By Gabriel Sekaly
On March 25th, Ontario will present a one-year fiscal and economic update, rather than a full budget, given the currently uncertain economic situation. This one-year outlook will allow transfer partners to plan their operations and for the government to table Expenditure Estimates and a Supply Act.
In order to try to simulate the potential impact of the COVID-19 pandemic on Ontario’s economy and the fiscal position of the province, we have looked at the impact of the 2008 recession caused by the subprime mortgage crisis and the ensuing economic fallout. This is not a perfect model, as the 2008 recession did not include significant and unknown health impacts resulting in the shutdown of significant portions of the economy. Many have surmised that what we are facing today is a combination of both SARS and the 2008 recession.
Given the recent actions of governments in Italy, France and Spain to contain the spread of COVID-19, even that comparison is probably understated. The complete lockdown of those countries, apart from food stores and pharmacies, will significantly impact their economies, though it is likely the most prudent way to deal with the transmission of the virus.
On March 23rd, the provincial government announced that all non-essential businesses in Ontario must close at midnight on March 24th for a minimum of 14 days, with the possibility for extension by another two weeks if deemed necessary. These actions will have significant multiplier effects on the economy as workers are laid off or have their work hours drastically reduced. Municipal and provincial governments have ordered the closures of schools, attractions, most childcare centres, casinos, and all professional sports. Furthermore, facilities such as the Metro Toronto Convention Centre have also closed, cancelling numerous upcoming trade shows.
The economic impacts of the COVID-19 response will vary greatly depending upon the measures taken by governments. Should government move to a complete lockdown, such as the one enacted in Italy, Spain and France, and should that lockdown last three to four months, the economic impact will be much more significant than in 2008.
This situation is changing daily in Canada and in the U.S. As a result, this note only looks at the potential impact on the 2020-21 fiscal year, though it is certain that the fourth quarter of the 2019-2020 fiscal year will also be impacted.
As a result of the 2008 recession, Ontario’s Real GDP fell from 2.3 per cent projected growth in 2008 to -0.9 per cent growth in 2009. It further declined to -3.6 per cent in 2010 before bouncing back in 2011 to a growth of 3.2 per cent.
During that time, the impact on government revenues was significant. Total revenue decreased by $6.6 billion (6.3 per cent) between 2007-2008 and 2008-2009. Total taxation revenue dropped by eight per cent, with Corporate Income Tax decreasing by over 48 per cent and the Land Transfer Tax decreasing by almost 26 per cent. Both Personal Income Tax (PIT) and Sales Tax experienced slight growth of over one per cent in between 2007-2008 and 2008-2009, though PIT was impacted in the next year as a result of some economic lag. Given PIT and Sales Taxes make up a large portion of revenue, they were able to offset some of the losses in other areas in the first year.
Between 2007-2008 and 2009-2010, total revenue decreased by over one per cent, while total taxation revenue increased by four per cent, due to a strong rebound in Corporate Income Tax and Sales Tax. PIT however, decreased by over eight per cent.
The total impact of the two-year period of 2007-2008 and 2009-2010 was impressive. In that time, total revenue decreased by over $7.8 billion, which was almost 7.5 per cent. Total taxation revenue decreased by over 4.3 per, which was more than $3.2 billion. Personal Income Tax revenue decreased by almost seven per cent ($1.8 billion) while Corporate Income Tax fell by 30.2 per cent ($3.9 billion), and Land Transfer Taxes decreased by 8.5 per cent. It is important to remember these losses happened over a two-year period, signifying a longer rebuild after the initial market shock in 2007-2008.
Possible Impact in 2020-2021:
In this analysis, the projections contained in the 2019 Fall Economic Outlook and Fiscal Review (November 6, 2019) are used as a starting point. The table below outlines the provincial government’s economic and fiscal projections to 2022.
Summary of Ontario’s Economic Outlook (per cent)
The government based its forecast on a consensus of private sector forecasts, already projecting modest economic growth into 2022. However, as a result of the drastic economic impact of COVID-19 on North America, JP Morgan estimated on March 18th that the Real GDP in the U.S. would be as follows:
- Q1: -4 per cent
- Q2: -14 per cent
- Q3: +8 per cent
- Q4: +4 per cent
- Full year: -1.5 per cent
On March 23rd, Morgan Stanley estimated that the U.S. economy would plunge by 30 per cent in the second quarter, with unemployment averaging 12.8 per cent and consumption falling by 31 per cent. Overall, Morgan Stanley predicts U.S. GDP will fall 2.3 per cent in 2020.
