In this critical and timely essay- a few days before the province’s 2024 Budget is tabled, fiscal planning expert Lennie Kaplan provides an in-depth analysis of problems embedded in the Smith government’s Sustainable Fiscal Planning and Reporting Act (SFPRA). Kaplan argues the SFPRA must be fully re-opened to meet Premier Smith’s commitment to long-term fiscal planning. This analysis reveals there is a great deal of flexibility in the government’s framework in spite of the impression that the government has little fiscal flexibility to spend.
In her televised address on February 21, 2024, Premier Smith promised to bring a long-term fiscal sustainability focus to Alberta fiscal planning, including building up the assets of the Alberta Heritage Savings Trust Fund (AHSTF) and paying down Alberta’s large stockpile of maturing debt. The Premier should be commended for making this commitment.
The fact that Alberta could once again be facing potential business-as-usual (BAU) budget deficits because it has failed in the past to gets its long-term fiscal house in order, as described by our Premier in her address to Albertans, is disturbing, but not surprising.
The culprit once again is overspending of oil and gas revenue windfalls, without due regard to their unique volatility.
Between 2021-22 year-end and 2023-24 second quarter, the Alberta government’s operating spending is estimated to have increased by over $7.8 billion, or nearly 16%. Meanwhile non-renewable resource revenues (NRR) are estimated to have grown by nearly $3.5 billion over the same time-period, a 22% increase. Windfall oil and gas revenues are once again driving spending choices as part of Alberta’s current fiscal planning framework.
Based on the allure of these transitory oil and gas revenue windfalls, during the 2023 election campaign, the United Conservative Party (UCP) committed to new fiscal actions totaling $890 million in 2023-24, $1.3 billion in 2024-25, $1.3 billion in 2025-26, and $1.3 billion in 2026-27. Now reality has once again set in as crude oil prices begin to moderate and long-term interest rates begin to rise from their historic lows. Just a $5.00 per barrel sustained decline in WTI crude oil prices from budget estimates would put Alberta’s finances in a projected deficit position in both 2024-25 and 2025-26. This evolving situation has put the implementation of the $1.1 billion middle class tax cut in 2024-25 on hold. Fiscal planning should not be based on the allure of transitory oil and gas revenue windfalls and election platforms.
Alberta’s new fiscal framework, the Sustainable Fiscal Planning and Reporting Act (SFPRA) was supposed to prevent overspending, but has instead perpetuated the province’s over-reliance on oil and gas revenues for current budget purposes and established various complex loopholes around permitted budget deficits, permitted year-end deficits, and permitted operating spending increases. The SFPRA has failed to “right the fiscal ship” and below are ten major reasons why I think it will not bring a long-term fiscal sustainability focus to fiscal planning in Alberta.
First, the SFPRA does not follow “best practice” of taking a percentage of oil and gas revenues “off the top” for debt repayment and long-term savings and closing off their use for current budgeting. In the past, Alberta’s “best practice” fiscal frameworks encouraged spending restraint by adopting clear and understandable “pay yourself first” rules. In the mid-1990s, Alberta used this approach – budgeting for a surplus dedicated to debt repayment before spending plans were determined to pay-off the accumulated debt. However, this easy to understand “pay yourself first approach” is not a feature of the SFPRA. Instead, debt payments and any long-term savings allocated to the AHSTF are generally treated as year-end “residuals.” In fact, saving a percentage of the year-end surplus rather than “off-the-top” allocations makes debt repayment and long-term savings a residual of spending decisions and would probably mean that during difficult fiscal periods government would not be paying off debt or saving. Under the SFPRA, allocations to debt repayment and AHSTF are taken from residual year-end cash surpluses. This means that virtually all NRR is still being used each year to balance the budget. In fact, based on 2023-24 mid-year fiscal update assumptions, 88% (2024-25), and 84% (2025-26) of non-renewable resource revenues (NRR) is needed to balance the provincial budget over the next two years. To illustrate how dependent Alberta is on NRR to fund current spending, without access to any NRR to balance the budget, Alberta annual non-NRR deficits would be $15.4 billion in 2024-25, and $14.6 billion in 2025-26.
