5 Alberta Sales Tax An Inevitability and an Opportunity to Reset

Melville McMillan

Albertans are accustomed to enjoying quality public services and low taxes thanks to the substantial contributions that non-renewable resource revenues—which I will refer to simply as resource revenues—have made to the provincial budget. Those contributions, however, have decreased to a fraction of earlier levels—a drop in revenue that has left a substantial hole in the province’s finances. Will resource revenues increase to close the budget gap and restore the Alberta Advantage? We can certainly hope for such a recovery but, despite the recent improvements, the prospects are uncertain and the projected magnitudes are insufficient to solve the problem in the long run.1 In a low resource revenue environment, Albertans need to reassess their fiscal options.

The effective contributions of the provincial government’s resource revenues to Alberta’s households since 1972 are reported in figure 5.1. The graph shows the share of household incomes that the government’s resource revenues would have comprised if, for example, they were paid out as “dividends” to Albertans. Of course, that was not done; the funds were actually retained by the province to finance public services and reduce the taxes paid by provincial taxpayers. However, by comparing resource revenues to household income in this way, we are able to look at the impact of resource revenues in a way that accounts for population growth, inflation, and real income growth over time. Also, because citizens pay out of income for the bulk of public services through taxes and a variety of other levies (e.g., charges, fees, and licenses), comparison to household income serves to indicate the impacts of provincial government resource revenues on their net of tax income. In addition, household income is a major determinant of demand for public (as well as private) goods and services and, since wages and salaries make up the majority of household income and of government costs, it is also an indicator of the cost of providing public goods and services.2

Two features stand out in figure 5.1. First is that resource revenues are quite volatile, as the up and down movements of the graph demonstrate. This is a widely recognized fact. The second is that there has been a downward trend in resource revenues, which have failed to grow as fast as population and average household income. They have, therefore, become less able to contribute to government revenues. Until the 1985–86 fiscal year, resource revenues averaged 15.3 percent of household incomes. Over the next fourteen years, they averaged only 4.4 percent. For almost a decade at the beginning of the 2000s, they saw some recovery in their contribution, averaging 7.3 percent. When the global financial crisis hit in 2008–09, Alberta saw a drop in natural gas prices, due in part to the emergence of fracking technology and shifting locations of energy developments. This resulted in resource revenues dropping to 4.4 percent of household incomes. The collapse of oil prices in 2014 and 2015, and the resulting industry problems led to resource revenues dropping again, this time to an average of 1.8 percent of household incomes from 2015–16 to 2019–20. The COVID-19 crisis led to resource revenues falling to 1.2 percent of household income in the 2020–21 fiscal year. Importantly, figure 5.1 shows that resource revenues between 2015 and 2020 have been the lowest they’ve ever been relative to household incomes (and, just as importantly, to the government’s budget) since 1973. However, oil and natural gas prices have increased markedly during 2021 and, as of August 2021, the provincial government’s resource revenues for 2021–22 are projected to be more than three times the 2020–21 level (Government of Alberta 2021a). Nevertheless, that resource revenues will only amount to 3.8 percent of household income.

The impacts of these changes on provincial finances are substantial. While the longer story is interesting, the focus in this chapter is the period post-2000. As resource revenues improved following the turn of the century, the Alberta government accumulated a Sustainability/Capital/Contingency Fund that reached $17 billion in 2007–08. Thereafter, those funds were drawn down to support government operating and capital expenditures. Borrowing grew during the recession, and the province ran a sequence of (typically small to modest) deficits until 2015–16, when another collapse of oil prices further negatively impacted the provincial budget. From 2015–16 on, deficits have been large and the extent of the province’s borrowing has greatly expanded. The 2020 COVID-19 pandemic has created an additional fiscal shock. The 2020–21 deficit rose from a projected $7.3 billion to an actual $17 billion and the total taxpayer-supported debt reached $93 billion by the end of the 31 March 2021 fiscal year (Government of Alberta 2021a, 2021c). Illustrative of the deteriorating fiscal situation, the province’s net financial assets have fallen from a positive $31.8 billion to a negative $59.5 billion since 2008–09—a decline of $91.4 billion, or $20,500 per capita at the 2021 population.

