Closing the budget gap by 2017–18 will not be easy. However, many Canadian governments have successfully faced deep fiscal problems in the past two decades and in the process have strengthened their capacity to deal with fresh challenges as they arose. Most of those episodes occurred in the 1990s, when a sharp recession was followed by a recovery that was halting at first before gathering enough momentum to generate a solid expansion. Economic growth helped governments back to fiscal health, but many restrained spending — in some cases, significantly — and some even raised taxes to balance their budgets. Lessons can be learned from these periods of restraint, but the underlying message — that the task is doable — must be tempered this time around by the expectation that economic growth alone will not be strong enough to skate us onside. Indeed, it may not even be strong enough, as it was in the 1990s, to lend much of a hand.
Nationally, the best-known example of deficit elimination was that of the federal government between 1995, when the Chretien government began to take serious action,1 and 1998, when the deficit disappeared. Four provinces that also engaged in vigorous deficit-cutting exercises are of special interest to us — Alberta, Saskatchewan, New Brunswick and (of greatest relevance) Ontario. “In spite of their different situations as well as approaches, all of these governments were successful in their efforts,” one study concluded.2 A thread common to all of these was their reliance on spending restraint or outright cuts to a much greater extent than tax increases.
Deficit-cutting was a feature of the 1990s in Canada following a severe recession that reduced government revenues and increased government debt. After a generation in which Canadians tolerated growing deficits, the public mood turned in the direction of greater fiscal responsibility, most obviously at the federal level, but also in many provinces, especially those whose debt had risen quickly.
The federal government’s debt reached two-thirds of annual GDP in fiscal 1993–94, the year in which the new government of Jean Chretien was elected promising to reduce the deficit — 5.6 per cent of GDP in the previous fiscal year — to 3.0 per cent of GDP over three years. Severe volatility in the financial markets, where investors did not believe that Canada was committed to deficit reduction, persuaded the government to go even further in 1995. The result was a round of significant cuts both to the operating budgets of departments and to their grants and contributions — many in the range of 15 per cent to 25 per cent, and some even higher. Transfers to the provinces were also cut sharply — by more than 21 per cent over a two-year period.
In the end, seven of every eight dollars needed to eliminate the deficit came from spending restraint rather than revenue-generating measures. By 1997–98, the federal budget was back in balance. Subsequently, taxes were cut several times and spending resumed at a rapid clip, but the federal government continued to balance its budget — and even run surpluses in many years — for more than a decade. The quick decline in the deficit during the three years while the deficit was being wiped out calmed the financial markets, giving the Bank of Canada room to reduce interest rates, while robust economic growth generated strong revenue increases. Total program spending, which had peaked in 1994–95, fell by almost 10 per cent in the first two years of the restraint period and remained below the pre-restraint peak for five years.
Worth remembering is the fact that declining interest rates and robust economic growth — not just in Canada, but worldwide and especially in the United States — greatly helped not only the federal government, but also the provinces, successfully attack their fiscal problems. Canada enjoyed a strong gain in its terms of trade and was fortunate that it was one of the few countries applying any kind of fiscal restraint. The economic environment is far different today, as world growth falters, partly because so many governments are working simultaneously to repair their fiscal regimes and reduce debt.
Alberta’s drive to eliminate its deficit began in the 1992–93 fiscal year, when the new Progressive Conservative Premier, Ralph Klein, inherited a deficit equal to 4.4 per cent of GDP and a debt equal to 15.8 per cent of GDP, a condition almost unimaginable in a province that had been debt-free only six years earlier. Klein promised to balance the budget within three years and get rid of the debt in 10 years. He beat both targets, returning the budget to a surplus in only two years (in 1994–95) and paying off the debt in eight (in 2000–01). He did this entirely through cuts to spending and services. Spending was cut substantially in all ministries, including health and education, while social assistance rates were reduced by nearly 20 per cent over three years. Almost 10,000 public service jobs were eliminated, while the remaining civil servants faced wage cuts and many social services were contracted out to non-governmental agencies. Notably, total spending on programs fell by almost 22 per cent in the three years from 1992–93 to 1995–96 and remained below its 1992–93 peak for six years, through 1998–99.
