Ontario steps on to a slippery debt path with budget

Ontario’s finances were sustainable, if only narrowly, before the pandemic hit.

Now, the Progressive Conservative government is forecasting huge deficits not only for this fiscal year, in the depths of the coronavirus crisis, but for the next two years as well – and not providing forecasts beyond that. At least three years of big deficits will send Ontario’s debt burden on a sharp upward path, with its net debt growing to nearly half of provincial gross domestic product by the end of fiscal 2023.

Rock-bottom interest rates will give Ontario some breathing room, but only a bit. The province is projecting that interest payments will rise from $12.5-billion in the current fiscal year 2019-20 to $13.9-billion in 2022-23. At that point, interest rates will have risen and Ontario will have just turned in a $28.2-billion deficit, still more than triple the size of the $8.7-billion shortfall in 2018-19. Those are the elements of a debt spiral, with rising interest costs inflating deficits that lead to more debt – and rising interest costs.

That is a problem for more than just Ontario. Setting aside the province’s role as the keystone of the Canadian economy, Ontario is far from alone in its fiscal woes.

The federal government has repeatedly touted its fiscal hardiness and ability to spend, but the debt path of Ontario shows the perils lurking in provincial finances. It was one of the few provinces to get relatively good grades on fiscal sustainability from the federal Parliamentary Budget Officer earlier this year, before the onset of the pandemic.

The PBO said Ontario was one of just four provinces (the others being Quebec, Nova Scotia and British Columbia) whose finances were sustainable, meaning that their spending and tax policies would keep their debt burden, relative to their economies, flat or falling. The Prairie and remaining three Atlantic provinces all had taxation and spending policies that made their debt levels unsustainable in the long term, ranging from a modest gap in Alberta to an enormous shortfall in Manitoba.

The PBO said Ontario had a small amount of fiscal flexibility, 0.1 per cent of its gross domestic product, that it could use to either cut taxes or to increase spending while still keeping its debt at sustainable levels.

But that was before the pandemic hit, when the government was still aiming to turn in a $6.8-billion deficit in 2020-21. Instead, the deficit this year is forecast to be $38.5-billion, more than five times as much. The PBO will issue a new fiscal outlook for the federal government and the provinces on Friday, but given Ontario’s deep dive into deficit spending, there’s little chance that it will emerge with a still-sustainable fiscal path.

And that may be an optimistic scenario. As part of the budget released Thursday, the provincial Finance Ministry took the unprecedented step of issuing three different fiscal scenarios: a pessimistic case with a slow-growing economy; the middle-of-the-road scenario used in the budget; and a more optimistic outlook with a hot economy. (It’s worth noting that Ontario, unlike the federal government, has decided that economic volatility is not an excuse for putting off a full budget.)

Under the more pessimistic fiscal scenario, the deficit rises to $35.6-billion in 2021-22 from the baseline projection of $33.1-billion; in 2022-23, the deficit rises to $33.4-billion from the current forecast of $28.2-billion. That would add $7.7-billion to Ontario’s debt, but it’s also possible that the soft economy would limit an expected rise in interest rates. Currently, Ontario is forecasting that its average annual borrowing rate will rise sharply from its current low of 1.6 per cent to 3 per cent in 2022-23.

Rising interest rates plus a growing debt is the equation driving Ontario’s projected increase in interest costs. If the province’s projections turn out to be correct, that will be a problem for other provinces and, to a lesser extent, the federal government, whose borrowing costs are lower than those of Canada’s subnational governments.

Economic volatility is one uncertainty. Another is the lack of visibility beyond 2022-23. Before the pandemic, the Ontario government had been projecting that it would wipe out the provincial deficit by 2023-24, as part of its balanced-budget legislation. In a sign of how just how volatile the economy is, the government is scrapping those estimates and now says it won’t be mapping out a new path to a balanced budget – instead sidestepping the law that requires it to do so.

Finance Minister Rod Phillips acknowledged the dangers of Ontario’s fiscal position in his budget speech on Thursday, saying that “current levels of government spending are neither sustainable or desirable over the long term.”

But the province is not indicating how quickly it plans to reduce its deficit. The entire decrease in the Ontario deficit between this fiscal year and 2022-23 comes from reduction in coronavirus-related spending. That temporary spending falls by $10.5-billion over the next two years, while the deficit declines by $10.3-billion, falling from $38.5-billion this year to $28.2-billion in 2022-23. At that point, the province plans to be spending just $2.8-billion on coronavirus measures.

That points to the difficult choices facing Ontario, and other provinces. Even if all temporary coronavirus spending turned out not to be needed in 2022-23, the province would still have a deficit of around $25.4-billion. Tax cuts for businesses, rebates to seniors who renovate their homes, subsidies for high electricity costs – all the outlays announced in Thursday’s budget – would be ingredients in that baked-in deficit.

Budget offers staycation rebates, hydro subsidies for businesses

Ontario’s budget projects a record deficit and pledges billions of dollars in added health care spending to fight COVID-19. But it also includes a series of targeted tax breaks, rebates and other measures aimed at businesses and residents.

Some of those measures include:

Hydro rates

A pledge to subsidize hydro rates for large and medium-sized businesses, which would cut their power costs by 14 to 16 per cent. The Progressive Conservative government says it is taking on the added costs of its predecessor Liberal government’s green energy plans, which it blames for driving up electricity costs and making Ontario businesses less competitive. But the budget is silent about reducing rates for residents, despite a campaign promise to cut their rates by 12 per cent, as well.

Renos for seniors

A new seniors home tax credit for 25 per cent of the costs of renovations, for projects with a maximum cost of $10,000, designed to encourage them to stay in their homes as they age. A similar, less-generous measure was phased out by the previous government in 2016 after few seniors applied for it.

Staycations

An Ontario “staycation” 20-per-cent rebate on tourism expenses is meant to encourage local travel in the province amid the pandemic. The government says it is committed to the idea, but that it must consult the industry first on how to design and execute the rebate.

Alcohol delivery

A commitment to allowing bars and restaurants to continue to sell alcohol along with delivery and takeout orders, making permanent a pandemic emergency measure.

Jeff Gray and Laura Stone

Tax and Spend examines the intricacies and oddities of taxation and government spending.