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Livio DiMatteo

Livio DiMatteo

LIVIO DI MATTEO

Budget diagnosis: Ontario’s addiction to debt now a chronic condition Add to ...

Livio Di Matteo is Professor of Economics at Lakehead University. He is co-author of Can Canada Prosper without a Prosperous Ontario that was recently released by the Fraser Institute.

Ontario’s 2014 budget does not balance the books anytime soon. Any stimulus the new spending offers the Ontario economy is offset by the hindrance of an increase in taxes, a growing public debt burden and the investor uncertainty it brings. Billions of dollars in proposed infrastructure investment may be useful in priming the pump, but does not fully address the productivity problems facing the Ontario economy. Creating a new provincial pension plan is a diversion from the problems of the provincial economy and promotes a belief that new spending programs should create a strong economy rather than the other way around.

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The 2013-14 fiscal year saw the expenditure growth rate exceed revenue, reversing the weak austerity of the previous two years that saw revenue grow faster than expenditure. The 2014-15 budget promises yet another deficit of $12.5-billion – up from $11.3-billion. For 2014-15, revenues will grow 2.8 per cent and expenditures 3.5 per cent. The two years after that project a shrinking deficit based on the assumption that revenues will grow faster than expenditures. Still, over the next three years Ontario will accumulate nearly $27-billion more in deficits.

Deficits are projected to 2016-17, matching the record nine-year run in the 1990s, but with a key difference. In 1990, Ontario’s net debt was $38.4-billion, growing to $114.7-billion by 1998. It has since more than doubled and is projected at $269.2-billion for 2013-14 and $289.3-billion for 2014-15. With the forecast deficits and compound interest, it will approach $300-billion within three years. While one might invoke the severity of the recession as the reason for the poor fiscal performance, Ontario’s net debt was already at $169.6-billion before the recession. Ontario’s debt addiction is a chronic condition.

Ontario is only able to sustain its large appetite for public debt because of historically low interest rates. When they rise, growing debt service costs will crowd out other government spending. At present, debt service costs Ontario taxpayers about $10.6-billion, making it the fourth-largest expenditure item after health, education and social services. The 2014 budgets projects debt service costs at $12-billion by 2015-16 and $13.3-billion by 2016-17.

Ontario’s economic growth has been anemic since the 21st century began – well before the 2009 recession – and its recent productivity in terms of output per worker has been flat. Boosting the province’s economic productivity requires private sector investment in plant, equipment and machinery. New capital spending in Ontario has grown slowly, and as a result Ontario’s share of Canadian gross fixed capital formation has declined and now sits at 31 per cent – well below its population share. Investment is the most volatile component of GDP and business expectations – the proverbial Keynesian animal spirits if you like – are central in driving these expenditures.

Unfortunately, as long as Ontario accumulates deficits, the private sector will remain skittish about new capital investment in an environment that may see even more tax increases down the road. The budget’s juxtaposition of tax increases for higher incomes with increases on tobacco sends the signal that hard work is also seen as a vice. Funding new infrastructure investment with tax increases sold as revenue tools does not send a reassuring message to the private sector. Public sector infrastructure investment without the accompanying private sector investment will be like rowing a boat with only one oar.

Restoring fiscal balance can happen in one of thee ways: an increase in revenues; a reduction in expenditures; or some combination of the two. Increasing revenues needs an economic expansion that grows the tax base and/or an increase in tax rates. Ontario’s post-recession economic growth has been poor, limiting revenue potential from an expanding tax base. Raising tax rates on a weak base is a measure that may reduce economic growth.

Despite the dire rumblings of the 2012 Drummond Report that Ontario had to reduce its spending, little was done. This situation has been exacerbated by minority government and the elaborate dance that is part of Ontario’s game of Queen’s Park thrones. The current legislative environment to date is one where two out of the three political parties have been able to agree on any solution that results in spending increases.

Yet, the only real option for Ontario now is expenditure restraint. The Ontario government needs to freeze total expenditure growth for at least two years and allow revenue growth to close the fiscal gap. Not taking action means the provincial net debt – already the largest amongst the provinces – will grow and restoring fiscal balance and private sector confidence will take even longer.

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