This report helps shed light on Ontario’s fiscal challenges in three ways. First, it provides an updated estimate of potential (or sustainable) economic growth in Ontario over the longer term, which determines expected revenue for the provincial government. Second, it provides detailed modelling of health and education spending to account for demographic changes, trends in technology and access to services, and trends in cost drivers in these sectors, over a long-term forecast horizon. And third, it produces projections on when the Ontario government is likely to rebalance its books, based on revised revenue projections and under different spending assumptions, for health care spending in particular. The analysis developed here helps to quantify the fiscal challenge the province is facing and provides tools necessary for future research, especially in evaluating policy alternatives.
The Challenge
The Ontario government is projecting an annual fiscal deficit of $16 billion in 2011–12, and it expects to remain in fiscal deficit for a number of years to come. In order to rebalance its books by 2017–18, the Ontario government laid out a plan in its 2011 budget to tightly control spending growth over the next seven years.1 The plan includes containing total program spending to growth of just 1.7 per cent per year over the next seven years, a radical break from recent history. This plan is already optimistic. Yet, our most recent Ontario economic outlook suggests that even if spending targets in the 2011 Ontario Budget are attained, the provincial government may still not be able to balance its books on schedule. Moreover, health care spending currently consumes 44 cents of every dollar in provincial revenue and must, therefore, be a vital part of any expenditure restraint package. To achieve the very frugal spending target set out in its 2011 budget, the government expected annual growth in public health care spending to slow sharply—from the 7 per cent pace experienced over the last decade, to just 3 per cent per year beginning in 2012–13.
The provincial economy is expected to continue to recover slowly from the effects of the recession and then grow in line with our estimates of potential output.
Achieving such a different growth path for health care spending will be extremely challenging, given the increasing demand for health care from the province’s aging population and the internal cost-drivers of the health care system. Slowing the rate of growth in spending won’t be much easier for other programs. Total spending, excluding health care, was slated to rise by just 0.3 per cent per year from 2010–11 to 2017–18 in the 2011 budget. This includes spending on social services, education, and other programs. Given that the government plans to slow spending on social services and education to a pace slightly below 3 per cent per year, spending on other programs will have to be cut sharply to meet the overall target of 0.3 per cent per year. Indeed, to achieve its overall spending target, the provincial government would have to cut all other program spending (i.e., all program spending except for health care, education, and social services) by an average of 5.4 per cent per year—a difficult feat indeed!
The Ontario fiscal plan will need adequate revenue growth to fund ongoing government program spending. The provincial economy is expected to continue to recover slowly from the effects of the recession, and thereafter grow in line with our estimates of potential output.2 A softer economic recovery, due largely to external factors such as the financial turbulence in Europe and the weakness of the U.S. economic recovery, means economic growth—and related growth in government revenues—will be weaker than what was forecast in Ontario’s 2011 budget. Moreover, aging demographics and slower labour force growth will reduce the province’s economic growth prospects over the longer term, which in turn limits the outlook for government revenue growth.
Based on the Conference Board’s latest economic outlook and our estimate of potential (or sustainable) economic growth over the longer term, the Ontario government would have to slow total program spending growth to just 0.7 per cent per year beginning in 2012–13 in order to balance its books by 2017–18 as planned in its 2011 budget. That is roughly 0.8 percentage points below the current plan. This means that bringing Ontario’s budget back into balance within a reasonable time frame will be a significant challenge. At the same time, meeting that goal is imperative if Ontario is to keep its finances from running out of control.
The Analytical Framework
As noted, the analysis in this study is founded on a re-estimation of Ontario’s growth potential, or the level of sustainable real economic growth (i.e., growth after inflation). The estimate of potential economic growth is based on three principal factors: the projected available labour force in Ontario, capital investment, and productivity growth. Over the longer term, aging demographics and slower labour force growth will reduce the province’s economic growth prospects, which in turn will limit the outlook for government revenue growth. Our estimate for Ontario’s economic growth potential is 1.9 per cent annually, which will translate into lower levels of annual government revenue over the longer term than previously expected.
