Ontarians want excellent public services from their government. The Commission understands and supports this desire. We see no reason why Ontario cannot have the best public services in the world — with the proviso that they must come at a cost Ontarians can afford. With such a goal, we face three overarching tasks. First, we must understand Ontario’s economic challenges and address them directly. Second, we must firmly establish a balanced fiscal position that can be sustained over the long term. And third, we must sharpen the efficiency of literally everything the government does so Ontarians get the greatest value for money from the taxes they pay. This report addresses these issues and offers a road map to a day when Ontarians can count on public services that are both excellent and affordable — the public services Ontarians want and deserve.
Ontario faces more severe economic and fiscal challenges than most Ontarians realize. We are in the midst of a period of deep and widespread uncertainty over the course of the world economy and its financial system — a period unprecedented in the lifetimes of almost all of us. But even after the world once more finds its footing, Ontarians can no longer simply assume the strong economic growth and prosperity to which they have become accustomed and on which the province has built its public services. Government programs can be sustained in the long term only if the government enjoys the steady and dependable revenue growth needed to finance them. An expanding economy is the foundation for rising revenues. If the economy fails to grow quickly enough, Ontario’s revenues will fall short of the sums needed to support government programs.
Improving Ontario’s economic prospects relative both to the past and to Canada’s resource-rich provinces should always be a priority for policy-makers. But they should act immediately to address the province’s fiscal position, which is entirely within their control. Endless deficits, which would undermine the province’s economic and social future, are not inevitable. The goal of eliminating the deficit can be met in large part through reforms to the delivery of public services that are desirable in their own right, not just because they are less costly. Affordability and excellence are not incompatible; they can be reconciled by greater efficiency, which serves both the fiscal imperative and Ontarians’ desire for better-run programs. Balancing the budget, however, will also require tough decisions that will entail reduced benefits for some. Given that many of these programs are not sustainable in their current form, the government will need to decide how best to target benefits to those who need them most. The treatment may be difficult, but it is worth the effort.
The public is familiar with the fiscal scenario laid out in the 2011 Ontario Budget. It was debated in the legislature at the time, formed the basis for the government’s Pre-Election Report on Ontario’s Finances and for the Auditor General’s review of that report. The “Budget Scenario,” updated to use the final numbers for the 2010–11 fiscal year, was the starting point for the work of the Commission on the Reform of Ontario’s Public Services. We began by constructing what we called our “Status Quo Scenario,” based on different assumptions than those used for the 2011 Budget. We were more cautious in our projections of both economic growth and revenue, largely because the economic outlook has deteriorated since March 2011; we assumed that spending on programs would be driven by the factors that usually push spending higher, such as inflation, population growth, aging, school enrolments and so on. Finally, we developed what we regard as the “Preferred Scenario,” a projection that combines our more cautious view of economic and revenue growth — along the lines of the Status Quo Scenario — with the spending target that would fulfil our mandate to eliminate the deficit by 2017–18.
A fiscal scenario is just that — a projection of the future based on specific assumptions about how quickly the economy, revenues and spending will grow and about the levels of interest rates that help determine how much the government will spend in interest costs on the public debt. A scenario is not a prediction (as in, this is what will happen); it is a projection (as in, this is what will happen if all our assumptions hold true). As it unfolds, the future always turns out differently than even the most carefully considered assumptions, so, in that sense, all three scenarios will turn out to be wrong. Nevertheless, scenario-building is the foundation of good fiscal planning. Without a view of the future, governments cannot assess what resources they will have available and cannot set priorities among competing programs.
In short, governments need a fiscal strategy. There is a wide range of possible outcomes for both the economy and the budget — a range that widens the further out we look. The government is confronted with a large debt and, in good part due to the aftershocks of a global recession that sideswiped the Ontario economy, a large deficit and the prospect of a long path back to a balanced budget. It needs to lay out a clear plan to eliminate the deficit by 2017–18 — its own target — with bold actions taken early and advanced steadily. Basing such initiatives on cautious assumptions will help to avoid the frustration of returning again and again for further rounds of restraint when events prove that the initial steps were too meek. Several European countries are today learning that lesson.
Ontario’s revenues now do not cover its spending. In 2010–11, the latest full fiscal year, the government ran a deficit of $14.0 billion — equivalent to $1,059 for every Ontarian and 2.3 per cent of the province’s gross domestic product (GDP), the largest deficit relative to GDP of any province. This is not because spending is particularly high; relative to GDP, Ontario’s spending is one of the lowest among the provinces. Net debt amounted to $214.5 billion, which is $16,216 per capita and 35.0 per cent of GDP. Relative to the government’s budget a year earlier, which had projected a deficit of $19.7 billion, the outcome was much better than expected.
The most recent Budget, in March 2011, set out a recovery plan that would return the province’s finances to balance — with the sum of total spending and the $1 billion contingency reserve equal to revenue — by the 2017–18 fiscal year. The choice of 2017–18 as the target year for a balanced budget put Ontario on a schedule at least three years behind that of any other province. It was three years behind the original federal target of 2014–15 for a return to a balanced budget, but is now two years behind after the revised target set out in the federal government’s fall fiscal update. To achieve its goal, the government presented a scenario of revenue projections and spending estimates that would meet its target date for balance. This path towards a balanced budget was reiterated (though only as far as 2013–14) in Finance Minister Dwight Duncan’s Pre-Election Report on Ontario’s Finances, in which the minister also expressed the hope that this Commission “would help accelerate the plan to eliminate the deficit while still protecting the gains made in health care and education.”
Since our job as a Commission is to make recommendations to meet — or even better — this target, we must assess the Budget Scenario and then develop, first, our own view of how we believe the seven years from 2010–11 to 2017–18 will unfold in the absence of any change in government policies, programs or practices. This, in other words, is our Status Quo outlook. If it fails to meet the target, we must devise a Preferred Scenario for the budget that does.
There are three key forecasts in any budget outlook — revenue, spending on government programs and spending to cover interest on the public debt. In the 2011 Budget, the government based its revenue projection to 2017–18 on forecasts of, and assumptions about,1 Ontario’s economic growth because revenues largely depend on the growth of nominal GDP. The Budget drew on an average of private-sector forecasters but, as a cautionary step, adjusted the average for GDP growth down slightly, which had the effect of increasing the size of the deficit. This is standard practice, and we do not fault the government for following this procedure. However, we believe the average private-sector forecast was not sufficiently cautious in light of the large uncertainties that even then hung over the global economy and thus the Ontario economy as well, a point to which we will return. Having produced this revenue outlook, the Budget then set out a similarly based projection for public debt interest costs over the seven years. In 2017–18, total revenue would amount to $142.2 billion and the cost of interest payments would be $16.3 billion. What remained was a gap of $125.9 billion, from which the government set aside $1 billion as a contingency reserve, leaving $124.9 billion to spend on all programs.
This projection for program spending was simply the residual that would bring the Budget to balance in 2017–18. It was not a spending forecast that depicted how spending would grow if current programs were maintained and continued to expand as usual; such a projection would involve higher levels of spending on programs. Implicit in this projection, then, were money-saving plans that had not yet been developed, let alone announced in the Budget. However, the 2011 Budget did not present a status quo scenario to identify the differences between its target track for program spending and the status quo spending outlook, so one could not get from the Budget a sense of the magnitude of the future cost savings needed to meet the target.
The government’s Pre-Election Report was required to present only the medium-term outlook to 2013–14, and did not address the extended outlook to 2017–18. However, the province’s Auditor General, Jim McCarter, in his review of the Pre-Election Report, cast doubt even on the government’s expense projections out to 2013–14, which were identical to those in the 2011 Budget.
The Auditor General, as stipulated by the Fiscal Transparency and Accountability Act, subjected the Budget forecast to the act’s stated principle that the government base its fiscal policy on “cautious and prudent assumptions.” He concluded that while the government’s estimates of revenues and interest on the public debt met that test, “many of the assumptions underlying its estimates for program expenses (that is, expenses excluding interest on the public debt and reserves) were optimistic and aggressive rather than cautious.”
Spending has been skewed in recent years by the government’s one-time support for the auto sector and record infrastructure stimulus expenditures after the global financial crisis that began in 2007. But after excluding those large one-time outlays from his comparisons, the Auditor General concluded that the government’s forecast assumed that there would be a very sharp drop in the growth rate of spending on programs — from an average of 6.9 per cent in the past eight years to 1.8 per cent in the three years from 2010–11 to 2013–14. He singled out the cost of compensation (salaries, wages and benefits comprise half of all program spending) and health care costs (which amounted to 40 per cent of spending in 2010–11, with considerable overlap with the compensation costs) as areas where spending pressures are the major contributors to what he called “a heightened risk that actual expenses will be higher than estimated.”
