A comment comparing Ontario’s fiscal situation to California’s recently hit the news (e.g. Ont. compared to cash-strapped Calif. ) It was meant as a warning to Ontarians. After some debate, we’ve decided to weigh in on the issue.

The issue raised above centers on a comparison of California’s fiscal situation, among the worst of all the states in the US, to Ontario’s. As we shall see, California’s situation is significantly better than Ontario’s. To make the issue clear, we reverse this statement: Ontario’s situation is significantly worse than California’s. To find out why, read on.

The Stats

We have compiled key statistics from various sources:

California Ontario Population 37.6 m 13.5 m (est.) Debt $388.5 B $257.5 B Debt per capita $10,360 $19,074 GDP $2,013 B $658.0 B (est) Debt/GDP 19.2% 39.1% 2012 Deficit $16 B $15.1 B

(Sources: Ontario Economic Update – GDP (nominal Q1 2012 x 0.7% per Q), Ontario Fact Sheet August 2012 – pop. (201106 x 1.2 % per annum), Ontario Financial Authority (debt issued), StateDebtClocks.org, California budget deficit has swelled to $16 billion, governor says)

Different sources come up with different numbers. The province has an unfunded liability of $12.3 billion in stranded debt from the provincial electricity system that the province took on but doesn’t carry on its balance sheet (as far as we know). Also see the Ontario Electricity Financial Corporation.

The deficit is somewhat harder to figure. If we look at the Ontario Financing Authority’s page on Borrowing & Debt, at the bottom, the difference between the Net Debt for 2012-13 and 2011-12 is $22.5 billion which to us is the deficit. We have noted other estimates including the Ontario Government’s, of $15.1 and $15.2 billion (see Highlights, or ONTARIO BUDGET 2012). We have an Ontario Government updated estimate as of April 25 of $14.8 billion against a fiscal forecast of $15.9 billion.

On another note, if we use real GDP estimated at $550.1 billion rather than nominal GDP and add the stranded debt to the debt issued we get a 49% debt/GDP ratio. The rationale for using real GDP is that debt is always recorded in real dollars – the value of the currency at the time the debt is created. At some later date when the debt is compared to GDP, if the GDP is measured in nominal dollars then the value of the debt is deflated. And perhaps this is precisely what the debtor hopes for. We will use the lower value calculated with the nominal GDP.

What should be noted is that Ontario’s per capita debt and debt to GDP is at least twice that of California. Perhaps the worst statistic is that the Ontario government deficit for 2012 is 94% the size of California’s.

Lies My Dad Told Me

The Premier of Ontario, Dalton McGuinty, sometimes known as “Premier Dad”, was quoted in the Toronto Sun in March in an article McGuinty insists $214B debt isn’t that bad as saying Ontario’s $214-billion debt, [is] about 35% of GDP. Is this true? In 2012 Ontario Budget: Chapter V: Borrowing and Debt Management, Ontario’s net debt is given as $237.6 billion while its actual debt is given as $257.5 billion. We say the later is the ‘actual’ debt or simply the provinces debt because this is the amount of debt that creditors hold.

The fiction or lie because the real intent here is to deceive the public – the alternative is that the Premier is naive, take your choice – is the concept of ‘net debt’. Another expression for this is attempting to put lipstick on a pig. The province defines net debt as the difference between total liabilities and total financial assets. The first comment is that this a ‘net liability’, an accounting notion, and not a net debt. The Ontario Financial Authority cited above administers the actual debt. This is the money owed creditors.

To understand the problem with this term, suppose you have a $30,000 5-year certificate of deposit (CD) with your bank, but no other liquid assets. Then you decide to buy a new Lexus. The dealer gives you a loan for $30,000. By the Ontario fiction, your ‘net debt’ is zero. Does this mean you owe nothing, that you have no debt? Hardly. The real numbers for Ontario are are in the table above and we stand by them since they all came from official Ontario government sources.

