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Budget Analysis: May 2, 2013

A Tough Spot … and a Difficult Road Ahead

At first glance, Ontario’s fiscal situation seems much improved from what we saw in last year’s budget. But much of the improvement from last year’s headline deficit number reflects one-time adjustments and will not carry forward to future years. As such, there is little doubt that unless economic conditions prove better than current expectations, Ontario will continue to face a stark fiscal challenge. Over the next three years, the government plans to tightly constrain spending, with projected increases averaging just 1.5 per cent annually. The most difficult restraint will have to wait until the final two years of the plan, when an outright cut to spending will be required to balance the books as targeted in fiscal 2017–18.

Despite the seriousness of Ontario’s economic and fiscal situation, this was not a budget filled with major announcements. That said, the budget includes a few conciliatory measures aimed at garnering support from the opposition parties.

One important (and positive) measure in our view is the Youth Jobs Strategy. The youth unemployment rate in Ontario remains above its pre-recession level, and it is certainly an area where improvement would be beneficial. This two-year, $295-million initiative aims to improve the employment outcomes for Ontario’s young people. The bulk of the funding ($195 million) will be directed toward incentives for hiring young Ontarians. The remaining funds will be directed toward entrepreneurship initiatives, such as mentorship and seed capital, as well as fostering entrepreneurial activities and commercialization of research at post-secondary institutions in the province.

As was reported earlier this week, the budget sets its aim on decreasing automobile insurance premiums by an average of 15 per cent. A specific date for meeting this target is not yet set; instead, it will be achieved “within a period of time to be prescribed by [future] regulation.” The government’s strategy is to limit fraudulent claims and the overcharging of insurers by service providers. (This will be done by introducing sanctions.) Pursuing those who file unjustified claims for benefit payments is an appropriate course of action, as these payments drive up the cost of insurance premiums for legitimate claimants. However, interfering with the market price mechanism by legislating a reduction in insurance rates could have unintended consequences, such as reduced benefit payments (perhaps simply through greater scrutiny of claims) or a change in the mix of insurance products—developments that could negatively impact all potential claimants.

The budget also notes that new revenue-raising tools to pay for transit infrastructure are being considered. One concrete action being taken to alleviate congestion in the Greater Toronto and Hamilton Area (the main geographic focus of the government’s transit funding concerns) is a conversion of certain high-occupancy highway lanes to high-occupancy toll lanes—carpooling drivers would still be able to use them without charge, but drivers of single-occupant cars could also use them as long as they pay a toll. Among other smaller measures, the budget sets aside $45 million over three years for a new Ontario Music Fund, which will support and promote Ontario’s music industry. Although this is a miniscule amount in terms of the overall budget envelope, the justification for this manner of expenditure in the current fiscal climate is unclear.

Fiscal Outlook

At a quick glance, the fiscal situation has improved significantly from last year. Estimated at $9.8 billion, the deficit for 2012–13 is $5 billion better than had been projected. However, much of this improvement was the result of one-time measures that will not carry forward into future years. A detailed analysis of the budget leaves little doubt that the fiscal situation in Ontario remains critical. The government’s fiscal austerity program is back-end loaded, with each year of restraint being more ambitious than the last. Next year, the deficit is expected to rise by $1.9 billion to $11.7 billion as program spending rises by 3 per cent. In the following two years, the deficit will improve slowly as the government attempts to hold program spending growth to 1.1 per cent and 0.4 per cent. In fiscal 2015–16 (the final year of the government’s detailed fiscal plan), Ontario will still have a $7.2 billion deficit. To balance its books in 2017–18 as promised, the government will have to freeze program spending in 2016–17 and cut spending by almost 1 per cent in 2017–18—a difficult task, for which few details are provided. (See chart.)

Chart showing how the Ontario government will have to keep a tight rein on spending to balance the books 

Of the $5-billion improvement in the deficit in 2012–13, $1 billion is attributed to the elimination of the contingency reserve that went unused and to other one-time savings that will not carry forward to future years. The elimination of banked sick days for teachers reduced education spending by $1.1 billion, as the government booked the unneeded liability against this year’s numbers. Corporate income taxes were also $1.2 billion higher than expected due to one-time assessments for years prior to 2011 and a higher tax base in 2011. Outside of these one-time factors, revenues and expenditures were only slightly better than in the 2012 budget’s projections. Ontario Power and Hydro One together generated an additional $313 million in profits, thanks to lower costs and higher transmission revenues. On the expenditure side, health spending came in almost $600 million below budget, thanks to a tightly restrained hospital sector. Interest payments were also $234 million lower due to the impact of lower interest rates.