In effect, he found — not surprisingly — that the Budget featured a spending track lower than the one that would unfold under current program designs and savings plans. The Auditor General surmised — and we have confirmed — that there were no fully developed plans at the time of the Budget to secure all of the depicted restraint. If there are now plans under development within government to secure all of the fiscal restraint, they have not been provided to the Commission. When the Auditor General’s report was released, the minister acknowledged that his plan was aggressive, but maintained that the government was committed to balancing the budget by 2017–18. “There are enormously difficult choices ahead,” Minister Duncan said. “This will give Ontarians greater insight and clarity as to the challenges coming at us.” Implicitly, then, the minister was promising to develop and implement over time the details of what would be an aggressive restraint plan. Indeed, the government acknowledged in its Pre-Election Report that “certain assumptions are based on anticipated actions, strategies and programs of the government that are consistent with the fiscal plan.” This, of course, is the main reason why the government created this Commission — to provide advice on what a restraint plan might look like.
Our mandate requires us to look even further ahead than the Auditor General — to 2017–18. We found both the Budget and the Auditor General’s report a difficult basis from which to begin our thinking. In particular, we could neither estimate nor fully comprehend the degree to which further restraint would be necessary because neither document offers a status quo outlook.
When we began this work in July 2011, we first created our own Status Quo Scenario that we believe offers a clearer perspective — certainly one based on updated and more cautious assumptions — of the seven fiscal years from 2010–11 through 2017–18, in the absence of new aggressive government action.
We took the same approach as the government in assessing future revenues and public debt costs, but came up with very different revenue numbers because we expected economic growth to be slower than the government did in the Budget and slower than private-sector economists were projecting at that time. We were not simply engaging here in an excess of prudence. In the short term, the outlook for the world, Canadian and Ontario economies had already dimmed substantially in the months after the Budget was presented. And beyond 2013, the immediate purview of most forecasters, we believe Ontario’s long-term economic growth potential will shrink as the labour force grows more slowly and productivity growth remains moderate.
We took a very different approach from that of the Budget on spending. We built our Status Quo spending line by projecting program expenditures in accordance with two key factors that affect the cost of government programs. First, we used the pressures that drive spending on programs as they are currently designed and delivered. Second, we allowed for current cost-saving measures that are already in place and likely to produce results in the years ahead. If a particular restraint measure has been proposed, but not yet fully developed and implemented, we did not count it.
The results of this exercise can be summarized easily. In our Status Quo Scenario, revenue growth will be lower and spending growth higher than assumed in the 2011 Budget. Our more cautious set of assumptions leads not to a balanced budget in 2017–18, but to a deficit in the order of $30.2 billion, more than double the 2010–11 deficit, and a net public debt of $411.4 billion, equivalent to just under 51 per cent of the province’s GDP, compared with 35 per cent today.
Briefly, the numbers look like this. The 2011 Budget projected revenues of $142.2 billion for 2017–18. In our Status Quo Scenario, they will be closer to $132.7 billion, or $9.4 billion less,2 in part because we believe economic growth will be slower than the government implied. The Budget also projected about $124.9 billion in spending on programs (plus a $1.0 billion contingency reserve) for that year and interest payments of $16.3 billion, for a total of $142.2 billion in spending (also including the reserve) — a sum equal to revenues; this would mean the Budget would be in balance in 2017–18. We believe instead that if programs retain their current designs and if restraint measures now in the works are fully implemented, the status quo trajectory implies $141.4 billion in program spending in 2017–18, plus a larger contingency reserve of $1.9 billion that we deem prudent. In addition, the growing debt would require interest payments of $19.7 billion. Total outlays would be $163.0 billion — $30.2 billion more than our projected revenues.
This Status Quo Scenario is, we believe, the manner in which the future will likely unfold if corrective action is not taken. It will shock many because it means that if Ontario is to attain its target of a balanced budget by 2017–18, the provincial government must take much tougher fiscal measures over a protracted period than anyone has yet discussed publicly. Postponing needed infrastructure projects until after that date, a technique governments often use to balance their books in the short term, is no solution; the province would simply slip back into deficit later on as it tried to correct an infrastructure deficit. Indeed, any such short-term measures would simply make more likely a resumption of deficit budgets after 2017–18, rather than put the province on a path to balanced budgets over the long haul. To pull total spending down onto a track that will match our more modest assessment of future revenue growth means that we must find total savings of $30.2 billion per year by 2017–18. Just as importantly, the government must be able to sustain these savings beyond that year.
We developed our Status Quo Scenario because we wanted to identify clearly the extent of any new spending restraint that will be needed to balance the budget by 2017–18; that is, the difference between the Status Quo spending outlook and the spending needed to eliminate the deficit by that date. The task then became one of creating a Preferred Scenario — one that will lead to a balanced budget in 2017–18. The government actually asked us to advise on how to attain balance before that year. However, we prefer to adopt a strategy of sticking to the official target and recommending ways to solidify the province’s chances of hitting it. One element of this strategy is the use of a contingency reserve much larger than that used in the Budget. Another element is our use of more cautious economic assumptions, exercising a degree of prudence that we believe is justified by the current economic outlook. We will also recommend other strategies for mitigating the risk of potential liabilities that are not explicitly recognized in the Budget or our own fiscal track. This approach leaves room to reach balance earlier if the future turns out more favourable than we have assumed.
Our bottom line will end up in the same place as the 2011 Budget; that is, with no deficit in the final year. But in light of our revenue trajectory being lower than that of the Budget, our track for program spending will have to be 0.8 per cent growth per year to 2017–18, substantially lower than the 1.4 per cent annual growth set out in the Budget to reach the goal of a balanced budget.
This is a very tall order, but we are optimistic it can be done. Throughout this report, we prescribe a realistic and feasible (albeit tough) way out of the fiscal predicament we have described. We offer 362 recommendations, sector by sector, that will allow the government to constrain spending enough to balance the budget without tax increases. Many of our recommendations are based on using public resources more efficiently; in many cases, better-quality services will also be an outcome. This will not make some of the recommended reforms painless for all involved, at least not in the short term, but, over the long haul, we believe they will give Ontarians much better value for the taxes they pay to support public services.
Since our mandate expressly forbids us from proposing new or increased taxes, most of the burden of eliminating the $30.2 billion shortfall revealed by the Status Quo Scenario must fall on spending. As we veer from the Status Quo outlook (with its persistent deficits) by aiming for a balanced budget in 2017–18, we would run ever-declining deficits along the way, which would reduce interest costs on the debt below those seen in the Status Quo outlook. This would save about $4.3 billion3 in 2017–18, but the province would still need to spend about $23.9 billion less on programs than the $141.4 billion that we see as the current Status Quo projection — a difference of 17 per cent. That implies, to put it mildly, a wrenching reduction from the path that spending is now on. It is, however, necessary if Ontario is to escape its recent history of rising public debt that forces the government to spend more than it should on interest payments — money that could otherwise be used to finance programs.
These are bold assertions, very clearly at odds with the recent public debate over Ontario’s fiscal outlook. During the recent election, all political parties pledged to balance the budget by 2017–18, but none presented a credible plan to accomplish this outcome. Our assertions therefore demand explanation and substantiation. We will spell out the details of the Preferred Scenario later in this chapter. Here, we will simply note that we lay out a plan designed to secure a budget balance in 2017–18 through spending restraint. And to foreshadow the rest of the report, we make recommendations throughout for reforming programs and service delivery to achieve the overall degree of spending restraint required. But before describing the Preferred Scenario in detail, we will briefly review Ontario’s fiscal record (Do we really have a debt problem?) and then set out the recent performance of the Ontario economy and its prospects for the future. This economic outlook is critical because it establishes the context in which budget policy must be set over the next several years.
Over the past two decades, Ontario’s fiscal record has been one of large deficits that have been only partially offset by sporadic episodes of small surpluses. Before that, from 1986–87 through 1989–90, the government’s debt averaged 14.1 per cent of GDP, a modest burden that was easily carried by a province as wealthy as Ontario. The recession of the early 1990s resulted in large deficits that were reduced only slowly as the decade wore on through spending restraint in all areas; by 1998–99, the debt-to-GDP ratio had doubled to 30 per cent. Small surpluses in seven of the next nine years allowed the debt ratio to ease to just under 27 per cent in 2007–08 before the substantial deficits associated with the most recent recession — and the stimulus programs of infrastructure spending deployed to alleviate it — rapidly pushed the debt higher yet again, this time to 35 per cent of GDP in 2010–11. The record is one in which recessions quickly create and magnify a deficit, thus pushing the debt higher in a hurry, but good economic times produce only small improvements in the province’s debt.
Carrying debt requires spending in the form of interest payments on the province’s outstanding bonds and other obligations. Interest rates have been low in recent years across most of the globe and, with a sound record in debt management, Ontario has been able to borrow cheaply. The province’s interest payments have been treading at around their lowest levels in the past 20 years, both in relation to GDP and to the province’s total spending. In 2010–11, interest amounted to 7.9 per cent of total spending (well below the 20-year average of 11.3 per cent) and 1.5 per cent of GDP (compared with the 20-year average of 2.0 per cent). The danger here is obvious. As interest rates rise to more normal levels, so will the cost of servicing the growing debt, diverting dollars away from public programs.