Will resource revenues recover and restore budget balance without further taxes or substantial expenditure reductions? Despite the 2021 improvement, the prospects are not optimistic. Projections appear in figure 5.2 for fiscal 2021–22 forward. To demonstrate the unpredictability of resource revenues, two projections appear for the years 2021–22 to 2026–27. The lower of the two is a projection I generated in the fall of 2020. At that time, the province had provided no post-COVID-19 budget projections or economic assumptions, so I generated projections of resource revenues and household incomes to 2026–27 from other sources.3 Fiscal 2026 is the year that Trevor Tombe (2020) expects that the Alberta government would be able to balance its budget without increasing taxes, if it continues to freeze expenditures (excluding those related to COVID-19 and recovery from the pandemic) at $56 billion.

The upper line is the six-year projection based on the Government of Alberta’s (2021a) projection that 2021–22 resource revenues will be $9.76 billion. At the time of writing, the province has not yet provided projections beyond 2021–22. Resource revenues might improve but, given that oil futures indicate that oil prices are expected to decline to $65 per barrel over the next three years, resource revenues might not be sustained (ARC Energy Research Institute 2021). Given the uncertainty, I simply assume that resource revenues will continue to be $10 billion each year until 2026–27.

The two projections imply quite different medium-term futures, but both lead to the same end. The more optimistic forecast is positive in that it implies that Alberta avoids a slow resource revenue recovery and a prolonged period of exceptionally low resource revenues. However, both projections lead to Tombe’s 2027–28 projection. At that time, resource revenues are expected to amount to 3.15 percent of household income—still well below pre-2015 levels. Hence, it appears unlikely that non-renewable resource revenues will recover to levels experienced during the first decade of the century when the economy boomed and provincial government budget surpluses were the norm.4

What about the long term? While resource revenues are notoriously difficult to predict, Trevor Tombe (2018) has ventured a look at Alberta’s fiscal future to 2040. Figure 5.2 shows the predicted contributions of resource revenues relative to household incomes to 2040 using my projections from 2021–22 to 2026–27 and Tombe’s projections from 2027–28 on. The graph also shows the percentages back to 2000, for comparison.5 The projections assume that a restoration of the energy market and improved resource revenues would be accompanied by improvements in household incomes.

As figure 5.2 shows, the long-term projections for the contributions of resource revenues are rather gloomy. Resource revenues as a percentage of household incomes are not predicted to increase beyond the government’s projected 2021–22 level of 3.8 percent. Indeed, under the more optimistic medium-term projections (which assume that resource revenues are steady at $10 billion per year to 2026–27), the percentage simply gradually declines to 2.8 percent in 2040–41. From 2027–28 to 2040–41, the average is only 3.0 percent. This is somewhat less than one-half the 6.4 percent average from 2000–01 to 2014–15 and about two-thirds of the average from 2009–10 to 2014–15, with the latter being a period during which the province was already experiencing fiscal problems. This long-term projection is even well below the 4.4 percent average experienced during the lows of the late 1980s and throughout the 1990s (see figure 5.1). Thus, these projections suggest that growing resource revenues alone will not restore the fiscal comfort Alberta enjoyed before 2015–16.

Projections are uncertain and are the product of the underlying assumptions. As is typical, a range of assumptions were used in deriving the long-term projections presented here. The 2027–28 to 2040–41 projections reported in figure 5.2 are the average of eight specifications. Those eight are the result of Tombe’s (2018) baseline and optimistic resource revenue projections in combination with four of my household income projections. It is also interesting to look at the range of outcomes that the set of specifications imply. That range is determined primarily by the difference in the assumptions about resource revenues.6

Figure 5.3 presents the high and low projections of resource revenues relative to household incomes for the years 2027–28 to 2040–41 along with, for perspective, the medium-term projections for the previous five years (as outlined in figure 5.2) and the actual levels from 2015–16 to 2020–21 (as outlined in figure 5.1). The low long-term projection line links to the low medium-term projection shown in figure 5.2 in 2027–28. The low long-term projection for 2027–28 is actually, at 2.84 percent, the highest level of that series. It then declines to 2.45 percent by 2040–41. Over the thirteen-year long-term projection period, resource revenues average 2.68 percent of household incomes in the low projection scenario.