Second, the new fiscal framework does allow the AHSTF to retain 100% of its net investment income, instead of the current requirement to retain only an amount for inflation-proofing. This is not a bad thing, but it comes with a caveat. Allowing the AHSTF to retain all its net investment income reduces cash available to cover current spending and continues the practice of narrowing Alberta’s own-source revenue base.
Perhaps the best solution at this time is to build up the assets of the AHSTF by allow inflation-proofing of the AHSTF, while legislating that a percentage of oil and gas revenues be taken “off the top” and allocated to the AHSTF. AHSTF net investment income, other than inflation-proofing, would thus continue to flow into the province’s General Revenue Fund (GRF) in order to stabilize Alberta’s near-term finances. As the province progressively reduces its reliance on non-renewable resource revenues (NRR) to fund current spending by taking NRR “off-the-top,” the net investment income of the AHSTF could eventually be progressively retained by the Fund in a more prudent and manageable manner.
Third, the SFPRA “bakes in” a high 2022-23 third quarter adjusted operating expense of over $46 billion as the initial base for determining year-over-year operating spending increases. Growing the permanent operating spending base from a year in which spending was already high only prolongs an already unsustainable fiscal situation, especially when NRR returns to more normal levels. In the absence of any comprehensive review of the effectiveness of the $46 billion adjusted operating expense base, there is no indication that this number is an appropriate starting point for determining year-over-year operating spending increases under the SFPRA.
Fourth, the SFPRA adopts the “rule of thumb” used by budget planners that operating spending increases should follow the combined rate of inflation and population growth. Premier Smith has now indicated that operating expenses will be held below the combined rate of inflation and population growth through 2050. But this is not what is reflected in the SFPRA. The year-over-year operating expense base rule (i.e. using the previous year’s combined growth in population and inflation), under the SFPRA, creates additional slack for injecting new operating spending into the budget on a year-to-year basis, while running SFPRA-induced deficits.
In 2024-25 and 2025-26, alone, the added operating expense increase permitted under the SFPRA is estimated at over $2.7 billion and $2.0 billion, respectively. In sum, although operating spending increases for 2024-25 and 2025-26 are projected in the 2023/24 mid-year fiscal update at 2.1% and 1.7%, respectively, they could go as high as a 7.6% increase in 2024-25 and a 5.4% increase in 2025-26, under the SFPRA, so long as total budget revenues fall by $1 billion from the previous year’s 3rd quarter total revenues or actual total revenues are $500 million less than the total budgeted revenues in a fiscal year. This is a possible scenario if crude oil prices continue to moderate to more historical levels. In addition, the timing of inflation and population data under the SFPRA is a concern. As budget preparations typically begin in fall, only the inflation and population growth from the prior year would be known. Given the volatility associated with Alberta’s economy, the difference in these two measures from year-to-year could be very significant.
Fifth, as the Fraser Institute has noted, the new fiscal framework does not actually protect Albertans from debt accumulation. With debt repayment being a residual to operating spending under the SFPRA, Alberta’s $76 billion in taxpayer-supported debt, and the resulting $2.3 billion in taxpayer-supported debt servicing costs, are heavily exposed to the expectation of higher short- and long-term interest rates over the next four fiscal years.
There is over $32.5 billion in Alberta taxpayer-supported debt maturing over the next four fiscal years, and we will likely see much of that debt refinanced at significantly higher interest rates. This refinancing of taxpayer-supported debt is estimated to cost Alberta taxpayers more than $500 million in cumulative additional taxpayer-supported debt servicing payments over the next four fiscal years. Under this higher long-term interest rate scenario, annual taxpayer-supported debt servicing costs in Alberta are estimated to reach over $2.75 billion per year by 2026-27. With each additional one percent sustained annual increase in interest rates, Alberta adds nearly $150 million more in annual debt servicing costs. As annual debt servicing costs grow, they “crowd out” more and more government spending in such vital areas as health and education. This is a very worrying trend for Albertans to consider, with the consequences of rapid BAU debt accumulation in Alberta over the past decade now coming home to roost, as long-term interest rates rise.