Until recently, Ontario’s debt record over the past quarter century was similar to that of other Canadian provinces. In the late 1980s, Ontario’s 14.1 per cent debt ratio was slightly below the average for all provinces. In the 1990s, the average debt of all provinces climbed to about 30 per cent of GDP, just like Ontario. The past decade has broken the historical pattern. A boom in commodities — notably oil — allowed provinces like Alberta, Saskatchewan, British Columbia, and Newfoundland and Labrador to run surpluses and reduce their debt. Alberta, the richest Canadian province, now has net assets, rather than debt, which renders the all-province average less meaningful. But while Ontario and Manitoba carried similar debt loads between 2000 and 2005, Manitoba’s debt has since fallen to about 25 per cent of GDP while Ontario’s has risen. Ontario’s 2010–11 debt ratio of 35 per cent is roughly the same as that of Nova Scotia, New Brunswick and Prince Edward Island. Quebec is the outlier among the provinces, with a net debt in 2010–11 of about 50 per cent of GDP. Another contributing factor to Ontario’s rising debt is the historic capital investments in infrastructure in recent years. When the financial requirements for these projects are included, Ontario’s borrowing has increased in every year since the early 1990s, with only one exception.
By current international standards, Ontario’s debt is relatively small. We are a very long way from the dreadful fiscal condition of countries that have dominated the news over the past two years. So, however, were many of the headline countries at one time and, in some cases, surprisingly recently. Spain’s net debt doubled to 56 per cent of GDP between 2007 and 2011, while Portugal’s debt has almost doubled to 102 per cent only since 2003. Among the headline nations whose net debt was once similar to Ontario’s current 35 per cent of GDP are Britain (2004), the United States (2001), Japan (1997) and France (1993). Even Greece, the poster child for rampant debt, carried an Ontario-style debt load as recently as 1984. Today, debt burdens have reached 73 per cent in Britain and the United States, 131 per cent in Japan, 81 per cent in France and 153 per cent in Greece.
There are, of course, huge differences between Ontario and each of those jurisdictions, so we cannot push comparisons too far. Ontario is one of the world’s largest non-sovereign borrowers and widely regarded as one of the most sophisticated. Ontario bonds are attractive to investors because they are highly rated, carry good returns and are very liquid, meaning they are easy to trade, which is always a plus for people who buy bonds. Ontario is viewed as a well-governed province in a well-governed country. We do not mean to be alarmist in noting the province’s debt picture, only to point out that government debt burdens can rise quickly if they are not headed off early with appropriate action.
Should the global economy turn nasty once again, any deterioration in investor confidence could be remarkably swift. In a world already awash with government debt, Ontarians should not assume that investors will always stand ready to buy the provincial bonds needed to finance new debt without asking for higher interest rates to compensate them for the accompanying risks.
This very question was thrown into sharp relief on Dec. 15, 2011, when Moody’s Investors Service revised its outlook on Ontario’s bonds from stable to negative. The revision affected some $190 billion in bonds that are rated Aa1, the agency’s second-highest rating. Moody’s said in its statement that the change in its outlook “reflects Moody’s assessment of risks surrounding the province’s ability to meet its medium term fiscal targets given the recent slowdown in provincial economic growth and the resulting risks to the province’s ability to stabilize the recent accumulation of debt.” Moody’s lead analyst for Ontario, assistant vice-president Jennifer Wong, said, “The negative outlook on the province reflects the softening economic outlook, Ontario’s growing debt burden, and the extended timeframe of achieving a balance budget.”
Ontario borrows money every year to finance needed long-term capital projects, a common practice with all governments. But annual deficits, which represent current spending that exceeds revenue, also add to the stock of debt. On that score, Ontario’s recent record is poor. Relative to GDP, it ran the biggest deficits in the country in the three fiscal years from 2008–09 through 2010–11. In the current fiscal year, which ends Mar. 31, 2012, Ontario’s deficit is again likely to be the largest in Canada.
This will strike many as a profoundly gloomy message. It is one that Ontarians have not heard, certainly not in the recent election campaign, but it is one this Commission believes it must deliver. If Ontarians and their government are going to come to grips with the fiscal challenges that lie ahead, they must understand the depth of the problem and its causes. Ontario must act soon to put its finances on a sustainable path and be prepared for tough action — not just for a few years but over an extended period, at least as far out as 2018.
We believe all Ontarians, and especially those in the broader public sector (BPS) who will be most affected by the government’s fiscal decisions, have the wit and creativity to make — and implement — the kind of thoughtful decisions needed to resolve the province’s fiscal dilemma while protecting to the greatest degree possible the public programs on which Ontarians rely, many of which are a source of justifiable pride.
We further believe that the province can do so in a manner that makes fiscal balance over the business cycle a permanent feature of Ontario’s finances. The rewards of such action will be considerable and tangible. High-debt governments are always vulnerable to the whims and demands of the financial markets from which they have borrowed; governments in this position can be forced to take draconian measures to keep their lenders happy. Low-debt governments have much more flexibility to set their own priorities — ones that meet the needs of their citizens and the good of their jurisdiction as a whole.
The roots of Ontario’s current fix lie in both the economy and in the province’s record of failing to keep growth in government spending in line with revenue growth. Ontarians have long been accustomed to their economy growing faster than the rest of the country. This was once true: in 15 of the 21 years from 1982 to 2002, Ontario grew faster than the national economy. But changing economic conditions have hit Ontario harder than other provinces over the past decade; in all nine years from 2003 to 2011, Ontario’s real economic growth was below that of the rest of the country.
The reasons are simple. Beginning in 2003, the Canadian dollar began a strong ascent that lifted it from the persistent lows of the previous decade (around 70 US cents) to the recent highs (around parity with the U.S. dollar) during the past four years, with only a brief dip in late 2008 and early 2009. This surge in the currency made Ontario’s exports more expensive for foreigners to buy and rendered the province’s exporters less competitive, while also making imports cheaper.
The impact on Ontario’s nominal GDP was huge. The contribution of trade to the economy is measured by net exports, the difference between what the province sells outside its boundaries and what it buys from other countries and provinces. Ontario’s net exports to other provinces, where there was no currency effect, remained relatively stable. But the contribution to GDP of net exports to other countries first vanished entirely and then began to detract from Ontario’s growth. The financial crisis and resulting U.S. recession, during which auto sales fell by about one-third, aggravated this trend. The province’s international trade surplus, which accounted for 4.3 per cent of GDP in the 1998–2002 period, disappeared by the middle of 2006 and was replaced by a trade deficit, which in the first three quarters of 2011 diminished nominal GDP by 7.5 per cent.
Ontario’s overall GDP per head relative to the rest of the country reflects the turnaround in trade. In 1998–2002, Ontario’s GDP per person was 14.1 per cent higher than the average for the other nine provinces and three territories; in the first three quarters of 2011, it was 6.5 per cent lower. Since 2006, Ontario’s GDP per person has been below the average for the rest of Canada.
Another way to look at the data is to track the growth of total GDP in current dollars, because that is the province’s tax base. Since 2002, the year before the dollar began its ascent, nominal GDP has grown by less than 33 per cent in Ontario, compared with almost 59 per cent in the rest of the country.
The recent recession was tougher on Ontario than on the rest of Canada. The province’s growth faltered in 2007, slowing while the rest of the country continued a brisk expansion. In 2008, Ontario’s real GDP fell during the winter (the first quarter) and, aside from a small uptick that spring, continued to shrink until growth resumed in the summer of 2009 (the third quarter) — five quarters of contraction over a period of six quarters. Elsewhere in Canada, the recession did not begin until the final quarter of 2008 and then lasted only three quarters in total. From peak to trough, Ontario lost 5.0 per cent of its GDP; the rest of the country lost only 3.7 per cent. Since the low point in the second quarter of 2009, the Canadian economy as a whole has recorded respectable real growth. But in the two years through the third quarter of 2011, Ontario lagged the rest of the country, with 5.8 per cent growth compared with 7.4 per cent elsewhere.
