Debunking Drummond

The Drummond report claims that Ontario is headed for a $30-billion deficit. This figure has been widely and uncritically reported. For example, The Globe and Mail printed four articles featuring this number in its February 18 edition.

The Ontario government projected a balanced budget with a $1-billion contingency reserve by 2017-18. To instead project a deficit of $30.2 billion, Drummond assumes that:
– Revenues grow slower than budgeted, leaving the province with $9.5 billion less;
– Budgeted expenditure restraint does not occur, boosting program spending by $16.5 billion;
– Deficits and debt grow faster, increasing interest payments by $3.4 billion; and
– The Ontario government must maintain a contingency reserve of $1.9 billion.

The final assumption just rounds $28 billion up to $30 billion. (No government would actually borrow those additional funds simply to maintain a contingency reserve.)

Projected interest payments flow from the assumptions about program spending and revenue. The expenditure assumption is essentially an arbitrary judgement about what the government might otherwise have done.

The important assumption is about revenue. One might suppose that slower revenue growth reflects Drummond’s other widely reported prediction: that the Ontario economy will grow by a bare 2% annually.

But 2% real growth plus 2% inflation is 4% nominal growth, which is not much below the private-sector average upon which the government budgeted. Drummond’s key assertion is that provincial revenues will lag well behind his own projection for nominal economic growth.

The following op-ed, also featured on The Toronto Star website, challenges that assertion. This table displays my breakdown of provincial revenues for the current fiscal year (2011-12):

Filling Don Drummond’s Revenue Gap

The Drummond report assumes feeble provincial revenues to justify deep cuts to public services. More realistic revenue projections and policies to bolster revenue would reduce the pressure for austerity.

Based on recent private-sector forecasts, the Ontario Ministry of Finance’s November update projected that the provincial economy and provincial revenues would grow by just over four per cent annually (including inflation).

Drummond projects economic growth of four per cent, but posits revenue growth of only 3.2 per cent. This difference, compounded from 2010-11 to 2017-18, implies a $10-billion shortfall in annual revenue.

The 500-page report provides no breakdown of provincial revenues to explain its key assumption that they will grow much slower than the provincial economy. It simply notes that “a number of revenue sources do not grow at the same pace as nominal GDP [Gross Domestic Product].”

Indeed, several grow faster than nominal GDP. Ontario’s largest revenue source, the personal income tax, outpaces economic growth because people graduate into higher tax brackets as incomes rise over time.

Drummond warns that federal plans to expand income splitting and Tax-Free Savings Accounts could detract from provincial income tax, a concern I had raised in The Star (“Premiers could be reaching for their wallets,” op-ed, April 25, 2011).

But the current federal government has promised these measures only after balancing its budget in 2016-17. They will have essentially no effect on Ontario’s fiscal position by 2017-18.

The Canada Health Transfer, a major source of provincial revenue, will rise by six per cent annually through 2016-17. It will then grow with national GDP, which is expected to outpace Ontario GDP.

Total Equalization payments also increase with national GDP. Ontario will receive a growing share of these payments, especially if its economy performs as poorly as Drummond fears.

Corporate tax applies to profits, which are growing far faster than the overall economy. As companies finish writing off losses from the economic crisis, a larger share of profits will become taxable. Profits from provincial government enterprises are also robust.

The Ontario government collects about half its revenues from the above sources, which grow faster than the provincial economy. Another quarter of provincial revenues come from sources that approximately equal economic growth: the HST on consumption, Ontario Health Premium on income and Employer Health Tax on payrolls.

If three-quarters of provincial revenues grow by four per cent or more, the only way to end up with Drummond’s average of 3.2 per cent would be for the remaining quarter to grow by just 0.8 per cent or less.

But this remaining quarter includes the Canada Social Transfer, which increases by three per cent annually. Taxes on property, fuel, tobacco and alcohol as well as fees and other non-tax revenues may lag the economy, but will collectively grow faster than 0.8 per cent.

Even accepting Drummond’s cautious economic projections, his revenue projections are much too low. Provincial revenues will grow at least as fast as the provincial economy.

Ontario can make policy choices to bolster revenues. Drummond sensibly proposes to collect an additional $2 billion annually by combatting tax avoidance, removing the “resource allowance” corporate tax break, and reviewing other business tax expenditures.

He rightly calls for a mining-tax review to ensure that Ontario is “receiving a fair return on its natural resources.” Mining tax revenue of $82 million was just one per cent of the $8 billion in minerals extracted from Ontario’s mines and quarries during 2010.

The McGuinty government prohibited Drummond from proposing to raise any tax rates. But restoring a 14 per cent provincial corporate tax would recoup $2 billion annually. Restoring the corporate capital tax just for banks and adding two percentage points of tax on personal income over half a million dollars would collect a further $1.2 billion annually.

Drummond notes “the phasing in of input tax credits under the HST” as a drag on revenue. Businesses already receive credits for inputs to the production process.

Between 2015 and 2018, the McGuinty government plans to phase in further input tax credits that large businesses could claim for energy not used to produce goods, phone service, automobiles, food, beverages and entertainment. Simply continuing to collect the HST’s provincial portion on these corporate purchases would retain $1.3 billion annually by 2018-19.

Adding these revenue enhancements to realistic revenue projections would balance the budget by 2017-18 with far fewer cutbacks than Drummond advocates. Ontarians should consider proposals to restructure public services on their own merits, rather than in the context of unduly pessimistic revenue assumptions.

Erin Weir is an economist with the United Steelworkers union’s Canadian National Office.

UPDATE (March 26): Quoted in today’s Sudbury Star