Livio Di Matteo is Professor of Economics at Lakehead University in Thunder Bay, Ontario. Visit his new Economics Blog “Northern Economist” at http://ldimatte.shawwebspace.ca/
The Ontario government’s final approach to deficit reduction has begun with selected leaks of economist Don Drummond’s “first draft” of his review via media interviews designed to dramatically present deficit reduction. A column by Martin Regg Cohn of the Toronto Star titled “Brace for a firestorm across Ontario” outlines cuts as high as 30 percent for some Ontario ministries with health and education being spared “somewhat”.
Yet, the same column has Don Drummond using the language of the Wall Street protestors by talking about how just one percent of the population accounts for half of hospital spending and one third of total health expenditures. Martin Regg Cohn’s most recent column on Don Drummond’s prescriptions titled “The grim reaper punctures Ontario’s fiscal fantasies” points out how unrealistic balancing the budget by 2017-18 was and shares the blame on fiscal forecasting by mentioning that the opposition parties embraced the same timetable during the election.
What is going on here? All of this advance work by the Ontario government reduces what should be a serious policy problem requiring a firm and measured approach to some kind of fiscal porn reality show. What’s next? Blaming 80 year-old cancer patients as the top 1 percent of health care spenders with cabinet ministers leading a protest movement to occupy hospital wards? The provincial government is being irresponsible by launching this media blitzkrieg in an effort to soften up the public for spending cuts that will be more modest than what Don Drummond is going to propose. In a sense, the provincial government is trading a leadership role on the deficit for what can only be termed a panicked posturing scaremonger approach designed to make them look benevolent when the cuts are not as draconian as their special adviser wanted them. At a time when sound policy is required, the provincial government should be ashamed for engaging in such a childish and irresponsible posturing in its approach to the public finances.
Ontario currently has expenditures of about 124 billion and revenues of almost 109 billion for a deficit of about 16 billion dollars. Of this spending, 38 percent or 47.6 billion dollars is health and 19 percent or 23.2 billion dollars is education. Another 10.3 billion (8 percent) is interest on the debt. Adding these components up brings you to 81 billion dollars, which leaves another 43 billion dollars in spending. Cutting this remaining spending by 30 percent – post-secondary and training, children and social services, justice, transportation and all other programs – would just about balance the budget. That is not going to happen. Restoring fiscal balance will require a balanced approach that affects all sectors. What should the government do?
Step one. There needs to be an immediate two-year freeze in total nominal provincial government spending – with inflation and population growth – this is effectively a real cut of six percent over the two years. If spending stays frozen at 124 billion and total revenue grows at 3 percent (it averaged 4.7 percent from 2001 to 2011 which includes the recession slowdown so we are indeed underestimating revenue growth here especially if the government does not raise taxes) in about two years the deficit would be down to about 6 billion dollars. A freeze entails real reductions, but not the operatic drama being bandied about by the government.
Step Two. During the two years of the freeze, the recommendations of Mr. Drummond need to be examined and evaluated for where there may indeed be measures to reduce spending in all sectors of government. Indeed, no sectors should be spared. Are there savings in health? Most models of health expenditure determinants I’ve looked at explain about 90 percent of provincial government health spending with income, federal transfers, aging, population growth and technology (as proxied by time trend). The other 10 percent or the residual is “unexplained”. Could it be inefficiency? Possibly. Is there 5 to 10 percent in inefficiency in most areas of provincial government spending? Perhaps. Do your homework and set an expenditure reduction target for the two years after the freeze that would take another 5 percent off of government spending via restructuring and reform of services by 2016-17. This would bring total annual provincial spending down by about 6 billion dollars to about 118 billion dollars. Assuming the revenue increases outlined above, this would effectively balance the budget by the target date and it would not be painless given inflation and population growth.
Step three. Rein in political ambition to resume “exciting” new spending initiatives once the finances start to improve. As dire as the province’s finances look, a freeze in spending combining with very modest revenue growth will start to improve the province’s finances more quickly than expected. As revenues improve, maintain the spending restraint plan and dedicate some of the additional revenues to paying down the debt. For each billion dollars of debt that is paid down, you will free up additional resources in terms of reduced debt servicing costs. Use this fiscal dividend to further reduce the provincial debt rather than plow it back into spending.
Ontario needs a solid and stable plan to address its fiscal situation and one that balances the need for government services with the necessity of providing them efficiently. The plan requires the cooperation of all the political parties as well as the public and grand political opera designed to terrorize the public and the opposition is not the way to do it. The province of Ontario needs to demonstrate to its citizens and to bond rating agencies that it has a serious plan to balance the budget, and not a strategy designed to yield partisan political benefits. Exercise some leadership.