This year, the government plans to increase program spending by 3 per cent. Adjusting for the effects of the sick day liability removal, which reduced spending in 2012–13, program spending is slated to increase by just 2 per cent in fiscal year 2013–14. This will mark the third year of significant spending restraint, and it stands in stark contrast to average annual increases of 6.1 per cent between 2000 and 2008. The most difficult challenge facing the government is its plan to constrain spending on health care. Health spending consumes 42.2 cents of every dollar in revenue and is slated to grow by just 2.3 per cent in fiscal year 2013–14, compared with average growth of 7.4 per cent annually between 2000 and 2008. Although growth in health spending was held to just 2.8 per cent last year, much of this was achieved through a wage freeze. Moving forward, more structural changes will be required—especially given the increasing demand for health care from the province’s aging population. The budget has listed some good ideas for efficiency improvements in health care, such as moving hospitals from a lump-sum payment model to a pay-for-patient-and-activity funding model and increasing investments in home care. Another measure included in the budget is the introduction of means testing for prescription drug payments, under which higher-income seniors will pay a greater share of their drug costs. Despite these proposed measures, achieving the required degree of spending restraint without overly affecting the quality of care will be a challenge.

Outside of health care, spending will be similarly restrained. Social services will see the highest growth this year due to a promised increase in social assistance rates. Excluding the liability adjustment, spending in education (including post-secondary) will rise by 2.9 per cent, an increase that includes the cost to complete the rollout for full-day kindergarten. The only other major recipient that will see any growth will be the justice department, which is slated to see its spending grow by 2.5 per cent. Excluding health, education, social services, and justice, spending will be cut by 2.7 per cent.

Unfortunately, unless revenues surprise on the upside, the government will be forced to tighten its belt even more in 2014–15 and 2015–16. Health and education will see below-inflation increases, spending on justice will be frozen, and all spending outside of health, education, and social services will be reduced by an average of almost 5 per cent per year. The only spending category slated to receive any meaningful growth in funding will be social services, reflecting the government’s planned increases to social assistance and its plan to increase the Ontario Child Benefit in 2013 and 2014. These tightly constrained spending numbers leave the government with no new funding available for any public sector wage increases over the life of the plan.

If the government sticks to its current plan, the province’s net debt, which includes operating and capital expenses, is projected to rise by $51.1 billion over the next three years. As a result, debt-servicing costs will rise from $10.4 billion in 2012–13 to $12.2 billion in 2015–16. In 2017–18, when the government is scheduled to balance its books, debt-servicing costs will be $14.5 billion, consuming 10.8 cents of every dollar in revenue.

Economic Outlook

The economic assumptions used by the Ontario Ministry of Finance for its budgetary projections are based largely on the consensus of private sector forecasters. The Conference Board of Canada’s most recent economic outlook is more or less in line with the ministry’s, but we are slightly more optimistic about Ontario’s prospects in 2014 and beyond. In our view, there exists some upside potential to the budget’s fiscal outlook.

In 2012, Ontario’s economy did not perform as strongly as expected. Concerns about the U.S. federal government’s sequester-related spending cuts and the ability of Congress to agree on a deficit-reduction plan for the medium term, along with continued uncertainty about the European debt crisis, weighed on business confidence. This resulted in sluggish business investment, which, coupled with fiscal restraint, pulled down real GDP growth to just 1.3 per cent. One bright spot last year was the strength in auto production and exports, which were pulled up by a solid recovery in U.S. vehicle sales. However, gains in this sector will be modest at best in 2013.

The Conference Board expects Ontario’s real GDP growth to be 1.4 per cent this year and 2.5 per cent in 2014. That compares with the budget’s slightly stronger projection of 1.5 per cent this year but a weaker forecast of 2.3 per cent in 2014. Our outlook for nominal GDP—the broadest measure of the tax base—matches that contained in the budget. The Conference Board’s more restrained growth assumption (in real terms) for this year is based on a weaker investment profile than the Ontario Ministry of Finance is assuming. Results from our most recent Survey of Business Confidence suggests that uncertainty over the direction of the economy and a buildup of excess capacity will cause business investment to be a laggard again this year.

Beyond 2014, our forecast for real GDP growth is somewhat higher than that contained in the budget, due largely to a better U.S. performance. In the wake of the 2008–09 recession, U.S. households deleveraged impressively. This, combined with the nascent recovery in the housing market and a brighter employment outlook, should help the U.S. economy gain traction over the medium term.

Still, risks to the outlook remain unusually high. Geopolitical tensions in the Middle East, Korea, Iran, and elsewhere could easily escalate. And the situation surrounding the sovereign debt crisis in the European Union is far from resolved and continues to keep investors on edge—especially in light of the bungled negotiations for a bailout of Cypriot banks. Finally, the weakening of commodity prices (especially gold) this year has had a negative impact on Canadian equities and is causing mining and exploration companies to pause when considering new investments in Northern Ontario and elsewhere.

In light of these risks, the economic assumptions adopted in the budget provide a prudent approach to the fiscal plan. However, we remain concerned about the government’s capacity to sustain the requisite level of restraint over the next five years—particularly in the final years of the deficit-reduction plan.

Matthew Stewart Matthew Stewart
Principal Economist
David Rosé David Rosé
Economist, Provincial Forecasting


Matthew Stewart of the Conference Board of Canada shares his thoughts on the Ontario budget.

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