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Ontario is not sinking into deficit: Better public services can be won

The Financial Accountability Office (FAO) predicts significant deficits over the next several years - despite also predicting significant economic growth. Using the government's accounting method, the FAO is predicting budget deficits of $0.5 billion this year, increasing to $3.6 billion in 2021-22. 

If the FAO is right then we do have a problem in terms of building our campaigns for better funding. Deficits will be used to clobber popular expectations for improved public services.  Already the right has taken up the FAO report to spread the deficit alarm.  

While the FAO does make some useful other points, its conclusions about the deficit are likely off base.

Revenues and Expenditures: The FAO expects tax revenue to grow 3.9% on average over the next five years, slightly below their expectations for nominal economic growth.  This is significantly better than their forecast for expenditure growth of 3.3% (which, notably, is a little below the underlying cost and demographic pressures identified of 3.6%). 

However the FAO also expects much slower growth for the second largest source of revenue, federal transfers -- 1.9% growth. 

As a result, the FAO places revenue growth at a more moderate 3.3% average over the five years -- exactly the same as their estimate for average expenditure growth. 

That sounds odd as the they expect the deficit to grow from $600 million this year (2017/18) to $3.6 billion by 2021-22.  

The base year problem: A big part of the explanation is that the base year for their five year forecast is not this year but last year, 2016/17, and they put the deficit for that year at $2.8 billion. 

So an increase to a $3.6 billion deficit after five years is in fact a modest increase in the deficit - - an increase of $800 million by 2021 -2022, or just under 0.5% of total expenditures.  On average, the deficit is expected to increase by less than 0.1% of expenditures each year for five years. 

In other words, there will be a big deficit in five years because there already is a big deficit. 

Is there really a big deficit in the base year?  The forecast deficit of $2.8 billion in the  base year of 2016/17 is itself quite odd.  It is well over a billion dollars higher than the Ministry of Finance estimated in the 2017/18 Budget.  

Key here is that the FAO estimates $1.2 billion less revenue for 2016/7 than the 2017/18 Budget estimated.  This is entirely due to a lower estimate of tax revenue by the FAO.

However, the 2017/18 Budget came out a month after the 2016/17 fiscal year ended. The finance ministry should have a pretty good estimate of revenue from the previous year one month into the next fiscal year.  They will, after all, finalize the books for that year in just a few months.  

Indeed, if past practice is any guide, this government almost always starts out with a very pessimistic assessment of the state of the deficit and then achieves a lower deficit.

Like a cautious middle manager, the government almost always initially overestimates the deficit and then in successive announcements beats its target and reports a lower deficit. Last year, for example, when they finalized the books for 2015/16 in the fall of 2016, they recognized that revenue was actually $2 billion higher than they had estimated in the 2016/17 Budget.

So the FAO forecast of a $2.8 billion deficit in the base year of 2016/17 is suspect. If past experience is any guide, it is more likely lower than the $1.5 billion the government has estimated rather than higher.  

What's the impact if the deficit in the base year is overestimated?  If the FAO's deficit in the base year is an overestimate, then what of their forecasts for the following five years? Well, Ontario will start from a much better position to avoid future deficits.

Notably, the FAO's predicted five year dollar growth in the deficit from $2.8 billion to $3.6 billion is based on the idea that a sizable deficit exists -- that expenditures in the base year were $2.8  billion more than revenues.  

Much of the predicted growth in the deficit is not because revenues are predicted to increase at a slower percentage rate than expenditures, but because the two are predicted to increase at the same percentage.     

As a result of this, the gap between the larger amount (expenditures) and the smaller (revenues) grows in dollar terms (although not in percentage terms). 

Over $500 million of the FAO's predicted $800 million increase in the deficit over five years is simply the result of the fact that both total expenditure and total revenue are supposed to increase at exactly the same percentage rate and expenditures are supposedly starting out at much higher dollar amount than revenues. 

But the math changes and the growth of the deficit is much less if the existing deficit is not as big as supposed.

(It is not clear where the FAO's other $300 million predicted growth in the deficit comes from -- rounding differences perhaps.)

The FAO Deficit Track Record: Notably, the FAO forecasting record has not been great. Well into the 2015/16 fiscal year (November 2015), they estimated the deficit for that year as between $6.8 billion and $8.5 billion.  The FAO now recognizes the deficit for that year as $3.5 billion, i.e. $3.3 billion to $5 billion less than they predicted.   

Even after 2015/16 ended the FAO was still way off.  Last year’s FAO spring economic and fiscal report (dated May 18, 2016) concluded the 2015/16 deficit would be $2.2 billion more than they now admit.  

In other words, a month and a half after the fiscal year ended, the FAO forecast the deficit as 63% higher than it was. 

If the FAO was off by that much predicting what happened the previous year, how much might they be off forecasting five years in the future?  Particularly as much of the FAO's predicted deficit five years in the future is based on the questionable notion that there already is a big deficit. 

Federal Transfers: On another related point, a big part of their modest revenue forecast is very modest  growth in federal transfers.  Part of this makes sense -- as Ontario's economy improves, federal equalization payments to Ontario will decline.  

But it is certainly worth considering that federal transfers for future years may turn out to be greater than currently announced.  The Feds don't get a lot of political credit for promising money years in the future.  They get more credit for cash that will come shortly. The federal election in 2019 may also shake some more federal cash loose (for example we won  a big increase in federal health care money from the Conservatives in the 2011 election).   As a result, the FAO's approach may inherently tend to underestimate future federal transfers.  

If the future is like the past, we will see an improved fiscal situation than predicted in the provincial Budget when the books are finalized for 2016-17 -- and not a worse situation, as predicted by the FAO.  

If that is the case, we will be in a much better situation to face the years ahead than the FAO forecasts -- even if revenue percentage increases simply match expenditure increases, as the FAO predicts

One last point: any long term forecast is dodgy, and the further into the future, the more dodgy.  Economic crisis, or revenue bonanza are hard to predict years in advance. But it is in the longer term that the FAO is more pessimistic. In the shorter term their forecast is much more optimistic.   

In  the immediate future, the FAO estimates very significant revenue growth for 2017/18 -- growth of $8.2 billion or 6.3%. That is very similar to the increase estimated by the Ministry of Finance for 2017/18 and is far above the FAO's five year forecast of only 3.3% annual revenue growth. 

This also provides some reason to think there is a little more gold to come, this year at least. 

Economic crisis will come at some point and create another crisis that will be used by our rulers to undermine public services.  

Good prospects: But barring economic crisis, discount the deficit doomsayers (they have been getting it wrong for years) and don't be discouraged. 

We remain in a good position to win better public services -- just as we did last year when the FAO (and the government) grossly overestimated the deficit.  


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