The high projection scenario looks rather different. It starts with the sharp increase in resource revenues projected in August 2021 for 2022–23, which are assumed to continue to 2026–27 (Government of Alberta 2021a). That medium-term projection transitions smoothly into the beginning of the long-term high projection in 2027–28, which is the beginning here of Tombe’s optimistic projections. Though optimistic and being a considerable improvement from the six years of fiscal 2015 to fiscal 2020, the 3.5 percent level in 2027–28 is still modest compared to the percentages before fiscal 2015. In addition, while the percentage is projected to almost be maintained until 2031–32, it thereafter declines gradually to 3.0 percent in 2040–41. The average over the thirteen years is 3.29 percent.

The differences between the low and high projections are not dramatic. Indeed, they are probably disappointingly small, especially given that even the high estimate is only about half of the 6.4 percent level that resource revenues generated over the first fifteen years of the century prior to the 2015–16 recession. Hence, even if resource revenues considerably exceed baseline expectations, they will still be insufficient to generate enough provincial government revenues to match even the moderate, let alone the high, levels of the past. Hence, it appears that even in recovery Alberta will be facing an extended period of relatively low resource revenues. During this time, resource revenues will be unable to contribute nearly as generously to provincial budgets as they have previously.

It is possible that future resource revenues might exceed current expectations and, specifically, Tombe’s (2018) projections post-2021–22. For one thing, as Tombe notes, his projections do not include (or do not fully include) the transition of oil sands projects from pre- to post-payout phases of the royalty system because of a lack of information. For another, Tombe is not the only one making projections. In 2017, the Canadian Energy Research Institute projected oil sands (bitumen) royalties to 2036 (Millington 2017, figure E7). Those estimates had royalties exceeding $20 billion in 2023. It’s worth noting, however, that this amount was about twice the $10.4 billion that the province projected for that year in its “Path to Balance” in the 2018 budget (Government of Alberta 2018, 86).7 More recently (although it does not include projections of government revenues), the Canadian Energy Research Institute also put forward a less rosy view, projecting oil sands production to 2039, with two of three scenarios allowing for setbacks in long-term output (Millington 2020a, 2020b).8 Also, the US Energy Information Administration in its Annual Energy Outlook 2020 reduced its nominal forecasts of West Texas Intermediate oil prices for the 2021 to 2040 time period by an average of $27.28, from a twenty-year average of $124.10 in 2018 to $96.81.9 In its Annual Energy Outlook 2021, the Energy Information Administration’s reference case projected oil prices returning to 2019 levels ($57 per barrel) after 2025. Clearly, projections can differ widely.10 For consistency, the analysis here relies on Tombe’s (2018) estimates.

What impact might lower resource revenues have upon provincial government expenditures in the absence of generating additional revenues (i.e., taxes) if the budget is to be balanced? The answer is substantial spending cuts. Since 2000, Alberta’s program expenditures have averaged 21.7 percent of household incomes with little year-to-year variation. Resource revenues contributed an average of 6.4 percent of that 21.7 percent (or just under one-third) before 2015–16. If future resource revenues amount to 3.0 percent of household income rather than 6.4 percent, that implies a revenue gap of 3.4 percent of household income that must be met by expenditure reductions in order to balance the provincial budget. That decrease alone implies that a reduction of 15.7 percent in program expenditures is needed if additional revenues are not to be raised from other sources. However, larger debt requires that more interest also be paid, which means that, for the budget to be balanced, program expenditure must be reduced further. Using 2022–23 as an example, additional interest will increase the demand for funds by at least 1.0 percent of household income. Combined, the loss of resource revenues plus the higher interest costs would necessitate a 20.3 percent reduction in program spending (i.e., to 17.3 percent of household incomes) in order to balance the budget by 2022–23.

The UCP government laid out a plan in its October 2019 and February 2020 budgets to achieve budget balance in 2022–23 (Government of Alberta 2019, 2020b). Taking the findings of the MacKinnon Report as justification (Blue Ribbon Panel on Alberta’s Finances 2019), the plan was (and still appears to be) to hold total expenses constant at approximately $56 billion.11 The COVID-19 crisis has upset those plans, but the subsequent budget documents and accompanying pronouncements suggest that post-2021–22, the expenditure freeze will effectively continue, though the timing of budget balance will be delayed (Government of Alberta 2020a; 2021a; 2021c, 7 para. 5).12 Tombe (2020) predicts that this strategy could result in budget balance in 2026–27.

