What Would the Ontario Deficit Look Like if the Quarantine Lasts Until August?

By Gabriel Sekaly

Ontario’s Action Plan announced by the Ontario government on March 25 hit the mark in terms of a good first step in dealing the economic and fiscal impacts of the COVID-19 pandemic. The economic situation arising out of this pandemic is unprecedented and the impact will be far reaching. When the Action Plan was released, gatherings over 5 people were still allowed in the province and non-essential businesses had just closed the day before. This pandemic and its impacts are changing day-by-day, meaning government forecasts are more like snapshots in time than predictive documents.

In preparing this assessment, we are not suggesting that we know “better” than the Ministry of Finance – merely that in this very dynamic and unpredictable situation, we now have the luxury of additional private sector forecasts that the Ministry of Finance did not possess at the time Ontario’s Action Plan was prepared.

First and foremost, this is a health crisis that must be dealt with and contained before the economy can truly be revived. With so much focus on jobs, the economy and layoffs, it is important to remember that a failure in health care will mean a prolonged failure in the economy. Currently, there is no clear timetable for the end of the COVID-19 health crisis, with more and more reports indicating the fight could last months, not weeks. As such, it is not really known how long the physical distance, stay at home and travel ban measures will stay in place.

Second, for Canada, and Ontario in particular, the situation in the United States is of increasing importance.  As Ontario’s largest trading partner, how well and how quickly the US deals with the pandemic will have economic repercussions on Ontario and Canada. To this point, the US response to COVID-19 has been worrisome and is underscored by their seemingly uncoordinated response. Some States, and even some cities, have implemented social distancing measures and lockdowns, while many others have not.  The caseload in the USA has risen dramatically in the last week and the country has the most cases of any country impacted by COVID-19.

Third, the 2020 economic forecast will also be dependent upon assumptions of how quickly the economy is able to re-start once the health measures are lifted or relaxed. If we think of the lockdown as a pyramid, with the summit being the end of new cases, we must descend the other side of the pyramid, slowly shedding each individual restriction that was placed.

How long after the “all clear” will it take before we feel comfortable sending our children to school or seating 50,000 people in the same baseball stadium? Simply, the longer the shutdown continues, the longer it will take to recover, and the higher the probability that many small businesses will go bankrupt and jobs will permanently disappear.

The Action Plan forecast of Real GDP growth of 0.0% and unemployment of 6.6% in 2020 reflected a “best case scenario” at the time of the drafting of the Action Plan. Since then, projections of the shutdown have grown longer and cases – especially in the United States – have grown even faster.

Normally when drafting a budget, the Ministry of Finance convenes private sector forecasters and bases the Ministry forecast at a level slightly below the private sector average. Given the unprecedented nature of this pandemic, this was not possible when finalizing the Action Plan since few if any private sector forecasts accommodating for the impact of COVID-19 existed.

Two days before the Action Plan was released, the Conference Board of Canada published an “Alternative Canadian Outlook” that was based on the assumption that the physical distancing measures and travel restrictions would continue to the end of August and would result in a Real GDP growth of  -1.1% and unemployment of 7.7%.

CIBC Capital Markets also released a forecast on March 23 that showed Real GDP growth of -2.6% and unemployment of 8.3% in Canada for 2020. CIBC also forecasted that second quarter Real GDP growth would be -18.4%.

Finally, on March 27, two days after the Action Plan was released, the Parliamentary Budget Office of Canada (PBO) published a report entitled “Scenario Analysis: COVID-19 Pandemic and Oil Price Shocks”. That report assumed that the existing physical distancing, self-isolation and travel ban measures would continue until the end of August. The PBO forecast Real GDP growth for Canada of -5.1% in 2020. This forecast includes a second quarter Real GDP of -25%. In terms of unemployment, the PBO estimates an unemployment rate of 12.4% in 2020. In this scenario, the PBO projects that the deficit would increase from $26.7B to $112.7B in 2020-21. Note that this deficit projection is before this week’s announcement of the 75% wage subsidy for all companies, nonprofits and charities that have experienced a 30% revenue decline.

For our purposes, we have reviewed the more detailed PBO forecast on Federal government revenue. Overall, the PBO forecasts a decline in revenue of 8.7% between 2019-20 and 2020-21 or $29.6 billion in less revenue. In this PBO forecast, federal Personal Income Tax (PIT) declines by 7%, Corporate Income Tax (CIT) is reduced by 14.7% and Duty/excise taxes drops by 17.6%.

