MEMO TO PREMIER WYNE ; THINK CREDIBILITY
No doubt you will be getting a lot of advice, especially from depressed Conservatives, recommending that you take the kind of tough fiscal action Mr. Hudak was proposing, in order to eliminate the deficit and halt the growth in Ontario’s public debt. Ontario, according to them, is in a fiscal crisis: the rating agencies are knocking at your door; and you must act immediately. Our first recommendation is that you ignore this advice. It was non-credible before the election and it still is. Nevertheless, our second recommendation is that you call Paul Martin and seek his assessment of the fiscal situation he faced in the mid-1990s and why he acted the way he did. He is, after all, credited with implementing in 1995 the toughest federal budget ever; a budget that eliminated the deficit in three years, cut the debt burden by more than half, and led to eleven consecutive years of surpluses. We expect (or hope) that Mr. Martin would say the following. First, Ontario is not facing the kind of fiscal situation that he was facing in 1995. He was confronting a fiscal crisis; Ontario today is not. Although the federal government had a primary surplus (budget balance excluding public debt charges) in 1995, it was not large enough to pay the interest on the public debt. Even worse, public debt charges were increasing faster than the primary surplus. In other words, the government was borrowing just to pay the interest on its debt. The government was stuck in a vicious circle of increasing debt leading to increasing debt charges, leading to increasing debt and so and so on. This is what is called a fiscal crisis. Mr. Martin knew he had no choice but to bring in an austerity budget, but his decision wasn’t based on an ideology that believes only a smaller government could solve the problem; quite the opposite. Mr. Martin was making pragmatic decisions. First, he needed to convince the bond markets that he meant business, which he succeeded in doing. And second, he understood very well that he needed a realistic and credible fiscal strategy that would restore fiscal sustainability. Without this, existing social programs would be put at risk and new programs and critical investments would not be possible. Mr. Martin also knew that the success of his fiscal strategy would depend more than on just austerity to eliminate the deficit and reduce the debt burden. His fiscal strategy depended upon a strong recovery in global economic growth to support domestic investment and exports. Fortunately, both China and the U.S. were just beginning one of the longest and strongest periods of economic growth. The second piece of advice Mr. Martin would probably give you (we hope) that despite the absence of a fiscal crisis in Ontario today, this is not the time for you to be complacent. A fiscal problem can soon turn into a fiscal crisis. In 1974-75, the federal government had debt ratio of 18.4%, the lowest since WWII. Ten years later, it had risen to 42.4% and by 1994-95, it was up to 66.6%. This is not the kind of trap you want to get into. Finally, Mr. Martin would probably advice you (we hope) that now is the time to act. You have a majority and you should use it to establish your fiscal credibility as quickly as possible. This means four things. First, fiscal policy must be realistic. By that we mean fiscal policy should be based on sound analysis and a careful and balanced view of the economic and fiscal prospects, challenges and risks. Fiscal policy should not be based on a “rosy” or an unrealistic view of future economic and fiscal prospects. Second, fiscal policy must be responsible. This means the government must be committed to establishing and maintaining a sustainable medium-term fiscal framework, one that supports long-run stable economic growth through control of the accumulation of public debt. Third, fiscal policy must be prudent by including a reasonable amount of “insurance” to guard against forecast errors and the impact of unforeseen events, requiring additional policy actions. Finally, fiscal policy must be transparent. This means providing full disclosure of analysis and information since, without this, independent experts will not be able to assess how realistic the economic and fiscal forecasts are. Without transparency, there can be no accountability. Such analysis should not be restricted to the current planning period, but also to potential risks in the future. You are committed to re-introducing your 2014 budget when the Legislature returns in July. There will certainly be some negative reaction to this from the rating agencies, other financial observers, and the media, among others. Ask Paul Martin about the reaction financial markets and others gave to his 1994 Budget. Despite the fact that the Liberal government had won a wide majority in the 1993 election on a commitment to reduce the deficit to 3 per cent of GDP within three years, Mr. Martin was forced