Ontario is caught in a fiscal squeeze play. Pressed between slower economic growth on one side and aging demographics on the other, Canada's largest province will be very hard-pressed to balance its books in 2018 under its current plan, even after having successfully reduced the deficit in 2013-14 below expectations.
The government could follow the usual pattern of further spending cuts or increased revenues to make up the difference, but that will only go so far when the fiscal deficit is due to structural and demographic forces – which The Conference Board of Canada believes is the case in Ontario. Instead, we believe the province will need to become even more innovative in how it raises money and delivers services.
One side of the fiscal squeeze play is continued slower economic growth. The 2008-09 global financial crisis and recession shrank revenues and prompted exceptional fiscal stimulus, pushing Ontario deep into deficit. Since then, Ontario's economy has been slow to fully recover due to factors like prolonged American economic weakness, the rise of emerging markets led by China, competitive pressures on key industries and a stronger loonie.
The Conference Board projects Ontario's real GDP growth in 2014 to be a modest 1.5 per cent – better than 2013, but still well below the national average. Growth is expected to improve to 2.5 per cent in 2015, but we do not expect that rate of growth to continue.
In its new Ontario Fiscal Snapshot (part of a series examining the budgets for all provinces and the federal government), the Conference Board expects Ontario's average annual growth rate over the 2014-17 period to be 0.4 percentage points slower than that projected in the July, 2014, budget.
Weaker economic growth quickly translates into slower tax revenue growth. Lower expected equalization payments from Ottawa will add to Ontario's fiscal squeeze, since Ontario remains less of a "have-not" than the other equalization-receiving provinces. As a result, we expect revenues to be a cumulative $6-billion below the government's projections to 2018.
The other side of the fiscal squeeze play is unrelenting pressure from aging demographics on public spending. Health care spending has grown faster than the economy for decades and now represents 42 per cent of program spending in Ontario. Yet, the province's plan for fiscal restraint announced in the July, 2014, budget is very back-end loaded.
Program spending was set to increase by an average of 0.8 per cent annually from 2013-14 to 2017-18, with exceptional adjustment expected in the final year. In our experience, back-end-loaded fiscal strategies seldom work; too many things tend to happen along the way to spoil the best of plans and intentions.
When slower revenue growth is combined with the spending path projected in the budget, Ontario will most likely be about $2.4-billion short of a balanced budget in 2018.
One approach to closing this gap is to keep squeezing spending growth. The Drummond report two years ago provided a long list of options for cutting spending on government programs and initiatives that are not top priorities. At the same time, the province could raise revenues through higher taxes on targeted sections of the population, as it did in the 2014 budget.
But a short-term approach is not likely to work against the unrelenting pressure of demographics from an aging population, and resulting slower growth. Ontario thus should be rethinking fundamentally how government programs are designed and delivered. Getting out of the fiscal trap may only be achieved through bold moves.
For example, could alternative approaches to health care delivery improve health outcomes at a lower cost? Could social welfare support that is delivered through myriad programs across the province be replaced with a guaranteed annual income delivered efficiently through the tax system?
In broader terms, the tax system itself is in need of policy innovation. Improving the simplicity, competitiveness and fairness of the tax system is the mandate of the Conference Board's new Centre for Tax and Fiscal Incentives, launching this month.
The Ontario government, with its four-year majority mandate, could take a leadership role in beginning to shift the burden of taxation away from things Canadians value – like income and investment – and toward things that society does not value – like carbon dioxide and other forms of pollution. Specific tax expenditures could be eliminated where no clear public policy purpose is being served (an area which Quebec is already examining).
The fiscal squeeze is structural and won't be going away, so now is the time for Ontario to explore highly innovative approaches and examine how policy objectives may be achieved through different means.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.