Policy Thoughts I — Ontario Government Debts and Deficits

This is the first of what I hope will be an ongoing series of quick thoughts on policy. I may end up creating a whole separate Medium blog for this, but for now, this will do.

Here’s the TL;DR version of this post:

• Ontario’s relatively high debt-to-GDP is largely due to 2 recessions (1990, 2008–09) that blew up our manufacturing sector and government finances.
• Ontario’s lack of resource revenues, low per-capita transfers from the federal government, and already low spending makes it practically impossible to save up enough in “good times” to finance these recessions.
• Ontario needs a plan to develop a plan now to finance and fight the next recession, and should consider unconventional tools, such as bond-financed equity purchases.

I’ve written about interest payments on Ontario government debt before (see here and here). I need to write more on this because:

There is no issue in Ontario policy discussions more misunderstood than Ontario government debt.

At the recent Macleans Chartapalooza, Philip Smith has a very helpful chart on the trajectory of debt-to-GDP ratios is every province:

Ontario’s debt-to-GDP story is pretty simple: During good times, it gradually falls, but over the last 35 years we’ve been hit with two massive recessions that more than decimated Ontario’s manufacturing base and caused the provincial government’s finances to blow up. This “fiscal bomb” was due to a combination of:

1. Things that happened outside of the Ontario government’s control: The recession causes tax revenues to fall, social assistance payments skyrocket.
2. Discretionary decisions made by the Ontario government to fight the recession: increased spending on infrastructure, social programs, etc.

In both the recession of 1990 and the Great Financial Crisis of 2008–09, it took seven years for the debt-to-GDP ratio to start falling again.

We also need to recognize the four broad realities of Ontario’s fiscal picture, relative to other provinces (in per-capita terms) [Updated to add — data from this wonderful piece from the Financial Accountability Office of Ontario: Comparing Ontario’s Fiscal Position with Other Provinces]:

1. Ontario has the lowest per-capita program spending of any province. ($9,829 per capita, with the rest of Canada averaging $11,862)
2. Unlike many other provinces in Canada, Ontario receives essentially zero resource revenue.
3. Ontario receives near the lowest level of per-capita transfers from the federal government. (9th overall, just slightly ahead of AB)
4. Ontario is near the middle of the pack when it comes to per-capita tax revenue. (3rd overall at $7,936, with the rest of Canada averaging $7,559).

Keeping all of that in mind, our “debt fighting” options are typically presented as either:

1. Don’t worry about the debt.
2. Run up big surpluses during good times (through spending cuts or higher taxes), and use those surpluses to finance large deficits in bad times.

I don’t believe either of those is particularly realistic. Given the pressures demographics will place on our health care system, we need to worry about the debt. We can’t afford to allow it to blow up again during another recession. And running big surpluses is unrealistic given Ontario’s already low levels of spending and aversion to large tax increases.

So what should we do? How do we prevent Ontario’s finances from blowing up again if there’s another recession?

We need to increase our option set. In my view, we have at least four:

1. Don’t worry about the debt.
2. Run up big surpluses during good times (through spending cuts or higher taxes), and use those surpluses to finance large deficits in bad times.
3. Reduce the size of deficits in bad times by leaving stimulus to the federal government and the Bank of Canada AND/OR find ways to stimulate the economy that do not increase the size of the deficit.
4. Find additional tools to finance recession-induced deficits.

One solution Ontario should consider that would address #3 and #4 is to have the provincial government purchase equities during recessions, and finance these purchases with bond issues. This would both stimulate the economy (as it would help boost household balance sheets after the typical stock market crash that occurs with a recession), and it would also help finance the deficit, as those equities will appreciate significantly in the economy recovery, which will outweigh the interest paid on the issued bonds.

That’s only one possible solution; I’m quite certain there are others. The provincial government (and, I’d argue, the federal government) needs to develop a plan to fight the next recession now. I fear we learned entirely the wrong lessons from the last two recessions, that Bob Rae, Brian Mulroney, Dalton McGuinty and Stephen Harper were all a bunch of spendthrifts that ran massive deficits.

The reality is that we didn’t have a plan to fight those recessions in a fiscally sustainable way. At some point, another recession will come and… we still don’t have a plan. That’s a problem.