By Peter Shannon, M.A. Economics, Queen’s University

Ontario’s 2018 budget was released March 28, projecting an unanticipated deficit of $6.7 billion for the 2018-19 fiscal year. The 2017 budget projected that Ontario was on track for consecutive balanced budgets and indeed, Ontario ended a 10 year string of deficits with a $642 million surplus in 2016-17. [1] Given the province’s rapid growth and low unemployment in recent years, tighter fiscal policy seemed imminent. However, pre-election promises of free childcare, expanded prescription drug coverage and increased health care spending will push Ontario back into red ink this year. [2]

The political motivations of Ontario’s 2018 budget are clear: with the June 7 election looming, Premier Wynne’s Liberals are attempting to replicate the success of their federal counterparts. Like Justin Trudeau in 2015, the Ontario Liberals are promising to run a series of deficits to expand social programs, with an emphasis on families with young children, seniors, and mental health. [2] Both governments display a shift in focus from net debt levels to debt-to-GDP ratios as a measure of sustainability.

The Wynne government is hardly the first incumbent to ramp up public spending prior to an election, nor is it the first to do so with deficits.  Quebec’s Liberal government is also ramping up spending following years of budget cuts in advance of their October 1^st election, although they will still maintain a fiscal surplus. Through tax cuts and military spending the United States government more than doubled its budget deficit to $378 billion in 2003 and further increased it to $413 billion in 2004 as George W. Bush sought re-election. [3] On the other hand, in 2013 Australia’s Labor government surprised voters with an unforecasted 19.4 billion Australian dollar deficit and was handily defeated by a centre-right coalition. Even as an opposition party in 2015, the federal Liberals ran on a platform of strategic deficits to make ‘target investments’ through public spending. But how effective are deficit-financed election promises? And are there other reasons that an incumbent might choose to run a deficit in an election year?

Brenden and Drazen (2008) provide insight on the effect of budget deficits on re-election prospects. They study a panel of 350 elections in 74 countries and examine the effects of GDP growth and deficits, both in election year or throughout the term, on an incumbent’s probability of being re-elected. They find that increased deficits relative to GDP both in election year and earlier in an incumbent’s term decrease their probability of re-election. Both of these effects are significant in developed countries, whereas the election year effect is insignificant in less developed countries. [4] Brenden and Drazen’s results are unfavourable to the Wynne government’s strat- egy of announcing a deficit in an election-year budget. However, their model does not distinguish between governments who were forced into running an election year deficit and those who chose fiscal expansion in spite of strong economic conditions. It is also unclear whether voters punished incumbents for the deficits themselves or for austerity measures that they may have implemented in response, or perhaps even for inflation caused by fiscal expansions.

Klomp and de Haan (2013) examine the way that elections influence fiscal policy as well as its effectiveness in determining election outcomes. They report that few countries exhibit political cycles, meaning aggregate fiscal policy is rarely used for electoral objectives. This makes the Ontario Liberals’ strategy an exception rather than a trend for governments in Canada. However, in countries with political budget cycles, increased government does result in a small but significant increase in electoral prospects. They also find that fiscal expansions can have an indirect effect on election outcomes by stimulating economic growth. [5]

Still, between Brenden and Drazen (2008) and Klomp and de Haan (2013) there is little evidence that incumbents can systemically improve their political prospects by loosening fiscal policy in an election year. To better understand the Wynne government’s possible motives, we need a model that predicts when fiscal expansion will be rewarded by voters and what other motives an incumbent might have for running a deficit. Hodler (2011) develops a model predicting when an incumbent will run a deficit or increase spending prior to an election. Hodler assumes that the incumbent has two objectives: to maximize their probability of re-election and to strategically influence their opponent’s policy in the event that they are not re-elected. They do so by choosing public spending and the budget deficit prior to the election, then the winner must repay the debt and choose the level of spending in the following period. [6]

Hodler’s model does not apply exactly to Ontario since it considers a right-wing incumbent running against an opponent who prefers higher public spending. In that case, pre-election deficits have the advantage of discouraging further spending even if the left-wing opposition wins the election. By contrast, in Ontario Wynne’s Liberals run the risk that a newly elected PC government would respond to the deficit with even harsher spending cuts than if they inherited a balanced budget. Hodler claims that the results from his model can be reversed for an incumbent who prefers higher spending. However, in practice if the Liberals chose a surplus prior to the election and the Tories won they might use the inherited surplus to cut taxes rather than increasing spending, reducing funds for future spending projects. Alternatively, Hodler proposes that an incumbent anticipating a loss may attempt to smooth private consumption taking their successor’s policy as given. In Ontario’s case this would mean the government anticipates a jump in private consumption as a result of reduced public spending under a PC government. Running a deficit this year and leaving the Tories to repay it helps smooth private consumption while still allowing the Liberals to maintain high public spending for the current period.

We will not know until June 7^th whether Wynne’s promises of expanded social programs financed by public debt will earn the Liberals a renewed mandate. History suggests that the fiscal expansion itself will do little to boost the Liberals’ electoral hopes and that the particular programs they choose to spend on will be a more important factor. It remains to be seen whether promises of free daycare and expanded pharmacare will outweigh voters’ tendency of punishing incumbents for deficits. But even if a Doug Ford government next year is inevitable, Ontarians will be glad to keep their present consumption high in spite of this year’s public spending increases. Intentionally or otherwise, the smoothing effects of Wynne’s deficit in the event of a loss provide a sound rationale for an otherwise questionable deficit.

 

References

[1] The Hon. Charles Sousa. 2018 Ontario Budget: A Plan for Care and Opportunity. Government of Ontario, March 28

[2] Lundy, and Cardoso, T. “Five things to watch for in Ontarios budget”. The Globe and Mail, March 28 2018.

[3] Federal Reserve Economic Database. “Federal Surplus or Deficit”. Federal Reserve Bank of St. Louis. Web, accessed April 12

[4] Brender, and Drazen, D. “How Do Budget Deficits and Economic Growth Affect Reelection Prospects? Evidence from a Large Panel of Countries”. American Economic Review, Vol. 94, No. 5, December 2008.

[5] Klomp, J., de Haan, J. “Political budget cycles and election outcomes”. Public Choice, 157, No. 1, July 2013.

[6] Hodler, I. “Elections and the strategic use of budget deficits”. Public Choice, 148, No. 1, July 2011.