The human cost of this lacklustre performance shows up in the employment picture, where the old verities of a labour market in which Ontario always outshone the rest of Canada have been replaced by new patterns:
Not surprisingly, incomes have also been affected. In the 1980s, real personal income per capita — that is, average personal income per person adjusted for increases in the implicit price index for all consumer spending — grew by an average of 1.9 per cent annually in Ontario, compared with 1.4 per cent in the rest of the country and 1.6 per cent nationally. Those were the days when Ontario was substantially richer than other parts of Canada. In the second half of the 1980s, when the Ontario economy was booming and other provinces were struggling with low prices for oil and other resources, Ontario’s average personal income was more than 20 per cent higher than the average in the rest of Canada. This changed dramatically after 1990. In both the 1990s and in the period from 2000 to 2010, Ontario’s real personal income per capita grew at only about half the rate that it did in the rest of Canada. In the period from 1990 to 2000, the average annual growth rates were 0.4 per cent and 0.8 per cent respectively; between 2000 and 2011,4 they were 1.0 per cent and 2.0 per cent. By the third quarter of 2011, this extended period of slow growth relative to other regions had left the average Ontario income, in current dollars, 0.5 per cent lower than incomes in the rest of Canada.
Can we expect better in the future? Barring another major global financial or economic crisis, a caveat that on some days feels shaky, Ontario and Canada will continue to recover from the recession and embark on a new expansion. But for Ontario, future growth will almost certainly be slower than it has been in the past. This has not been a normal business cycle for the world economy, one in which recession is usually followed by a rapid return to full capacity and further growth beyond that. It has been one set in motion by a financial crisis. As Bank of Canada Governor Mark Carney noted recently, “… history teaches that recessions involving financial crises tend to be more severe and have recoveries that take twice as long.”
Ontario also faces further structural changes. Manufacturing, once the vibrant heart of the Ontario economy, has for years been dwindling as a share of the province’s output and employment base. This is true in most of the developed world as factory work continues to migrate to low-cost Asia. In addition, the higher dollar continues to make it harder for Ontario to compete in world markets, especially in the United States, the province’s main external market. The U.S. is choking on public and private debt and faces years of slow growth as governments and individuals work off their excess borrowing. At the same time, U.S. auto sales, though up from their low point, will take many years to fully recover from a precipitous decline between 2007 and 2009. Ontario’s auto industry has also bounced back from its even steeper drop in production during those years, but it remains much diminished, perhaps permanently. Ontario industry, which has benefited for decades from plentiful electricity at subsidized rates, faces much higher power prices, made necessary by the imperative to replace essential infrastructure after years of neglect.
There is another barrier to income growth: almost all the growth in Ontario’s working-age population and labour force will come from immigration, but the incomes of recent immigrants have been well below those of workers who were born in Canada or arrived earlier. The average wage of recent immigrants (those who have been here for five years or less) was only about 76 per cent that of Canadian-born workers in 2010, while immigrants who have been here for 5 to 10 years had an average wage that was 85 per cent that of Canadian-born workers. Those with over 10 years in Canada had wages comparable to Canadian-born workers. Since more than two-thirds of future jobs will require some form of post-secondary education, it is particularly distressing that immigrants with university degrees are having such a difficult time integrating into the workforce. In 2005, recent immigrants with a university degree had median earnings of only $24,636, less than half the $51,656 earned by those with degrees who were born in Canada. The $27,020 gap was wider than it had been in 1995.5
In short, we cannot count on robust economic growth alone to resolve our difficult fiscal challenges.
Ontario’s three per cent increase in real GDP in 2010 reflected its recovery from the recession. At the time of the 2011 Budget, private-sector forecasters were predicting an average of only 2.7 per cent real annual growth in the four years from 2011 to 2014; the government scaled this back to 2.6 per cent for planning purposes. By November, the private-sector forecast average for this period had fallen to 2.3 per cent and the government, in its 2011 Ontario Economic Outlook and Fiscal Review, reduced this to 2.2 per cent for planning purposes. Few forecasters have looked out to 2018, the period covered in the Commission’s mandate.
We accept the government’s planning assumptions for economic growth out to 2014 from the 2011 Ontario Economic Outlook and Fiscal Review, but beyond that, we take a cautious approach — one dictated by our view of Ontario’s economic capacity and its ability to grow. No matter how much demand exists for Ontario’s goods and services, there is a limit to the level and growth rate of its potential output, both to what the province can produce and how fast its economy can grow without causing rising inflation. If an economy is already running at full capacity (or potential), there are limits to the speed at which it can continue to expand in the long term. A recession reduces actual output below potential, and, during the recovery period, the economy can exceed the speed limit and grow rapidly until its actual output returns to full capacity. After that, the growth rate must fall back to the slower pace that keeps inflation in check.
There is no firm measure of Ontario’s potential long-term real growth rate, but most estimates centre around two per cent annually, recognizing that the actual figure could be half a percentage point larger or smaller. Such variations can quickly accumulate to large differences. An economy growing at 1.5 per cent annually expands by 6.1 per cent over four years; at 2.5 per cent annual growth, the four-year expansion is 10.4 per cent.
As for the level issue, Ontario’s actual output is now below its potential, a consequence of the global recession, but there is little agreement on the size of the output gap. If there is plenty of slack in both the capital and labour markets, the economy can grow faster than potential for several years before creating inflationary pressures. The Bank of Canada estimates that the output gap for the country is about one per cent and, though it does not provide provincial estimates, the Ontario gap is unlikely to be much larger than that. Others see a bigger gap nationally and thus believe that the economy will grow briskly in the short term as it closes the gap. We lean towards the Bank of Canada view. If there were plenty of slack, we would more likely see a drop in wages and a falling inflation rate. Neither of those things has happened; inflation has remained quite firm.
A brutal characteristic of recessions is that they not only reduce actual output below potential, but they also destroy some of the potential of both capital and labour to produce. Unused machinery and equipment are rendered less productive or are superseded by more state-of-the-art machinery and equipment that competitors have put into use. Unemployed workers see their skills atrophy as they are unable to keep on top of the latest trends in their fields; some retire, while others lose confidence in their abilities. Even if unemployed workers from the diminished manufacturing sector can find other work, they are unlikely to be working at their previous levels of productivity; there are few alternative sources of employment that will pay a skilled auto worker $70 per hour including benefits. Tragically, we believe the recession has destroyed some of Ontario’s capacity in both its capital and labour markets. Ontario’s ability to supply goods and services has been diminished by the recession.
Supply is, of course, only half the picture; the other half is demand. Rapid growth in world demand helped Ontario (and Canada) to shuck off the recession of the 1990s. These days, prospects for a quick return to full potential have been dimmed by the worsening position of both the United States and Europe, where the economic outlook has taken a grim turn in the months since the Budget. Both markets appear likely to grow more slowly than predicted at the time of the Budget. Unfortunately, the demand and supply sides of the economy are intertwined. The longer it takes for demand to absorb unused capacity, the more that productive capacity withers and the less of it will be productively available.
The private-sector forecasters who, at the time of the Budget in March 2011, were predicting growth of 2.6 per cent in 2011 and 2.8 per cent in 2012 had, by the time of the Ontario Economic Outlook and Fiscal Review in November 2011, taken account of the gloomier picture abroad and reduced their predictions to 2.0 per cent for 2011 and 1.9 per cent for 2012. They project somewhat stronger growth of 2.6 per cent in 2013 and 2.7 per cent in 2014 as the economy returns to full potential by the end of 2015. Once that occurs, the most prudent assumption about Ontario’s economic growth to 2018 is the province’s long-term potential rate of growth. That is the one we have adopted — that real GDP will expand by about 2.0 per cent per year from 2016 through 2018.
There are two components to potential growth — the labour force and productivity. The labour force is the number of people working or looking for work; productivity is the output produced by every employee. In effect, potential growth is a function of people and the goods and services they can produce. A rapidly growing workforce with steadily rising productivity will generate rising prosperity.
Like the rest of Canada, Ontario faces a slowdown in the growth of the labour force. The long-anticipated retirement of baby boomers from the workforce has begun. Over the past two decades, the labour force has grown by an average of 1.3 per cent per year. By the second half of this decade, it is reasonable to expect growth of only 0.8 per cent annually. At the same time, productivity is likely to expand by about 1.2 per cent per year. Even this figure may be slightly optimistic since productivity growth has been substantially lower than that over the past decade. Between 2001 and 2010, productivity grew by a meagre 0.2 per cent per year on average; in 2008 and 2009, productivity actually fell. However, this should improve as a result of recent increases in public and private capital — in part because companies have used the increased purchasing power of the higher Canadian dollar to buy more imported machinery and equipment, which usually enhances productivity — along with policy moves such as lower corporate taxes and the introduction of the harmonized sales tax (HST).
Any assumption about productivity growth is imprecise at best, but we have chosen 1.2 per cent, a figure that is slightly lower than what appears to be implicitly embedded in the private-sector consensus forecast. This is the source of our 2.0 per cent assumption for annual potential real growth — 0.8 per cent more workers, with each producing 1.2 per cent more each year on average.
Important as real GDP growth is for fiscal planning, the growth of nominal GDP, which includes the impact of inflation, is even more critical. To our real growth of 2.0 per cent per year, we can add another 1.9 per cent worth of rising prices to produce a projection of 3.9 per cent annual growth in nominal GDP. We arrive at the inflation estimate by assuming that the Bank of Canada will continue to meet its target of keeping consumer price inflation at 2.0 per cent. Historically, that suggests that inflation across the whole economy, not just at the consumer level, will be only 1.9 per cent annually.