Saskatchewan’s initial position was even more perilous. When elected in 1991, New Democratic Party Premier Roy Romanow took over a province that was close to defaulting on its $6 billion debt. At 28 per cent of GDP in 1991–92, the debt had climbed by more than 10 percentage points in only one year from 17.4 per cent in 1990–91. Saskatchewan’s plight was so serious that “the federal government had to step in with emergency financial assistance and contingency plans were drawn up in the event the province found itself in a position where it could not raise money in the foreign bond markets.”3 The Romanow government’s solution involved a mix of spending cuts and tax increases, which it called “The Saskatchewan Way.” The plan, like Alberta’s, included an extended period in which program spending was held below the 1990–91 peak, though in Saskatchewan’s case, the peak-to-trough decline amounted to only 10 per cent. Still, it lasted a year longer than Alberta’s restraint, for a full seven years to 1997–98. Departmental spending was cut, civil servants’ wages were frozen and the government, more generally, downsized. Welfare reforms encouraged people receiving social assistance to become more independent through earned income supplements and training initiatives. In the end, it took Saskatchewan only three years to get its budget back to balance.
New Brunswick, which went through two episodes of restraint under Liberal Premier Frank McKenna, has a mixed record. The first began after the province recorded a deficit in 1986–87 amounting to 3.5 per cent of GDP, which raised the debt-to-GDP ratio to 24.7 per cent. By 1989–90, the deficit had shrunk to $24 million from $368 million three years earlier. Revenue increases accounted for most of this progress; the growth of program spending slowed, but never fell. However, the return to an almost balanced budget was short-lived. By 1991–92, the recession had pushed the deficit back up to 2.6 per cent of GDP while the debt ratio, which had fallen to 23 per cent during the restraint years, was back up to 26.4 per cent. This time, a combination of expenditure curbs — which held the growth of spending to an average of only 0.7 per cent annually — and revenue-raising measures brought the budget to surplus in four years. This was not a major, or even prolonged, attack on government spending, which actually fell in only one of those years and remained below its pre-restraint peak for two.
Ontario’s experience in the 1990s is, of course, more familiar to Ontarians. A negligible surplus in 1989–90, when the debt was only 12.7 per cent of GDP, had marked the last hurrah of the 1980s economic boom. It was followed by a deep recession and five years of deficits from 1990–91 through 1994–95 that raised the debt to 29.2 per cent of GDP. In the 1995 election, the Progressive Conservatives under Mike Harris won power after running on a platform called the “Common Sense Revolution” (CSR). The platform set out four key objectives: tax reduction, balancing the budget, reducing the size of government, and greater emphasis on individual economic responsibility. The new government substantially implemented its platform. With the exception of health care, spending was reined in; the two most dramatic moves were a 22 per cent cut in social assistance rates and a downloading of program responsibilities to municipal governments, with a partial fiscal offset from other changes in Ontario-municipal relations and the induced reductions in social assistance expenditures. Personal taxes were cut by almost 30 per cent over a period of several years, while a new health tax on high income earners was levied to help pay for rising health care costs. Corporate taxes were cut as well.
Strong economic and revenue growth after 1995 helped the province balance its budget by 1999–2000, by which time spending had begun to rise again. Although the Harris government retains its reputation as one that made deep and lasting spending cuts, the reality is rather different. From its 1995–96 peak, program spending fell by only 4.1 per cent and stayed below the peak for only three years. By comparison with Alberta and Saskatchewan, Ontario’s restraint was both milder and much shorter. Even Quebec cut program spending by more than Ontario during this period — 4.6 per cent in the two years from 1994–95 to 1996–97.
Holding program spending in check is never easy, especially not when governments face constant pressure to increase spending. Inflation, population growth, compensation demands and sheer need all push governments in the direction of higher spending, as do vocal interest groups that advance any number of causes, many of them worthy. Since the current government faces some of the same issues as the Harris government, Ontario’s experience in the 1990s merits closer examination.