The research then considers three spending scenarios in order to gain insights into the challenges the provincial government will face in trying to rebalance its budget. Each scenario uses the same economic growth outlook, which determines revenue growth. The provincial economy is expected to continue to recover slowly from the effects of the recession and to grow thereafter in line with our estimates of potential output. Ontario’s gross domestic product is estimated to grow in nominal terms (i.e., real economic growth plus inflation) at an average annual pace of 3.9 per cent over the 2011–30 forecast period. Since nominal GDP growth sets the broad revenue base that is available to government, success in rebalancing Ontario’s books will hinge on the government’s ability to constrain overall spending growth and/or raise additional revenues until the budget is rebalanced, and then to keep spending growth at this 3.9 per cent nominal GDP growth benchmark. Our analysis assumes that the Canada Health Transfer (CHT) to the provinces from the federal government will continue to increase by 6 per cent per year until 2016–17. Afterward, growth slows to match the increase in nominal GDP, as recently announced by finance minister Jim Flaherty.
Ontario’s GDP is estimated to grow in nominal terms (real economic growth plus inflation) at an average annual pace of 3.9 per cent over the 2011–30 forecast period.
Scenario 1 is the “maintain the spending plan” scenario. In Scenario 1, projections for spending on health care and other programs are aligned with the provincial government’s most recent budget, which was released in the spring of 2011, and economic update, which was delivered in November. Revenues, however, are adjusted to align with the Conference Board’s detailed economic outlook for Ontario. Under these assumptions, the Ontario government will not be able to eliminate the deficit by 2017–18 as set out in the 2011 budget. Instead, it would take until 2021–22 to balance the budget. If the government were to maintain its balanced budget target of 2017–18, overall program spending growth would have to be slowed to 0.7 per cent per year beginning in 2012–13.
Meeting this spending path will be extremely challenging. Together, health care and education spending eat up nearly 72 per cent of provincial government revenues. The 2011 budget calls for growth in health care spending to be held to 3 per cent annually. By way of comparison, health care budgets have expanded by roughly 7 per cent per year over the past 30 years, with periods of restraint typically followed by periods of above-average spending growth to catch up with increased demand.
For scenarios 2 and 3, the Conference Board relies on its detailed, demographically driven model to properly assess future demand for health care. Scenario 2 is an “adjust for aging population” scenario. It examines what the spending plan would look like if health care funding were increased to account only for demographics and inflation; that is, real per capita spending remains constant over the forecast period. In essence, constant real per capita spending implies that there are few modifications made to the delivery of health care to account for increased utilization, new procedures, drugs, or new technologies. Even under these restrictive assumptions, demand-driven growth for health care spending averages 4.7 per cent per year, well above the Ontario government’s current target, and above our estimate for sustainable nominal GDP growth. Educational spending is forecast under this scenario by keeping real per-student spending constant. Beyond health care and education, strict spending restrictions are maintained for social services, and sizable declines in spending are projected beyond health care, education, and social services. Under these assumptions, Scenario 2 indicates that the provincial government would be unable to rebalance its budget over the time frame of this study (to 2031).
Scenario 3, the “maintain spending growth” scenario, assumes that funding for Ontario’s health care system will continue to grow at a pace that is more closely aligned with demand. In this scenario, real per person increases in public health care funding would allow for continued increases in health care delivery in line with the levels of growth we’ve seen in the past. In this case, health care spending averages annual growth of 5.6 per cent, with spending restraint maintained on other provincial programs. Rather than leave the province in deficit over the forecast horizon, additional financial resources would be required to bring the deficit under control in addition to the sharp cuts in programs other than health care. The provincial sales tax rate would have to increase from 8 per cent to 15 per cent by 2017–18, in order to generate enough revenue to allow the provincial government to balance the budget in that year.
Scenarios 2 and 3 provide estimates for the likely paths for future provincial expenditures that are consistent with past spending trends. With an aging population in Ontario, there will be intense pressure on the government to improve the delivery of health care, such as through shorter wait times. Moreover, the aging baby-boom cohort is growing and will continue to wield significant political clout. In fiscal terms, these scenarios highlight the challenges of controlling health care spending growth, of transforming the publicly funded health care delivery system in Ontario, and/or of increasing available government revenues. If Ontario residents want their public health care system to continue to receive strong funding growth, they will most likely have to pay for it through higher taxes. If the public is unwilling to accept and support higher taxes, other transformative changes will be required in the way in which publicly funded health care is delivered in Ontario.