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2010 Ontario Budget: Restraint to Come ... Tomorrow

by Sabrina Browarski and Matthew Stewart

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Introduction

After one of the most economically and fiscally challenging years in the province’s history, the 2010 budget provided the Ontario government with an opportunity to craft a fiscal exit strategy from fiscal stimulus. A detailed plan is needed to ensure that Ontario repositions itself as the growth engine of the Canadian economy—a plan that addresses expenditure management and improves productivity in the health-care sector.

In its budget, the Ontario government promises another year of fiscal stimulus (alongside the second year of stimulus included in the recent federal budget). This is not surprising, given the depth of the recession in Ontario, the uncertainty still surrounding the recovery, and the structural changes required to revive Ontario’s economy. The budget also contains some immediate initiatives, such as the plans to freeze public sector wages and reduce the size of the Ontario public service by 5 per cent. The majority of the restraint, however, won’t begin until 2011–12.

Nevertheless, the budget does not provide a detailed plan for implementing the kind of fiscal restraint needed to return the province to balance. According to the budget, the province is expected to return to fiscal balance only by 2017–18. But although the provincial government intends to improve the efficiency of the health-care system and will cap growth in this largest expenditure category to 3 per cent annually, the budget contains no explicit description of how this sharp slowing of spending growth will be undertaken.

According to Ontario Finance, two decades ago, 32 cents out of every dollar of Ontario government program spending were directed to health care; in 2010–11, that figure will rise to 46 cents. With the aging of the baby boomers, the sustainability of health-care financing will become increasingly tenuous. The government speculates that in 12 years, when the oldest members of the baby-boom cohort reach 75, costs associated with health care could balloon to 70 per cent of program spending. Moderating spending here will remain a difficult feat, given that health expenditures have risen by an average of 7 per cent annually since 2000. (See chart.)

Chart: Reining in Health-Care Spending

Despite the restraint measures introduced in the budget, Ontario is not yet out of the woods. With a planned deficit of $21.3 billion forecast for fiscal year 2009–10, and per capita debt slated to increase from $11,123 in 2007–08 to over $18,100 by 2012–13, Ontario faces the most challenging fiscal position of all the provinces. But the bulk of the spending restraints will only begin in 2011–12 when the stimulus plan is complete. However, the government is imposing immediate wage freezes for non-unionized public sector workers, and some infrastructure commitments have been delayed. New spending measures are relatively modest, but they include $310 million slated for colleges and universities to create 20,000 new spaces this coming September.

Economic Outlook

To provide the economic indicators required in producing budgetary projections, the Ontario Ministry of Finance benchmarks its internal economic forecast to a consensus of private sector forecasts. The outlook behind the ministry’s current budget estimates is based on information available to March 12, 2010.

The Conference Board of Canada estimates that there exists moderate upside potential to the economic forecast underpinning the 2010 Ontario Budget. After a year of considerable economic duress, the bounce-back in labour markets, industrial production (particularly in the manufacturing industry), and consumer activity (both domestically and in the United States) are providing significant upward momentum for the Ontario economy.

Looking forward, the Conference Board’s own forecast incorporates a stronger and earlier recovery than does the Ontario budget. Our outlook calls for nominal gross domestic product to grow by 6.1 per cent in 2010, compared with a projected 4.4 per cent in the budget. The difference between the forecasts through the medium term is significant. Given our assumptions, GDP could be $1.1 billion higher this year alone. The gap between our forecast and the budget’s forecast peaks at $13.7 billion in 2012. Historically, the Ontario government has been able to capture roughly 12.5 per cent of nominal GDP as provincial tax revenues. By 2013, this higher growth could generate revenues $1.7 billion higher than projected in the budget, thus providing the province with some additional fiscal manoeuvring room in its battle to eliminate the deficit.

The Conference Board’s stronger growth assumptions arise from macroeconomic drivers at both the U.S. and Canadian national levels. We anticipate a more pronounced U.S. recovery from 2011 to 2012 than does Ontario Finance, with our U.S. real GDP growth forecast averaging 0.2 per cent per year above the budget’s targets. Even after accounting for a Canadian dollar trending around parity with its U.S. counterpart after 2011, this still translates into a stronger trade outlook for Ontario. Our estimates of export growth exceed the ministry’s estimates by an average of 1.1 per cent per year from 2010 to 2013. Furthermore, we believe that financing conditions—as measured by the Canadian 3-month T-bill rate and 10-year Canadian government bond rate—will remain stimulative for months to come, boosting private residential and non-residential investment activity above what is projected in the budget.

