The Big Challenges Addressing Ontario’s Deficit & Debt Problem

The last couple of days have seen two reports – one by Statistics Canada and one by the Ontario Financial Accountability Office – which taken together provide the best picture yet as to why Ontario faces a big fiscal challenge in resolving its deficit and debt issues.  First, the Financial Accountability Office (FAO) in its Spring 2019 Economic and Budget Outlook under its baseline projection projects that Ontario’s budget deficit decreases from $11.7 billion in 2018-19 to $7.3 billion in 2020-21 and improves rapidly over the following three years, reaching balance in 2022-23 and a relatively large surplus of $6.4 billion by 2023-24.  

Yet, the FAO notes that the 2019 Ontario Budget projects smaller deficits over the next two years due to the government’s more optimistic outlook for revenue growth.  However, beginning in 2021-22, the 2019 budget incorporates provisions for unannounced revenue reductions and spending measures. This would lead to higher deficits and add to Ontario’s debt. The Province should still achieve a balanced budget by 2023-24, due to its plan to significantly restrain the growth in program spending.  The 2019 budget will see program spending grow at just 1 percent annually over the next five years bringing per capita government spending from $10,494 in 2018-19 to $9,391 – a decrease of 10.5 percent.  Per capita government spending in Ontario is already the lowest in the country and this additional decline would widen the gap even more.

So why is Ontario unable to provide provincial government program spending closer to the national average? The answer to that lies in another report by Statistics Canada titled Income Growth per Capita in the Provinces since 1950 which examines GDP per capita and real GDI per capita over a 66-year period to provide insight on which provinces experienced the most growth over the course of this period, and how this affected per capita income levels across provinces.  The news for Ontario is pretty grim in terms of economic growth rates.  Whereas in 1950, Ontario had the highest GDP per capita of the ten provinces – followed by British Columbia and Alberta – by 2016 it was down to 4^thplace with Alberta, Saskatchewan and Newfoundland and Labrador in the top three positions.  More startling is the growth rate of per capita income – which places Ontario at the bottom of all the provinces over this period (See figure).

So, Ontario in a sense over the last 50 years has spent beyond its means in an effort to keep up with the other provinces in terms of the provision of public services but that has still not been enough.  It now has the lowest per capita spending of the ten provinces, the largest provincial total public debt, the second highest per capita public debt, and is engaged in an effort to balance its budget which will widen the program spending gap further with the other provinces.  Now some may point to the factor here as a revenue problem driven by the unwillingness of Ontario to raise taxes.  Ontario indeed has the lowest total revenue per capita among the ten provinces but it has the third highest per capita tax revenue – after Quebec and Newfoundland.  Ontario’s relatively higher per capita tax revenue is offset by lower revenues from resource royalties, federal transfers as well as all other revenues when compared to other provinces.  No, it is not a tax revenue problem.

The problem is three-fold: First, Ontario has had a weaker economic growth rate relative to the other provinces and needs to boost its productivity and economy to grow faster thereby expanding its tax base.  Second, Ontario has not had has a resource sector boom that has enabled provinces like Alberta and Saskatchewan to leap ahead in terms of income and ultimately government spending and nor is it likely to get one from northern Ontario resources anytime soon given the slow pace of development.  Third, as a result of its strong tax base - all things considered – Ontario is still a source of federal government revenue and ultimately transfers to other parts of the country which allow those regions to maintain a higher level of spending.  While balancing the budget by 2022-23 will resolve Ontario’s fiscal situation, it remains that the long-term pressures driving its fiscal imbalance are still there.  

Canada's World Role: Time to Grow Up

Canada is experiencing a particularly rough patch in terms of its international relations given the recent acrimonious trade negotiations with the United States over NAFTA, the deterioration in diplomatic and economic relations with China in the wake of the Meng Wanzhou affair and the recent spats with Saudi Arabia and now even the Phillipines.  Despite our efforts to reach out diplomatically to our allies and gain their support for our predicaments, no one is going to come to our aid.  While some of this can be traced to the deterioration of a rules-based world economic and political order and the rise of more populist regimes, the recent setbacks suffered by Canada have another direct contributor – the United States and especially President Trump. 

