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Budget Analysis: March 27, 2012

An Ambitious Plan—The Challenge Now Is Execution

The 2012 Ontario Budget sets Ontario’s public sector on a long-term path to frugality. Over the next six years, a program of fiscal austerity will see growth in total program spending average well below 1 per cent per year. The Liberal government plans to achieve this by freezing or limiting gains in public sector wages, increasing efficiency, trimming infrastructure spending, and reducing the generosity of public pensions. Compared with a “business as usual” scenario, the reductions in program spending and cost containment under this austerity program will generate a cumulative $17.7 billion in savings over 2012–13 to 2014–15. New revenue measures will also help. The government announced that it will delay corporate tax reductions (a saving of $2.1 billion), increase user fees for some services ($600 million), and optimize revenues from gambling and alcoholic beverage sales ($700 million). Along with some other smaller measures, this will generate a total of $4.4 billion in cumulative additional revenues over the next three years.

The combination of expenditure and revenue measures places the government on a path to balance its books by 2017–18. But containing costs over such a long-term horizon will be difficult. While the government will not impede the collective bargaining process, it is prepared to impose administrative and legislative measures to ensure that public sector agreements are consistent with the budgetary plan. In essence, the government is looking to freeze public sector salaries for at least two years and to modestly reduce public employment levels. Efficiency gains in health care delivery, education, and other government departments are also expected to contribute $6.8 billion in savings over the next three years. In comparison with other provinces, Ontario has the lowest number of public servants (and associated costs) per capita, and the 2012 budget will likely extend this situation for years to come.

The budget’s revenue projections are based on prudent assumptions about economic growth, and the fiscal plan contains an additional $1.5-billion contingency reserve. Overall, the budget deficit will decline slowly—from $15.3 billion in 2011–12 to $10.7 billion in 2014–15. Another three years of fiscal restraint will then still be needed before the budget is balanced in 2017–18.

Fiscal Outlook

Ontario’s fiscal situation is critical. The province’s deficit is large—2.4 per cent of GDP. And Ontario has run substantial deficits in each of the last four years. With total debt rising from 28 per cent of GDP in 2007–08 to 40 per cent this fiscal year, it is clear that substantial changes are needed before debt downgrades and spiralling debt costs threaten the quality of social programs. According to the budget estimates, if the government were to continue on its current course, the deficit would reach almost $25 billion in 2014–15. To address this challenge, the Ontario government has laid out an ambitious plan of program restraint and revenue measures. If it succeeds in carrying out its plan, the government will have presided over the kind of fiscal austerity seen only in a few provinces back in the late 1990s.

For the fiscal year just ending, the province will post a deficit of $15.3 billion. That is $1 billion lower than predicted in the 2011 budget. However, most of this improvement is due to the unused contingency fund and a saving of $200 million in debt-servicing charges as a result of lower-than-expected interest rates. In addition, total program spending is now projected to be $200 million below budget.

With the deficit at such a high level, it is imperative that the province begin to control program spending immediately. In that regard, the budget doesn’t disappoint. The government plans to limit overall spending growth to an average of just 0.6 per cent over the next six years. While the restraint is somewhat back-end loaded (growth averages 1 per cent over the next three years but just 0.3 per cent over the final three years of the plan), that compares with average annual growth of 6.3 per cent over the five-year period from 2003–04 to 2008–09. And even that high rate of growth came before the stimulus spending associated with the 2008–09 recession kicked in and sent the deficit soaring. These numbers speak to the ambition of the plan. (See chart.)

Austerity Budget Will Keep a Tight Rein on Program Spending Growth  

With total health care spending currently consuming 43 cents of every dollar in provincial revenue, containing health care budgets must be a vital part of any expenditure restraint package. The government plans to slow annual growth in public health care spending sharply—from the 7 per cent pace experienced over the last decade to just 2.1 per cent per year beginning in 2012–13. Achieving such a scaled-down growth path for health care spending will be 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 on other programs won’t be much easier. Total spending excluding health care is slated to rise by just 0.2 per cent per year from 2011–12 to 2014–15. This includes spending on social services, education, and other programs. Given that the government plans to increase spending on social services at a pace slightly below 3 per cent per year and to hold growth in education spending to just below 2 per cent, spending on other programs will have to be cut sharply to meet the overall target of 0.2 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 more than 3.5 per cent per year over the next three years—a difficult feat indeed! Yet, given the outlook for health, education, and social services, the cuts in these other areas can only accelerate in the final three years of the austerity program.

