Ontario presents a balanced budget—for now

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The Ontario government tabled its first balanced budget in 10 years, announcing a slew of spending measures to appeal to voters as an election looms in 2018. With approval ratings for Premier Kathleen Wynne tanking, the 2017 budget provides plenty of initiatives the government can tout in the coming months, not the least of which is the notion of fiscal responsibility.

But the Liberals’ balanced budget is far more precarious than the government is letting on. Rosy economic projections could easily be derailed by any number of risks, from protectionist sentiments in the U.S. to interest rates to a slowdown in the province’s booming housing market.

The budget itself contained few surprises. Many initiatives have been previously announced, such as the province’s Fair Hydro Plan, an effort to reduce electricity bills for consumers and businesses. Likewise, the Fair Housing Plan, a suite of measures designed help renters and first-time homebuyers in an overheated real estate market, was unveiled last week.

• Ontario 2017 budget speech: Watch the video live

The major spending measures the Liberals have held back until now concern health care. The budget contains an additional $7-billion “booster shot” to the sector, which the province says will improve access to care and expand mental health and addiction services.

The amount includes $1.3 billion to reduce wait times, while hospital operating funding will increase by 3 per cent to $518 million. Also new is a plan to provide free prescription drug coverage to everyone under the age of 24, regardless of family income. The budget allots $6.4 billion for education and training, and a $30 billion increase to the province’s multi-year infrastructure plan.

For Finance Minister Charles Sousa, though, the biggest accomplishment is eliminating the deficit. “We did it,” Sousa declared in his prepared remarks. “The 2017 Ontario Budget is a balanced budget.” Sousa intoned that the path to balance was not an easy one, demanding the government make critical choices along the way. Progressive Conservative leader Patrick Brown, meanwhile, accused the Liberals of using accounting tricks, such as one-time asset sales, to hide a $5-billion operational deficit. “It’s a scam,” Brown said. “The numbers do not add up.”

The focus on the deficits and surpluses is, in some ways, a distraction. More important is what’s happening below the top line, and the risks to the assumptions behind the Liberals’ projections.

The government is benefitting for now from a growing provincial economy. Last year, Ontario’s GDP increased by 2.7 per cent, outpacing the rest of Canada. A red-hot real estate market has played no small part in the province’s economic fortunes, however. Residential investment, which includes a wide swath of real estate activity, accounted for nearly one-quarter of that 2.7 per cent growth in GDP last year.

When it comes to the housing market, the province’s finances benefit most directly through the land transfer tax, which is payable by property buyers. As a result of soaring home prices, the budget estimates revenue from the levy will be $637 million higher than forecast last year, for a total of $2.7 billion.

But the double-digit price increases in the Greater Toronto Area are not expected to last, especially when the government’s intent with its recently announced housing measures is to tame the market. The government estimates that every percentage point change in either home prices or resales amounts to a $26-million change in revenue from the transfer tax. Even accounting for a slower real estate market, the government assumes the tax will bring in a record $3.1 billion over the coming fiscal year.

“Some of the projections seem optimistic,” says Michael Dolega, a senior economist with TD Bank Group. The government assumes, for example, that business investment will rise 3.1 per cent annually between 2017 and 2020, owing in part to solid U.S. demand and a low Canadian dollar. But business investment has been anemic for the past few years, a big concern for the Bank of Canada. Machinery and equipment investment in Ontario, the largest component of business investment, has averaged -1 per cent growth since 2012.

Other risks to the government’s forecast loom large, too. With interest rates at near rock bottom levels, borrowing costs are low, and the government is locking in for longer terms. But rates will inevitably rise, increasing borrowing costs in the future. The province estimates that a one percentage point increase in borrowing rates would cost it $300 million.

• Wynne lays out measures to cool GTA housing

Growing protectionist sentiments in the U.S., Canada’s biggest trading partner, along with potential changes to the North American Free Trade Agreement, also threaten to hamper exports. Changes to U.S. tax policy add a further element of uncertainty. If U.S. President Donald Trump follows through on a promise to slash the corporate tax rate to 15 per cent, that could cause companies to reconsider investing in Ontario, despite the province’s moves to lower tax rates since 2009.

Provincial debt is still rising, and is projected to tick up to $311 billion this fiscal year. Budget documents characterize that increase as “good debt”, as it’s tied to capital investments in infrastructure. Whether it lives up to the label “good debt” depends a lot on the government’s ability to invest wisely. The reality is the province’s finances remain concerning. Net debt-to-GDP stands at 37.8 per cent, down slightly from a record high of 39.1 per cent in 2014-15. The government set a goal to reduce it further to 35 per cent by 2023-24. The Liberals don’t anticipate returning to pre-recession levels until 2029-30—two decades after the financial crisis.

Projections that far into the future should be taken with a grain of salt. It’s likely that at least another recession could hit between now and then. “It’s going to leave the province vulnerable should there be an economic shock,” Dolega says. When the last recession hit, Ontario’s debt-to-GDP was in the mid-20s, on a percentage basis, which gave the province room to absorb the economic shock. The elevated levels of debt today and into the future leave Ontario far more vulnerable to the next downturn.

A short-term focus on balancing the budget will no doubt be helpful for the Liberals on the campaign trail next year. But addressing the underlying debt situation would also be helpful in the long run.