Overlooking the blip due to COVID-19 and recovery plan expenses in 2020–21 and 2021–22, what are the consequences of freezing total expenditures? That is, what would happen to the expenditures that fund public goods and services for Albertans if total expenses are held constant at approximately $56 billion until 2026–27? To answer these questions, we first have to account for the fact that population will continue to grow—specifically, from 4.43 million in 2020 to an estimated 4.76 million in 2026 (based upon Alberta’s expected medium-term population growth path). Over that time, per capita program expenditures would decline from $12,576 to $10,832 (a nominal reduction of 14 percent). At the same time, we must consider that prices will continue to increase. Accounting for inflation, real per capita program expenditures would fall to $9,503 in 2020 dollars (a 24 percent drop). Household incomes will also change over the six years. Comparing program expenditures to predicted household incomes, the percentage would decline from 21.8 percent to 16.8 percent (a 23 percent drop). The consequences of balancing the budget by freezing total spending for a sustained period, then, are large reductions in real program expenditures and thus in the provincial services available to Alberta residents.

Given the current plans, how might Alberta’s program spending compare with that in other provinces? Here, the comparison is limited to looking forward to 2023–24 because that is the year to which several provinces forecast revenues and expenditures.13 Assuming that Alberta is back on its spending target path in 2023–24 and it and other provinces are past their pandemic-related expenditures, Alberta in 2023–24 plans to spend $12,191 per capita (in nominal dollars) on programs. Interestingly, this amount is essentially equal to British Columbia’s planned expenditure of $12,361 per person in that year.14 The comparison with British Columbia is of interest because it is one of the three “big” provinces with which the MacKinnon Report made comparisons, the others being Ontario and Québec (Blue Ribbon Panel on Alberta’s Finances 2019). Québec anticipates 2023–24 spending of $14,174 per person. There is no 2023–24 Ontario forecast in the November 2021 tables, but the Royal Bank of Canada September 2020 report recorded $10,231 per capita for 2022–23.15 Thus, by 2023–24 Alberta would achieve program spending per person equal to the average per capita spending in the other three big provinces.16 In addition, it is very likely that by 2026–27 the spending freeze will result in only Ontario spending less per capita than Alberta (and Alberta might even be lower than Ontario). Making interprovincial comparisons through the lens of household income provides further insight. Program spending as a percentage of household incomes in Alberta has been essentially equal to that in British Columbia and Ontario extending back to at least 2005–07 (McMillan 2018). Typically, program expenditures in Alberta (at about 21.7 percent) represent essentially the same share of household incomes as those in the two lowest-spending provinces. In the other seven provinces, the shares have been much larger, averaging 29.1 percent. Pursuing an expenditure freeze to 2026–27 would reduce Alberta’s program expenditure share to 16.8 percent of household income, or about 20 percent lower than recent levels in British Columbia and Ontario.

How might Albertans respond to substantial reductions in provincial government expenditures and services in a persistent low-resource-revenue environment? If resource revenues materialize much as projected, and alternative revenues (e.g., expanded tax revenues) are not employed, anticipated real reductions in program expenditures in the order of 20 to 25 percent will be necessary to balance the budget.17 The idea that Albertans will prefer reductions of this magnitude seems remote for various reasons. One reason is that such cuts would leave Alberta—a high-income (if not the highest-income) province and definitely the province with the lowest tax—at the bottom of the provincial spending ladder. Another is that Alberta tested low spending during the early Klein years when public program expenditures reached a low of 19 percent of household incomes in 1998–99, but that level was abandoned within two years to move closer to the 21.7 percent post-2000 average. The estimated budget-balancing cuts would reduce program expenditures to about 17 percent of household incomes, a level that Albertans have not experienced within the last fifty years at least. Currently, Albertans are being asked to absorb the entire reduction in resource revenues as a reduction in provincial services. Experience suggests that it is unlikely that, at least after adjusting fully to the alternatives, Albertans will prefer that option. Consumer theory supports the argument. A decrease in resource revenues effectively increases the tax price (or tax cost) of provincial services. Consumer behaviour suggests that when faced with a higher price of an important product in the budget, they normally reduce the consumption of that product somewhat but also reduce expenditures on other products to some degree. Not all of the cut is made to expenditures on the more expensive product. In the public finance context, this suggests that citizens will prefer some reduction in government goods and services in combination with some reduction in private goods and services—that is, some tax increase.