Chapter 1, The Need for Strong Fiscal Action, included our scenario for the seven years from 2010–11 through 2017–18. Now we want to compare, using broad strokes, the path we have laid out with a comparable period in the 1990s, the last time the province grappled with a substantial deficit. Specifically, we have chosen the six-year span from 1993–94, when the deficit was $11.2 billion, through 1999–2000, when the government reported a surplus of $1.0 billion.4
We will deal first with revenues. Our Preferred Scenario projects that revenue will grow by 3.4 per cent annually from 2010–11 to 2017–18. This is a much more modest increase than the one that occurred during the recovery period from deficit in the 1990s. Between 1993–94 and 1999–2000, revenue grew by a robust 4.7 per cent annually, even though taxes were cut during the period after 1995. The late 1990s were a period of robust economic growth that generated a strong flow of revenues to the provincial government. The timing of the economic expansion was fortuitous, since federal transfer payments fell as the federal government worked to eliminate its own deficit. However, Ontario’s revenue from its own sources grew substantially.
Revenue from personal income taxes grew by only 26.2 per cent between 1993–94 and 1999–2000, an extremely weak showing given the 39.4 per cent rise in the underlying nominal GDP during that period, but there was a reason for this. Tax revenues tend to be highly elastic during a period of strong economic growth following a recession; that is, tax revenues typically grow faster than GDP if tax rates are left unchanged. But over the 1995 to 1999 period, personal income tax rates were reduced sharply. However, retail sales tax revenue increased by 55.3 per cent and takings from corporate income taxes more than doubled. Two other revenue sources displayed strong growth. Revenue from government enterprises rose briskly, primarily because of the expanding lottery and gaming businesses; so did other forms of revenue, largely as a result of increased revenues to the province from municipalities. The government of the day transferred a number of programs to municipalities, but during a transition period, the municipalities reimbursed the province for services it was still providing on their behalf.
Relative to the size of the provincial economy, own-source revenues in 1999–2000 were 15.9 per cent of GDP. In 2010–11, the own-source revenue share was even lower —
13.65 per cent. Since the Commission’s Status Quo Scenario for the next seven years assumes that revenues will grow more slowly than the economy as a whole, this share will decline further, to only 13.09 per cent of GDP, in the absence of any measures to increase revenue. In Chapter 1, The Need for Strong Fiscal Action, we recommended a series of revenue measures worth almost $2 billion by 2017–18; these steps, involving contraband tobacco, the underground economy, collections issues, tax expenditures and additional revenues from Crown agencies, would raise the share to 13.33 per cent by that year. Federal transfers related to the recent economic stimulus package and transition to the HST will fall off over the next few years; all told, transfers are expected to amount to 3.3 per cent of GDP by 2017–18, down from 3.8 per cent in 2010–11.
Matching spending to revenues by 2017–18 — the target set out in the 2011 Budget — was never going to be easy. Even so, the Budget clearly signalled the need for the provincial government to restrain spending in the seven years to 2017–18. Its scenario for the target year put program spending at $124.9 billion; with its projection of $142.2 billion in revenue, $16.3 billion in interest costs and a $1 billion reserve, the budget would be in balance.
Remarkably, the implications of this spending goal went almost entirely unremarked by the public in the months since the Budget was released. The target of $124.9 billion in programs represented an increase of 10.2 per cent from what the Budget estimated was the $113.3 billion spent in 2010–11, an increase of 1.4 per cent per year.5 But if you adjust for population growth of 1.2 per cent annually and for inflation of 2.2 per cent annually, the government’s Budget Scenario points to a steady decline in real program spending per capita that would average 1.9 per cent per year. It is startling to compare this with the 1993–94 to 1999–2000 period. During that time, real per capita program spending fell at an annual rate of 2.0 per cent. Ontarians may not have noticed it, but the 2011 Budget was projecting seven years in which program spending on a real per capita basis would fall at almost the same rate as it did in the 1990s.
Unfortunately, the Commission believes that these measures will not be enough, as noted in Chapter 1, The Need for Strong Fiscal Action. Given our greater caution in projecting revenue growth, our scenario suggested that program spending — again on a real per capita basis — will have to fall by 2.5 per cent annually.