The Debt Issue in California

The Economic Policy Journal released an article yesterday titled Paul Volcker Warns on Debt of California, Illinois, New Jersey,New York and Other States that concluded the debt situation at the state level is bad, real bad. The report it is based on, Report of the State Budget Crisis Task Force, (summary report available) by Paul Volcker and Dick Ravitch identifies Six Major Threats to Fiscal Sustainability:

Medicaid Spending Growth Is Crowding Out Other Needs Federal Deficit Reduction Threatens State Economies and Budgets Underfunded Retirement Promises Create Risks for Future Budgets Narrow, Eroding Tax Bases and Volatile Tax Revenues Undermine State Finances Local Government Fiscal Stress Poses Challenges for States State Budget Laws and Practices Hinder Fiscal Stability and Mask Imbalances

Further, certain large expenditures are growing at rates that exceed reasonable expectations for revenues:

Medicaid programs. At recent rates of growth, state Medicaid costs will outstrip revenue growth by a wide margin, and the gap will continue to expand. Pension funds for state and local government workers are underfunded by approximately a trillion dollars. Unfunded liabilities for health care benefits for state and local government retirees amount to more than $1 trillion.

At the same time as costs are escalating, the capacity to raise revenues is increasingly impaired:

Untaxed transactions are eroding the sales tax base. Gasoline taxes are eroding as well, making it more difficult for states to finance roads, highways, and bridges. Income taxes have become increasingly volatile, particularly during and after the recent economic crisis.

It is expected that the federal budget crisis will have serious spillover effects on state and local governments with a spillover effect from states to local governments:

Cuts in federal grant dollars, lower spending on federal installations, procurement, and infrastructure, and potential changes to the federal tax code. State and local government cuts pose a significant risk to the overall economic and social fabric of states.

In short, state and local governments are experiencing a degrading economic situation that feeds on itself. The early results are the following municipal municipal bankruptcies in 2012:

San Bernardino, population 211,000 Stockton, population 292,000 Bell, population 35,000

Other cities such as Compton are considering bankruptcy.

Ontario (Canada, Not Ontario California)

First, let’s review the six major threats California faces in Ontario’s context, point by point:

Health care spending is or shortly will be crowding out other spending. If the Feds have to be more aggressive in deficit cutting, look for transfer payments to be capped if not reduced (already happened for health care). Underfunded retirement benefits a growing problem. Tax base is eroding with the loss of industry and the decrease in the quality of jobs (see The Service Sector in Canada), a trend that will not reverse under the provinces cost structure. Municipalities, particularly Ottawa and Toronto, are in constant battle with the province to upload costs and services while receiving a greater share of provincial revenues. NA.

The province faces the same three large expenditures, OHIP, public sector pension benefits and public sector retiree health care benefits.

The last point has to do with revenues. The current governing party has implemented a large number of tax increases. Most have been user fees and indirect forms of taxation aimed at specific assets and groups of individuals. For example, the Ontario government is implementing a program of fees of $100 to $200 for tradespeople and $600 to $700 for employers in the construction, service, manufacturing and industrial trades sectors. (see Critics call Ontario College of Trades a tax grab).

This reduces provincial income from the VAT and moves towards a position of neutral revenue. The cumulative effect of all the increases is to reduce consumption and reduce employment as employers struggle to control costs. As an anecdotal story, we recount a discussion with a local employer who was faced with increasing provincial health tax premiums. He was musing on how many employees he would have to let go to retain his profit margin. And don’t forget the Laffer curve (untaxed transactions: think Greece).

Summary

California is arguably one of the six most financially precarious states in the US. Ontario Canada, with economic statistics significantly worse than California’s, is in an exceedingly vulnerable and precarious state, unrecognized by its citizens and unadmitted by its government. Its cities are likewise oblivious to their financial precariousness. Ontario has the same fundamental problems as California of unsustainable public sector liabilities and a panoply of social benefit programs it cannot afford.

Ontario is not California but we may reach the point where we wish it were.