to go back to the drawing board and craft a very different 1995 Budget. Bond markets may well be looking for more aggressive action in your upcoming budget than what you indicated in your first 2014 Budget. Our third recommendation is that you introduce stronger and clearer expenditure restraint actions into your 2014 budget. The spending restraint actions proposed in your 2014 budget are too vague to be viewed as being credible. To gain credibility, the upcoming budget should be more specific on the proposed cuts. More details must be provided regarding the nature of the cuts and the potential savings to be realized. In your original 2014 Budget, it was extremely difficult to assess the impact of the proposed cuts. Your proposal to have departments and agencies absorb wage increases will have a direct impact on departmental spending. If they can absorb the wage increases without cutting services to the public, they likely have too much money to start with. If not, what services are they going to reduce or eliminate? In addition, you might want to consider some of Mr. Hudak’s suggestions, such as reducing subsidies to businesses. Programs should be reviewed on a regular basis to ensure they are still needed and are delivered in the most cost-effective manner. The previous Liberal government spent a lot of money on the Drummond Report. The citizens of Ontario deserve a “score card” on what has been implemented and what has not and why. In addition, it is high time that inter-provincial trade barriers be eliminated or significantly reduced to spur economic growth across the country. As the leader of the largest province, you can play an instrumental role in this. Our fourth and final recommendation is that you consider revenue-raising options as part of your budget planning. This will very likely be necessary if you want to eliminate the deficit by 2017-18 through credible actions. We are not in favor of raising income taxes or tinkering with small tax changes. What needs to be considered is an increase in the HST. The two point cut to the GST by the federal government has provided you with the “tax room” to raise the HST. Adjusting the HST rebates could offset the impact on low-income families. This would yield about $2.5 to $3 billion in additional revenues. In addition, you may want to seriously consider the impact of federal tax changes on your fiscal position. Once the federal government achieves a balanced budget and surpluses, its priority will be to reduce taxes. Many of these changes will negatively affect your revenues, as you noted in the 2014 Budget. It may be time to consider if you can offset the impact of such federal tax changes, given your fiscal position. We realize that this may not be easy as it would require opening the Canada-Ontario Tax Collection Agreement. However, given the differences in fiscal situations, you cannot afford to be held hostage to federal tax changes. No doubt the Conservatives and other others will criticize you for raising taxes. After all, their only objective is lower taxes, less spending on public goods and services and a smaller government. These criticisms have no substance and should be ignored. A credible fiscal strategy does not require a strategy to solely reduce the size and role of the Ontario government. It was the approach recommended by Mr. Hudak and Ontario voters rejected it. Ontario does not have a “large” government when compared to other provinces. Program expenditures per capita are the lowest of all provinces. Other than Alberta, Ontario program spending and revenues as a share of provincial GDP are lower than in all other provinces. This does not mean, however, that the Ontario government can continue to run a policy of high deficits and a growing debt burden. In our view, a credible fiscal strategy aimed at establishing a sustainable fiscal structure will require credible expenditure restraint actions and an increase in the HST. Bond markets don’t care about whether you raise taxes to eliminate the deficit and reduce the debt burden. They only care about the end result. Finally, we support your commitment to begin the much needed renewal and modernization of Ontario’s infrastructure. These investments will be critical to supporting economic growth in Ontario at a time when support from the federal government is declining and global economic prospects remain weak and uncertain. These investments should be financed through the issuance of new debt. There is absolutely no reason why future generations should not contribute to the cost of the infrastructure they will be using. Not only that, the cost of borrowing for 10 or 30 years is so low that it makes complete sense to take advantage of these low rates for pressing infrastructure needs. It has been said many times, but it is worth saying it again, credibility is hard to earn and easy to lose. You credibility will be on the line with the upcoming budget and for the next four years.