BILL CURRY - The Harper government is signalling that it intends to scale back the growth rate of federal transfers to the provinces – a warning that means tough decisions lie ahead on health care, education and social programs as Canada moves to balance the books.

Finance Minister Jim Flaherty on Tuesday released his government’s fall economic update, which pegged last year’s deficit at a higher-than-predicted $55.6-billion and projects bigger-than-planned deficits for three out of the next four years.

Even so, the government is promising to return Canada’s finances to surplus by 2016.

A key factor between now and then is that all three major transfers to the provinces expire in three years. Negotiations are already under way toward a new deal that will have major implications for provinces grappling with health costs that are growing far faster than inflation.

Yet Mr. Flaherty is pointing to inflation and economic growth – which are both projected to be low over the coming years – as a guide for a future deal.

“We all know what the rate of inflation is these days, which is relatively modest. We also know what the economic growth is these days, which is moderate,” he said when asked how he is planning for the expiry of the transfer arrangements.

The current deal ties equalization payments to economic growth. But the social transfer – which finances postsecondary education and social services – rises 3 per cent a year, and the health transfer is pegged at 6-per-cent annual growth.

In contrast to his words, Mr. Flaherty’s fiscal update report assumes all three programs will continue at their current rates and the budget will still be balanced by 2016.

Officials explained the assumption as a mere accounting tool to budget for an unknown cost, although it is sure to be seized on by Canada’s provinces and territories, who are concerned with what might happen when current deals expire in 2013-14.

Debate over provincial transfers is expected to play a key role during the next federal election. Liberal Leader Michael Ignatieff has suggested Canadians would rather have his party in charge to strike the next deal. In contrast, Mr. Flaherty regularly points out that the Liberals slashed provincial transfers in the 1990s to erase the last deficit.

Some private sector economists have warned that while Ottawa’s deficit fighting plan appears realistic, the deficit situation in Canada’s larger provinces – particularly Ontario – is more of a concern.

B.C. Health Minister Kevin Falcon said he plans to make a strong case for health transfers continuing “in very much similar mode to what they have been in the past.”

He noted that the provinces bear 80 per cent of health-care costs, leaving the federal government with a 20-per-cent load.

“That is an important 20 per cent, and I can’t imagine any scenario in which any federal government could imagine there is going to be reduced costs in health care in the coming years,” he said.

But he said the province does not mind being held accountable for outcomes financed by those dollars.

“We fully commit in British Columbia to also look at how we can be leaders in bringing about innovation and driving the kind of change that will see every single one of those additional dollars provided by the federal government go towards better outcomes,” he said.

Ontario Finance Minister Dwight Duncan responded diplomatically on Tuesday when asked for reaction on Mr. Flaherty’s comments.

“We continue to have discussions with the federal government regarding all our transfers and ensuring fairness for Ontarians,” he said in an e-mail.

Public opinion surveys have shown that while the economy remains a top of mind concern among Canadians, health care is rising again as a priority.

Mr. Flaherty had warned that last year’s deficit might come in slightly higher than the $53.8-billion projected in the March, 2010, budget. The government says the main reason for the change is that the Auditor General advised the government to book $5.6-billion in “transitional assistance payments” to Ontario and British Columbia to help them move to harmonizing their provincial sales taxes with the federal goods and services tax.

The government projects Canada’s deficit will be $45.4-billion in 2010-2011; $29.8-billion in 2011-12; $21.2-billion in 2012-13; $11.5-billion in 2013-2014; $1.7-billion in 2014-2015. For the first time, the government lists a clear timeline for returning to balance, promising a $2.6-billion surplus in 2015-2016.

Tuesday's forecast reveals that Mr. Flaherty is taking the advice of some private-sector economists, who say the economic recovery is so fragile that Ottawa should err on the side of lower-than-expected growth.

The update confirms this, by reducing the government’s projected revenues downward $1.5-billion for each of the next two years in comparison to the private-sector average, with smaller adjustments in future years.

Liberal finance critic Scott Brison said the Conservatives’ deficit promises simply lack credibility because of Mr. Flaherty’s track record.

“This is another failure of the minister to meet a deficit target,” he said.

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With reports from Tim Kiladze in Mississauga, Karen Howlett in Toronto and Ian Bailey in Vancouver