Provincial Public Finance in Ontario: An Empirical Analysis of the Last Twenty-five Years 9781487595418

Table of contents :
Contents
Tables
Preface
Acknowledgments
PART ONE: INTRODUCTION
1. The postwar Ontario setting
2. A model of provincial public finance
PART TWO: DESCRIPTION
3. The revenue categories
4. The expenditure categories
PART THREE: ANALYSIS
5. An empirical analysis of the revenue categories
6. An empirical analysis of the expenditure categories
PART FOUR: CONCLUSIONS
7. Summary and conclusions
Appendices
Bibliography

Citation preview

PROVINCIAL PUBLIC FINANCE IN ONTARIO: AN E M P I R I C A L ANALYSIS OF THE LAST T W E N T Y - F I V E YEARS

This page intentionally left blank

O.K. Foot

Provincial Public Finance in Ontario: an empirical analysis of the last twenty-five years

PUBLISHED FOR THE ONTARIO ECONOMIC COUNCIL BY U N I V E R S I T Y OF TORONTO PRESS TORONTO AND BUFFALO

©Ontario Economie Council 1977 Reprinted 2015 ISBN 978-0-8020-3350-5 (paper)

Canadian Cataloguing in Publication Data Foot, David K., 1944Provincial public finance in Ontario (Ontario Economic Council research studies; 12 ISSN 0078-5091) Bibliography: p. ISBN 978-0-8020-3350-5 (pbk.) 1. Finance, Public — Ontario. 2. Finance, Public — Ontario — Mathematical models. I. Title. II. Series: Ontario Economic Council. Ontario Economic Council research studies; 12. HJ795.05F65

336.713

C77-001369-4

This study reflects the views of the author and not necessarily those of the Ontario Economic Council. This book has been published during the Sesquicentennial year of the University of Toronto.

Contents

TABLES VU PREFACE ix ACKNOWLEDGMENTS xi PART ONE: INTRODUCTION 1

The postwar Ontario setting 3 2

A model of provincial public finance 24 PART TWO: DESCRIPTION 3

The revenue catégories 43 4 The expenditure categories 69

vi Contents PART THREE: ANALYSIS

5 An empirical analysis of the revenue categories 105 6 An empirical analysis of the expenditure categories 152 PART FOUR: CONCLUSIONS

7 Summary and conclusions 195 APPENDICES

A Revised data 197 B Growth rate calculations 199 C Weighted tax rates on a calendar year basis 205 BIBLIOGRAPHY 209

Tables

1 The Ontario economy, selected series, 1947-74 6 2 The age structure of the population of Ontario, 1947-74 7 3 The Ontario economy in relation to the Canadian economy, selected series, 1947-74 9 4 Expenditure estimates for the Government of Ontario, 1950/51-1974/5 12 5 Gross expenditures by the Government of Ontario, 1950/51-1974/5 14 6 Employment by the Government of Ontario, 1959/60-1974/5 17 7 The changing structure of the Government of Ontario, 1950/51-1974/5 20 8 The 1974/5 structure of the Government of Ontario 22 9 Total budgetary revenue, Government of Ontario, 1954/5-1974/5 31 10 Total non-budgetary revenue, Government of Ontario, 1954/5-1974/5 32 11 Distribution of total revenue, Government of Ontario, 1954/5-1974/5 33 12 Expenditure estimates by ministry, Government of Ontario, 1950/51-1974/5 34 13 Distribution of expenditure estimates by ministry, Government of Ontario, 1950/51-1974/5 35 14 Total financing, Government of Ontario, 1969/70-1974/5 37 15 Details of total revenue, Government of Ontario, 1974/5 53 16 Ontario taxation revenue categories: the personal and corporation income taxes and succession duties, 1951/2-1972/3 59 17 Ontario taxation revenue categories: detailed corporation taxes, 1951/2-1972/3 60 18 Ontario taxation revenue categories: retail sales taxes, 1951/2-1972/3 61

