You have to give Tim Hudak credit. He is presenting Ontario voters with a very clear policy choice  - choose austerity or choose growth.

On the one hand, there is the Conservative Party (PC), which would commit to eliminating the deficit in three years, through deep spending cuts, and on the other, there is the Liberal Party, which is expanding the budget in the short term but “targeting” for deficit elimination within four years.

Ontario has a fiscal problem, but not a fiscal crisis. Currently, the deficit sits a 1.4 per cent of provincial GDP, not a large number. Ontario is often criticized for being over taxed and with over spending. The fact is that in 2012-13, revenues as share of provincial GDP were lower in Ontario than in every other province than Alberta.  The same was true for program expenses.

The real fiscal problem is the upward trend in the debt-to-provincial GDP ratio, which has risen steadily from 27.1 per cent in 2002-03 to 37.4 percent in 2012-13, and is forecast to rise to over 40 percent. This trend must be halted and reversed.

The question is how best to do it?

Mr. Hudak’s plan is to halt the growth in the debt burden, by eliminating the deficit through the imposition of “severe austerity” over the next three years. He plans to layoff 100,00 public sector employees but the plan is vague as to this would be done. His plan also ignores the potential impact this austerity might have on output and employment during this three year period and longer, despite evidence in other countries that these effects could be quite large and long lasting.

This strategy is what we have referred to in previous articles as a strategy of “self-levitation”. It is based on the “hope” that as the government downsizes, the private sector would immediately “levitate” itself so that there would be little or no loss in output and employment.

Mr. Hudak is so sure of this “levitation” response that he says his plan would create a million jobs over eight years. Just to help it along, however, he is promising a 30 per cent cut in corporate taxes, despite the evidence that cuts in the federal corporate tax rate beginning in 2008 only led to companies building up cash balances (i.e., “dead money”, according to Mark Carney, the former Governor of the Bank of Canada).

Of course a claim by Mr. Hudak that his austerity strategy would have no affect on output and employment and in fact would create a million jobs is completely ridiculous and without merit. But to make his commitment even more ridiculous, the PCs have released precise estimates of jobs that would be created as a result of restraint actions. For example, the reduction in the corporate tax rate will lead to the creation of “exactly” 119,808 jobs. The elimination of 100,000 jobs in the public sector will lead to the creation of “exactly” 43,184 jobs in the private sector. No credible economist/forecaster would ever make such projections.

Why did Mr. Hudak commit to eliminate the deficit in three years? There is no economic or empirical justification for three, or four, or even five years for deficit elimination. The answer is obvious; the Liberals had a plan to eliminate the deficit in four years and Mr. Hudak couldn’t possibly have said five years.

After all, the federal government will have taken five years to eliminate the federal deficit. The International Monetary Fund (IMF) even recommended to the federal government that if employment growth remained weak, the date of deficit elimination should be delayed a year. The IMF has significantly changed its tune over the last few years, realizing that fiscal consolidation must be supported with economic growth.

According to the Hudak plan released last Wednesday, program restraint “adjustments” of $1.8 billion in 2014-15, rising to $6.5 billion in 2015-16 and $7.4 billion in 2016-17 would be needed to eliminate the deficit in three years.

These numbers, however, are actually wrong. The PCs didn’t do their math right. They have underestimated the size of fiscal adjustments required to eliminate the deficit in three years, because they have double counted in at least two areas.

First, the largest restraint measure in the Hudak plan is a two-year wage freeze on the public sector.  However, the Liberal’s 2014 Budget plan already proposed that departments and agencies absorb any wage increases over the next two years in their existing budgets.  In other words Hudak was announcing a “fiscal adjustment” that was already in the Liberal budget.

Second, the Hudak plan also proposes a Program Review exercise, yielding savings of $300 million in 2015-16, $400 million in 2016-17 and $500 million in 2017-18.  But, the Liberal 2014 Budget already included a Program Review exercise, generating savings of $250 million in 2014-15 and $500 million ongoing.  

Adjusting for the double counting of the 2014 Budget measures implies that Hudak would need to find additional restraint “adjustments” of $250 million in 2014-15 and $2.6 billion ongoing.  As a result, to eliminate the deficit in three years would require restraint “adjustments “of  $2.1 billion in 2014-15, $9.1 billion in 2015-16 and $10.0 billion in 2016-17.

A $10 billion cut in 2016-17 would be equivalent to 1.3 percent of provincial GDP. Cumulatively over the three years, the amount of restraint required would be $21.1 billion.  These are big numbers. Imposing such a large amount of restraint in a short three-year period, on an economy, in which the manufacturing sector is already struggling to be competitive, would seriously reduce economic growth and employment.

Compare the Hudak “austerity” strategy with the Flaherty “austerity” strategy, initiated in the 2010 budget. In the first year of Flaherty’s plan total expenditure cuts amounted to only $452 million; in the second year $880 million; and, by 2012-13, $5.9 billion. Over the first three years of Flaherty’s deficit elimination strategy, total expenditure restraint amounted to only $7.2 billion, less than one-third of what Hudak is proposing to impose on Ontario alone.

Finance Minister Joe Oliver should wake up and take a close look at what Mr. Hudak is proposing for Ontario, and what it would mean for his federal budget. Ontario accounts for roughly 40 percent of total GDP, much of it in the manufacturing sector. A severe drop in output and employment, because of extreme austerity, would seriously impact federal revenues and expenditures. There would definitely be smaller projected surpluses for the 2015 budget.

The Liberal strategy is focused on supporting economic growth while “targeting” deficit elimination in 2017-18. This objective is based on the assumption that the government will hold the annual growth of program spending to 1.1 percent. This is the most vulnerable part of the Liberal strategy. The track record is not good.

A strategy to support economic growth must be complemented with a firm and “credible” commitment to halt and reduce the government’s debt burden. Expenditure control is absolutely essential and there can be no backsliding on this target. Ontario cannot continue to record a rising debt burden. This is what happened federally in the 1970s and 1980s and led to a fiscal crisis in the early 1990s.  This cannot be allowed to happen in Ontario.

If a new Liberal government were to fail to restrain program spending then the fiscal credibility of the government would be permanently damaged. Much more severe fiscal adjustments would then be required.

Credibility is hard to earn, easy to lose, and once lost, difficult to regain.