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CIBC World Markets: Provinces 'Should Condition Their Populace For Deeper Cuts'

Canada's provincial governments "should condition their populace for deeper cuts," says a CIBC World Markets report that warns the world's slowing economy will hit provinces' ability to provide services.

In a report released Monday, analyst Warren Lovely said that with Canada shifting gears from an economy that typically grows three per cent per year to an economy that typically grows two per cent per year, provinces should prepare for their revenue projections to come in lower than expected.

Lovely's model forecasts a total shortfall of $10 billion per year for all provinces combined, possibly rising to $15 billion if the global economy falls into a recession in the coming months.

"Provincial governments could have difficulty offsetting even relatively modest revenue losses without enacting unpopular tax increases or jeopardizing fiscal targets," Lovely wrote.

"With global fragilities impairing Canadian growth, more and more government programs could ultimately prove unaffordable. Governments should condition their populace for deeper cuts, now," the report stated.

With that conclusion, CIBC World Markets placed itself clearly on one side of a debate raging among politicians and economists alike: Whether increased spending or strict austerity measures are the way to address the current economic crisis.

Prime Minister Stephen Harper and Finance Minister Jim Flaherty have placed themselves on the austerity side of the debate, along with conservative economists who argue current spending levels among Western countries are unsustainable and could lead to fiscal collapse.

But progressive economists argue recessionary times are precisely the wrong moment for spending cutbacks. Often pointing to the massive deficit spending the U.S. enacted during World War II as evidence huge deficits can overcome economic stagnation, they argue that recent stimulus spending was simply too little to help pull the U.S. and other economies out of the fiscal crisis.

In a speech in Toronto last week, Nobel prize-winning economist Joseph Stiglitz said the austerity measures being pushed by world leaders like Harper and British Prime Minister David Cameron are "effectively a suicide pact for our economies."

Stiglitz said that cutting government spending would cause job losses at a time when the economy is already failing to create enough employment. That in turn would lead to a "vicious circle" of shrinking economic demand.

Stiglitz suggested the U.S. should be building infrastructure rather than looking at ways to cut spending. Despite the fact the U.S.'s budget deficit has amounted to nearly half of government spending in recent years, Stiglitz said the U.S. has "considerable scope" to spend more.

For those on this side of the argument, the popular solution these days is increasing taxes on the wealthy. That’s the position NDP leadership candidate Brian Topp took last month.

It was ridiculed by Finance Minister Jim Flaherty, who called the plan "nonsense" because, he argued, the wealthiest don’t pay enough of a share of income taxes for a hike to make much difference. Flaherty pointed out the middle class pays the lion's share of income taxes.

Like Flaherty, many conservative and libertarian economists say that increasing spending at a time when revenues are shrinking amounts to fiscal insanity.

They point to the crisis in Greece as an example of the vicious circle countries fall into when faced with too much debt. Wary creditors demand higher interest rates on new government-issued debt, causing the costs of debt servicing to go up, making it even harder for governments to pay their bills.

That's the scenario CIBC's Lovely presented as possible for Canada's provinces should their revenue not meet targets.

"Provinces that are unable or unwilling to tackle budget shortfalls in a strategic and timely manner leave themselves ill prepared for the next recession," he wrote. "They risk inviting credit downgrades, which could jeopardize heretofore hearty foreign demand, weigh on spreads and erode long-term debt affordability."

That Canada's economic performance will be below expectations is hardly in dispute at this point. In the latest indicator of tougher times ahead, Parliamentary Budget Officer Kevin Page released a report Tuesday lowering Canada's projected GDP by $49 billion.

The PBO also predicted higher-than-expected unemployment and lowered tax revenue.

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