A $1.6 Trillion Fiscal Hole

Canadian governments have amassed huge obligations which current tax rates leave unfunded. As a result, young Canadians and future taxpayers are on the hook for the over-promises governments have made in the form of public pensions and medical services. We estimate that the unfunded liabilities of these government programs amount to a $1.6 trillion fiscal hole or $102,168 per Canadian taxpayer.

Unfunded liabilities are commitments made by the current and past generations that a future generation will end up paying for. When a government program promises to provide certain benefits for a specific period but lacks the necessary resources to provide them, the program is said to have an unfunded liability.

Consider the Old Age Security (OAS) program, the “cornerstone” of Canada’s retirement income system. Old Age Security pensions are available to all Canadian citizens and legal residents 65 years of age and over, providing they have lived in Canada for a minimum of 10 years of their adult lives.

Current Old Age Security benefits (including the Guaranteed Income Supplement and Survivors Allowance) are paid for out of current federal tax revenue. In 2005, these benefits accounted for 16.3 per cent of total federal program spending up from 13.1 per cent 20 years ago.

At their inception, programs like OAS were based on the assumption that the demographics prevailing in the 1960s would persist. It was considered favourable social and economic policy to transfer a small amount of money from a large group of younger workers to benefit a small group of relatively poor retirees.

Unfortunately, demographic assumptions have proven false. In 1956, only 7.7 per cent of Canadians were over 65 years old. That proportion increased to 13.3 per cent in 2006 and is expected to rise to 24.9 per cent by 2050.

This change in Canada’s demographic makeup has and will continue to increase the portion of federal revenues needed to fund OAS benefits. We estimate that the difference between the stream of promised benefits and the expected future stream of revenues – the unfunded liability of the OAS program - currently stands at $470 billion.

Canada’s Medicare obligations suffer the same ills. In 2005/06, Medicare consumed 19.3 per cent of total federal, provincial and local government revenue. Given that those over 65 years old account for approximately 44 per cent of all health spending, and the fact that the per cent of the population over 65 years old will increase dramatically, the portion of revenue currently used to fund Medicare will not be sufficient to deliver future medical expenses. As such, Medicare’s unfunded liability stands at $555 billion.

Adding the unfunded liabilities of the Old Age Security program and Medicare to that of the Canada & Quebec Pension Plans ($599 billion) puts total Canadian unfunded liabilities at $1.6 trillion. Further, these unfunded liabilities have increased by nearly 20 per cent over the most recent five years for which data is available (1999-2003).

To put these unfunded liabilities in context, the current direct debt of the federal, provincial and local governments stands at $798 million. In other words, Canada’s unfunded liabilities are over twice the total direct debt held by all levels of government.

Given the magnitude of these unfunded liabilities, Canadians are faced with a difficult choice. Either the level of service and benefits will have to decrease or tomorrow’s taxpayers must be burdened with higher taxes.

As a first step, Canadian governments must acknowledge their total liabilities and determine the revenues these existing programs will require over the next 50 years. Canadian governments must also justify any new spending in light of the fact that we do not know how we are going to pay for the programs to which we have already committed.

Further, fundamental reform of government programs such as Medicare and OAS is required to reduce the future burden of these government programs. Greater use of the private sector is one way governments can slow increases in health spending and reduce the unfunded liability of the Medicare system. Canadians must rethink the structure of “pay-as-you-go” systems where current contributions finance current benefits. A more prudent approach would be to accumulate funds in individual accounts for future payment.

Our hope is that the massive fiscal hole created by the unfunded liabilities of government programs begins to receive the same attention as Canada’s debt. Awareness of the debt on the part of the public helped push federal and provincial governments to essentially stop using deficit financing and to begin to decrease Canada’s debt burden. Unless action is taken to reduce Canada’s unfunded liabilities, young Canadians will be hit with a very significant, future tax bill.