The Conference Board of Canada published an alternate Canadian outlook on March 23rd, assuming travel bans will remain in place until the end of August 2020. Under this scenario, they forecast that Canadian Real GDP would decline 1.1 per cent in 2020 and that 330,000 jobs would be lost in Q2 and Q3 (7.7 per cent unemployment). This forecast assumes that COVID-19 is contained by September and that the economy would rebound, with Real GDP growth of 3.3 per cent in 2021.
Recent reports have indicated that U.S. applications for Unemployment Assistance increased to over 2.5 million claims, while in Canada, Employment Insurance claims rose to over 900,000 during the week of March 16th.
The 2019 Ontario Fall Economic Statement does suggest the impact of various external risks on Ontario’s GDP. That document estimated a one per cent increase in Real U.S. GDP would increase Ontario’s GDP by 0.2-0.6 per cent in the first year, and 0.3-0.7 per cent the next. The planning assumption for U.S. Real GDP growth was 2.3 per cent in 2019, and 1.7 per cent in 2020. A decline in U.S. Real GDP of the magnitude which has been forecasted by Morgan Stanley or JP Morgan could mean that Ontario’s Real GDP would decline by 0.6 to 2.4 per cent in the first year, and 1.0-2.8 per cent in the second year. Given the connection between the U.S. economy and Ontario’s, the Real GDP in Ontario would likely mirror this trend.
It is more than likely that Real GDP will be in negative territory in the first three fiscal quarters of 2020. Should COVID-19 be controlled within the next three to four months, then Real GDP should rebound into positive territory in Q4.
What Does This Mean for Ontario’s Budget Projections?
Given the near cessation of activity in large parts of the economy, the government will see a significant decrease in total taxation revenue in 2020-21 compared to their Fall 2019 economic forecast.
- Corporate Income Tax will likely decline by at least 48 per cent, the amount that occurred in 2008, though it is likely much higher given the shutdown.
- Given the very quick layoffs occurring across Ontario, especially in the service industry, as well as the deferral of Personal Income Tax filing, these revenues will likely decline in 2020. This will be somewhat offset by any income support programs that governments bring in, such as Employment Insurance. Any Ontario income support programs will, of course, increase expenses.
- In the 2008 recession, Sales Tax revenue held steady in the first year and then grew significantly in the second and third year. Given the shut-down of stores, restaurants, bars, and other non-essential businesses, it is very likely that Sales Tax revenue will experience a decline in 2020 compared to the Fall 2019 projection.
- In terms of the other taxes, it is likely that the Land Transfer Tax will also be reduced from the Fall 2019 forecast, as individuals curtail large purchases until the situation stabilizes.
- With the closure of casinos, the income from government enterprises will also decrease, though that may be offset somewhat by an increase in sales at the LCBO and cannabis stores.
- On the expense side, the increase in expenses will be also likely be significant, as the government attempts to support the beleaguered health care system.
- This will include support to hospitals for surge capacity and the opening of new critical care beds.
- In addition to the health care system, it is likely that the government will provide additional supports to individuals who have lost their jobs. This will be in addition to the measures taken by the federal government. For example, the province has announced that it is prohibiting any evictions for non-payment of rent, but landlords cannot be expected to forego this revenue for the next two to three months, or more. Therefore, the government will need to bring in a program that provides support to landlords.
- Many small businesses that have seen their business grind to a halt will require assistance in paying their leases, among other fixed costs. Providing a salary subsidy of ten per cent as was part of the federal announcement on March 18th will not assist these small businesses.
- The total impact of the substantial decrease in revenues and increase in expenses would be a substantial provincial deficit in 2020-21, as well as a substantial increase in the net debt to GDP ratio.
The COVID-19 pandemic is a relatively “perfect storm” against the government’s books. It will increase program spending on health care and other relief programs, decrease most traditional revenue streams, such as personal and corporate income taxes, but it will also decrease taxation revenue streams that did not decrease markedly in the 2008 recession. The COVID-19 pandemic, as well as the corresponding economic shutdown means that Sales Tax revenue may also decline, in addition to more traditional income taxes.
What does all this mean? The Ontario deficit this year will be substantially increased, despite a healthy reserve and contingency fund. Though the deficit will grow substantially, now is not the time to hesitate. That money will be needed badly by businesses and workers impacted if Ontario is to position itself for a healthy and strong recovery post COVID-19.