If the cuts of the 1990s appear smaller than the figures that loom in the memories of many Ontarians, bear in mind that in 1999–2000, the final year of the period we are using, total program spending increased by 3.0 per cent. The government of the day was heading for a balanced budget and loosened the purse strings that year, mainly to deal with the pressures that had accumulated during the previous six years of restraint. This was especially evident in health spending, which increased by 11.4 per cent that year. It is also worth recalling that a 22 per cent reduction in social assistance rates was a key element of the Harris years; since these rates have for the most part not increased since then, that avenue is not open now so restraint in other areas will have to be much tougher.
There is a lesson here from exercises in restraint. Governments can hold the lid on spending for a while by taking extraordinary measures to contain compensation costs, postponing capital projects and scrimping on infrastructure maintenance. Unless more fundamental reforms to spending programs are implemented, however, old pressures reassert themselves and governments with newly balanced budgets have a harder time resisting them. The Ontario experience of the 1990s is particularly instructive in this regard because reforms were applied in several areas including hospitals, schools and municipal relations, and still the fiscal pressures grew.
It is always instructive — and sometimes surprising — to compare ourselves with other provinces.
Ontario’s provincial government, for example, takes relatively less from its economy than almost all other provinces. From 1981 through 2006, for example, Ontario’s total revenues were the lowest in Canada, ranging in a narrow band between 14.5 per cent and 16.6 per cent of GDP; from 2007 to 2009, Alberta fell below Ontario, with an average take of 14.3 per cent, while Ontario was second lowest with an average of 16.3 per cent.6 Quebec, Manitoba and the four Atlantic provinces, in the most recent data, have generated the largest revenues — between 23 per cent and 33 per cent of GDP.
In broad terms, there are two sources of revenue for a provincial government: transfers from the federal government and the revenues it can raise on its own, mainly by taxing people, companies and retail sales. For the poorer provinces, transfers from the federal government have historically been an important source of revenue, averaging about 36 per cent to 43 per cent of revenue in the Atlantic provinces in the latest decade for which there are data (2000 through 2009). In Ontario, transfers accounted for 14.8 per cent of revenues during this period, though the recent trend is rising. Traditionally, Alberta’s reliance on federal transfers has been the lowest of any province, with Ontario and British Columbia jostling for the second-lowest spot. In 2009, however, Ontario received 18.7 per cent of its revenues from Ottawa,7 which
put it third from the bottom; below it were Alberta (13.8 per cent) and British Columbia (17.6 per cent).
The rest of Ontario’s revenues come from its own sources. From 1981 through 2003, the Ontario government’s own-source revenues relative to GDP — which represents the government’s tax burden on the province — were the lowest in the country, averaging 13.3 per cent through this period. It lost that distinction in 2004, when Newfoundland and Labrador and, subsequently, Alberta, moved below Ontario. In 2009, however, Ontario’s tax load, at 13.2 per cent of GDP, was the second lowest in Canada; only Alberta’s, at 11.6 per cent, was lower. The average for all provinces in that year was 14.6 per cent. Quebec’s own-source revenue amounted to 19.9 per cent of GDP in 2009, making it by a wide margin the heaviest-taxed province in Canada.8
Every province has its own mix of revenue sources and their power to fill the government coffers varies according to the rates of taxation they levy and the ability of each tax base to yield revenues. Direct taxes on persons, a category in the Provincial Economic Accounts that consists mainly of personal income taxes, will generate more revenue for governments in a province with high average personal incomes than in one with low average personal incomes. Natural resource wealth is a major point of difference among the provinces. In the 10 years from 2000 through 2009, just over 38 per cent of the Alberta government’s revenue came from what Statistics Canada classifies as investment income, which consists of returns from government-owned businesses and natural resource royalties. In Alberta’s case, this means royalties on oil and natural gas production. As a revenue source, royalties can be very volatile, tending to rise and fall with the price of the commodity; in the last decade of data, Alberta’s revenue share from investment income has ranged from 26.5 per cent (in 2009) to 43.9 per cent (in 2006). Ontario has no such luxury of easy money from resource wealth. Only about four per cent of its revenues have come from investment income (mostly as returns from Crown corporations) in recent years and the share is declining. Only Prince Edward Island relies less than Ontario on investment income.
