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Canada’s Cities: Struggling Financially But Still Solvent

Aug 30, 2012

Centre for Municipal Studies

For years now, the Conference Board’s Centre for Municipal Studies has published numerous studies documenting the financial struggles of Canada’s cities. The recent bankruptcy filing of three California cities have some of our clients wondering whether Canada’s cities are heading in the same direction. On this one, we have a clear and resounding response: No. Canadian cities are still solvent and not at financial risk.

On July 10, San Bernardino, California, became the third city in the U.S.’s most populous state to file for bankruptcy since June. Stockton and the mountain resort town of Mammoth Lakes are the other two cities to file for bankruptcy. While each case varies in detail, they share a common set of factors: a depressed housing market. This depressed market resulted in large declines in home values and, in turn, a significant drop in property tax revenues, which played a crucial role in the financial struggles of each city. Moreover, while cities in California have access to consumption-based taxes, the 2009 recession and slow recovery of the past few years also eroded revenues from these sources.

California map of cities declaring bankruptcy

In the case of San Bernardino, a city of 209,000 residents, a drop in revenues of roughly $16 million per year over the past six years had contributed to a build-up of over $1 billion in debt. When this year’s annual city budget had another expected deficit, of $46 million, local officials were pushed to vote for bankruptcy. By way of comparison, Stockton, which is larger than San Bernardino, declared bankruptcy in June over a $26 million shortfall in its latest budget and a debt totalling $700 million. By voting for bankruptcy, both cities are protected from their creditors while they execute a restructuring plan. The alternative would have implied drastic cuts in services, including public safety (policing and fire protection). San Bernardino has already made it clear that pensions, which account for a sizeable share of the city’s budget, will not be affected by the restructuring.

Is this where Canada’s cities are headed? After all, there are concerns in some quarters that the housing market may be beginning a significant correction, which could lead to a similar drop in property tax revenues. Our answer again: no.

Why do we hold this view? To begin, cities in Canada cannot, by law, run operating deficits. Therefore, even if home values were to fall steeply, Canadian cities would have to find a way to balance their books. In the past, this was done by a combination of lifting the tax rate on properties and by reducing expenditures. The Conference Board views a sharp drop in property values as unlikely, since there are no signs of uncontrolled inventory accumulation or a collapse in demand. True enough, a slowdown in activity is in the cards and housing price growth should stall and even be negative in some areas. But a “U.S.-style” house price correction is not our expectation.

However, Canadian cities are allowed to run deficits on their budget for capital projects and investment. Therefore, a housing price correction and fiscal revenue decline might heighten concern about cities increasing their debt levels, especially given that many cities in Canada have increased their infrastructure spending in recent years to address the infrastructure deficit across the country. But the level of debt of Canada’s cities is unlikely to become a problem. The amount of debt undertaken by cities is closely monitored by provincial governments, who themselves are taking public debt management seriously. In addition, most cities in Canada continue to be quite reluctant to take on debt for capital projects, even if they are legally able to do so—with the exception of Quebec municipalities, where municipalities have been using debt to finance capital investment to a much greater extent than cities of any other province.

The Conference Board of Canada has recommended that cities, again with the exception of Quebec municipalities, should be more willing to take on debt, particularly to finance infrastructure, if it is prudently managed.1 In the case of Quebec municipalities, after working closely with several of them, the advice has been to ensure that the ratio of debt to total revenues does not rise any further.

What does it all mean? For the most part, our cities have mastered an art: doing what they can with what they have. Unfortunately, this has meant systematically investing less than they should in infrastructure. It has also meant doing less than needed on key programs for future success such as economic development and immigrant integration. These expenditures have to be added to cities’ operating budgets, which are already very tight. Therefore, tough decisions have to be made and not by choice, but due to fiscal necessity. Even though Canada’s cities are the economic engine of the country,2 they still do not have the financial means to fulfill this role. Cities continue to rely far too much on property taxes, even though they do much more than just provide services to home owners. So while it is true that Canada’s cities are financially solvent, their financial situation is far from healthy—they are starved of revenue sources. Remedying this situation should be a priority for both the federal and provincial governments.

1    See Anne Golden, Glen Hodgson and Mario Lefebvre, Implement Sustainable Funding for Canada’s Cities, The Conference Board of Canada, January 2008.

2    See Mario Lefebvre and Nathalie Brender, Canada’s Hub Cities: A Driving Force of the National Economy, The Conference Board of Canada, July 2006.