Nominal GDP is crucial because it constitutes the provincial government’s tax base — the economic activity on which it levies its taxes on income, sales and corporate profits. Fully 80 per cent of the Ontario government’s revenue comes from its own sources. Transfers from the federal government account for the remaining 20 per cent. Only Alberta and British Columbia rely less than Ontario on federal transfers. Although the 2011 Budget did not make a forecast of nominal GDP growth for the 2015–18 period, it appears that the Budget assumed growth of 4.5 per cent annually. Our assumption of 3.9 per cent annual growth has profound implications for Ontario’s fiscal outlook.
Before exploring those implications, we must acknowledge the basic problem with all forecasts and projections. There is a cone of uncertainty that broadens the further out into the future we look. There will always be errors, and the further out those forecasts and projections look, the larger the errors will be. We could choose the mid-point in the range of forecasts and possible outcomes as the basis for budget planning, but that would leave a 50–50 chance of getting a result that is worse than the one we want. In this case, that would mean getting a deficit that is larger, year by year, than the one needed to meet the 2017–18 target for balance. Strategically, it is better to plan on the basis of the less favourable economic outcomes; pleasant surprises are much better than nasty ones.
Our caution over the outlook for provincial revenues reflects a number of factors and applies both to the short term — out to 2013–14 — and the longer-term period from then until 2017–18. This caution has been with us from the beginning of our work in July 2011, by which time it was already evident that the economic growth prospects for Ontario — and the rest of the world — had soured considerably since the Budget in March. Subsequently, all forecasts of Ontario economic growth have been further marked down, which has obvious implications for revenue growth. We also found the Budget’s implicit relationship between revenue and economic growth unduly optimistic for two reasons. First, revenues were projected to grow faster than nominal GDP even though a number of revenue sources do not grow at the same pace as nominal GDP. Second, some tax reductions are still being phased in — a lower corporate tax rate, the phase-in of input tax credits under the HST, some personal income tax cuts related to introduction of the HST and some changes by the federal government to the Tax-Free Savings Account program, which spill over into Ontario’s tax collections.
With the release in November of the 2011 Ontario Economic Outlook and Fiscal Review (also known as the “fall update”), we had the opportunity to re-benchmark our analysis and projections onto the fall update rather than relying on the 2011 Budget. We agree with the economic growth projections in the fall update, which is hardly surprising, since the government largely adopted the advice that we had given internally on what we believed were the most appropriate economic assumptions — ones that reflected the global economic situation, current data and need for prudence.
We continue to be more cautious on government revenues. While the fall update scaled back the projections for economic growth, its revenue projections out to 2013–14 did not fully reflect the deterioration in the economy.
In making our revenue projections, the upshot is this:
Compared with the 2011 Budget, we see a weaker short-term economic outlook, weaker medium-term economic growth rates, weaker short-term revenue growth and weaker medium-term revenue growth numbers. Accordingly, our revenue numbers are significantly below the Budget track in each year. And for three of those four reasons (the first no longer applies), our revenue numbers are substantially below the fall update in every year.
For the period from 2013–14 to 2017–18, the Budget assumed annual revenue growth of 5.0 per cent, a pace exceeding the apparent 4.5 per cent projection of annual growth in nominal GDP. Instead, we have projected revenue growth of about 3.7 per cent annually, below our 4.1 per cent expectation for annual growth in nominal GDP. That is why our Status Quo Scenario sees total revenues of only $132.7 billion in 2017–18, $9.5 billion less than the Budget Scenario’s of $142.2 billion.
We do see some room for a small amount of additional revenue growth without raising taxes. A variety of modest revenue measures could yield almost $2 billion in annual revenue by 2017–18. These would involve a variety of measures: new strategies on contraband tobacco and the underground economy; better compliance with existing tax rules; better targeting of or eliminating some tax expenditures; and additional revenues from Crown agencies. Such initiatives, which we have incorporated in our Preferred Scenario, could bring total revenues in 2017–18 to $134.7 billion.
We can — and do — hope for better. But we cannot count on the kind of revenue growth the government expects and, more importantly, we must not make firm budget plans on the basis of that hope. Rather, we must adopt the “cautious assumptions” for fiscal policy — the first principle set out in the Fiscal Transparency and Accountability Act. We must apply that principle to our projections for provincial revenues and then work to fit our spending plans to match the revenue projections. This is not strictly a case of hoping for the best and planning for the worst, as the old adage goes; we are planning not for the worst, but for an outcome we think more likely. We can hope too that another adage will apply: underpromise and overdeliver. If the economy and revenues exceed our assumptions, future governments will be left with the pleasant task of deciding what to do with the resulting surpluses.
Related to the revenue outlook is the usual contingency reserve that budgets include for reasons of prudence — in case revenues fall short of the budget forecast. The 2011 Budget set the contingency reserve at $700 million per year in 2011–12 and $1.0 billion in all subsequent years. Such a static approach, however, might not cover the impact of long-term trends that give rise to forecast errors. Projections are not only subject to short-term uncertainty emanating, for example, from the fragile global recovery. There is great uncertainty over longer-term trends such as productivity growth as well, which affects our assumed rate of economic growth and therefore our assumed revenue growth. We assume productivity growth of 1.2 per cent annually, but it could just as easily come in at only 1.0 per cent. A persistent shortfall in productivity growth would then have a compound effect on our projected revenue growth. Accordingly, we have set the contingency reserve to cover the possibility of overestimating the growth rate in revenue by roughly 0.2 per cent per year. From 0.2 per cent of revenue in the first year of this exercise (2011–12), our reserve rises by 0.2 percentage point per year to 1.4 per cent in the target year (2017–18), when the cushion would amount to $1.9 billion.
As an aside, we would like to make one other point. Our mandate precludes us from recommending increases in tax rates, though we have made some recommendations for bringing in more revenues through better compliance, acting on some tax expenditures and generating larger returns from Crown agencies. By 2017–18, the actions we recommend could raise revenues by almost $2 billion. However, we would be remiss if we failed to point out that even with these non-tax-rate revenue measures, the overall tax burden, as measured crudely by the ratio of the government’s revenues from its own sources to GDP, will actually fall as a share of GDP over the projection period. There are two reasons for this. First, revenues are reduced by over $4 billion per year by 2017–18 as a result of policy decisions already taken. These include planned reductions to the corporate income tax rate, the phasing in of input tax credits under the HST, revenue losses from the increased use of Tax-Free Savings Accounts and the policy of reducing property education tax rates every time the base rises. Second, some revenue sources do not tend to grow apace with nominal GDP. For example, gasoline and beer taxes are specific in that they are applied to the volume of sales, so revenues do not rise with inflation. Also, many user fees are set as fixed levies and do not automatically rise as the economy grows or with inflation. We estimate that for every one per cent rise in nominal GDP, Ontario’s revenues from its own sources rise only about 0.96 per cent. A switch to ad valorem taxes and adopting either full cost recovery on user fees or indexing user fees to inflation would increase this revenue yield.
A striking fact in our Status Quo Scenario is that own-source revenue falls from 13.65 per cent of GDP in 2010–11 to 13.09 per cent in 2017–18. In other words, the tax burden will fall; the government will be taking less from the economy, relative to annual output, at the end of the period than the beginning. We have suggested a number of measures, worth almost $2 billion in 2017–18, that the government could take to increase revenues without raising taxes; these would bring the revenue ratio back up to 13.33 per cent. In line with our mandate, the Commission is not recommending tax rate increases. However, we note that if the ratio of own-source revenue to GDP were kept constant at 13.65 per cent of GDP over the projection period, the additional 0.32 per cent of GDP would generate almost $2.6 billion in additional revenues in 2017–18. This would allow the government to balance the budget with program spending that is $2.6 billion higher than in our scenario. The growth rate of program spending could be 1.1 per cent rather than 0.8 per cent. Clearly, such a revenue scenario does not in any meaningful way negate the need for bold spending reforms. It does, however, ease the burden of spending restraint somewhat.
Inevitably, some people will balk at the severity of program spending restraint to balance the budget by 2017–18 without any increases in tax rates; naturally, some will suggest that higher taxes be part of the solution to Ontario’s budget problem. This is, of course, not an option for the Commission; our mandate precludes any such recommendations or even much discussion of the issue.
Nonetheless, we do wish to register some thoughts.
Most of the reforms we recommend should go ahead regardless of the particular spending growth rate target. Many programs and services are not being delivered efficiently. Whether or not the savings are needed to meet some particular spending target, there is no valid reason not to address this question. It is just plain good sense for taxpayers to want everything to run as efficiently as possible and for the government to ensure that this occurs. So any reprieve that might be taken from the spending austerity we recommend should not be applied across the board. Given the number of our recommendations, it should come as no surprise that some would have been avoided if not for the spending limits imposed by the 2017–18 target date for balancing the budget.
