Provincial Debt/Deficit Paper

17 Feb 2010

THE ISSUE

The Ontario Government is projecting deficits of $21.1 billion in 2010-2011 and $19.4 billion in 2011-2012. These projections reflect a reduction in anticipated revenue due to the recent weakening of economic conditions and the simultaneous increase in spending to offset some of the (temporary) effects of weaker private consumption and investment. (Note: The deficit to GDP ratio for 2010-2011 is approximately $21.1 billion/$581,609 billion = 3.3%)

Ontario's total debt, which represents all borrowing without offsetting financial assets, is projected to be $213.2 billion as at March 31, 2010, compared to $176.9 billion as at March 31, 2009. Ontario�s net debt, the difference between total liabilities and total financial assets, is projected to be $184.1 billion as at March 31, 2010, compared to $153.3 billion as at March 31, 20091. (Note: The debt to GDP ratio for 2009-2010 is approximately $213 billion/$581,609 billion = 37%)

Rising debt not only exposes the budget to the risk of higher interest rates, as was the case in the early 1990's, but it also creates an intergenerational shift of the tax burden. Without a realistic plan to reduce the current deficit and ultimately the current level of debt, we will then be leaving that cumulative debt for future generations to resolve. The Ontario Chamber of Commerce does not believe this is the prudent or responsible approach to managing Ontario's debt.

BACKGROUND:

In response to the severe recession, the Ontario government, (and other governments around the world), has relaxed fiscal policy by running significant deficits. While there are many arguments in favour of continuing to run relaxed fiscal policy during the coming fiscal year, it is imperative that the government move to credibly outline a plan to balance the budget by fiscal year 2015-16.

One useful measure of the capacity to borrow and repay debt and, more broadly for the scope for national fiscal policy, is the debt-GDP ratio. Provinces (or countries) with lower debt-GDP ratios are better able to sustain higher deficits (and thereby increase their debt-GDP ratio) during economic slowdowns. Conversely, provinces (or countries) with high debt-GDP ratios find themselves both the challenge of having to allocate a larger share of their budgets to debt service while having little room to borrow to finance additional deficits during future recessions.

While London's business community, for instance, is deeply concerned about the size of the projected deficits and the level of debt, they are equally concerned at the lack of a clearly articulated plan to balance the budget within a reasonable period of time. This concern is illustrated on the following chart where the size of the deficit, the size of the debt and the lack of a plan all received a similar score on a recent pre-budget survey.

The need for a credible and responsible plan is based on two principles. First, the business cycle is not dead. In order for the provincial government to maintain the option to respond to future downturns in the business cycle, it must move to, at the very least, balance its budget over the business cycle. (Over the good years, you need to run a surplus to finance the deficit you expect to run over the bad years thus balance the books over the entire length of the business cycle.)

Given that post-war business cycles have averaged five to seven years, this suggests that a minimal objective is a plan to bring the budget into balance within 5 years.

The second principle is that the ability to borrow at reasonable rates of interest depends critically upon the confidence of lenders. While it should be emphasized that the current Ontario debt load is manageable, it is important that the government credibly commit to a medium run fiscal plan that will maintain the Ontario debt-GPP ratio in a reasonable range over the next 5 years. This will ensure that current credit ratings are maintained and prevent risk premiums from being added to the rate of interest attached to Ontario's debt.

An additional reason for fiscal prudence in the coming years is projected demographic changes. The most recent Ontario Population Projections highlight two trends that will put increased pressure on provincial budgets. First, the growth rate of adults aged 15-64 is projected to grow more slowly than over the past two decades. This will be a downward force on future nominal GDP growth rates, relative to the past 20 years. The second key factor is the growth rate of those greater than 65 will be above historical averages, due to the aging of the baby-boomers and increased life expectancy. This will put increased pressure on future health care costs.

There is no avoiding the fact that any credible fiscal plan will involve tough choices. Some simple calculations clearly illustrate these challenges. The 2009 Ontario Economic Outlook and Fiscal Review provide revenue and expense projections out to the 2011-2012 fiscal year. As a recent TD- Bank Financial Group report discusses, a reasonably optimistic growth rate of government revenues is on the order of 6 % per annum. Combining this with the current fiscal projection for 2011-12, to balance the budget by 2015-16 the Ontario government would have to hold expenditure growth to less than 1.7 % per year over 2012-2016.

This rough calculation highlights the urgent need for the government to outline realistic options to hold down expenditure growth. In particular, the government has no alternative but to seriously explore ways of reducing the growth rate in health care expenditures either by promoting efficiency measures or by allowing for more direct billing for some services. However, the government should not accomplish this goal by simply rationing health care.

These calculations also highlight the important role played by revenue growth. This further emphasizes that policies which help to increase the growth rate of GDP will increase the sustainable level of future government expenditures. This implies that the government should stay the course on recent tax reforms which will help to increase investment and growth (see Mintz (2009)). In addition, the government should avoid slashing expenditures on high return investments, such as key infrastructure, education and training given their direct link to levels of productivity and economic growth.

Now that federal/provincial stimulus initiatives are well underway and a time table for their implementation put in place, we believe that this is the most appropriate time to implement a defined formula for Ontario's provincial deficit strategy. In other words, Ontario needs a comprehensive and practical plan to eliminate the provincial deficit without jeopardizing a very fragile economic recovery.

RECOMMENDATIONS:

The Ontario Chamber of Commerce urges the Government of Ontario to:

1. Have a working target of getting into surplus by 2015-16. The government should provide an accurate accounting and recovery plan that will clearly communicate the government's intention to be in surplus by 2015-16 and will update this plan in all future budgets and economic statements. In this area, transparency is key to enhancing credibility and reducing uncertainty.

2. Not retreat on its commitments or timelines for stimulus capital spending until we are out of the recession. The government should look to spending restraints but not reduce its deficit through cuts to existing municipal transfer payments, nor reducing investments in education and training and needed infrastructure which will promote our competitiveness and economic growth in the future.

3. The government will not reverse tax-cut reforms or investment decisions which are creating an internationally competitive business environment.

4. The government will maintain and improve its Net Debt to GPP (gross provincial product) ratios at better than the provincial average of the five provinces with the lowest ratios.

5. Enhance the efficiency of health care spending, including by ensuring that international best practices are adopted at the strategic and operational levels.

References

Mintz, Jack (2007). 2007 Tax Competiveness Report, CD-Howe Institute Commentary 254, September 2007.

Ontario Ministry of Finance (2009). 2009 Ontario Economic Outlook and Fiscal Review, http://www.fin.gov.on.ca/en/budget/fallstatement/2009/paper_all.pdf

Ontario Ministry of Finance (2009). Ontario Population Projections: 2008-2036 Ontario and its 49 Census Divisions, Fall 2009. http://www.fin.gov.on.ca/en/economy/demographics/projections/demog09.pdf

TD Bank Financial Group (2009). �The Coming Era of Fiscal Restraint�, http://www.td.com/economics/special/db1009_fiscal.pdf

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