Canadian City Finances Ailing from COVID-19

With most of us staying at home, cities’ usual revenue streams—including transit fares and parking fees—have all but dried up, and hard-hit businesses and households may struggle to pay property taxes this year. Meanwhile, cities must maintain essential services and cover new pandemic-related costs.

Canadian cities’ unique fiscal structure—they can’t plan for operating deficits—has long affected their ability to smooth revenue shocks between years. Now, they’re in an especially tough position. Canada’s big cities predict the pandemic will lead to budget shortfalls well into the billions, and even smaller ones could see significant revenue declines. The options are bleak: draconian spending cuts, steep property-tax increases, or both. That puts municipal services, and the businesses they support, on the chopping block. Cities’ inability to bounce back quickly could weigh on Canada’s broader economic recovery.

Key findings

• Across Canada, we estimate that municipal shortfalls could total nearly $12 billion this year
• Cities with transit systems and that rely on user fees suffer more from COVID-19
• Measures designed to help cities have thus far fallen short, since they must be repaid
• Preventing big spending cuts or tax hikes should be a priority for provincial governments, and could be achieved with transfers to cities
• Cities will need to do their part by finding some workable cost reductions

COVID-19 is severely disrupting transit and user fee revenue

We assessed the hit to revenues in five big Canadian cities: Toronto, Vancouver, Montreal, Calgary and Halifax. Combining city estimates with our own forecasts, we outlined a scenario in which social-distancing measures were imposed for three months, followed by six months of gradual easing. We also considered a pessimistic scenario in which restrictions were in place for six months before easing.

Median city-level losses total 9.7% of revenues in our base case, and 12.1% in our pessimistic case. Property taxes and utility fees tend to be relatively stable in recessionary times, but this pandemic is different. Widespread closures have hurt businesses and commercial landlords more than households, so non-residential taxes will falter more (we’ve penciled in arrears of 15%). In most cases, the share of business and residential-property taxes is roughly equal, but businesses face higher tax rates. In the end, property tax-related losses averaged about 5% of each city’s total revenues, the bulk of losses due to COVID-19. These taxes will likely be collected eventually, but budget pressures will exist in the interim.

User fees, fines, and land transfer taxes are volatile sources of revenues in the best of times, and cities expect precipitous drops in parking revenue, by-law fines, recreation and libraries, and licensing revenue. We expect land transfer taxes will suffer due to weaker housing markets, and cities responsible for transit systems will see significant drops in fare revenue.

At the same time, municipalities face increased costs for equipment required to facilitate physical distancing, higher sanitation costs, increased shelter capacity to ensure the safety of homeless populations, subsidizing affordable housing, and public daycare costs for children of front-line workers. Montreal will have to foot the bill for overtime costs associated with police and fire departments. Toronto has committed to building modular housing for its homeless population.

Often-overlooked city finances will play a key role in the recovery

Unlike higher-order governments, cities’ fiscal situations tend to garner less attention, since they can’t plan for operating shortfalls which leaves less room for fiscal mismanagement. Cities can only carry forward unexpected shortfalls for one year. The sheer size of COVID-related losses means that if they are forced to weather this fiscal crisis alone, many cities will likely need to cut costs and increase taxes significantly. By our calculations, the big cities we looked at would have to raise property taxes between 7% and 15%, or cut services a similar degree, in order to cover costs under current rules.

But cost cuts and tax increases affect the economic health of our cities, affecting the broader economy. Municipal services underpin large swaths of the economy, with activity around Canada’s three largest cities accounting for about 40% of Canadian GDP. Toronto alone accounts for 18.5% of GDP and nearly a fifth of employment. Cities also house more high-wage industries: workers in the biggest Canadian cities are about 20% more likely to work in financial and real estate service and over 30% more likely to work in professional or technical services.

This economic activity is facilitated by transit systems that get Canadians to and from work, roads that support the movement of goods, and utilities that power and heat homes and businesses. Gone are the days of packed subway cars and buses: if transit systems don’t have sufficient funding to adjust to physical distancing, many people won’t be able to get to work. In some cases, cities administer childcare programs, which, if not well managed, will slow employees’ return to workplaces. City officials will also need to inspect and enforce distancing restrictions, and municipal public-health outreach will be more important than ever to ensure contact tracing and virus awareness.

Forced to cut transit service (like Calgary) and other city services, local government may hinder the return to pre-crisis economic activity levels. While many big employers in cities are well equipped to work from home, other industries that support these workers can’t do so (accommodation and food services, retail trade, etc.). They have been hard-hit by the crisis, representing smaller shares of pre-crisis urban employment, but have made up many more of the job losses. Failure to move people and keep cities operating safely will be a one-two punch for these industries. As they start to recover in rural parts of the country, urban establishments will be held back as their customers stay away from their offices and city cores.

Just as other crises have shown that austerity during a downturn hurts more than it helps, tax increases on businesses that can scarcely afford to remain open will slow reopening efforts. Cities will need help managing these pressures, if higher levels of government are to avoid hindering their already extensive efforts to support the economy.

Existing financing measures are insufficient to help smooth these shocks

New measures in BC allow cities to borrow for five years from reserves held for capital spending (e.g., replacement of aging infrastructure) and Nova Scotia municipalities can borrow from the province for three years. This will assist cash flow for cities, but mostly delays the inevitable. Even if allowed to borrow for five years, taxes would still need to be at least 3% to 6% higher than current levels. The full effects of COVID-19 on city revenues may also be longer lived. Our forecasts suggest property values may fall in some cities, potentially eroding the value on which taxes are assessed. Downtown firms have also been disproportionately hard-hit by the crisis: internal RBC data suggests consumer spending has pulled back more in urban areas. In both cases, cities would need to raise property taxes meaningfully just to maintain their current service level, and perhaps raise them more than we consider above.

The federal government pledged to expedite its $2.2 billion gas tax grant to cities this year. The help will only go so far, since cities have already accounted for that revenue and can only use it to fund capital expenses, not bolster tightening operating budgets.

Provinces have room to help more, but cities will still need to adjust

Generalizing our findings for major cities to all municipalities, we found that reduced user fees and property taxes will total nearly $5 billion for Ontario municipalities and about $11.7 billion nationwide this year. While cities are ill-placed to smooth revenue shocks of this magnitude, the provinces and federal government have much larger budgets and borrowing capabilities. Based on our estimates, shortfalls in each province’s municipalities are below 1% of provincial GDP, and few would have sizable interest costs arising from grant programs if they chose to borrow to fund them. Other levels of government face budgetary pressures of their own, but have larger balance sheets on which to house these costs.

Increased transfers from provinces for all sizes of cities, or targeted funding for public-transit operations for larger ones could help. Transit funding may also speed economic recovery if it subsidizes more trips with fewer passengers per trip. Making it safe for people to stay on the train rather than drive would also alleviate pressures on other infrastructure and mitigate carbon emissions.

To prevent significant tax increases or deep spending cuts, other levels of government will need to provide more help, perhaps even non-repayable support. But that support shouldn’t preclude all city-level spending cuts. In recent years, some municipal budgets have grown faster than the populations supporting them. While many city services are essential for daily life, others are unlikely to hinder growth if reduced. Councils should use the crisis to reexamine their spending mix and create structures that allow them to buffer shocks like a pandemic.

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This report was authored by Economist, Colin Guldimann , and Economist, Carrie Freestone.

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