Sixth, there is a need to appropriately budget for “emergencies and disasters” as a separate line item in the Fiscal Plan, based on past experiences and future trends, rather than initially rolling it into a broader contingency reserve, which is exempted from the in-year spending limits under the SFPRA. The high level of annual “emergencies and disaster” spending, particularly forest firefighting and drought expense, in recent years suggests these are not one-time or unforeseen events. Therefore, an amount for “emergencies and disasters” should be clearly budgeted, based on the previous rolling five-year average. If additional funds are required during the fiscal year, they would not be counted under the in-year spending limits of the SFPRA.
Seventh, within the SFPRA, there are loopholes permitting actual year-end deficits in the audited financial statements. At year-end, a deficit is allowed in the audited financial statements if actual total revenue has declined by $500 million or more from the current year budgeted amount. Under the $500 million rule, the revenue decline permitted to run a year-end deficit is rather small as a percentage of total revenues, just 0.68% of total revenues in 2024-25 and just 0.67% of total revenues in 2025-26. This begs the question of how and why the $500 million actual revenue decline rule was chosen? The deficit permitted under the SFPRA, based on a $500 million actual revenue decline from budget, could be as high as $1.1 billion in 2024-25, if the government were to use the full operating expense base permitted under the SFPRA. And when a year-end deficit does occur under the SFPRA, the government has an additional two full fiscal years to return to balance. This rule hardly encourages fiscal discipline.
Eighth, the SFPRA also allows budget deficits in the Fiscal Plan when total budgeted revenues decline by $1 billion or more from the prior-year third quarter (3Q) revenue forecast. This loophole under the SFPRA is also rather generous and could lead to significant budget deficits. For example, if total revenues fell by $1 billion from the previous year’s 3Q total revenues, the projected deficit permitted under the SFPRA could be $1.6 billion in 2024-25. This begs the question of how and why the $1 billion budgeted revenue decline rule was chosen?
Ninth, the SFPRA does not include capital spending within the parameters of limiting year-to-year and in-year increases to spending. Alberta’s Capital Plan (capital grants and capital investment) has averaged nearly $6.7 billion over the past decade. These amounts are a significant component of Alberta’s annual program spending. What this means is that in times of sustained revenue growth, there would be no restraint on capital spending, while there would be at least some restraint on operating spending. This could create a situation where the lack of restraint on capital spending creates future year pressures on the operating side. Given the lag between capital spending and the operating costs associated with capital spending, the lack of restraint could put pressure on year-over-year spending.
Applying spending limits under the SFPRA to only a portion of government spending distorts fiscal decisions, making public spending less effective. This loophole favours capital and could focus fiscal adjustments to prevent deficits on the operating expense side.
Tenth, the SFPRA lacks many critical features of fiscal transparency and accountability of “best practice” fiscal frameworks. Among other deficiencies, there is no legal requirement for the tabling of an annual Debt Management Strategy setting out the key goals, objectives, strategies actions and performance measures associated with the management of the province’s debt portfolio.
There is no legal requirement for a long-term assessment of Alberta’s fiscal environment, the Long-Term Fiscal Sustainability Report. There is no legal requirement for tabling a budget stress testing and revenue and expenditure at risk report. There is no legal requirement for an annual program and service transformation review to ensure its permanence as a critical feature of the budget and fiscal planning process. There is no legal requirement for a Revenue Forecast Allowance. And there is no legal requirement for a comprehensive review of the SFPRA, every four or five years, to ensure its continued relevance.