A critical sequencing is involved here. We are adamant that the government’s first priority must be to implement a process that ensures greater efficiency in spending. Nothing that might be done on the tax side should ever distract from this. Push the tax button too quickly and that discipline might be lost. Ministries should be given seven-year spending targets, for example, regardless of the degree of overall spending restraint. And again, most of our reforms should be done just for the sake of delivering better value for taxpayers’ money.
Finally, it should be understood that it takes a lot of tax rate effort to get much relief from the spending restraint. Suppose that instead of our recommended 0.8 per cent growth rate for program spending, the government preferred a target of 2.0 per cent. That would raise the level of program spending by around $10 billion in 2017–18 relative to our Preferred Scenario. But if the budget were still to be balanced, revenues would also have to be $10 billion higher. That amounts to almost a 10 per cent increase in every provincial source of tax and non-tax revenue. The personal income tax rate, corporate income tax rate, HST rate, gasoline tax, user fees and so on would all have to rise by the equivalent of 10 per cent, or the government would have to find some combination (i.e., less of one, more of another) that produces the same result. The most economically neutral way of doing this would be to raise the money through a broad-based consumption tax, such as the HST. If that were the only source of higher taxes, then to raise an extra $10 billion, the provincial portion of the HST would have to rise from 8 per cent to 11 per cent, which would lift the whole HST from its current 13 per cent to 16 per cent.
So whether you like our recommendations or not, there is no escaping the need to pay attention to the ones for spending restraint and the processes required to deliver them.
The revenue outlook is only the first building block in our Status Quo Scenario. We now turn to spending.
The 2011 Budget set out a profile for spending on programs (everything, that is, except interest on the debt) that was, as the Auditor General put it, “optimistic and aggressive rather than cautious.” In plainer language, the Budget assumed spending growth that would be slower than the Auditor General believed likely. Our work has confirmed the Auditor General’s assessment.
Combined with its revenue projection, the government’s 2011 Budget scenario contained a projection for program spending that would bring the overall budget into balance by 2017–18, when total revenue and total spending would each come to $142.2 billion. The Budget Scenario was based on an assumption that program spending would grow by 1.0 per cent annually from 2010–11 to 2013–14; after that, it would grow by only 1.7 per cent per year. (If the effects of one-time stimulus spending are excluded, the growth rate for program spending would be 1.8 per cent for 2010–11 to 2013–14.) This projection for the period after 2013–14, as we explained earlier, was really just a residual — the amounts left over after the 2011 Budget had projected revenues and interest costs. Each year’s estimate for program spending constituted a target the government would have to hit to keep its projected year-by-year reductions in the deficit on track.
However, if we assume that government programs continue as they are now delivered, then the money spent on all goods and services is actually on track to grow by more than double that pace — 3.5 per cent per year on average over the seven-year period. Still, it is noteworthy that this is around half the pace of the past decade, so significant action has been taken.
This trajectory is our Status Quo outlook for program spending: it incorporates the increases that are likely to take place if current programs are retained in their current form, if no new programs are introduced, and if nothing further is done to restrain spending. This Status Quo outlook is not just a mechanistic extension into the future of past trends in total program spending. Rather, it is based on what are called the drivers of spending growth — the forces that determine how much the government would have to spend in the future to maintain current services. Two of those drivers — inflation and population growth — are common to many programs, but most programs have their own additional unique pressures that drive up costs.
Four blocks of spending accounted for over 77 per cent of all program expenses in 2010–11: health; education (kindergarten through Grade 12); children’s and social services; and post-secondary education. Left on their own, they would approach 83 per cent of program spending in 2017–18. These programs will command ever-growing shares, squeezing out spending on the government’s other programs — justice, transportation, economic development, tourism, agriculture, natural resources and others.
Here is how some of the cost drivers work in those four major areas of government spending.
Health care expenses accounted for 40.3 per cent of program spending in 2010–11 — $44.8 billion out of $111.2 billion spent on programs. A continuation of current practices would require the province to increase spending on health care by an average of 4.7 per cent annually through 2013–14 and 5.0 per cent annually from then until 2017–18, when it would reach $62.5 billion. A look at the drivers in the three biggest components of health care funding shows why.
The cost of running hospitals, the single biggest item in the overall health care budget at $15.5 billion in 2010–11, is driven primarily by three factors — inflation, population growth and aging (older people need hospitals more than younger people). Population growth will add 1.2 per cent to costs each year through the whole period to 2017–18 and aging another 1 per cent. Inflation, the rising cost of buying the goods and services needed to operate hospitals, is expected to add 3.0 per cent to costs this year and about another 2.0 per cent in the next four years. Most of what hospitals buy are the services of their employees, so the inflation driver is primarily the cost of compensation — wages, salaries and benefits. Whether hospitals can hold this 2.0 per cent line on inflation over such a long period is open to question. Note, however, that population aging — which in much of the public debate has become the major “source” of future cost pressures — accounts for less than a quarter of the cost drivers for hospital spending. All told, hospital spending in our Status Quo Scenario would rise by an average of 4.1 per cent annually over seven years to $20.5 billion in 2017–18.
The Ontario Health Insurance Plan (OHIP) is the next biggest item in health spending — $11.9 billion in 2010–11. It is subject to the same population and inflation drivers as hospitals; in this case, the inflation driver is the cost of paying doctors. An additional driver, which we might call “utilization above population growth,” is expected to add 3.0 per cent annually to costs. This reflects the fact that, over time, there has been an increase in the use of health care. New technology permits more interventions (hip and knee replacements, for example) and more tests become possible. Such developments improve the population’s well-being, but they also add new costs to the system. (Health care may be the only area in which technological advances increase costs, rather than reduce them.) So any projection of future costs must go beyond estimating how much today’s practices will cost in the future. There will doubtless be an expanding array of health care services that become feasible and that physicians and patients will want to use. The Status Quo Scenario for OHIP sees an average of 6.4 per cent growth per year that would lift spending to $18.4 billion in 2017–18.
The cost of the ministry’s drug benefit programs would rise by 4.3 per cent per year in the Status Quo Scenario from $3.5 billion in 2010–11 to $4.6 billion in 2017–18. One cost driver, the growing population of those aged 65 or older, will raise costs by 3.5 per cent per year; the other driver, new drugs and technology, will add 1.5 per cent annually. These are simply examples of how cost drivers work in the biggest programs that make up the health care budget. Every program in the health care budget has its own drivers that may be stronger or weaker than the average.
Education spending, at $21.9 billion, accounted for almost 20 per cent of program spending in 2010–11, a sum that would grow to $29.1 billion in 2017–18 if the Status Quo is maintained. This is based on average annual increases of 5.3 per cent to 2013–14 and further 3.3 per cent average annual increases to 2017–18. Almost all of that goes to funding elementary and secondary schools. Collective bargaining agreements for the province’s teachers expire in August 2012, and the cost drivers reflect that. The current arrangements show up prominently in the higher short-term growth. The five years from 2013–14 through 2017–18 inclusive are not covered by existing collective agreements. For the purposes of this report, inflationary growth is the key cost driver for the five years. The education budget also features the implementation of full-day kindergarten, which in the Status Quo Scenario will rapidly drive costs higher as it is rolled out between now and September 2014, when it is scheduled to be fully in place.
Post-secondary education cost $6.1 billion in 2010–11, or 5.5 per cent of program spending, and is on track to grow to $7.9 billion in 2017–18. The biggest chunk of this consists of operating grants to universities and colleges: $4.7 billion in 2010–11, growing to $6.1 billion in 2017–18. Here, the cost drivers are inflation and enrolment growth.
The cost of children’s and social services programs was $13 billion in 2010–11, or 11.7 per cent of program spending. In a Status Quo Scenario, that sum grows to $17.6 billion in 2017–18. The drivers are population growth among the relevant age groups — children in some instances, adults in others — and inflation, mainly in the form of compensation. Growing caseloads constitute another cost driver for social assistance programs like the Ontario Child Benefit, Ontario Disability Support Program and Ontario Works — and for Ontario Works, the uploading of programs from municipalities to the provincial government will also push up costs.
