Conference Board of Canada - 2008 Ontario Budget:

Hits the Right Notes, Based on Cautious Outlook

Overview

With the headwinds challenging Ontario’s economy, the provincial government put forth a very careful budget for 2008. A cautious economic outlook underpins an even more cautious revenue forecast. Despite this, overall spending growth is so limited that the government expects to produce surpluses—planned as reserves—totalling $1.8 billion over fiscal years 2008–09 and 2009–10. While economists could argue that a little more stimulus would have been timely (perhaps in the form of additional tax cuts), the politics of the day do not allow the government to plan for a deficit. Although small, many of the new measures are aimed at the right places. Education and skills training, innovation, infrastructure, and targeted business tax cuts—all should help the province’s competitiveness and productivity down the road. These priorities are consistent with previous Conference Board analysis and recommendations.

Highlights

With the U.S. economy faltering, Ontario is facing its most important economic challenge since the high-tech bust. A large reduction in auto production in the first quarter of 2008 is prompting the Conference Board to revise its economic forecast for Ontario’s real gross domestic product (GDP) growth to 1.5 per cent in 2008, down from the 2.1 per cent growth estimated in 2007. An even-weaker real GDP growth projection of just 1.1 per cent underpins the 2008 budget. There is some upside potential to the Budget 2008 forecast since job creation and consumer demand have remained strong since the start of the year.

Although the outlook is weak, provincial finances remained healthy last year. Including new measures in the 2008 budget and last fall’s economic statement, the government has redirected roughly $1.9 billion from the 2007–08 bottom line to future infrastructure spending, plus a further $190 million to fund the retroactive elimination of capital taxes for manufacturers and the forestry sector. This suggests that the true surplus for the year just ending was closer to $2.7 billion rather than the stated $600 million.

Due to increased transfers from the federal government and much stronger personal and corporate income tax collections, total revenues in fiscal year 2007–08 are now expected to be $2.6 billion higher than what was announced in the 2007 fall Economic Outlook and Fiscal Review and $5 billion above what was initially planned in the 2007 budget. This allowed the Ontario government to increase program spending in 2007–08 by a corresponding $5 billion over previously budgeted levels.

Budget 2008 emphasizes creative measures targeted at fostering investment, innovation, and research activities. Already announced capital tax cuts for manufacturers for the forestry sector have been accelerated and are now retroactive to January 1, 2007. A 10-year tax holiday has been introduced for firms for new ideas they commercialize, and capital cost allowance rates have been accelerated until 2012. In addition, the provincial government has implemented a refundable Ontario Innovation Tax Credit which extends to small and medium-sized corporations that undertake scientific research and experimental development in Ontario. This measure provides a refundable 10 per cent tax credit on qualifying research and development expenditures carried out by businesses in Ontario.

Budget 2008 allocates $355 million over the next three years for educating and training of displaced workers. Other measures include funds targeted for focused apprenticeship and employer-based training programs as well as post-secondary education. These are important initiatives in an era of tightening labour markets and skills shortages in the workforce.

The provincial government will expand its list of goods exempt from the retail sales tax (RST), reducing personal consumption taxes by $173 million through to fiscal year 2010–11. This falls short of the ultimate goal of the outright harmonization of provincial and federal sales tax bases. The Conference Board estimates that around $1 billion in interim fiscal relief from the federal government would be necessary to offset revenue losses for Ontario if it were to harmonize its retail sales tax base with that of the federal goods and services tax (GST) on a revenue-neutral basis.

Some $1 billion in new infrastructure spending was announced in Budget 2008 in addition to ongoing pledges announced under the pre-existing ReNew Ontario and MoveOntario 2020 plans. (The Municipal Infrastructure Investment Initiative [MIII] earmarked some $300 million for municipal infrastructure renewal in Budget 2007, including road and bridge construction. MIII funding was augmented by $150 million at the 2008 Ontario Good Roads Association/Rural Ontario Municipal Association conference.)

The health-care sector will continue to consume all available resources and crowd out other priority areas. Spending on health care is set to rise by 6 per cent in fiscal year 2008–09, forcing the Ontario government to reduce non-health-care spending by 4.1 per cent. (See Chart 1.) Moreover, health-care spending will continue to grow at about 5 per cent per year in the two fiscal years following 2008–09. This year, health-care spending will consume nearly 42 cents of every dollar in revenue, up from 36.3 cents in fiscal year 2001–02.