The expenditure savings will be coming from three main sources: removing duplication and improving efficiency of services delivery, restraining the growth in compensation of public sector employees, and curtailing costs across the broader public sector. The Ontario government is committed to bringing compensation costs, which currently account for around 30 per cent of total program spending, under control. As a result, the government is proposing a two-year wage freeze for teachers and will extend a wage freeze for executives at Ontario’s hospitals, colleges, universities, school boards, and agencies for an additional two years. The government will pursue a very similar mandate with other public sector employees, including physicians.

Almost half of the $4.4 billion in additional revenues will come from delaying further cuts to business tax rates until a balanced budget is achieved. More specifically, the corporate income tax rate, which had been scheduled to drop to 10 per cent by 2013, will be maintained at 11.5 per cent. As well, the business education tax rate will remain where it is for now. Furthermore, additional revenues will come from improved profitability of Crown corporations and increased fees for some public services.

Even if the government does manage to balance its books by 2017–18, the province’s debt (which includes operating and capital expenses) is still projected to rise by $56.6 billion over the next six years. As a result, debt-servicing costs will increase from $10.1 billion in 2011–12 to $15.4 billion in 2017–18, by which time they will consume 11.3 cents of every dollar of revenue.

Economic Outlook

The Ontario Ministry of Finance’s economic assumptions underpinning the budgetary projections are very similar to the consensus assumptions of private sector forecasters.

In 2011, the economic performance was hindered by a number of external factors, such as a sluggish economic recovery in the United States (the main destination for Ontario’s exports) and the sovereign debt woes in Europe. Furthermore, Ontario’s auto industry was hurt by supply-chain disruptions caused by natural disasters in Asia. Unfortunately, economic conditions are unlikely to improve this year. Economic growth will be held back by softer global economic growth, a modest recession in Europe, fiscal austerity packages at the federal and provincial levels, and a slower pace of business investment.

The Conference Board of Canada expects Ontario’s real GDP growth to be 1.9 per cent this year and 2.8 per cent in 2013, compared with a slightly weaker budget projection of 1.7 per cent this year and 2.2 per cent in 2013. Our outlook for nominal GDP—the broadest measure of the tax base— is also slightly higher than that contained in the budget. The Conference Board’s more optimistic growth assumptions are based on stronger macroeconomic drivers, both domestically and in the United States. More specifically, U.S. employment growth has been robust in recent months, helping to bolster consumer confidence. Improved consumer sentiment and strong pent-up demand is expected to support brisk vehicle sales south of border, helping to lift Ontario’s exports.

We expect Ontario’s labour markets to perform relatively well, with employment growing 1.6 per cent in 2012 and 2.3 per cent next year. The budget assumes a more modest pace of job creation. Our stronger outlook for employment translates into a stronger forecast for growth in retail sales and new housing starts. Even with the job gains and lower inflation, however, real income will improve only slightly as tax credits introduced during the recession and the harmonized sales tax transitional payments come to an end.

Despite our stronger outlook, there remains significant downside risk to the current economic forecast. Geopolitical tensions, in particular with Iran, could push oil prices higher, causing the Canadian dollar to appreciate further and hurt Ontario’s exports. Furthermore, the situation surrounding the sovereign debt crisis in the European Union remains unresolved, keeping investors on edge. Stock market volatility, combined with strong growth in the developing countries, is causing a surge in commodity prices. High prices for oil and other commodities will raise costs for Ontario’s manufacturers and stretch household budgets.

Overall, the Conference Board agrees with the assumptions set out in the budget. But we remain concerned about the government’s capacity to sustain the requisite level of restraint over the next six years.

Matthew Stewart Matthew Stewart
Principal Economist
Ksenia Bushmeneva
Economist

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