The United States has signaled to the world that its America First policies extend to its closest North American neighbours – Canada and Mexico – and that there are limits to any “special” relationship with Canada.  The lifting today of the tariffs on steel and aluminum does not change this.  The NAFTA negotiations not only saw tariffs imposed on Canada but a set of particularly personal attacks on the Prime Minister and the negotiating team.  Essentially, the Prime minister was “slapped around” in public by President Trump and the message this conveyed did not go unnoticed in the rest of the world.  The message was that Canada no longer enjoyed any special protection from its close affiliation with the Americans – it was just another American foreign relation.

This may all seem far-fetched to the members of Canada’s governing Laurentian elites whose views are still anchored in the Golden Age of Canadian diplomacy of Lester Pearson but then most of them probably did not attend a rough and tumble northern Ontario elementary school in the 1970s.  Unlike the zero tolerance environments of today’s elementary schools, violence in the playground was quite prevalent several decades ago.   If the biggest kid took a dislike to you during recess and slapped you around, it was a signal to his minions that they could slap you around too.  Taking a stand on principle and shouting out the importance of fairness and values would simply get you another pummeling.  The trick to survival in that environment was to lay low and not attract too much attention while still getting things done.

So, Canada is in a situation not of its own making but one in which it is going to have to work hard to forge the economic relationships we need to support our standard of living.  After all, about one third of our GDP is rooted in exports which means that we cannot just take our balls and go home to play. However, we do have to be more hard-nosed about reciprocity in our economic relationships with countries that are able to use Canadian rule of law to their advantage when it comes to investing in Canada but do not extend the same privileges to our citizens and companies.  Our overall diplomatic efforts to build alliances must continue but in the long run they need to be coupled with something else – we need to get bigger if we want to ensure we are not so readily pushed around on the world playground. 

Canada needs to continue to grow its population to expand its economic mass and needs to do so through migration incentives that place population in centers other than Toronto, Montreal and Vancouver to promote broader development.  Canada also needs to spend more on its own defense if it wants to be taken more seriously.  There are challenges coming to our Arctic sovereignty and unless we are planning to give the region away to Russia, the United States and China, we need to be able to effectively command access and transit through the region.  We cannot depend on the United States or other allies to promote our interests – we need to do it more astutely and assertively ourselves. 
 

Thunder Bay's Municipal Tax-Ratio Challenge

One of the items at the Monday April 29^th Thunder Bay City Council meeting was a discussion on tax policy and a move to bring it more in line with provincial requirements.  Namely, the province has property tax ratio thresholds and in order to meet them there needed to be a reduction in non-residential tax ratios as follows: Industrial ratio from 2.925444 to 2.63, Multi-residential from 2.422438 to 2.0, and Commercial from 2.137932 to 1.98.  This has been a process that has been underway since 1998 and partly as a result the share of the tax levy paid by residential ratepayers has been rising over time while that of non-residential has been declining. 

In Thunder Bay at present, nearly two-thirds of the tax levy is borne by residential ratepayers while the other third is non-residential or essentially business property taxation. In 1990, it was about a 50/50 split. It should be noted that the City of Thunder Bay’s financial statements now report taxation revenue without dividing it into residential and non-residential as used to be the case only a few years ago.  To get that information, one now has to go onto the government of Ontario website and access the Financial Information Returns provided by municipalities which can be quite a daunting task.  This lack of transparency on the part of the City of Thunder Bay in reporting these important numbers more directly is a disappointment.

Of course, municipal public finance can be a pretty arcane and complex issue– even for an economist - and the discussion the other evening was actually more spirited and informative than usual, all other things given.  Administration affirmed that the tax levy this year would remain the same and the changes to the residential burden would be phased in but in the end based on the short segment I observed they did not successfully allay the concerns of councilors that residential taxes could rise even if the tax levy stayed the same.  Indeed, the emphasis that the tax levy is going to remain the same this year did not deal with the concern that taxes for residential will rise more than they otherwise might in future.  How can this be?

