As we discuss on pages 9-19, parts of the puzzle have already been put into place. But other parts need to be added and the pieces must fit together.

Wanted: a broad discussion paper this fall …

We recommend that the Ontario government put out a broad discussion paper this fall on where it wants to take the economy over time. Such a report, which would replace the relatively sterile exercise of the mandated long-term economic and fiscal outlook, could form the basis of debate on the issue. It is vital that the discussion paper not just be about numbers and budget balances. It should address the fundamental issues that matter to Ontarians – jobs, income and making people’s lives better.

…followed by action starting in the 2009 budget

As importantly, the government must move swiftly to turn the vision into reality. An overnight shift to a desired state along the lines of the one we’ve defined above would be very expensive. Yet the Ontario government is likely to find itself with shrinking fiscal wiggle room over the next few years. In fact, based on TD Economics’ 5-year “status-quo” fiscal forecast, the provincial government is facing modest planning deficits (i.e., shortfalls after deducting the customary reserve allowance) over the next two years and small but growing surpluses beginning in fiscal 2010-11. The status-quo forecast builds in TD Economics’ projections and measures already committed to in past budgets and economic updates.

Slowing economy no excuse for inaction

The government can still make a significant downpayment on an economic vision, however. On pages 20-21, we touch on several ways that fiscal leeway can be augmented. One in particular is the elimination of the Ontario government’s annual contingency reserve, which typically amounts to about $1 billion. This recommendation is made with some reservation and is most definitely not an invitation to return to an era of fiscal recklessness. Rather, it flows from a belief that policy measures – notably tax cuts targeted at improving Ontario’s competitiveness – would be a better use of resources at this time.

Furthermore, Ontario’s ability to strengthen its economic foundation would improve further if the federal government stepped up and addressed outstanding aspects of “discrimination” with the province. Put simply, any long-term Ontario vision is surely to fail without supportive federal policy. Yet the net federal fiscal take from Ontario amounts to a huge 4% of Ontario’s GDP. We call on the federal government to immediately move to per-capita block funding for health care and to promptly tackle Ontario’s legitimate beefs in other areas, including funding for infrastructure, worker training, and immigration settlement.

Together, these actions would enhance Ontario’s fiscal fiscal flexibility over the 5-year forecast horizon. Rather than edge up to a mere $1.4 billion by fiscal 2012-13, the province’s planning surplus would reach $5 billion, which would represent the amount that could be earmarked for new tax and spending measures without moving into a deficit. That said, $5 billion is still a finite amount that requires tough decisions on how it should be divvied up among the key policy areas.

Tax cuts need to feature more prominently

In our view, one thing is for sure. Tax reductions need to feature more prominently in the vision than they have in recent budgets. Since fiscal 2004-05, virtually all the $20-$25 billion in new resources was earmarked to new spending. In contrast, the sum of total tax cuts announced over the period was not enough to offset the revenue hike resulting from the introduction of the health-care premium tax in 2004. Going forward, a more effective division of resources would be 50:50. Based on our forecast, that would mean $2.5 billion annually in both tax cuts and spending increases by fiscal 2012-13.

In our view, new spending measures should encompass additional support for education and for municipalities through a further upload of social services. The focus on the tax side should be on addressing those areas most damaging to growth. And with the productivity-impeding capital tax set to be eliminated, the priority should become improving business and personal income-tax competitiveness. As well, we strongly urge the government to replace the provincial sales tax with a harmonized GST or a system such as that applied in Quebec. The negative hit on Ontario finances due to sales-tax reform could be partly offset by offered federal financial assistance for provinces that harmonize with the GST.

Still, $2.5 billion in resources would only allow the government to scratch the surface in terms of addressing these tax competitiveness challenges. For example, cutting the corporate income tax by 1 percentage point alone would absorb about one third of the room. There is an option, however. A key pillar of the vision we lay out is environmental leadership. Accordingly, the government could consider introducing a new revenue source, such as a carbon tax, that would clear the deck for significant reductions in higher-priority corporate and personal income taxes.

For illustrative purposes, the introduction of a B.C.-style carbon tax could enhance resources available for income and other tax cuts by a further $4 billion by fiscal 2012-13. That would leave enough room to cut the CIT rate from 14 to 10%, accelerate already-announced moves to reduce business education tax rates and eliminate the small business income-tax clawback. We figure that at least $1.5-$2 billion or about one-third of the total amount available for tax cuts could be used for personal income tax reductions. Admittedly, that is not a huge amount, given that a fulsome plan to address the province’s high personal marginal tax rates would run more in the order of $7-$10 billion. As such, the reductions should, at least initially, be earmarked towards lowering marginal personal income tax rates for low- and modest-income earners. Cutting the first tier of income-tax rates and further scaling back the tax-back rate of benefits on the additional income of welfare recipients are two areas deserving attention.

With much of Ontario’s economic success driven by advantages that no longer exist, a new direction is required. We look to the provincial government to take leadership on this front by developing a vision on where it plans to take the economy down the road. Some of the pieces have already been put in place. But as we discuss, other parts need to be added and all the pieces need to fit together.

Derek Burleton
AVP & Director of Economic Analysis
416-982-2514