At the provincial level, a swifter return to labour market stability will allow considerable growth in personal income and total labour income through the forecast horizon. Between 2010 and 2013, the Conference Board expects the Ontario economy to generate some 121,000 jobs more than the budget estimates. Our more robust outlook for personal consumption growth, housing starts, and retail sales is based on our expectation of stronger household wealth and incomes.

Collectively, these key drivers of economic growth will persist through the medium term, helping to close the output gap by 2013. While some sectors—such as the automotive manufacturing industry—doubtless have a long way to go before returning to their pre-recession output levels, for the economy as a whole, the output gap should close at a fairly rapid pace in the near term.

Fiscal Plan

Among all the provinces, Ontario is in the most difficult fiscal position. For fiscal year 2009–10, the province will post a deficit of $21.3 billion—equal to 3.8 percent of nominal GDP. On only two previous occasions—in fiscal years 1991–92 and 1992–93—has the deficit-to-GDP ratio exceeded this level. And although the deficit is $3.4 billion less than the $24.7 billion predicted by the government in its fall 2009 Ontario Economic Outlook and Fiscal Review, the improvement is almost entirely due to delayed infrastructure spending and the removal of the fiscal reserve. With the deficit at such a high level, it is imperative that the province begin to lay out a detailed plan to improve the fiscal situation. Although the province has stated that it will attempt to sharply curtail program expenses, spending restraint will have to wait until fiscal year 2011–12 when the stimulus spending has come to an end. Until then, spending will continue to increase. In fact, after increasing program spending by 14.5 per cent in 2009–10, program spending is slated to advance by a further 6.5 per cent in 2010–11. In 2011–12, the stimulus program will pass from the numbers. Program spending will then fall by 2.6 per cent that year, although most departments—including health and education—will continue to see solid spending growth.

The government’s plan does call for program spending to be sharply controlled, with the bulk of the restraint beginning in 2012–13. Effective immediately, however, the plan freezes all wages and salaries for its non-unionized public employees for two years, and the government says it will not agree to compensation increases in any future collective agreements with unionized workers for at least two years. Furthermore, the Ontario government intends to reduce the size of the public service by 5 per cent by March 2012.

The key to controlling the overall growth in program spending (and the biggest challenge) will be to limit future increases in health-care spending. Over the last five years, health-care spending has risen by an annual average of 6.5 per cent. It now consumes 46 cents out of every dollar collected by the province in taxes or received from the federal government in transfers. Ontario finance minister Dwight Duncan says that if spending is left unchecked, this number could rise to 70 cents of every dollar within 12 years. In response to this challenge, from 2012–13 to 2017–18, the Ontario government will attempt to hold health-care spending increases to just 3 per cent per year. However, this will be a Herculean task. The province will need to craft a detailed plan and demonstrate the ability to control rising health-care costs, something that has been absent in the past. Health-care funding will only grow more difficult as the substantial aging of the population over the next decade puts upward pressure on the demand for health care. Nevertheless, without further constraints to health-care spending, substantial cuts to other program services, or tax hikes, it would be very difficult for Ontario to balance its books.

Even if the Ontario government manages to stick to its current fiscal targets, net debt is projected to rise from $176 billion as of March 2009 to $267.8 billion by fiscal year 2012–13—an increase of almost $92 billion, or almost $7,000 per Ontarian. Furthermore, by 2012–13, the interest payments required to service the debt will rise by over 40 per cent. Those numbers provide a strong fiscal imperative to develop and implement a detailed plan for controlling health-care and other spending.

Economic Impact of the 2010 Ontario Budget

Given the combination of $1.6 billion in cuts to planned infrastructure spending and $400 million in reduced government program spending included in the budget, we are making a modest reduction in our 2010 and 2011 GDP estimates for Ontario. The economic impacts of the 2010 Ontario Budget are sufficiently small that they will not affect our medium-term outlook for real GDP growth.

Sabrina Browarski Sabrina Browarski
Economist

Matthew Stewart Matthew Stewart
Senior Economist

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