Overall, the 2008 Ontario budget will add, at most, 0.2 per cent to GDP growth this year largely due to the effects of an extra $1 billion earmarked for new infrastructure investment. Although the funds were drawn from the 2007–08 accounts, the impact on the economy is expected to be felt largely in the 2008 calendar year.

The 2008 Budget Measures

Expenditures

Health Care Continues to Absorb Lion’s Share of New Spending

The health-care sector remains the priority area for the Ontario government with increased health funding projected to consume 6.6 times the projected increase in total revenues for fiscal year 2008–09. In particular, the Ontario government announced $771 million in new health-care spending over the next three years. This funding is directed toward hiring 9,000 nurses by 2011–12, reducing emergency department wait times, adding more Family Health Teams, increasing nurse practitioner-led clinics, and increasing enrolment spaces for midwives and nurse practitioners.

The Ontario government has set aside its attempt to restrain health-care spending to below the rate of economic growth. In the 2004 budget, the Ontario government asserted that health-care costs could not continue to grow faster than the rate of economic growth over the long-term as this would “. . . only lead to the continued crowding out of available funding for other priorities.” At that time, the Ontario government planned on improving efficiency in the health-care sector in an effort to constrain rising health-care costs. However, since fiscal year 2001–02, health-care spending has grown by an average annual compound rate of 7.9 per cent. Moreover, health-care spending is now forecast to grow by 6 per cent in fiscal year 2008–09 compared with projected nominal GDP growth of 2.9 per cent for 2008. In fiscal year 2008–09, health-care spending will consume 41.7 per cent of provincial revenues, up from 36.3 per cent in fiscal year 2001–02.

Some New Initiatives for Education

Total education sector spending will rise by only 2 per cent in fiscal year 2008–09 due to the elimination of a one-time $700 million capital investment in colleges and universities in fiscal year 2007–08. Nevertheless, the 2008 budget announces an additional $385 million over three years on a permanent textbook and technology grant for full-time university and college students. Moreover, $27 million is pledged to assist students from remote or rural areas with the travel costs of attending college or university. The Ontario Budget also announced $355 million over three years for the Second Career Strategy initiative. This initiative will provide funding to help cover the cost of tuition and living expenses for unemployed workers making the transition to new careers.

Municipalities Benefit From Infrastructure Renewal

Budget 2008 pledges nearly $1 billion toward new investments in municipal infrastructure in 2007–08. That is in addition to ongoing infrastructure construction and rehabilitation for health-care and educational facilities. The new $400 million municipal roads and bridges fund will assist in revitalizing transportation networks in communities outside Toronto. Some $497 million has been allocated to enhancing public transit networks in the Greater Toronto Area and Hamilton. A further $100 million will be earmarked for improvements to existing social housing units and refurbishment of existing infrastructure with energy-efficient technologies . In total, funding to municipalities is scheduled to increase from $2.2 billion in 2008 to $2.8 billion by 2011.

Revenues

Accelerated Capital Tax Elimination

In its autumn economic statement, the Ontario government implemented a plan to eliminate productivity-inhibiting capital taxes for all industries by July 1, 2010. Moreover, for companies engaged primarily in manufacturing and resource activities, the capital tax was eliminated effective January 1, 2008. Budget 2008 provides an extra temporary stimulus to manufacturers and resource sector firms by extending the capital tax elimination retroactively to January 1, 2007. Although this new measure is small (providing about $190 million of fiscal relief in 2007–08), it is still one of the most substantive revenue initiatives adopted in Budget 2008.

Extended Capital Cost Allowance Rates

Ontario will parallel the initiatives adopted in the federal Budget 2008 by extending an accelerated capital cost allowance (CCA) schedule to manufacturing and processing industries. Subject to the enactment of the federal regulations, Ontario will apply a 50 per cent straight-line CCA rate to manufacturing and processing machinery and equipment acquired between March 19, 2007 and the end of 2011, and on a declining basis thereafter as prescribed in the federal Budget 2008. CCA eligibility will also be expanded to include clean energy-generating industries, as implemented under the recent federal budget. In total, these new CCA measures will provide $433 million in fiscal relief to eligible industries through to fiscal year 2010–11.