Ontario Budget 2019: Some Spending Details

Well, the dust is settling from the April 11^th 2019 Ontario provincial government budget and it is time to spend a little more time looking at some of the details in spending.  There are many stories in the media about assorted cuts coming down the pipeline, but it remains that overall spending is up and projected to continue rising though at a much lower rate.  Indeed, as discussed in my previous post, total spending is expected to rise from $162.5 billion in 2018/19 to reach $164.4 billion representing an overall increase in spending of 0.6 percent. This of course is a much lower growth rate in spending than was the case under the previous government.

What is more interesting is what a more detailed analysis by ministry expense category reveals.  Approximately two-thirds of ministry expense categories are expected to decrease while one-third have actually experienced an increase. Table 1 lists the ministry expenses by ranked percentage increases whereas Table 2 does it by ranked expenditure decreases. Increases in spending range from 550 percent for the Treasury Board Secretariat Capital Contingency Fund to 0.5 percent for the Training, Colleges and University Base Budget. Despite what may seem to be very large increases for the Treasury Board Secretariat they are on amounts that represent less than one percent of total spending. With respect to the Treasury Board Secretariat, the government also notes that: “The Province has put in place a prudent Operating and Capital Contingency Fund housed in the Treasury Board Secretariat. This fund is the main driver of the increase in the Ministry’s 2019–20 budget, in addition to an increase in employee pension benefits paid.” (Ontario 2019 Budget, p. 298).  Other increase of note also include Infrastructure (Base) (261%), Total Transportation (10.9 %) and Interest on the Debt (6.4%).

It should be noted that Health and Long-Term Care and Education (Primary & Secondary) together represent in 2019/20 a total of $95 billion or about 60 percent of the spending total.  While there are changes within both these categories underway designed to create efficiencies it remains that Education is going to grow by 2.6 percent and Health by 2.2 percent.  It is fairly simply math to realize that if categories representing 60 percent of government spending are going to grow by over 2 percent when total spending is growing by 0.6 percent, then there are going to have to be reductions in many other categories which account for the other 40 percent of spending.

 
Here the list is much larger (therefore two tables) and some of the percentage increases also larger.  Reductions range from -0.4 percent for the base budget of Municipal Affairs and Housing to -67.1 percent for Natural Resources and Forestry Emergency Forest Fire Fighting.  However, the total budget for Natural Resources and Forestry is declining by -19 percent while the base budget is declining by -3.2 percent.  While the Total Budget for Training, Colleges and Universities is declining by -6.1 percent, its base budget is actually growing by 0.5 percent while the student assistance component is declining by -33 percent.

To its credit, the provincial government has embarked on what appears to be a pretty substantial review and restructuring of government spending in all categories.  Within expenditure categories it is choosing what to increase – albeit at a lower rate than in the past – and what to substantially reduce.  Some categories have been hit immediately with some large reductions.  Some of these reductions include the winding up of one-time funding and therefore appear quite large for the coming year which is why a comparison of base budget rather than overall totals might be more appropriate.  However, the ultimate aim appears to be a substantial restructuring with priorities being selected.  It would appear the priority is to deal with the province’s fiscal situation while ensuring that overall budgetary cuts do not occur particularly in the key areas of health and education.  Indeed, all things considered, the transfer partners in the municipalities, universities, schools and hospital sectors (MUSH) have gotten off relatively lightly.  This naturally means larger declines in the remaining 40 percent of government spending. It cannot realistically be otherwise.

Ontario Budget 2019: Some Preliminary Thoughts

Well, the Ford Government’s first budget is out. Detailed analysis of the new fiscal numbers takes time but for now, some quick preliminary thoughts on what I think will ultimately be a positively received budget by the Ontario public despite the criticisms that will be leveled by both the right and left of center critics.  This positive public reception is not just because of popular new measures in alcohol, gaming and cannabis – such as earlier starts to establishments - that will facilitate consumption.

The right will argue that the move towards fiscal balance is not occurring fast enough.  Moreover, Ontario’s debt pile is projected to grow past $343 billion to reach $360 billion with an accompanying increase in debt service costs.  Meanwhile, the left will emphasize any harm to services from reductions needed to find public sector efficiencies. Indeed, the lead up to this budget has seen some particularly vociferous commentary about the “storm” coming to Ontario and the "apocalyptic" cuts coming to public services.

