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The Parliamentary Budget Officer’s latest report on the fiscal sustainability of Canadian public finances shows that the prepandemic trend of declining debt and deficits is back on track and that Ottawa and several provincial governments have room to increase spending or cut taxes without further leveraging.

With the exception of Newfoundland and Labrador and Manitoba, which are on track to see their debt ratios balloon over the next 25 years, the federal government and most provinces are set to see gradually declining debt ratios or require only modest budget tweaks to get there.

Under an alternative scenario that sees health care spending growing faster than the PBO’s baseline projection – an entirely plausible outcome – the public finances of every province except Quebec would fall into the “unsustainable” category. But the main takeaway from the 2022 Fiscal Sustainability Report, released last week, is that Canadian public finances have survived the pandemic without major scars.

Over all, the report appears to validate Finance Minister Chrystia Freeland’s contention that Ottawa’s books remain in good shape, even after the federal government took on more than $500-billion in new debt to fund income support programs during the pandemic. And that the federal debt will continue to decline relative to the size of the Canadian economy, as the rate of economic growth exceeds the average cost of borrowing.

There’s just one hitch. The PBO’s 2020 fiscal sustainability report, released just before the pandemic, concluded that the federal net debt-to-gross domestic product ratio could be held at its prepandemic level of 28.5 per cent over the long term even if Ottawa increased spending by a sum equivalent to 1.8 per cent of GDP, an amount then equivalent to $41-billion.

The budget watchdog now pegs the net debt-to-GDP ratio at 39.4 per cent of GDP and bases its determination of fiscal sustainability on maintaining the ratio at that higher level after new spending or tax cuts amounting to 1.8 per cent of GDP, or about $45-billion in current dollars. Whether that nearly 11 percentage-point increase in the federal debt ratio matters is up for debate.

The PBO’s figures differ from those contained in April’s federal budget, which pegged the net debt-to-GDP ratio at 46.5 per cent at the end of the 2021-22 fiscal year, since the Finance Department and the budget watchdog use somewhat different accounting methods. The PBO says its method allows for more accurate intergovernmental and international comparisons.

Still, the bottom line remains the same. The COVID-19 spending that many of us worried could send Canada hurtling toward a painful fiscal reckoning once the pandemic was in the rear-view mirror will turn out to have been a blip in an otherwise good-news fiscal story. Indeed, based on current policies, Ottawa’s net debt-to-GDP ratio is slated to fall to zero by 2061, the PBO says.

The report suggests Ottawa has room to increase spending on defence, health transfers to the provinces and new programs such as pharmacare without going deeper into debt. That could make it harder for Prime Minister Justin Trudeau’s government to deflect provincial demands for a big permanent increase in the Canada Health Transfer and pressure from New Democrats for the Liberals to fulfill their promise of a national drug insurance program.

The PBO report projects that provincial and territorial health care spending will grow faster than nominal GDP growth over the next 75 years. As a result, based on the current CHT formula, federal health transfers will decline from 19.3 per cent of provincial and territorial health care spending in 2021 to 16.6 per cent by 2096. The PBO notes that the “most acute” period of population aging will occur over the next 15 years, putting pressure on the provinces.

Of course, the PBO’s projections are only as dependable as the assumptions they are based on. The budget watchdog has not altered its long-term assumptions for inflation and interest rates from last year’s fiscal sustainability report, despite both indicators surging in recent months. It still sees inflation settling at around the Bank of Canada’s 2-per-cent target in the medium-term. The effective interest rate on federal borrowing is projected to hover around 2.84 per cent.

There is no guarantee that the PBO’s projections will materialize. The danger is that its latest fiscal sustainability report breeds complacency among federal policy makers and voters. That is not the PBO’s fault. The agency is simply crunching the numbers as it sees them.

But if the past couple of years have taught us anything, it is to expect the unexpected. The next game-changing global crisis could be just around the corner, or several years down the road. Either way, Ottawa and the provinces need to prepare for it, preferably by pro-actively reducing their debt-to-GDP ratios to prepandemic levels to free up additional fiscal space.

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