What might such a service reduction–tax increase trade-off look like? To illustrate, if Alberta was to levy a 5 percent harmonized sales tax (HST), which would be the lowest rate among all other provinces, it would generate revenue amounting to about 2.1 percent of household incomes. Of the 3.4 percent budget gap expected to be left by diminished future resource revenues, that amount would leave 1.3 percent (or just over one-third) to be met by reduced expenditure, and in turn reduced service.18

For a more specific example, consider an HST in the context of the 2019–20 fiscal year. A 5 percent HST in 2019–20 would have generated about $5.3 billion. That revenue would have reduced the budgeted deficit of $8.7 billion to $3.4 billion.19 If the 5 percent HST had been combined with $3.4 billion in expenditure reductions—a 60:40 split of tax revenue to spending cuts—the budget would have been balanced. Even with $5.3 billion of additional tax revenue, Alberta would have maintained a significant tax advantage over every other province and, notably, a tax advantage of $8.2 billion over Ontario, the next-lowest-taxed province.20 Yes, even with a 5 percent HST, Albertans would still have paid $8.2 billion less in taxes than if taxed under the Ontario system.

The already reduced and projected low contributions of resource revenues to the Alberta government will make the province’s revenue base more similar to those of other provinces. Even if the medium-term improvement forecast offers some relief, the long-term picture is unchanged. In this situation, it is reasonable to expect that Alberta’s tax structure will need to, and will, become more like those of the other provinces. Besides resource revenues, the obvious difference between Alberta and other provinces is Alberta’s lack of a general sales tax. Also, pursuing alternative sources (such as PIT or CIT) for equivalent revenues appears generally economically and politically unappealing. Hence, when fiscally squeezed, an Alberta sales tax seems the logical and, indeed, the inevitable choice.

As demonstrated earlier, energy prices and government resource revenues are notoriously difficult to predict. Hence, resource revenues might exceed our expectations. If so, Albertans would be delighted. Although this possibility exists, we should still address the existing and projected budget gaps quickly through both tax and fiscal restraint measures to restore budget balance. This call to action has only been reinforced by the additional negative fiscal consequences of the COVID-19 crisis. Making the adjustments and, in particular, introducing a modest HST, would open neglected opportunities. The good fortune of unexpectedly large resource revenues resulting in unexpected surpluses would create an opportunity for Alberta to adopt a fiscal strategy supportive of a province richly endowed with resources but experiencing large resource revenue and economic volatility. Surpluses arising from any new, bountiful resource revenues should be allocated towards reducing provincial debt, accumulating a stabilization fund to avoid borrowing during cyclic downturns, augmenting the Alberta Heritage Savings Trust Fund to cover population increases and inflation (that is, maintaining it in real, per capita terms), and establishing a program to distribute earnings to Albertans should saving become adequate.21 To put it plainly, should the province be so blessed as to realize resource revenues beyond those projected here, it should not relapse into devoting those revenues to expenditure increases and/or tax reductions. Instead, it should use them to reset its fiscal course and direct funds to a suite of (probably modest) savings alternatives.

The Alberta government’s non-renewable resource revenues have shrunk in relative importance as they have failed to keep up with population growth, price change, and real income growth. Since 2015, these revenues have hovered at record lows. The sharp boost in resource revenues expected in 2021–22 will not solve Alberta’s immediate fiscal problems and does not change the long-term prospects for significant recovery, which remain rather dim. Even favourable projections suggest that resource revenues will contribute to the province’s revenue-generating capacity only one-half of what they did from 2000 to 2014. Although that represents a notable improvement from the one-quarter level experienced since 2015, the prospect is sobering. The province has a structural deficit problem from which resource revenues alone should not be expected to provide an escape. The current and the projected deterioration of resource revenues’ contribution to provincial government coffers calls for a reorientation of fiscal policy. A review of the evidence indicates that Albertans can expect an expenditure cut of 20 percent or more and implies a level of services with which they are unlikely to be satisfied. Ultimately, while seeking some fiscal restraint, Albertans are expected to also choose some additional taxes. The HST is the logical revenue alternative and, if low resource revenues continue into the long term, it is the inevitable choice. A moderate HST plus moderate fiscal restraint can solve the budget gap problem and put Alberta on a sustainable (and budget-balancing) fiscal path, all while continuing to leave Alberta with a considerable tax advantage over all other provinces. Should the province be so fortunate as to see resource revenues exceed expectations, it would be an opportunity to reduce debt and to pursue revised fiscal policies aimed at maintaining stable public finances despite resource revenue volatility.