Ontario Budget 2009: Big Stimulus, Big Deficits
by Marie-Christine Bernard, Sabrina Browarski and Matthew Stewart
The coming year will prove to be a year of “firsts” for Ontario, the traditional engine of growth in the Canadian economy. For the first time since the inception of provincial trade records in 1981, Ontario will record a net trade deficit. This unfortunate development will trickle into the medium-term outlook for the province even as U.S. consumer sentiment revives. Ontario is also poised to go from “have” to “have not” status for the first time, and it will receive $347 million in federal equalization payments. Budget 2009 revealed the final “first” in the trifecta of the province’s woes: Ontario will run the largest provincial deficit in history—$14.1 billion—for the coming fiscal year! With an ambitious near-term spending plan and soft own-source revenue growth as a result of the global downturn, the province will not return to fiscal balance until 2015.
Despite this bad news, Ontario’s most recent budget does provide a silver lining to an otherwise dismal outlook in the form of timely stimulus. Many of the measures introduced in Budget 2009 are consistent with the Conference Board’s view on how to mitigate the effects of the current recession.1 At a time when slower economic growth is squeezing revenue collections, Ontario has opted to harmonize its provincial retail sales tax (RST) with the federal goods and services tax (GST), a move that will promote long-term business efficiency and generate upward of $2 billion in new annual revenues, starting in 2010. Various tax credits for business and households will be provided to offset increased tax burdens resulting from harmonization (with a few exceptions). The personal income tax rate will also be reduced by one percentage point for the lowest tax bracket, but clawed back from those in the highest income bracket. Businesses will benefit from modest corporate tax relief. Furthermore, an extension of the manufacturing and processing capital cost allowance schedule will provide some cost offset to weakening exports, and will encourage export-sensitive manufacturing firms to adopt productivity-enhancing technologies.
The province will also prioritize infrastructure spending—mobilizing an additional $3.4 billion in financing for new projects in each of the two upcoming fiscal years. This spending is in addition to the existing multibillion-dollar ReNew Ontario and MoveOntario 2020 initiatives. In concert with the substantial federal infrastructure stimulus package, Ontario will spend upward of $12.7 billion on new capital development and refurbishment projects in 2009, and a further $14.7 billion in 2010, in an effort to stave off a prolonged recessionary cycle. As is true for all levels of government, the effectiveness of these capital projects as recession-fighting tools will rely heavily on how quickly new “shovel-ready” plans can be implemented.
Fiscal Outlook—The Largest Deficit in History
Over the last four years, the Ontario government saw revenues rise by an incredible amount. The increase allowed the government to eliminate a $5.5-billion dollar deficit and ramp up program expenditures to the largest share of GDP in 12 years. In fact, from 2003–04 to 2007–08, average revenue growth increased by 9.2 per cent per year. By fiscal year 2007–08, revenue was 42 per cent higher than just four years earlier. However, this trend could not continue forever, and the global financial crisis is taking a large toll on the Ontario economy. The Ontario government is now expecting a substantial decline of 2.4 per cent in nominal GDP (the widest measure of the government tax base) for 2009. Therefore, it is not surprising that for fiscal year 2008–09, provincial revenues will show a similar collapse, falling by 3.8 per cent. This decline, together with a large increase in program expenditures in fiscal year 2009–10, will drive Ontario further into the red than it has ever gone before. This will come at a cost. Net debt will rise by $56 billion over the next three years and interest payments required to service that debt are expected to rise by over $2 billion per year. It will take seven years and a highly ambitious expenditure control plan before the Ontario government will again be able to balance its books.
Over the medium term, the Ontario government will ramp up program spending in an effort to stimulate the economy. In fact, total program expenses are forecast to rise by 12.5 per cent in fiscal year 2009–10 and by a further 5.1 per cent in 2010–11. However, in 2011–12 the Ontario government will begin its attempt to control spending in an effort to climb out of deficit. After a 2.7 per cent projected decline in program expenditures in 2012 as the stimulus package comes to an end, the Ontario government plans to limit growth in program spending to only 2.3 per cent per year until 2015–16, when it hopes to climb out of the red. There are few details on which departments will be constrained. But there is little doubt that to meet these targets, the provincial government will have to control health and education spending, which together make up two-thirds of total program expenditures. However, spending in these departments has risen at an average annual rate of 7.2 per cent over the last four years, and previous efforts to control spending—especially in health—have failed.
