Western weakness won’t help Ontario’s budget woes

With the plunge in oil prices over the last six months (and already soft natural gas prices), it’s not headline news to note that provinces heavily dependent on energy-related revenues are suffering.

The decline in the resource sector has also contributed to a decline in the value of the Canadian dollar against the greenback. That has led some to speculate that Ontario’s economy will improve. (The depreciation of the loonie makes Ontario’s manufactured goods artificially more competitive.)

Perhaps. But as the resource economies of the West and Newfoundland and Labrador see significantly less revenue, there is this consequence for Ontario: the provincial treasury will receive less in equalization payments from the federal government. So balancing the books may not get any easier for the Ontario government.

For those not familiar with the details of federal transfers to the provinces and territories, in total, Ottawa “cut” cheques worth $65 billion to the provinces and territories in 2014/15 (the fiscal year now ending). One federal program, equalization was worth $16.7 billion.

Equalization, in its constitutional mandate, is meant to ensure “that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation.”

That means not every province receives equalization. That only happens if a province’s assumed ability to raise revenues, its “fiscal capacity,” is below the average of all 10 provinces. And that average is calculated measuring a variety of revenues including personal and corporate taxes, and resource revenues.

And that’s where we circle back to Ontario. In the past six years, Ontario’s own poor economic performance combined with the gusher of western and Newfoundland and Labrador resource revenues, meant that Ontario fell below the 10-province average.

As a result, since 2009/10, Ontario was and still is an equalization recipient—a “have not” in equalization speak. From that first equalization cheque six years ago to the end of this March, Ontario will have garnered $12 billion in equalization payments from the federal government.

Ontario’s equalization cheques have ranged from $347 million (and 2.4 per cent of the total equalization kitty in 2009/10) to $3.3 billion (and 21 per cent of all equalization cash in 2012/13). In the year now ending, Ontario will receive $2 billion in equalization payments, or just under 12 per cent of all equalization paid by Ottawa to the six ”have not” provinces.

Now, think about the future.

Alberta’s government has already hinted it may see a $7 billion hole in previously expected provincial revenues this year. The Saskatchewan government says it will have a deficit in its next fiscal year because of falling revenues. Newfoundland and Labrador’s government has also publicly stated it expects a $1.5 billion revenue shortfall because of low oil prices.

Given that resource-rich provinces are taking significant hits to revenues, Ontario will move closer to the 10-province average for fiscal capacity. That means its equalization payments will decline.

That’s fine; that’s how equalization works. In fact, some provinces will benefit from higher equalization payments as the equalization pie is divided in larger portions among the remaining recipients. Think Quebec, the Maritimes and Manitoba—provinces that have received equalization payments year-in, year-out, for decades.

As that decline in equalization for Ontario occurs, it brings up this tricky issue for Ontario’s government: That forecasted $12.5 billion provincial deficit target next year, high as it is, might be even more difficult to achieve, never mind reduce.

For the record, Ontario Premier Kathleen Wynne has long demanded that the federal government send more federal tax dollars to Ontario, given Ontario’s taxpayers are still net contributors to Confederation.

But on a net basis (money sent to the federal government by provincial taxpayers versus money transferred to or spent in a province by Ottawa), that is even more true of Alberta. But it’s a moot point. Equalization payments are meant to decline when a province’s revenues improve vis-à-vis the 10-province average.

Instead of demanding more money from the federal government, Ontario could a) cut provincial spending or b) reform everything from labour laws to regulation to tax policy and electricity policy, to unleash the economy and thus produce more at-home tax revenue or c) both.

Ontario should not expect continued billions in annual equalization payments. While the exact decline in equalization is unknown—it depends on how badly the resource economies and their provincial treasuries are hit—Ontario should face reality and act accordingly.