Alberta ‘fiscal capacity’ plummeting, Kenney government must react

Many Canadians have long thought of their country as divided between affluent “have” provinces and poorer “have-nots.” The traditional dividing line has been whether a province receives equalization payments.

But this bifurcation is outdated. Over the past 15 years, a process we call the “Great Convergence” has occurred. Simply put, the 10 provinces have moved closer together—closer than ever before—in terms of their ability to raise money to fund their own government services.

Before going any further, we should provide a loose definition of a wonky-yet-important term—"fiscal capacity,” which measures a province’s ability to raise “own-source” revenues at similar tax rates to fund government services. Richer provinces, or those with ample natural resource revenues, tend to have high fiscal capacities compared to lower-income provinces without similar resource revenues. Provinces with lower fiscal capacities are eligible for equalization.

And the “fiscal capacity” gap between provinces is shrinking—quickly—which has important policy implications across Canada, especially in Alberta.

Alberta’s drop in fiscal capacity generally, and natural resource revenue specifically, is the primary driver of these national trends. In fact, Alberta’s fiscal capacity (per-capita inflation-adjusted) dropped by an estimated 45.1 per cent between 2007 and this year.

To better understand the fall, consider this. In 2008/09, Alberta’s per-capita fiscal capacity was more than twice as high as the rest of Canada’s. This advantage has disappeared almost entirely thanks to the “Great Convergence.” We estimate Alberta’s fiscal capacity will only be four per cent higher than the rest of Canada (excluding Alberta) this year. What’s more, Alberta will likely lose its spot as the highest fiscal capacity province this year, with British Columbia set to replace it.

So what does this mean for Alberta?

In short, unless the Kenney government wants to raise taxes, it must find a way to live within the province’s significantly reduced means. Alberta currently spends substantially more per person on government services the other large province in Canada. This feature of Alberta’s governance has been unsustainable for some time, but the province’s fiscal capacity collapse means that (again, barring tax increases) the province can expect massive budget deficits for the foreseeable future—unless it reins in spending.

Of course, at this moment Alberta is in the midst of a public health and economic crisis. The province can afford to take necessary emergency measures to protect public health and provide well-considered support for families and businesses. This should be the government’s top priority at the moment.

However, Alberta’s daunting fiscal challenges pre-date the COVID recession and will still be there when the crisis subsides. Today, the government should be developing a plan to restore the province’s finances, which must include reckoning with the “Great Convergence” and its consequences for the province.

Alberta Finance Minister Travis Toews recently said “we can no longer spend like the rich kids on the block because quite frankly, we’re not anymore.” The data very much support Minister Toews’ characterization, which would make an excellent guide to policymaking in Alberta in the years ahead.