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 Budget Analysis THE 2008 ONTARIO BUDGET Released on March 25, 2008 HIGHLIGHTS
In the weeks leading up to the budget, Finance Minister Dwight Duncan had been prepping Ontario’s residents and businesses for a relatively low-key affair in view of the rapidly-fading economic prospects of late, the cost of measures contained in the December 2007 Fall Fiscal Update, and campaign pledges to maintain a balanced budget while not raising taxes. And, indeed, today’s document follows through with that pledge, as it contained even fewer surprises than last year. The centerpieces of the document were a $1.5 billion investment in education and skills training and $1 billion for municipal infrastructure, with the latter measure funded out of the surplus in FY 07-08. But while these areas are likely to top the headlines, health care spending remains set to absorb an ever-growing share of the provincial budget. New tax relief was relatively modest and targeted at manufacturers and seniors. $1.5-2.5 billion per year more in the till Uncertainty about the direction of the Ontario economy has added a few layers of challenge to planning this year’s budget. While domestic spending has been holding up extremely well, the downturn in the U.S. economy has darkened the outlook for the province’s key manufacturers, which had already been confronting the impacts of the high Canadian dollar and elevated energy prices. As the export sector languishes, the risk of significant knock-on effects to domestic spending and job creation mount. In today’s budget, the Ontario government (which relies on private-sector projections in devising its revenue and spending forecasts) has assumed that real economic growth in Ontario will succumb to these external pressures to some extent, and slow to 1.1% in 2008. This represents a hefty 0.7 percentage point downward revision from the forecast presented in the Fall Update and about half of last year’s estimated rate. For 2009, the economy is expected to regain some modest momentum (2.1%), but to still underperform its December assumption of 2.4% growth. Despite the impact of these downward growth revisions to the underlying tax base, the Finance Minister has benefitted from a brighter medium-term fiscal picture than envisaged four months ago. The helping hand has come on two fronts. First, the starting point is considerably stronger. In particular, the province’s revenue take in the current fiscal year ending March 31st has been revised up $2.5 billion from the Update and a whopping $5 billion since last year’s budget projection. About half of this outperformance vis-à-vis the Update has been considered “permanent” rather than the result of transitory factors, hence raising the bar for future years. Second, one partial counterbalance to the weaker growth picture is the outlook for lower interest rates. As such, compared to the Update, debt service costs are assumed to be $300 million lower per year in FY 08-09 and FY 09-10 than presented in the Update. Overall, compared to the Update, the fiscal plan received a roughly $1.5-$2.5 billion annual boost over the next few years in which to undertake new tax and spending measures in FY 07-08 to FY 09-10. Moreover, the year-end removal of the unneeded $750 million reserve provided some additional leeway in the current year to book up-front future spending. Armed with this added flexibility, the government forged ahead with a sprinkling of measures across a number of priority areas, including support for various health care initiatives, funding for education, working to reduce poverty and spurring innovation. Among the big winners were municipalities, which are set to receive $1 billion in funding for new capital projects. In addition, the government has confirmed a previously-announced plan to allocate a share of year-end surpluses above $800 million to municipal infrastructure beginning with FY 07-08 (see box below). However, the biggest outlay was earmarked for education and skills training, at $1.5 billion over three years. New tax reductions unveiled today, which accounted for roughly $750 million over three years, are largely directed at manufacturers. Spending Initiatives Tax & Revenue Measures Fiscal noose tightens in FY 08-09 The fiscal table shown on page 1 combines the impact of these new measures with those announced in earlier budgets, including the $3 billion package of business tax cuts and spending increases announced in the Fall Update. Of note, the government has continued with its practice of targeting a balanced budget after deducting an amount for contingences (i.e., reserve allowance) and allowing the debt-to-GDP ratio to remain on its downward path. In FY 08-09, revenues and spending are essentially flat, a significant change from the robust rates of recent years. A good part of the spending slowdown reflects the fact that the infrastructure funding that has been booked in FY 07-08 is not assumed to repeat next year. In contrast, health spending is set to rise by a further 6% next year. Thereafter, overall spending grows by a moderate 3-3.5% rate, pulled up by 5.5% gains in health outlays. By FY 10-11, health care’s share of total program spending will reach a whopping 48%. Larger downside fiscal risks in FY 09-10 Despite the fact that governments in Ontario and across the country have systematically under-predicted surpluses in recent years, we see the risks to the government’s revenue performance (and hence fiscal plan) skewed to the downside. For one, compared to the budget assumptions, TD Economics’ projection of nominal GDP growth for 2008 is 0.3 percentage points lower, before jumping to a cumulative 1.4 percentage points in 2009. The government predicts that each percentage point subtraction to GDP growth results in a $730 million hit on the bottom line. Based on this rough sensitivity, the underlying surplus would shrink by $200 million and more than $1 billion by FY 09-10. A second downside risk relates to the level of revenue as a share of nominal GDP (i.e., effective tax rate). Over the past few years, the revenue-to-GDP ratio has jumped from about 15% in 2004-05 to a high of 16.5% in FY 07-08. Undeniably, a good part of this strength is attributable to surprisingly strong profit growth and the progressive nature of the personal income tax system. But while the government has assumed the revenue-to-GDP ratio falls back to 16.1%, it will remain historically high. Between FY 1999-00 and 2000-01, the ratio fell by 1.2 percentage points. While unlikely, a similar drop would shave the overall take by an additional $3 billion above and beyond the direct GDP impacts. These scenarios do not indicate that a deficit is imminent, but are hypothetical and merely highlight the heightened risk of a shortfall, especially in FY 09-10. Bottom LineAs has been the government’s approach since it took office in 2003, today’s budget focuses on a couple of key themes supplemented by efforts to gradually chip away at other priorities. At the same time, the government has resisted calls on both sides of the political spectrum for bold actions. On the left, there were calls to dramatically step up efforts to address poverty and/or other social areas regardless of whether it would risk a return to deficit. Canadian experience has shown that while running small budget shortfalls imposes no harm on an economy, small deficits quickly turn into larger ones – a path that we can ill afford to embark on. And on the right, the government has rejected calls to offer significant immediate broad-based tax cuts, notably for businesses, which would be financed in part by curtailing the spending side. Given the structural changes underway in the economy, the focus on business tax competitiveness in Ontario is unlikely to fade any time soon despite the Ontario government’s recent moves – and ones that we applaud – to eliminate capital taxes on all businesses by 2010 (which is the most punishing tax on economic growth) and to lower business education property tax rates. We have long argued that Ontario will face growing problems of attracting and retaining businesses if it has more than a 2 percentage point spread between the Ontario general corporate income tax rate and that prevailing in other large provinces. With Alberta at a 10% rate, B.C. heading to 10%, Quebec at 11.4% (soon to be 11.9%), that suggests that over the next several years Ontario needs to get its rate down to 12%. We have also argued that a retail sales tax where a large portion of the revenue comes from capital and business inputs has no place in a modern economy. Ontario should plan to reform its retail sales tax to move it to a value-added structure that places the burden on final consumption. Derek Burleton Pascal Gauthier, Economist For the full report in PDF format - including all charts and tables click here. |
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