In fiscal year 2009–10, total revenues are expected to rise by 2.8 per cent thanks to a whopping 15.7 per cent increase in federal transfers. However, due to the recession in Ontario, own-source revenues are expected to remain flat. As much of the increase in federal transfers will be directed to infrastructure spending, the Ontario deficit will rise to $14.1 billion—the largest provincial deficit in history. However, in fiscal year 2010–11, own-source revenues will increase by almost 5 per cent, primarily due to an increase in taxes coming from the harmonization of the provincial sales tax with the GST. Harmonization is expected to generate more than $2 billion a year in additional revenue when fully phased in. As well, the federal government will increase federal transfers by an additional 20 per cent in 2010–11, pushing up total revenues by almost 8 per cent. This will help the provincial government reduce its deficit to $12.2 billion in 2010–11. Beyond 2010–11, provincial revenues are expected to grow at almost twice the pace of projected expenditure growth, allowing the province to slowly climb out of the red.
The Ontario government has announced two permanent tax cuts designed to stimulate the economy. On the personal income tax side, the provincial government has announced a reduction in the lowest bracket tax rate from 6.05 per cent to 5.05 per cent effective in the 2010 tax year. The lowest rate is applied on the first $36,848 in taxable income. This reduction will save each filer up to $205. However, for the highest income earners, the government will claw back most of this tax reduction by adjusting the thresholds to which the Ontario surtax applies. The Ontario government currently levies a 20 per cent surtax on Ontario income tax over $4,257 and a 36 per cent surtax on income tax over $5,370. The budget adjusts the surtax thresholds to claw back from the highest income earners $156 of the $205 in tax savings that result from the reduction of the lowest tax rate.
In an effort to improve competitiveness, the Ontario government will reduce the general rate and the manufacturing and processing (M&P) corporate income tax rate by two percentage points—from 14 per cent to 12 per cent for the general rate, and from 12 per cent to 10 per cent for the M&P rate. The Ontario government will also reduce the small business tax rate by one percentage point, from 5.5 per cent to 4.5 per cent. The small business tax reduction and the M&P tax rate reduction will be effective in 2010, while the general tax rate reduction will be phased in over four years.
New Harmonized Provincial Sales Tax
The decision to convert Ontario’s retail sales tax to a harmonized value-added structure (with a few exemptions) in partnership with the federal government by July 1, 2010 is arguably the centrepiece of Budget 2009. Under Ontario’s new value-added harmonized sales tax (HST) regime, a 13 per cent rate will be collected by the federal government (8 per cent of which will accrue to Ontario) on sales of eligible goods and services covered by the federal GST base.
In the long run, harmonization with the federal base will generate myriad economic efficiency benefits for businesses and consumers.2 Whereas the existing RST is collected only by retailers on covered goods at the point of sale to consumers, the HST will be collected at each stage of the production process. Under the HST, firms are assessed taxes on the total value of their sales, but receive invoice credits for the taxes previously paid by their suppliers. In this way, only the incremental value added that is generated at each stage of the supply chain will be taxed, eliminating the distortionary effects of “tax cascading,” such as inflated prices on final consumer products and arbitrarily high business input costs. Businesses will benefit from reduced compliance costs (estimated at $500 million per year in Budget 2009) under a simplified tax administration system, which could ultimately be passed on to consumers in the form of lower prices. Ontario exports will also be free of the embedded RST, which will increase export competitiveness.
The provinces first began to introduce retail sales taxes in response to revenue needs created by the Great Depression. Similarly, the new HST will be a major source of new revenues going forward, given that the federal GST base is much broader than Ontario’s current coverage. (In particular, Ontario’s current RST isn’t levied on most services.) With aggressive spending targets projected in the medium term, and with an aging population that will increasingly draw upon provincial health care, the more-than $2.3 billion in additional own-source revenues generated by the HST by 2012 will be crucial if Ontario is to meet its target of returning to balanced budgets by 2015–16.
A number of tax credits will be supplied to businesses and households to offset an increased tax burden. Accordingly, a total of $4 billion in offsetting relief will be provided to Ontarians to facilitate the transition to the new sales tax system. The federal government will provide Ontario with $4.3 billion in cash transfer payments to meet this objective—$3 billion upon implementation of the combined tax on July 1, 2010, and a further $1.3 billion on July 1, 2011. The following is a list of some of the new administrative and tax changes:
A total of $400 million in one-time payments will be made to help cover the costs of changes to point-of-sale and accounting systems for small businesses. Most non-financial businesses with less than $2 million in revenue will be eligible for a transition credit of up to $1,000.