Fiscal Anchors
A word on Alberta’s two informal fiscal anchors: the requirement to keep the net financial debt-to-GDP ratio under 30% and Alberta’s program expenses per person in line with the average of comparator provinces of B.C., Ontario and Quebec. The net financial debt-to-GDP limit of 30% does not inspire fiscal discipline. In fact, using the rule and applying it to the 2024 Alberta nominal GDP of $466.2 billion would permit a net financial debt of nearly $140 billion for 2024-25, some $100 billion higher than the net financial debt of $40 billion estimated for that fiscal year, The net financial debt-to-GDP limit needs to be lowered to no more than 15 percent, and either continue to serve as an informal anchor, or, more logically, as a legislated rule in the SFPRA. Legislating the net financial debt-to-GDP in the SFPRA is much more transparent and focuses the bright light of public attention on any government that decides in the future to raise the debt limit ceiling above 15 percent by amending the SFPRA.
The informal anchor that Alberta program spending per person be near the average of B.C, Ontario and Quebec, while a starting point back in 2019, seems to act now as an instrument preventing the government from adopting an annual, comprehensive and legislated program and service transformation framework. The attitude in government could be that now that we have reached the average spending of comparator provinces, why should we continue to examine the effectiveness and efficiency of government programs and services, But who says that program spending per person at the average level of B.C, Ontario and Quebec is the right level for Alberta? According to RBC Economics, for example, in 2022/23 (the latest year of actual data), Alberta’s program spending was $13,570 per person, which was still more than $1,200 higher than Ontario.
Maybe Alberta’s program spending per person should be closer to Ontario’s? But we do not know because the Alberta government has not finished the difficult, but needed, work to fully evaluate the effectiveness and efficiency of all its program and services.
Clearly the SFPRA and the two informal fiscal anchors has fallen short on meeting their objective, that is to bring a long-term sustainability focus to fiscal planning Here is what others have to say – those who closely follow Alberta’s finances.
Trevor Tombe notes that
the central focus of the Smith government’s (2023) budget was a new fiscal framework to help deal with Alberta’s unique economic and revenue volatility. It requires a balanced budget (unless revenues fall), limits spending growth to inflation plus population growth (conveniently allowing today’s big increase, with inflation so high), and creates a rule to allocate surplus cash (including on new “one-time” spending). This framework falls far short of addressing its own stated goal. To achieve any meaningful degree of stability in Alberta’s finances, more resource revenues must be saved. This budget was a unique opportunity to present a longer-term vision beyond the next election. It was an opportunity to finally help stabilize Alberta’s finances. It was an opportunity to save windfall dollars that we were not previously counting on. But in the end, it made instability and risks worse. It was an opportunity missed.
According to the credit rating agency, Moody’s, “the province’s overall fiscal strength remains very much tied to continued high levels of non-renewable resource revenue, in particular oil. Therefore, a key risk to the budget remains the province’s susceptibility to volatile oil prices which drive a material share of revenue…The continued reliance in budgeting on a volatile non-renewable resource exposes the province to significant uncertainty as global price shifts can create large swings in its fiscal results.”
The Fraser Institute states “ in the absence of tax increases, the government must reduce spending so it more closely aligns with stable ongoing levels of government revenue rather than volatile resource revenue. So far, the Smith government has increased the spending plan at every turn. And rather than tackle high spending, it’s developed a new fiscal framework, which won’t actually protect Albertans from debt accumulation.”
Dilemma of funding ever rising expenses with volatile sources of revenue
Transitory oil and gas revenue windfalls merely paper over the underlying fiscal risks to which the provincial budget is exposed, including: (1) volatile crude oil price movements within each fiscal year; (2) continued inflationary pressures leading to further requests for government relief; (3) energy and environmental policy and regulatory uncertainty continuing to constrain oil and gas investment; (4) rising environmental concerns, including emerging environmental liabilities and climate change policies on the oil and gas sector and government revenues; (5) increasing risk of significant emergencies and disasters, such as increased severity of forest fires and drought conditions; (6) a debt burden risk heightened as interest rates begin to rise from historically low levels; (7) population growth driving various volume pressures, such as K-12 schools and post-secondary education; (8) an aging population placing growing pressure on core programs in health care and social services; (9) continued demands for increases to public sector compensation; and (10) capital demands (for both new infrastructure and maintenance) as a result of a growing population. And, over the longer-run, strengthened global climate change policies and an accelerating energy transition will reduce oil and gas revenues as a contributor to provincial finances.
