Why is Ontario’s debt burden shrinking so slowly?

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Appeared in the Globe and Mail, August 14, 2017
Why is Ontario’s debt burden shrinking so slowly

Premier Wynne’s government has repeatedly stated the importance of bringing down the province’s debt-to-GDP ratio, which shot up during and after the 2008/09 recession. Specifically, it wants to bring this metric (which economists use to measure the sustainability of a government’s debt burden) back to its pre-recession level of 26 per cent.

Cutting Ontario’s debt burden down to size is certainly a worthwhile objective. After all, an elevated debt burden means more taxpayer dollars go to interest payments and are therefore unavailable for other important priorities.

Unfortunately, to date, her government has made little progress towards this objective. After a period of rapid increase, the ratio peaked at 39.1 per cent in 2014/15. Since then it has inched down—but very slowly.

This year, for example, Ontario’s debt-to-GDP ratio is expected to ease by 0.3 percentage points, to 37.5 per cent. The government expects even less progress next year. At this rate, it will take decades to get back to pre-recession levels.

So the government has set an important goal but is making almost no progress. Why?

The answer, quite simply, is that Ontario’s government won’t stop adding new debt.

Let’s explain. For a jurisdiction to shrink its debt-to-GDP ratio, it doesn’t need to actually stop adding debt. Instead, it needs only for the pace of new debt accumulation to be slower (in percentage terms) than the rate of nominal economic growth. If that happens, the debt-to-GDP ratio shrinks. If the opposite occurs, it goes up.

Ontario has gotten into so much trouble in recent years because its government debt grew so much faster than the economy. Specifically, between 2008 and 2016, nominal economic growth in Ontario averaged 3.2 per cent. Meanwhile nominal debt grew more than twice as fast—averaging 7.6 per cent growth annually. Of course, this meant that the debt-to-GDP ratio climbed significantly.

The government can only reverse this damage if GDP growth begins to significantly outpace the growth of debt.

With the government forecasting annual nominal GDP growth of more than four per cent between 2017 and 2019, it’s possible to reduce the ratio substantially and reasonably quickly—but again, only if Queen’s Park stops piling up debt or at least dramatically slows down the pace.

Unfortunately, the Wynne government’s fiscal plan calls for more debt in the years ahead including an average of $11.8 billion annually in new debt between now and 2019/20. For context, that’s almost the exact same amount it added annually over the past three years.

Translated into percentage terms, this means the province’s nominal debt will grow at an average rate of 3.6 per cent annually over the next three years. Yes, it’s slower than the forecasted pace of nominal GDP growth, but just barely. So the provincial debt-to-GDP ratio will hover very close to its current level for years to come. And crucially, this minimal progress relies on upbeat economic projections, which are hardly set in stone.

The Wynne government’s determination to keep adding new debt suggests it simply isn’t serious about getting the debt-to-GDP ratio down—at least not any time soon. If it were a priority, the government would follow Quebec, which has stopped adding to its (very large) nominal net debt load since 2014. With no new net debt being added to the books, economic growth is shrinking Quebec’s debt-to-GDP ratio at a good clip—by 1.2 percentage points this year.

This contrast—of real action in Quebec compared to empty rhetoric in Ontario—is an important reason why Quebec’s credit rating was recently upgraded above Ontario’s. It’s also why, in a stunning historic reversal, Ontario’s per-person net provincial debt will exceed Quebec’s for the first time next year.

Simply put, if Ontario is serious about getting out of its debt hole, it must finally stop digging.