Indirect taxes, the kind people pay as a consequence of some other activity, constitute the most important source of revenues for Ontario. In addition to the provincial sales tax (or more precisely, the provincial portion of the HST), this category includes gasoline taxes, payroll taxes, gaming profits and motor vehicle licence fees. Collectively, these accounted for about 38 per cent of the Ontario government’s total revenues in the latest decade, compared with a national average of 32 per cent. Ontario relies more on indirect taxes than any other province; next in line are British Columbia and Quebec, at just over 35 per cent. Alberta, with no provincial sales tax, relied least on indirect taxes — less than 18 per cent of its total revenues. Direct taxes on persons are the next biggest revenue source; in the latest decade, they accounted for 28 per cent of the Ontario government’s total revenues, compared with a national average of 24.5 per cent.
Direct taxes on corporations9 are another significant income source for Ontario, accounting for 8.5 per cent of total revenues on average during the last decade, second only to Alberta’s 8.6 per cent. Depending on the price of oil and gas, which in high-price years naturally makes Alberta-based energy companies more profitable, Ontario and Alberta take turns as the province with the greatest reliance on direct business taxes. These two are well ahead of other provinces in this category, primarily because they have more head offices than the others. Social insurance taxes (workers’ compensation levies are the biggest example) have accounted for another 3.7 per cent of Ontario’s revenue in the latest decade. Ontario and Quebec are the leaders in this category.
When it comes to spending, Ontario is very much on the low end of the scale. In the latest 10 years for which there are data, Ontario spent an average of only 14.7 per cent of GDP on government programs. Only Alberta, at 13.1 per cent, spent less. Averages do not tell the whole story, however. As a share of GDP, program spending by the Ontario government peaked at 18 per cent in 1992, fell to 12.8 per cent in 2000 and since then has been rising steadily — to 17.7 per cent in 2009, close to the national average of 19.3 per cent.
The biggest broad expense category is spending on goods and services, which includes compensation for the public service. That amounted to an average of 8.7 per cent of GDP over the latest 10-year period (compared with 10.3 per cent for all provinces) and 10.7 per cent in 2009 (12.0 per cent for all provinces). Transfers to local governments were the next biggest expense, coming in at 3.3 per cent in the latest decade (3.1 per cent for all provinces) and 3.9 per cent in 2009 (3.5 per cent for all provinces). Transfers to persons, that is, social services, amounted to 2.3 per cent in the latest decade (below the 2.6 per cent for all provinces) and 2.7 per cent in 2009 (again below the 2.9 per cent for all provinces).
A separate Statistics Canada database10 offers even more detail on provincial government spending. In 2008–09, the latest year available in Financial Management System data, the Ontario government’s total spending amounted to 17.8 per cent of GDP, the third lowest of all provinces; the average for all provinces was 19.6 per cent. In the latest decade, from 1998–99 to 2008–09, spending grew by an average of 4.8 per cent annually, fourth lowest in Canada and below the all-province average of 5.3 per cent.
This pattern is reflected in spending on the major provincial budget items, in comparisons that are only possible from this source:
Ontario’s role as a laggard in public spending was highlighted in a 2011 report11 from the Ontario Chamber of Commerce that included the following comparisons:
These are narrow measures and, unlike the Financial Management System data, do not take in the breadth of all spending on health, education and social services. But in each of these cases, the provinces offering their citizens a better, or cheaper, service are among the traditionally “have-not” provinces that receive substantial federal transfers.
Although Ontario is now receiving Equalization payments, the fact remains that the federal government takes a larger share of its revenues from Ontario than Ontario’s population share and devotes a smaller share of its spending to Ontario than Ontario’s population share. (See Chapter 20, Intergovernmental Relations.) As a rule, whenever the federal government’s budget is balanced or in surplus, it takes more from Ontario in taxes than it provides in the way of federal services to the province and in transfers both to Ontarians and to their provincial government. From 1997 through 2007 inclusive, the years in which the federal government ran a surplus (on a national accounts basis), Ontario’s net contribution averaged 4.6 per cent of GDP, a figure exceeded only by Alberta’s 5.6 per cent.