Expanded Retail Sales Tax Exemptions

A handful of targeted new RST exemptions are proposed in Budget 2008, which will reduce provincial consumption taxes by some $173 million through to fiscal year 2010–11. Amended exemptions apply to the following goods and services:

Community and ethnic newspapers and publications with less frequent publishing schedules. The exemption will be finalized in the spring of 2008 and will apply retroactively to January 1, 2000.

Destination marketing fees for Ontario’s tourism and hotel industries. The RST exemption will be extended for an additional two years on marketing fees billed on or before June 30, 2010.

Admissions to live theatres with capacities of less than 3,200 seats, effective permanently from April 1, 2008.

Health and environment-related products (Energy Star household appliances and light bulbs, bicycles, and nicotine replacement therapies).

These measures fall short of the ultimate goal of harmonization of the provincial and federal sales tax bases. The Conference Board estimates that approximately $1 billion of interim federal relief would be required for harmonization to be adopted on a revenue-neutral basis in Ontario.

Senior Homeowners’ Property Tax Grant

Effective permanently as of 2009, a new grant is being extended to low- and moderate-income senior homeowners to assist in defraying municipal and education property taxes. This measure supplements existing property tax credits, with a maximum new grant of $250 available to single seniors with annual incomes of not more than $35,000 and who pay at least $2,000 in property taxes. The grant will be phased out proportionately for seniors with incomes up to $50,000. The maximum grant will be increased to $500 for 2010 and in subsequent fiscal years. A similar allowance schedule is proposed for senior couples. Total fiscal relief to beneficiaries will total $450 million by fiscal year 2010–11.

The Economic and Fiscal Outlook

Budget 2008 provides a very cautious outlook for Ontario’s economy—one that projects only gradual improvement. Modest real GDP growth of 1.1 per cent is forecast for 2008, with a recovery to 2.1 per cent in 2009 and a further 2.7 per cent advance in 2010. The Ontario Ministry of Finance’s forecast is derived from a survey of private sector forecasts. As in recent years, the ministry has once again exercised caution by setting its GDP growth projections below the private sector average. With a large drop in auto production in the first quarter of 2008, the Conference Board is revising down its real GDP growth forecast for Ontario from 2.1 per cent to 1.5 per cent for 2008. That is still more optimistic than the budget’s forecast. The Conference Board’s optimism is based on the belief that, despite the challenging external factors, the domestic economy is still carrying plenty of momentum—as demonstrated by the recent strength in job creation and consumer demand early in 2008.

The Conference Board anticipates stronger growth of 2.9 per cent in 2009 and 3.4 per cent in 2010, in line with improving trade prospects south of the border.

Budget 2008 also assumes higher near-term interest rates than projected in the Conference Board’s spring 2008 edition of the Canadian Outlook Economic Forecast. The budget foresees 90-day Treasury bills rising from an average of 3.3 per cent this year to 3.8 per cent in 2009—roughly 20 basis points above the Board’s forecast. (Higher interest rates suppress household spending and inflate the cost of servicing public debt.)

Although the Ontario government will need to deal with weaker revenue growth in the future, revenue gains in 2007–08 were exceptional for the public purse. This was due to increased transfers from the federal government and stronger-than-expected economic growth that resulted in considerably higher personal and corporate income tax collections. Overall, total revenues in fiscal year 2007–08 are now expected to be $5 billion higher than forecast in the 2007 budget. This allowed the Ontario government to increase program spending by a corresponding $5 billion above previous budgeted levels. However, in 2008 a weaker outlook for economic growth will reduce substantially the amount of fiscal room available for new spending initiatives. In fact, in fiscal year 2008–09, total revenues are forecast to increase by only 0.3 per cent.

Consequently, the Ontario government will be forced to constrain program spending growth to maintain its surplus position. However, with health-care spending (the largest category of program spending) set to increase by 6 per cent in fiscal year 2008–09, other areas of government spending will be forced to tighten their belts. The government will free up spending room by not repeating several one-time payments made in fiscal year 2007–08. The largest of these one-time payments—including funds for transit infrastructure, municipal infrastructure, and education—were all expensed in fiscal year 2007–08. The Ontario government is also banking on finding further efficiencies, amounting to $1.1 billion by year-end, in as yet undisclosed departments.

Taking account of the new spending initiatives, program spending is expected to grow by only 0.3 per cent this fiscal year, resulting in a projected surplus of $0.8 billion in fiscal 2008–09.