Unfortunately, the SFPRA appears to continue the trend of recent fiscal frameworks, most notably the NDP’s Fiscal Planning and Transparency Act (FPTA), hoping for a sustained rebound in oil prices to fulfill spending promises and paper over concerns about long-term fiscal sustainability. While this strategy has worked over the past couple of years, historically high NRR will provide only a temporary patch job as the fiscal pressures noted above, mount.
High resource revenues merely obscure the underlying fiscal risk and structural issues to which Alberta finances are already exposed.
The SFPRA simply is not geared towards the promotion of long-term-oriented fiscal policy.
Finally, speaking about Alberta getting its long-term fiscal house in order, there is a need to put revenue diversification on the table for discussion in conjunction with a more durable long-term oriented fiscal framework. Alberta has been progressively narrowing its revenue base over the past decade and a half; eliminating health care premiums; eliminating the Climate Leadership Plan consumer carbon tax; reducing the corporate income tax rate from 12 percent to 8 percent; allowing the Heritage Fund to retain all its investment income; making personal income taxes and corporate income tax increases subject to the Taxpayer Protection Act, and now a plan down the road to create a new 8% bracket on personal income under $60,000. Without diversifying Alberta’s revenue streams, it is difficult to see how the current revenue base, incorporating an inevitable moderation in resource revenues, can keep pace with Alberta’s long-term spending pressures.
So, what now? Alberta’s current fiscal framework had not been comprehensively reviewed, including a major “best practice” review, in over a decade. Other provinces and jurisdictions outside Canada have used and continue to use well designed fiscal planning frameworks —which constrain fiscal policy by controlling factors like expenditures, revenues, deficits and debt and increasing compliance and transparency—as a cornerstone for long-term fiscal planning. The IMF has noted that well-designed fiscal frameworks have been effective in containing excessive deficits and debts in other countries. The OECD has noted that targets can serve as a fiscal policy anchor for government to help ensure the sustainability of fiscal policy and maintain sufficient policy room for the government to cope with adverse shocks. Alberta is being passed by others in developing and implementing “best practice” fiscal frameworks.
The time to act is now. Fundamental changes are required to position Alberta government finances over the medium- to long-term for the “new normal” in a post-COVID-19 era; a “new normal” marked by volatile revenues and the impacts of population aging, the energy transition, and net zero, among other factors. And, comprehensive reform of Alberta’s current fiscal framework is needed to encourage fiscal sustainability, manage revenue volatility, provide stability to fiscal planning, save for the future, pay down debt, and contribute to the long-term ability of the government to maintain competitive tax rates and key programs and services which are vital elements of the province’s economic and social prosperity.
Alberta’s new fiscal framework as currently enacted will not bring a long-term sustainability focus to fiscal planning, as Premier Smith committed to in her speech to Albertans, last week. Alberta’s current fiscal framework needs to be re-opened as part of Budget 2024.
Lennie Kaplan is a former senior manager in the Fiscal and Economic Policy Division of Alberta’s Ministry of Treasury Board and Finance (TB&F) where, among other duties, he examined best practices in fiscal frameworks for oil and gas-producing jurisdictions, including savings strategies foe non-renewable resource revenues (NRR). In 2012, he won a Corporate Values Award in TB&F for his work on Alberta’s Fiscal Framework Review. In 2019, Mr. Kaplan served as Executive Director to the MacKinnon Report on Alberta’s Finances. He recently retired from his position as Executive Director of Research at the Canadian Energy Centre.
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