A new rebate, valued at $1.1 billion per year, will be extended to homebuyers to ensure that new homes valued under $400,000 are not subject to additional tax burden. Above that value, the rebates will be phased out, and they will be eliminated altogether on homes valued at more than $500,000. Resale homes will not be subject to the single sales tax.
Under the new Ontario Sales Tax Transition Benefit, $300 will go to single Ontarians earning less than $80,000 per year, and $1,000 will go to eligible households earning less than $160,000 per year. The total will be spread out in three payments, with cheques going out in June 2010, December 2010, and June 2011.
A new permanent Ontario Sales Tax Credit valued at up to $260 annually will go to low- and middle-income households to help offset an increased tax burden.
The existing Ontario Property and Sales Tax Credits will be replaced by a new refundable Ontario Property Tax Credit, based on occupancy costs. A credit of up to $250 (seniors will get up to $625) plus 10 per cent of occupancy costs will be available to low- and middle-income earners.
Ontario will parallel the GST small supplier threshold, which exempts businesses with limited total revenues ($30,000 for private sector firms, and $50,000 for public service bodies) from having to collect the HST.
Temporarily restricted input tax credits (similar to the restricted input tax credit system in Quebec) will be implemented. Select temporary restrictions will apply only to the provincial portion of the tax for the five years following HST implementation. Full input tax credits will be phased in over the next three years on taxable supplies.
In response to the deteriorating economic climate, new expenditure measures in Budget 2009 are limited. Mirroring the stimulus package unveiled by the federal government in Budget 2009, the bulk of Ontario’s new expenditure measures will be concentrated in infrastructure spending. In addition to the multibillion-dollar ReNew Ontario and MoveOntario 2020 plans, a further $3.4 billion in infrastructure commitments were announced in Budget 2009 for each of fiscal years 2009–10 and 2010–11. Of particular interest, Ontario will spend more than $700 million over the next two years on social housing, and $780 million in new funds will be provided for municipal projects by leveraging federal funding over the same period.
Modest new funding is earmarked for skills training and literacy initiatives, as well as for enhancements to existing programs (such as the Second Career Strategy, which was introduced in 2008). Among the new initiatives, $90 million will be directed to expanding literacy and basic skills training, and $94 million will be made available to recent immigrants to assist them in entering the labour market over the next two years.
A handful of new measures targeted at commercializing new products and services were tabled in Budget 2009, including:
$300 million in new capital funds over six years for research infrastructure, to be leveraged against the federal Canada Foundation for Innovation;
$250 million over five years for a new Emerging Technologies Fund;
$100 million in additional operating funds over four years for biomedical and genomics-related research; and
$390 million to match Ontario’s share of the federal Green Infrastructure Fund.
The vulnerability of the Ontario economy to fluctuations in global markets, particularly in the United States, is embedded in Budget 2009’s economic outlook. The Ontario Ministry of Finance anticipates that real gross domestic product in Ontario will contract by 2.5 per cent this year, with a modest recovery expected in the near term as economic growth performs closer to underlying potential. The Ontario Ministry of Finance’s economic forecast is derived from a survey of private sector forecasts. The Conference Board agrees with the consensus, which has the economy continuing to contract until the second half of 2009 and gradually recovering in 2010.
Several measures in Budget 2009 will help stimulate Ontario’s economy over the next two years. The province has been investing heavily in new infrastructure and upgrades over the past few years, and the budget includes $3.2 billion in infrastructure spending for fiscal 2009–10 and 2010–11 on top of previous commitments. Ontario is proposing to accelerate the phase-in of the Ontario Child Benefit by two years starting in July 2009, providing a total of $400 million to low- and moderate-income families over the next three years. In addition, as of January 1, 2010, the province will provide personal income tax cuts totalling $1.1 billion. The extra disposable income will stimulate consumer demand, adding roughly 0.2 percentage point to real GDP in 2010. Finally, the government’s plan to boost program spending by 12.5 per cent this fiscal year—a $4.7 billion increase—will also provide plenty of stimulus. Assuming that infrastructure spending is timely, new measures announced in Budget 2009 will add a sizable 1.2 percentage points to real GDP growth in 2009.
1 See, for example, our December 2008 briefing Fixing the Recession: Policy Guidance for Canada and Governments Everywhere.
2 See our Harmonize Consumption Taxes to Improve Economic Efficiency by Glen Hodgson and Sabrina Browarski for a detailed analysis of the mechanics of, and benefits associated with, sales tax harmonization.
| || ||Marie-Christine Bernard |
| || ||Sabrina Browarski |
| || ||Matthew Stewart |