Drummond: The Good, The Bad and The Ugly

The Drummond Commission reported today.

The Good

While the McGuinty government prevented the Commission from considering tax rates, it proposes some sensible measures to raise revenue. Chapter 18, “Revenue Integrity,” recommends combating corporate tax avoidance and cracking down on the underground economy.

Businesses sometimes hire workers as “contractors” to avoid paying Ontario’s Employer Health Tax. Drummond advises the province to deem them as employees.

Chapter 11 advocates greater scrutiny of tax expenditures and business subsidies, which might threaten worthwhile targeted measures but could end some useless giveaways. We should similarly scrutinize the supposed benefits of cutting the corporate income tax rate.

Recommendation 11-12 is to “eliminate the Ontario resource tax credit and review the mining tax system to ensure that the province is supporting the exploration and production of minerals in Ontario while receiving a fair return on its natural resources.” I have drawn attention to this resource allowance (tax credit) and how little revenue Ontario’s mining tax collects.

Chapter 17 makes the case against selling the Ontario Lottery and Gaming Corporation, Liquor Control Board of Ontario, Ontario Power Generation and Hydro One:

A full divestiture of any or all of the GBEs [government business enterprises] would result in a lump-sum payment to the province at the expense of future revenue streams. If proceeds of a sale were used to pay down provincial debt, Ontario could save on interest costs of up to four per cent, based on recent bond yields. By comparison, GBEs provide a return on assets (ROA) of at least eight per cent. Any full divestiture would have to overcome this spread to provide a fiscal benefit to Ontario.

I made the same argument in a Toronto Star op-ed a couple of years ago (when the long-term provincial bond rate was more like 5%).

Recommendation 5-59 is to shift doctors’ compensation away from fee-for-service and toward salaries. This reasonable means of limiting healthcare costs is quite consistent with the Co-operative Commonwealth Federation’s original vision of medicare.

The Drummond report validates several other arguments that progressives have been making. Page 63 notes, “Proposed federal changes on income splitting and Tax-Free Savings Accounts could cost Ontario $1.3 billion in lost revenue, since the province would likely mirror these changes.” I made this point in another Toronto Star op-ed during the last federal election campaign.

Page 460 echoes a concern raised by critics of Canada-EU free trade:

The outcome of the negotiations for a comprehensive free trade agreement with the European Union could have significant impact on the cost of prescription drugs in Ontario. A key negotiating point, the extension of Canadian patent protections for pharmaceutical drugs to European standards, could cost Ontario taxpayers up to $1.2 billion annually ($551 million for the Ontario government and $672 million for the private sector) . . .

The Bad

Unfortunately, the McGuinty government appointed the Commission to usher in an age of austerity. Drummond does so by positing that spending will grow twice as fast as, and revenue will grow much less than, provincial budget projections (Table 1.1). Instead of a balanced budget by 2017-18, Drummond’s scenario projects a $30-billion deficit that year.

His revenue measures raise only $2 billion annually, so the remaining $28 billion must be slashed from projected public spending. Toby has already laid out the implications of such cuts.

Why does Drummond envision such weak provincial revenues? The provincial budget projected that, going forward, revenue would grow a bit faster than nominal Gross Domestic Product (GDP). Drummond assumes less GDP growth and that revenue will grow even slower than GDP.

The report provides some plausible reasons why own-source revenue might lag economic growth, including the continued phase-in of corporate tax cuts and HST input tax credits. The NDP emphasized the fiscal cost of both policies during the last provincial election campaign.

If Ontario’s economy underperforms private-sector forecasts (and other provinces) as badly as Drummond predicts, it strikes me that the Ontario government would consequently collect a much larger share of Equalization payments. These payments and the Canada Health Transfer will grow in line with national GDP rather than provincial GDP.

So, it seems likely that federal transfers to Ontario will grow faster than the provincial economy, at least partly offsetting slower growth in own-source revenues. Drummond says that he took these factors into account, but his 543-page report presents no breakdown of projected revenue. His scenarios lump all revenue together into a single line with a single (sluggish) growth rate.

The Ugly

The Drummond report contains several seemingly unpalatable cuts such as cancelling full-day kindergarten (except at the few schools that already had it). These objectionable proposals could serve to allow the McGuinty government to make other deep cuts that seem less painful.

Recommendation 19-3 is that “the province either terminate the Pension Benefits Guarantee Fund or explore the possibility of transferring it to a private insurer.” This fund backstops pensions when an employer goes bankrupt, safeguarding the retirement income of Ontario workers.

Although the provincial government made a one-time contribution a couple of years ago, the Pension Benefits Guarantee Fund is financed by premiums from defined-benefit pension plans. Terminating it would have no effect on annual provincial expenditures. (Instead, this recommendation is presented as reducing provincial liabilities.)

The Ontario government should adopt the good, minimize the bad by reversing corporate tax cuts and permanently restricting HST input tax credits, and forget the ugly.

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