Addressing Ontario's Fiscal Challenges

While 2017-18 saw a surplus of $642 million after years of deficits, the 2018-19 Ontario budget now projects a deficit of $6.7 billion and a net provincial debt of $325 billion with deficits projected to continue for five years afterwards.  If one considers the recent report of the Auditor-General, then Ontario’s deficit may be even larger at $11.7 billion.  Furthermore, the Ontario government has committed to spending more on public infrastructure and as a result can be expected to add at least another $156 billion to its net debt bringing it near $500 billion dollars by 2026-27.  This will add substantially to provincial government debt charges even if interest rates remain at historic lows.  There are a number of measures that Ontario’s provincial government could adopt in an effort to address the sustainability of the public finances over the medium-term.  I recently put out one of the Ontario 360 policy papers run through University of Toronto School of Public Policy and Governance in which I outlined the long-term evolution of Ontario’s fiscal situation as well as outlined some recommendations for change.  Here is a quick summary of the five-point strategy.

1. Setting Expenditure Growth Targets

Sustainability of government expenditures over the long-term is assisted by ensuring that expenditures growth does not exceed the growth of the resource base.  By setting an annual expenditure target growth rate equal to the annual rate of inflation (currently 2 percent) plus the rate of population growth of approximately 1 percent, expenditure sustainability will be assured by having expenditure growth well below historical revenue growth rates which recently have averaged 4 percent.

2. Comprehensive Expenditure Review Process

The provincial government should undertake a comprehensive review of what it does with the aim of enacting trans-formative change and efficiencies in public spending.   Key sectors that should be revisited include health, education, and social services as well capital project financing and subsidies to the corporate sector.  If the provincial government is looking for more explicit guidance in an expenditure review, then one model worth considering would be the program review initiated by the Federal government in response to the federal fiscal crisis of the early 1990s.  That review was rooted in a systematic process to determine what spending should be sustained and what programs and services should be reformed or eliminated and resulted in an era of federal budget surpluses.

3. Surplus Disposition Strategy

It is important that there be a responsible plan to use the fiscal room created by surpluses.  A positive fiscal situation will inevitably generate a loud public chorus demanding new “investments” and spending so there should be a disciplined plan to make sure that future surpluses are not eaten up by new initiatives.  A prudent strategy would be to earmark the fiscal dividend from future surpluses three ways: one-third to paying down the public debt; one-third to reducing the tax burden in an effort to stimulate new economic activity and one-third to finance new initiatives. 

4. New Independent Capital Expenditure Review Process

In our haste to renew infrastructure and stimulate the economy, we risk wasting tax dollars if we build poorly designed or unnecessary infrastructure as well as bid up the cost of building. Key to any infrastructure building is developing a list of priorities as well as choose the projects that can generate the highest rate of return.  Establishing an independent project review panel consisting of an arms-length expert panel (accountants, economists, engineers, business people) to do economic evaluations as to whether a project is needed or not would be a good step in the direction of more responsible provincial fiscal management and reduce the impact of political pressure on which projects are selected. 

5. Sinking funds for new debt to finance capital infrastructure

If the provincial government is to continue its current approach of separating capital from operating budgets, then it needs to account for more than the user cost of capital when calculating the deficit and also make provisions for paying back an annual portion of the capital project principal borrowing via a sinking fund approach.  Whenever debt to fund capital projects is issued, the commitment should be made to make payments on the principal over a 20 to 30-year period with those payments recorded as part of operating expenditure.  For example, for the $12 billion dollars in infrastructure spending borrowed for in 2016-17, assuming a 25-year sinking fund, there would be 480 million dollars a year added to operating budgets over the next 25 budget years paying down the amount borrowed.

These suggestions would be a start to restoring Ontario's public finances onto a more sustainable path.

For further reading:  Ontario 360 Memorandum: Fiscal Policy: Transition Briefing: Restoring Ontario's long-term fiscal sustainability.  Ontario 360 is a project of University of Toronto's School of Public Policy and Governance whose purpose is to develop evidence based public policy in advance of the election and during the post-election transition.

Comments

[Stephen]

Re: point #5, Ontario's accrual accounting already does amortize capital projects over the life of the asset. The amortization incurred for each consolidated capital project, in each fiscal year, is therefore included as part of the government's total expense for the year. In other words, to use your example of $12 billion, if all of those assets were amortized over 25 years, the government would, in fact, record an expense of $480 million per year; and this $480 million WOULD count towards the net surplus/deficit position.

[CCabb91]

So, basically, take the public out of public policy?

[Livio Di Matteo]

Stephen:
My understanding is that the accounting approach currently used is not an amortization over the life of the asset with an aim to paying off the "borrowing plus interest" but a capital depreciation or user cost of capital charge applied as an expense in the spending of the applicable government ministry. This is indeed counted towards the net surplus/defcit position but I do not believe it is the same as a sinking fund concept which aims to pay off the amount borrowed. However, I am open to further explanation on this point.
CCabb91:
I do not understand where the comment is directed.

[CCabb91]

"Establishing an independent project review panel consisting of an arms-length expert panel (accountants, economists, engineers, business people) to do economic evaluations as to whether a project is needed or not would be a good step in the direction of more responsible provincial fiscal management and reduce the impact of political pressure on which projects are selected."

In effect, you're advocating for the removal of fiscal discretion from normal political debate. Does this not depoliticize economic policy and reduce the scope to practice democratic politics?
I have problems with each of your points, but #4 seems to be blatantly undemocratic.

[Livio Di Matteo]

CCabb91:
Any panel would make recommendations to the government in power based on their expertise. The ultimate decision would always rest with the politicians.

[Frank Restly]

Uhhmmm... equity financing anyone?

The problem with debt is that governments lack the forethought to properly plan ahead as clearly indicated in your bullet list (expenditure growth targets, expenditure review process, surplus disposition strategy, capital expenditure review process, sinking funds, etc.).

That lack of forethought is in part politically driven, why as an elected official should I plan ahead for 10 to 30 years from now when I am unlikely to be in office.
Over time the debt builds upon itself (rolls over) until it becomes unsustainable and is defaulted upon.

Instead, let the buyer of the securities bear some portion of the risk involved in the investment.