On cutting debt, Ontario ought look to Quebec

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As Ontario inches toward at long last eliminating its deficit, the biggest obstacle it faces in getting there and staying there may be the massive debt it accumulated by, well, running deficits. This conundrum is a reminder that tackling the deficit isn't enough without a plan to tackle the debt, too – something about which Ontario could take a lesson or two from the country's fast-reforming debt basket case, Quebec.

In its fall economic and fiscal update this week, Ontario reiterated its estimate from last spring's budget of a modest $4.3-billion deficit in the current fiscal year ending March 31, 2017. (Sure, it had to eat up $600-million of its $1-billion contingency reserve set aside in the spring 2016 budget for "unforeseen adverse changes," but hey, that's what the reserve is for, right?) That keeps it on track to meet its pledge to eliminate the deficit entirely in the next fiscal year, 2017-2018.

But the government's own fiscal watchdog, the Financial Accountability Office of Ontario, isn't so confident. A couple of weeks ago, the FAO issued a report projecting that the government won't do any better than a $2.6-billion deficit in 2017-2018, citing a declining outlook for economic growth and recent increases in spending plans (most notably the sales-tax rebate on electricity bills). What's more, the FAO predicts that deficits will begin to grow modestly again after 2017-2018, "as growth in revenue is outpaced by increases in program expense and interest on debt."

That last point, "interest on debt," is a key one. Ontario is carrying nearly $320-billion in net debt, more than all the other Canadian provinces put together. The province expects to pay $11.4-billion this fiscal year in interest alone, or about 9 per cent of its total budget. The government expects that cost to swell by another $1-billion by 2018-2019. And if interest rates were to go up significantly (a legitimate risk, given the spike we have seen in bond-market rates in just the past week in reaction to the U.S. presidential election result), those debt-servicing costs could lean even harder against efforts to keep the budget in check.

The government gets that this matters, at least enough to have set a target to reduce the net-debt-to-GDP ratio (a key yardstick for an economy's debt burden) from its current 40 per cent to its pre-recession level of 27 per cent. But it has laid out no specific time frame nor a concrete debt-reduction game plan – it is predicated on a combination of economic growth and balanced budgets. In contrast, the FAO's forecast for continued modest deficits (as well as infrastructure-spending requirements) leads it to project that net debt will swell to $370-billion by 2020-2021. Combine that with a slower projected path for economic growth, and the FAO predicts the debt-to-GDP ratio won't shrink as the government has pledged, but rather swell to about 41 per cent – making balancing the budget even more challenging as the annual interest expense continues to creep higher.

In short, the FAO concludes, the Ontario budget will have to make some hard choices if it wants to reverse the course of its Titanic-sized debt.

"Achieving and maintaining budget balance will likely require additional measures to raise revenue or reduce expense," the report said.

Quebec knows all about the debt straitjacket. The province's net-debt-to-GDP ratio peaked at just over 50 per cent a couple of years ago, the worst in the country. But unlike Ontario, Quebec has a concrete plan to do something about it – and the evidence suggests it's working.

Late last month, Quebec's fall economic update projected a second straight balanced budget in 2016-2017. For the first time since 1959, the province reduced its gross debt (by $610-million) in 2015-2016. It net debt-to-GDP ratio is on track for a fourth straight decline. It's putting $2-billion this fiscal year into its Generations debt-reduction fund, a figure it plans to increase to $2.5-billion next year and nearly $3-billion the year after.

If Quebec is going to sustain its fiscal success story, the key lies in its focus on debt reduction. Its debt-service costs, which had swollen to 11.4 per cent of revenues a couple of years ago, are on track to be below 10 per cent this year; in a budget that exceeds $100-billion, that equates to about a $1.5-billion savings. With debt servicing taking a smaller bite out of the province's revenue pie, and destined to continue to do so, the province has increased capacity to fund programs and balance budgets.

Quebec's debt-reduction discipline is entrenched in law: Under the 2006 Act to Reduce the Debt and Establish the Generations Fund, the Quebec government is obliged to reduce the gross-debt-to-GDP ratio to 45 per cent or less by 2025-2026, and to contribute to the Generations Fund annually as part of that requirement. (This year, Quebec is on course for a gross-debt-to-GDP of 53.7 per cent.)

Mind you, even 45 per cent would still be the highest ratio in the country; Quebec still has a serious debt burden, which is precisely why it has placed debt reduction so high on its fiscal agenda. But at least it has turned the ship around. Ontario's debt-to-GDP is headed for its ninth straight increase, and has continued to climb this year, to significantly above what the government had projected in the spring budget.

Ontario needs to move beyond a "target" for reducing its debt-to-GDP, and, like Quebec, put some force behind it. Without a specific strategy to get there, without the enforced discipline of legislation, Ontario's debt-reduction goal is more a wish than a policy. If it ever wants to move beyond short-term fiscal successes and toward securing the longer-term health of the province's finances, wishes aren't good enough.