No one should get the impression from all this that spending is out of control or wildly excessive. Indeed, Ontario runs one of the lowest-cost provincial governments in Canada relative to its GDP and has done so for decades. We must also recognize that important steps have been taken in recent years to help manage costs, improve prospects for future economic growth and enhance services to the public. There are many positive examples. Improvements to the health care system that begin to reflect more of a patient-centric approach and apply evidence-based policy decisions have been introduced through the Excellent Care for All Act. While the cost of prescription drugs is still a huge burden for government, the recent move to reduce the cost of generic drugs has already created dividends to the province of hundreds of millions of dollars annually. Our elementary and secondary education systems have set a very high standard with dramatic improvements in test scores and graduation rates, and the 64 per cent higher education attainment rate is the highest of the 34 Organization for Economic Co-operation and Development (OECD) countries. ServiceOntario is a one-stop delivery network for a range of government services that recently increased its overall customer satisfaction rating to 92 per cent. And the HST has given Ontario a competitiveness edge that helped vault Canada to number one in Forbes magazine’s ranking of best countries in which to do business. Regrettably, staying the course on these critical improvements is not enough. There is an undeniable need to accelerate progress in these areas and implement new reforms in many other areas to create a sustainable climate for public services in the province. And we must do so at a time when the need to eliminate a still-substantial deficit is compelling.
Across all programs, the Status Quo spending scenario — adjusted for cases where the government has already implemented firm plans to restrain spending — points to spending in 2017–18 that is $17.4 billion higher than the sums contained in the 2011 Budget scenario for a balanced budget in that year. (This includes our $900 million increase in the contingency reserve, explained earlier.) Tack on interest payments that are $3.4 billion higher than found in the Budget (a consequence of higher deficits on the way to 2017–18) and the result is total expenditures that are about $20.8 billion higher than the Budget projection. Since we assume that total revenue in 2017–18 will fall $9.4 billion short of the Budget’s assumption, the result in our scenario is a $30.2 billion gap compared with the Budget Scenario.
All scenarios are projections based on assumptions, of course, but we believe the dynamics of revenue and spending growth point almost inescapably to this Status Quo outcome if no action is taken — a provincial government with a debt of $411.4 billion, equivalent to 50.7 per cent of annual GDP, not the more benign $322.5 billion (39.7 per cent of GDP) implied in the 2011 Budget.
To prevent that outcome, the government can raise taxes or cut the rate of growth of spending, or both. We need to find $30.2 billion to close the 2017–18 gap between revenue and spending. Since our mandate precludes us from recommending new or increased taxes, we are forced to examine government spending as the primary source of a solution. However, we have already suggested that a set of revenue measures that do not constitute tax increases — these involve contraband tobacco, the underground economy, collections issues, tax expenditures and Crown agencies — could raise almost $2 billion and we recommend that the government proceed with these measures. Steadily reducing the deficit to zero by 2017–18 would save $4.3 billion in interest costs in that year. This means we need to shave about $23.9 billion off our projection for program spending seven years from now to fully close the gap and balance the budget.
The arithmetic is simple: in 2017–18, we expect revenues of $132.7 billion from the existing tax structure and federal transfers. The revenue collection measures mentioned above would bring total revenue in 2017–18 to about $134.7 billion, so a balanced budget requires total spending of the same amount. Interest on the debt would cost $15.3 billion; though we, too, like the 2011 Budget, are setting a course to eliminate the deficit in seven years, this interest cost is lower than the budget figure primarily because forecasters now anticipate lower interest rates than they did at budget time. This leaves a residual — after we have set aside a $1.9 billion contingency reserve for unforeseen events — of only $117.5 billion to be spent on programs in 2017–18, up somewhat from the $111.2 billion spent on programs in 2010–11, but below the $124.9 billion foreseen in the 2011 Budget for that year.
|2010–11||2017–18||2010–11 to 2017–18||2010–11||2017–18||2010–11 to 2017–18||2010–11||2017–18||2010–11 to 2017–18|
|Billions ($)||Billions ($)||Per Cent Change||CAGR* (Per Cent)||Per Capita in current dollars||Per Capita in current dollars||Per Cent Change||CAGR* (Per Cent)||Per Capita in 2010 dollars
|Per Capita in 2010 dollars
|Per Cent Change||CAGR** (Per Cent)|
|Interest on Debt||9.5||16.3||70.7||7.9||720||1,132||57.2||6.7||720||975||35.4||4.4|
|Net Debt/ GDP||35.5%||39.7%||–||–||–||–||–||–||–||–||–||–|
|Interest on Debt||9.5||19.7||107.5||11.0||717||1,369||91.1||9.7||717||1,180||64.6||7.4|
|Net Debt/ GDP||35.0%||50.7%||–||–||–||–||–||–||–||–||–||–|
|Interest on Debt||9.5||15.3||61.8||7.1||717||1,068||49.0||5.9||717||920||28.4||3.6|
|Net Debt/ GDP||35.0%||37.0%||–||–||–||–||–||–||–||–||–||–|
|* Certain figures may not add due to rounding.|
|** CAGR = Compound Annual Growth Rate.|
|*** Deflated by the CPI.|
Our number represents a very small increase in overall spending on programs, only 5.6 per cent over seven years, for a compound annual growth rate of only 0.8 per cent.
That does not take into account either population growth or inflation. Meeting the target of a balanced budget means that program spending for every man, woman and child living in Ontario would have to fall by 2.7 per cent over the next seven years, or 0.4 per cent annually. In real terms, with inflationary increases removed, the cut in programs per person would amount to 16.2 per cent, making for steady 2.5 per cent declines on average in every year from 2010–11 through 2017–18. For Ontario, indeed for any province, this represents a decline in government spending that is almost certainly unprecedented.
The big picture then is this: Ontario must keep the growth in total program spending to a meagre 0.8 per cent per year for seven years if it is to reach the official target of balancing the budget by 2017–18. (Given that it is by now too late to reduce the growth in program expenses to that level in the current 2011–12 fiscal year, the actual rate for the subsequent six years would have to be even lower.)
We can express these numbers another way — in actual dollars. The 3.5 per cent annual growth in projected program spending under the Status Quo Scenario would lead to outlays in 2017–18 that are $30.2 billion higher than they were in 2010–11. The 0.8 per cent growth rate in our Preferred Scenario leads to an increase of only $6.3 billion.6
Our mandate was to provide advice on how to balance the books before 2017–18. Our projections indicate that even getting to balance as late as 2017–18 requires a degree of government spending restraint that is perhaps unprecedented in Canadian history. The restraint must be so tight that many people will inevitably suggest that we go in the other direction and let the target date for fiscal balance slip still further into the future. We examined this option, but found that it offers little relief from the need for severe spending curbs. If we delay the target for balance by one year to 2018–19, we could allow program spending to grow by 1.0 per cent annually instead of 0.8 per cent. But the Commission does not recommend such slippage. The minor additional flexibility on spending does not outweigh the risk of slipping out of fiscal control.
Not every program should grow at the 0.8 per cent rate, however. Ontarians and their government attach different priorities to different programs, and some offer more opportunities for efficiency gains than others.
Anyone with even a smattering of arithmetic will realize that if some programs grow faster than 0.8 per cent annually, other programs will have to grow more slowly. Health care is always the highest priority of Ontarians and it is difficult to know how far down its growth rate can be driven without compromising the services delivered. The system needs fundamental reform in its organization, as we will argue later in more detail, but it is worth noting here that health care is unique in that new technology increases costs rather than reduces them. Few countries have succeeded in achieving a sustainable growth rate in health spending of less than four per cent in real terms; that is, before accounting for inflation.
Our basic problem is simple: the faster health spending grows, the more other programs will be squeezed. If, over the period from 2010–11 to 2017–18, health spending continues to grow by 6.3 per cent per year — its track record in the five years from 2005–06 to 2010–11 — then all programs other than health would have to contract by 4.1 per cent annually to meet our target of 0.8 per cent growth in total program spending. Over the whole period, total health spending would rise by 53.4 per cent; all other program spending would fall by 25.2 per cent. By 2017–18, health would account for 58.5 per cent of Ontario’s program spending, compared with 40.3 per cent in 2010–11.
This cannot be our future. Important as it is, health care must not be allowed to run roughshod over every other priority. It must not be allowed to gut every other government service that Ontarians rely on for their education, social welfare, justice system, infrastructure needs and a host of other programs that matter to the people of this province.
While total program spending growth must come to an average of 0.8 per cent annually, there is an almost infinite set of possibilities for allocating spending across the government’s many programs.
The choices we make on how to allocate funds should first reflect public policy priorities. The Commission was instructed to respect the priority attached to health and education, and for good reason. Ontarians always identify health as their top interest in terms of public services. And in this knowledge-based era, education is the key to economic success. It is also the most powerful social equalizer. The Commission not only accepts but heartily agrees with this designation of priorities. Such ranking must continue on through the full range of programs and services. Spending choices must also reflect any opportunities for the government to achieve efficiency gains in its programs. They should even consider whether a particular service even needs to be provided by the Ontario government.