The forecast in the Ontario Action Plan contains only slight variances between 2019-20 and 2020-21 for revenue projections. The Action Plan projects a net decrease of $0.5B in Taxation Revenues between 2019-20 and 2020-21, with PIT declining by $0.3B and CIT by $0.2B. Sales Tax remains constant in the Action Plan. The lack of growth is consistent with a 0% Real GDP figure, but if that number is too optimistic, so is the revenue. The Action Plan does, however, establish a Reserve of $2.5B to cushion some of the downside revenue risk. The government should be commended for establishing such a large Reserve in this uncertain time.

In this analysis we present two approaches to try to forecast the impact on the Government of Ontario’s revenue picture as a result of the economic impact of COVID-19.  The first approach utilizes the revenue impacts forecast by the PBO which are then applied to the Ontario context. In this approach we utilize the same percentage decreases in the PBO report by tax source and apply them to the Action Plan’s 2019-20 revenue numbers to establish a forecast for 2020-21.

The second approach is based on our earlier piece that looked at the impact of the 2008 recession on Government of Ontario revenues in order to approximate the impact of the pandemic.

Approach 1: Overlay PBO Model (Restrictions Until August, -5.1% Real GDP)

  • Corporate Income Tax would decline in proportion to the PBO estimate for the Federal government and would decline 14.7% between 2019-20 and 2020-21, or about $2.4B.
  • Personal Income Tax would decline by 7% between 2019-20 and 2020-21 or about $2.6B.
  • Sales Tax would decline by the amount of the decline of Excise taxes/duties, 17.6% or about $4.95B.
  • Total Revenue would decline in line with the PBO estimate of 7% or about $13.5B between 2019-20 and 2020-21.

Approach 2: 2008 Adapted Recession Model

  • Corporate Income Tax will likely decline by at least the percentage amount that occurred in 2008, though it is likely much higher given the shutdown. This would mean a decline of at least $8.4 Billion.
  • Given the very quick layoffs that are occurring across Ontario, especially in the important service industry, Personal Income Tax will likely decline in 2020. This will be somewhat offset by any income support programs that governments bring in (EI and CERB). In our recession model this decrease occurred in the second year of the recession (2008/09 to 2009/10). It will not likely be the case this time and PIT will likely decline at least 10% versus the Action Plan estimate or $4.0 Billion.
  • In the 2008 recession, Sales Tax held steady in the first year and then grew significantly in the 2nd and 3rd Given the shut-down of stores, restaurants, bars, etc., and the decrease in personal disposable income, it is very likely that Sales Tax will experience a decline in 2020 compared to the Action Plan projection. We assume that the decrease will be 15% or $4.4B.
  • In terms of the other taxes, it is likely that the Land Transfer Tax will also be reduced from the Action Plan 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. The Government Action Plan has reflected this, and GBE income has decreased from $5.7 B to $4.1B.
  • Based on the above analysis, Total Revenue would decrease by $16.8 B or 11% in 2020-21 as compared to the Action Plan forecast.

Under either scenario, the Government of Ontario would experience a revenue decline in 2020-21 as compared to 2019-20. This decline in revenue is in the range of $13.5 to $16.8B. This would result in a Total Revenue range for Ontario of $139.9B – $143.2B versus the Action Plan forecast of $156.3B in 2020-21.

That would increase the provincial deficit in 2020-21 from a projected $20.5B to a range of approximately $34B to $37.3B, before any additional unforeseen expenses are included, nearly doubling the largest deficit in Ontario’s history. Though the number may be staggering, it is clear that spending now to support the economy and affected workers is paramount. This number illustrates the size and scope of the challenge being faced by all governments at this difficult time.

We also want to be clear that this is not a critique of the March 25 projections, but rather an acknowledgement of the ever-evolving and deteriorating health and economic situations caused by COVID-19. At the time of drafting of the Action Plan, there was no clear indication of how long the social distancing measures would need to remain in place. This has become clearer in recent days with the Toronto Chief Medical Officer extending the actions for another 12 weeks.

The Government of Ontario is taking all the correct measures to deal with this pandemic. Hopefully, we will soon be focusing on the measures and supports needed to restart the economy and getting back to “normal”.