A European-style debt crisis could happen in Canada unless a number of provinces, specifically Ontario and Alberta, change the long-term direction of their finances, a report from a major Canadian think-tank warned Thursday.

A study commissioned by the Ottawa-based Macdonald-Laurier Institute published Thursday warned that unsustainable fiscal policies in a number of Canadian provinces raise "the spectre of debt crises, damaged credit ratings, and federal bailouts if corrective steps are not taken."

"Canadians may be too complacent if they think that the debt crisis racking Europe cannot happen here," the report's author Marc Joffe said.

Fates intertwined

The report draws a parallel between the European Union and Canada in that both are confederations of nominally independent units that are, nonetheless, intrinsically tied to each other. As the economies of Greece, Spain, Italy and Portugal wobble, the stronger economies of northern and central Europe were affected and compelled to bail out weaker sisters.

"In Canada’s case, with an implicit federal guarantee of provincial debt, the federal government may ultimately bear the fiscal consequences of any provincial default and in the meantime may be implicitly subsidizing inappropriate provincial policies," the report says.

The paper singles out Ontario and Alberta as being most at risk. Quebec is deemed least likely.

The report's methodology attempts to measure each province’s risk of failing to service its debt over the next 30 years. It used the benchmark of 25 per cent because historically, the likelihood of any government defaulting on its debts is quite high if more than 25 per cent of a province’s revenue take is required to service its debt load.

The paper calls a province's interest expense to total revenue ratio its "interest bite" rate and it notes that all provinces currently have an interest bite below 10 per cent and as such, none seem in any danger of hitting that 25 per cent threshold in the near term. But as time passes, without fiscal changes, the odds increase.

Ontario, Alberta prospects bleakest

The report found the most vulnerable in the 10-to-20-year window to be Ontario, because of large deficits. On its current path, the paper estimates the percentage of revenue dedicated to servicing the province's debt load would give it a 42.9 per cent  chance of defaulting within 20 years.

'Quebec has the lowest statistical probability of default.' —Marc Joffee, report author

But Alberta was found to be most at risk in the 30-year range because the province could swing from deficits to a large debt load by then. That's because Alberta's population is expected by Statistics Canada to age more rapidly than other provinces and also because it is heavily exposed to volatile energy revenues. The paper estimates the province's likelihood of defaulting could be as high as 84 per cent by 2042. 

Over the long term, Quebec is deemed the least likely to be in trouble, but it, too, has a 28 per cent chance of defaulting 30 years from now. As the paper puts it: "Quebec has the lowest statistical probability of default, but that risk is still nearly one in three."

Provincial bond rates are all well below those levels at the moment and fairly uniform across the country. That suggests one of three things, Joffe said. Either investors have ignored the possibility of default entirely, or they're confident provinces will fix their finances by then, or they're banking on the federal government stepping in with a bailout if necessary.

If any province nears the default point, people in other provinces and the federal government would have to "shoulder the costs of assisting the fiscally challenged government, yet have no influence over its policies," the report says.

All four western Canadian provinces were insolvent during the Great Depression of the 1930s and Ottawa provided a rescue in each case. Newfoundland, then a sovereign dominion, had to give up home rule in exchange for a bailout package from Britain and Canada, the report notes.

The paper singles out health-care costs as a major burden down the line. Health-care spending already represents almost 50 per cent of program spending in every province as it is. And under any plausible projection, it will grow much faster than incomes in every province, the paper says.

"Ultimately governments will need to figure out how to do everything, especially health care, more efficiently so they don’t risk bankruptcy and don’t raise taxes unacceptably," Joffe said.