have their annual financial statements independently audited. Many municipalities also publish variance reports to demonstrate in-year progress against the budget.

Municipal disclosure tends to be greater than that of the provinces, owing to the provinces' oversight of the sector. Statutes mandate some disclosure requirements, especially budgets and annual financial statements. Municipal budgets and financial statements are available to the public. No standards exist for governance, controls, or financial planning. Nevertheless, municipal practices, especially in larger cities, are usually quite advanced, in our view.

Strong control levels and reliability of information

We believe reporting standards are high: Annual financial information is timely, accurate, and comprehensive. The restatement of financial information tends to have only a minor impact on results. Expenditure control systems are timely, allowing municipal managers to implement spending measures within the current year.

Related Criteria

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

Related Research

• Institutional Framework Assessments For Local And Regional Governments Outside Of The U.S., Dec. 15, 2023