Despite its relatively modest expenses relative to the size of its economy and population, Ontario must now close a large gap between that spending and its revenues. The $14 billion deficit in 2010–11 is a significant improvement from the $19.3 billion shortfall a year earlier. But Ontario has a long and tough spell ahead if it wants to eliminate the deficit entirely by 2017–18. It is neither a high-tax nor a high-spend province; it does not enjoy the easy pickings of natural resource revenue nor is it a major recipient of federal transfers by comparison with the rest of Canada.
But just to meet the government’s goal of a balanced budget seven years hence, the government will have to cut even more deeply from its spending on a real per-capita basis, and over a much longer period than the Harris government did in the 1990s, without the option of an immediate deep cut in social assistance rates. It will have to maintain restraint for as long as Alberta’s Klein government and Saskatchewan’s Romanow government did in the 1990s, recognizing that Klein also made deep cuts to social assistance payments, while Romanow raised taxes to help meet his goal. Indeed, Ontario faces the prospect that such restraint may not end with a renewed burst of spending as it did in the late 1990s, but persist in a world of slower economic growth that reins in the possibilities of what government can do.
The ultimate challenge in the years ahead will be to find ways to make government work better; to find more efficient ways of delivering the services Ontarians need and want; to get better value for money from the tax revenues the government raises; and ultimately to preserve as much as possible the programs Ontarians cherish most.
1. The Chretien government applied some restraint in 1994, its first year in office, but its efforts were widely regarded, especially in financial markets, as too tepid.
2. This section relies heavily on work done by Don Drummond and Sonya Gulati of TD Economics and published under the title “New Brunswick Faces Tough Fiscal Choices Ahead,” Nov. 29, 2010. The figures used are all drawn from the Fiscal Reference Tables (FRT) published annually by Finance Canada, which make some adjustments to standardize the data for accounting differences across jurisdictions. As a result, some of the FRT data differ from those published by the Ontario Ministry of Finance. Interprovincial comparisons using FRT data must be made with caution because the accounting systems of the provinces differ.
3. Drummond and Gulati, p. 10.
4. We would have preferred to begin our 1990s comparison with 1992–93 for two reasons. First, the reported deficit peaked in that year and, second, it would have given us a seven-year span in the 1990s to compare with the seven years to 2017–18 that we are now working with. However, the government switched from cash accounting to accrual accounting in 1993–94, so the 1992–93 figures are no longer comparable. The reported surplus of $0.7 billion in 1999–2000 has been adjusted to eliminate another accounting change that arose from the restructuring of the Ontario electricity industry.
5. Program spending eventually came in at $111.2 billion as a result of larger-than-expected year-end savings.
6. These figures are based on the Provincial Economic Accounts compiled by Statistics Canada. The latest data for governments are from 2009.
7. The figure of 20 per cent cited in Chapter 1, The Need for Strong Fiscal Action, was based on the Ontario public accounts measure.
8. To make the data fully comparable, the average own-source ratios for all provinces and for Quebec have been adjusted from the original data to reflect the Quebec abatement. In the 1960s, the federal government offered provinces opting-out arrangements for some federal–provincial programs, such as hospital care and social assistance; only Quebec chose to use this mechanism. Under the arrangements, the federal government reduced, or “abated,” personal income tax by 13.5 percentage points while Quebec increased its personal income taxes by an equivalent amount. Quebec continues to receive the value of these extra tax points through its own income tax system, in lieu of cash, while other provinces receive the corresponding amounts in cash. Transfers to Quebec for the Canada Health Transfer and the Canada Social Transfer and Equalization are shown in the federal budget on the same basis as transfers to other provinces. But since part of the Quebec transfer is made through lower federal taxes, this amount is netted out of transfer program spending.
9. This category includes government business enterprises and provincial taxes on mining and forestry.
10. The Financial Management System database is the most detailed source of comparable data for government finance. Statistics Canada dismantles every government budget — federal, provincial and municipal — and reconstructs its revenue and spending on a common grid, regardless of the accounting system used by each government. The result is a data set that is fully comparable, a huge advantage, given that most governments use different accounting systems. The disadvantage is that the numbers come only with a lag; the latest data go up to 2008–09.
11. David MacKinnon, “Dollars and Sense, A Case for Modernizing Canada’s Transfer Agreements,” a report prepared for the Ontario Chamber of Commerce, February 2011.