Health is critical not only for whether the overall spending target will be achieved, but since it represents $4 of every $10 spent on programs, it also determines how much can be spent on everything else. Table 1.2 shows the size of each major spending category.
|Share of Program Spending
|Average Annual Growth Rate,
2001–02 to 2010–11
|Education, Primary and Secondary School||21.9||19.7||4.5|
|All Other Program Spending||25.5||22.9||8.5|
|Total Program Spending||111.2*||100.0||6.8|
|*Numbers may not add due to rounding.|
To illustrate how health affects all program spending, we can begin with the 2011 Budget, which implicitly projected 3.0 per cent annual increases for health spending through 2017–18. If health grows at 3.0 per cent per year, then we will have to cut all other programs by 0.7 per cent annually to meet our overall target of 0.8 per cent growth in program spending. Now extend this exercise. If health is at 3.0 per cent, both parts of education are at 1.0 per cent and social services (social assistance rates have yet to recover from a 21 per cent cut in 1995) are at 1.0 per cent, then everything else will have to be cut by an average of 3.8 per cent per year, for a cumulative decline of almost 24 per cent in the level of spending over the seven years.
Let us ponder this scenario for a moment. At three per cent per year, health would be growing at less than half its recent historical pace (6.3 per cent annually in the last five years). Yet it would still be “crowding out” everything else to a significant degree. At one per cent annual growth, post-secondary education spending would not keep pace with the expected rise in enrolment, so there would be a reduction in grants per student in nominal terms and an even larger cut when inflation is factored in.
The 3.8 per cent annual cut to “everything else” would be almost impossible to manage. The prospect of squeezing more each year would force ministries to simply chop an activity altogether or impose the 24 per cent cut all at once and then sort out the future with a budget fixed at the new lower level. In some cases, such cuts would border on the technically infeasible or require decisions that could be counterproductive. For example, a substantial portion of the “everything else” category consists of the cost of amortizing existing capital (mainly infrastructure projects), the government’s contributions to existing pension arrangements with public-sector employees and the cost of electricity contracts. These items, which in 2017–18 will account for over 31 per cent of the “everything else” spending, cannot be cut. This implies that the cut to everything other than those fixed items would be in the order of 6.4 per cent annually, for a cumulative decline of more than 37 per cent over seven years.
Also included here are cost-sharing programs with the federal government, so if the province cut $100 million from programs in which the federal–provincial cost split is 60–40, then Ottawa’s contribution would fall by $150 million and total spending in the province would be cut by $250 million. Accordingly, the burden of restraint will fall even more heavily on other programs.
This is a simple illustration of the kind of choices Ontarians must face in the months ahead. Another choice involves labour compensation. Since the total bill for wages, salaries and benefits accounts for about half of all program spending, it is difficult to believe that program spending can be held to annual growth of 0.8 per cent if labour costs rise by much more than that.
Having developed a number of scenarios for program spending, we have opted to recommend one that seeks even greater savings from health care to leave room for additional growth in spending on other programs. As we will spell out in detail in Chapter 5, Health, we believe there is ample scope in the health care system for efficiencies that will allow health care providers to deliver the services Ontarians need without getting annual increases of the kind seen in recent years.
Recommendation 1-1: We recommend the following annual changes in program spending out to 2017–18:
This permits post-secondary education grants to almost keep pace with enrolment and provides a more realistic path for non-health, non-education, non-social services spending. For the latter programs, it still represents a very significant degree of restraint — a cumulative decline in the level of spending of about 15.6 per cent over seven years — even though a significant portion of this “everything else” category is either fully committed by historical arrangements such as amortization and pension contributions or simply unwise to cut, such as existing shared-cost agreements, where the province would be giving up federal dollars. For everything other than the fixed items, the cumulative decline would come to about 27 per cent over seven years.
As mentioned earlier, program spending would rise by $6.3 billion between 2s010–11 and 2017–18. Our recommendation implies the following changes for the major program categories: health, up $8.4 billion; education (primary and secondary), up $1.6 billion; post-secondary education, up $0.7 billion; social services, up $0.5 billion; all other programs, down $4.0 billion.7
Ontario’s finances do not yet constitute a crisis and with early strong action, a crisis can be averted. Crises always spur action, but almost inevitably, they also bring forth bad public policy decisions. Faced with the need to make huge corrections in very short order, governments grasp at what look like fast and easy solutions, but too often meet the demands of the present by pushing off expenses for future generations to pay. The current actions of many U.S. states as they cope with the recession and a terribly weak recovery should serve as a warning. Almost all are bound by constitutional requirements to balance their budgets and many are responding to sudden revenue drops with spending cuts that are utterly inappropriate — like savage cuts to education budgets that will undermine the lives of their children for decades.
The lessons of history and of what is happening elsewhere today are clear: The government must take daring fiscal action early, before today’s challenges are transformed into tomorrow’s crises. A challenge, unlike a crisis, can be met with well-considered, firm, steady and even imaginative action that deals with the problems methodically and phases in the needed changes over a period of years, giving people a chance to adjust. The government’s decision to create the Commission and give it a broad mandate to address near- and long-term fiscal issues signals its intent to address these challenges and head off any crisis. Our goal in this report is to set out the kind of measures that will meet the task.
|Actual||Forecast||Compound Annual Growth Rate|
|Real GDP ($ Millions)|
|MOF* 2011 Ontario Budget||527,813||540,481||555,073||570,060||584,882||N/A||N/A||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||527,813||537,314||546,985||560,660||575,237||N/A||N/A||N/A||N/A||N/A||N/A|
|Private-Sector November Average||527,813||538,369||548,598||562,862||578,059||591,933||607,323||621,291||634,960||2.3%||2.4%|
|Real GDP Growth:|
|Annual Per Cent|
|MOF* 2011 Ontario Budget||3.0||2.4||2.7||2.7||2.6||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||3.0||1.8||1.8||2.5||2.6||N/A||N/A||N/A||N/A|
|Private-Sector November Average||3.0||2.0||1.9||2.6||2.7||2.4||2.6||2.3||2.2|
|MOF* 2011 Ontario Budget||116.0||118.5||121.3||123.8||126.2||N/A||N/A||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||116.0||118.6||120.8||123.0||125.3||N/A||N/A||N/A||N/A||N/A||N/A|
|Private-Sector November Average||116.0||119.0||121.3||123.6||125.8||128.0||130.2||132.4||134.6||2.0%||1.7%|
|Nominal GDP ($ Millions)|
|MOF* 2011 Ontario Budget||612,494||640,669||673,343||705,663||738,134||N/A||N/A||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||612,494||636,996||660,563||689,627||720,661||N/A||N/A||N/A||N/A||N/A||N/A|
|Private-Sector November Average||612,494||640,669||665,655||695,609||726,912||757,442||790,769||822,400||854,474||4.3%||4.1%|
|Nominal GDP Growth:|
|Annual Per Cent|
|MOF* 2011 Ontario Budget||5.3||4.6||5.1||4.8||4.6||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||5.3||4.0||3.7||4.4||4.5||N/A||N/A||N/A||N/A|
|Private-Sector November Average||5.3||4.6||3.9||4.5||4.5||4.2||4.4||4.0||3.9|
|Three-Month Treasury Bill Rate* (Per Cent)|
|MOF* 2011 Ontario Budget||0.6||1.4||2.6||2.7||2.5||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||0.6||0.9||1.2||2.3||2.5||N/A||N/A||N/A||N/A|
|Private-Sector November Average||0.6||0.9||1.1||1.8||2.9||3.6||4.2||4.5||4.6|
|10-year Government Bond Rate* (Per Cent)|
|MOF* 2011 Ontario Budget||3.2||3.4||4.0||4.3||4.3||N/A||N/A||N/A||N/A|
|MOF 2011 Fall Economic Statement||3.2||2.8||2.7||4.0||4.3||N/A||N/A||N/A||N/A|
|Private-Sector November Average||3.2||2.8||2.5||3.3||4.1||4.6||4.8||5.1||5.1|
|* Government of Canada interest rates. Interest rate assumptions reflect private-sector estimates.|
|N/A = data not available.|
|MOF=Ministry of Finance.|
|To make the projections comparable, 2010 GDP levels are benchmarked to the latest Provincial Economic Accounts, which results in discrepancy from published Budget levels.|
5. Don Drummond and Francis Fong, “The Changing Canadian Workplace,” Mar. 8, 2010, TD Economics, downloaded from
6. For perspective, here are the changes in the key numbers between 2010–11 and 2017–18. In the Status Quo Scenario: revenue, up $26.1 billion; program spending, up $30.2 billion; interest on debt, up $10.2 billion; total spending, up $40.4 billion; the reserve, up $1.9 billion; the deficit, up $16.2 billion; net debt, up $196.9 billion. In the Preferred Scenario: revenue, up $28.0 billion, program spending, up $6.3 billion; interest on debt, up $5.9 billion; total spending, up $12.1 billion; the reserve, up $1.9 billion; the deficit, down $14.0 billion; net debt, up $85.5 billion.
7. These items add to $7.2 billion. An operating reserve would be up $0.3 billion, but year-end savings, a standard feature of Ontario’s budgeting, would subtract $1.2 billion, leaving the $6.3 billion total increase in program spending.