Yet, many middle of the road Ontarians may probably find this to be a reasonable budget that is less harsh than many expected. After all, spending is still going to be up slightly next year – from $162.5 billion to $163.4 billion and then to $165.6 billion the year after.  With signs the economy may be slowing down, the government is certainly not keen to worsen any potential downturn with a slash and burn budget.  However, the next four years may also be one of the most transformative periods in recent Ontario public finance if the government succeeds in implementing its vision to better manage Ontario’s public sector while maintaining services.

The Ford government is expected to end 2018-19 with an $11.7 billion deficit and is bringing in the 2019-20 fiscal year with a $9.3 billion deficit with plans to balance the budget by 2023-24. With respect to fiscal progress, the Ford government could have balanced the budget in about three years if it had decided to freeze nominal spending for a couple of years.  Instead, it is planning to allow total spending to grow at about one percent annually which is still very restrictive relative to the projected increases of the last Liberal budget.  Spending in Ontario is being placed on a much lower growth trajectory so that over time it will eventually match revenues.  Given that compensation is a big part of public sector spending in Ontario, the one percent number is a signal of what wage increases can be expected in the public sector. 

 

After inflation, real spending in Ontario will nevertheless decline and therefore there will need to be choices made on where greater reductions and efficiencies will occur. However, some of those efficiencies will be used to fund new initiatives whether they be dental care for seniors, a new child daycare tax credit, opening new long-term care beds on a faster schedule, investments in public transit, and ultimately even some tax relief down the road.

More specifically, despite creating a new single health agency and optimizing productivity, over the medium-term health sector spending is still expected to grow an average of 1.6% annually to 2021-22. Education is expected to grow 1.2 percent annually.  On the other hand, post-secondary education and training is expected to decrease at 1% annually and while justice, and children and social services, will each decline at about 2% annually. 

In terms of efficiencies, aspects of the government plan are going to take shape via coming expert panels and task forces. Education is a key area with changes in class sizes the first step that was taken.  A task force to find efficiencies in how the four systems operate will inevitably lead to suggestions for more coordination of procurement and spending across school boards, standardization of pay scales and perhaps even some type of consolidation of facilities in declining enrollment areas as well as administrative and management functions that preserve the distinctive nature of each system.

Then there is post-secondary education where the budget has communicated a desire to tie college and university funding more to performance outcomes.  The key issue here is what those performance outcomes are going to be. Along with graduation rates and employment success, one might expect to see research output and measures of commercialization success or community outcomes as additional measures.  However, Ontario’s post-secondary sector especially at the university level is quite diverse and constructing a one-size-fits all set of measures will be politically challenging given the regional role many universities play. 

However, where the government will garner more sympathy from the public is with respect to its position on trying to do something about aging university faculty who can continue working past 65 and earn a salary and if still working after age 71 also collect a pension. However, university pensions are not like school teacher pensions – there is no province wide university pension system but each university has its own so again there is no easy one-size-fits-all solution.  The government will at minimum need to separate its thinking with respect to those universities with plans that are defined benefit-where the employer bears the risk - from those that are defined contribution – where the employee bears the risk.

And then there is health care, Ontario’s largest single budgetary expenditure.  Health care in Canada has been looking for transformative change for years and the inevitable result has been more and more spending.  The slowdown in growth rates of the last few years may ultimately prove to be temporary, driven in part by a slowdown in new drug products and postponement of capital spending. With a pledge to end hallway medicine and increase the number of long-term care beds, combined with an aging population and the arrival of new high demand pharmaceutical products, any savings found by true transformative change in Ontario will be rapidly eaten up by other spending.  This will be the area of greatest challenge.

So, there you have it.  This budget has a lot of plans for change by implementing reforms and best practices and innovation but for the moment they are just plans.  Politics is the art of the possible and the next couple of years will reveal what is possible and what is not.  Much hinges on how the economy performs, and especially whether we go into a small recession.  If the economy does better than expected and revenues are buoyant, the government will be able to shrink the deficit more than expected and spend more money.  Angst generated for media purposes and twitter universe rants aside, I think a sizeable silent chunk of the Ontario population will give the provincial government the benefit of the doubt for now.