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March 20, 2012

How to manufacture a fiscal crisis

In his recent report on reforming public services in Ontario, retired bank economist Don Drummond painted a picture of Ontario on the verge of fiscal ruin. But a close analysis of the assumptions that Mr. Drummond used to reach his projected $30 billion deficit by 2017-18 contends that number is unrealistic.

That analysis was done by another economist, Hugh Mackenzie, for the Canadian Centre for Policy Alternatives. Mackenzie has years of experience analysing and forecasting provincial finances. Here is a summary of the findings of his analysis, Ontario's Fiscal Reality: Cup Half Empty or Half Full.

Although the Drummond exercise ended up producing a massive report with hundreds of  recommendations, its main role was to establish the atmosphere of financial crisis that is needed to create the political space for painful spending cuts.
To that end, the exercise began with a pessimistic economic forecast that implied a modest but manageable deficit persisting until 2017–18. From that base, step-by-step, it built that economic forecast into an unmanageable fiscal crisis.
That forecast of crisis is based on five key assumptions, each of which was carefully designed to inflate the 2017–18 deficit.
It assumed that Ontario’s corporate tax cut plan would remain intact and on schedule, despite its growing impact on the province’s fiscal capacity.
In a departure from the norm in long-term fiscal forecasts, it added a contingency amount of $1.9 billion to the projected deficit in 2017–18.
It assumed that debt service costs in Ontario would soar from their current rate of 3.5% for new debt to 5.3%.
It assumed that program spending would increase at a rate greater than the rate of inflation and population growth, creating a politically-inspired straw man on the expenditure side of the fiscal projection.
And most tellingly, it assumed that revenue would grow at a substantially lower rate than the already pessimistic assumed rate of growth of Ontario’s economy—a development which, if it were to take place, would be without precedent.
Together, these five assumptions turned a $6.4 billion projected deficit in 2017–18 into a $30.1 billion catastrophe. More to the point, this manipulative exercise turned an issue that would go away by itself with even a modest improvement in growth rates (and would be readily manageable even without) into a steadily increasing deficit culminating in a fiscal crisis.

Mackenzie's analysis suggests Ontario has the fiscal room to make the kind of smart social investments that MCCO recommended in its recent letter to Finance Minister Dwight Duncan.

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