viii Tables 19 Ontario taxation revenue categories: motive fuel, race tracks, land transfer, and property taxes, 1951/2-1972/3 62 20 Ontario other revenue categories: health premiums, motor vehicles, and liquor revenues, 1951/2-1972/3 63 21 Ontario other revenue categories: natural resources revenues, 1951/2-1972/3 64 22 Ontario other revenue categories: fines and penalties, sales and rentals, interest on investments, and WCB contributions, 1951/2-1972/3 65 23 Payments to Ontario from other levels of government, 1951/2-1972/3 67 24 The relation between expenditure rank and budget size, 1974/5 77 25 Ontario health expenditure categories, 1950/51-1972/3 79 26 OHSC income statement, 1956-71 81 26 OHSC expenditure statement, 1956-71 82 28 Ontario education expenditure categories, 1950/51-1974/5 85 29 Ontario TKIA expenditure categories, 1950/51-1974/5 87 30 Ontario transportation expenditure categories, 1950/51-1974/5 91 31 Ontario social services expenditure categories, 1950/51-1974/5 93 32 Ontario'other'expenditure categories, 1950/51-1974/5 95 33 Ontario'other'expenditure categories, 1950/51-1974/5 98 34 Summary of Ontario expenditure categories 100 35 Ontario tax rates for selected revenue categories, 1951/2-1973/4 120 36 Ontario weighted tax rates for selected revenue categories, fiscal year basis, 1951/2-1973/4 128 37 Per capita personal disposable income, Ontario, 1950-73 166 38 Urbanization in Ontario, selected years, 1951-71 168 39 Elections in Ontario, some descriptive variables, 1950/51-1972/3 171 40 Results for the preliminary per capita expenditure equation 182 41 Extended per capita expenditure equation results 186 42 Tests of the long-run stimulation-substitution hypothesis 189 A.I The Ontario economy, selected series, 1969-74 197 A.2 The Ontario economy in relation to the Canadian economy, selected series, 1969-74 198 B.I Regression estimates of growth rates for revenue categories 202 B.2 Regression estimates of growth rates for expenditure categories 204 C.I Ontario weighted tax rates for selected revenue categories, calendar year basis, 1951-73 206

Preface

This study has been divided into four main parts. Part one presents introductory information, with chapter one providing economic and institutional background material and chapter two providing a brief review of the analytical background material with some descriptive analysis of aggregative medium-term trends. Both of these chapters are presented for those interested in a review of the structure, size, and medium-term trends of the operations of the Government of Ontario and the provincial economy in which it operates. The first section of chapter two (pp. 24-9), which can be excluded without interrupting the flow of this review, outlines the analytical background material which is used later in the study. Part two presents a detailed description of the various revenues (chapter three) and expenditures (chapter four) of the provincial government. Each of the chapters commences with a historical overview, followed by a brief discussion of the data sources and definitions used in the study. The main contribution of each of these two chapters is the development of historical data for numerous categories of revenues and expenditures for the Government of Ontario. The historical growth rate for each category is presented (in current and constant dollars) and the trends linked to the historical development of the operations of the provincial government over the postwar years. This part is historically descriptive and contains almost no material of a technical nature. Part three presents an analysis of the growth trends described in the previous two chapters. The analytical approach is econometric in nature and some familiarity with this type of approach is assumed. The revenue and expenditure sub-models are developed as an extension of the existing literature on these

x Preface subjects. However, in reviewing the relevant literature in the first sections of each of these chapters, it becomes readily apparent that almost no empirical work has been undertaken of the type reported in this study;namely a detailed, time-series analysis of the operations of a single sub-national government. Moreover, it is not hard to find repeated requests in the literature for such studies. This study is aimed directly at filling that void. The detailed data presented in part two are used to test the sub-models developed in part three and a number of conclusions are drawn from the estimated equations. The orientation of this part is toward explaining the medium-term trends in each of the detailed categories. Projection and simulation exercises are not examined in this study. Finally, part four of the study contains a brief chapter outlining the main findings of the research. It provides a very brief review of the conclusions obtained in the previous three parts, but provides no details to substantiate the conclusions. The reader is referred to the relevant section of the previous chapters of the study for such substantiation. It is hoped that this study provides a useful reference for those interested in an over-all review, a detailed description, and a detailed analysis of the revenue and expenditure operations of the Government of Ontario. The above chapter organization attempts to satisfy these interests. In addition, it is hoped that besides satisfying the above-mentioned interests, it also provides some impetus for a new orientation to the positive study of sub-national government finance: namely, an examination and analysis of the medium-term trends of the changing operations of a particular government over time. POSTSCRIPT

The analysis presented in this volume has since been updated and used to develop economic projections for the Ontario economy over the decade 1977-87. This work, authored by O.K. Foot, I.E. Pesando, J.A. Sawyer, and J.W.L. Winder, has been published separately by the Ontario Economic Council under the title The Ontario Economy 1977-87.

Acknowledgments

This study was commenced in the summer of 1974 and completed during the summer of 1975. The version for publication was prepared during the summer of 1976. During the summer of 1974 I was competently assisted with the preparation of the data base for the project and with the initial specifications of the equations by Ian Dalrymple and Keith Weaver. Mr Dalrymple's primary responsibility was for the compilation of the revenue series (see chapter three), while Mr Weaver assumed the responsibility for compiling the expenditure series (see chapter four). In carrying out these tasks both received invaluable assistance from numerous federal and provincial officials. Once the data base was well established more detailed work on the specification of the equations was possible. In preparing the empirical results (see chapters five and six) during the subsequent spring and summer I received able assistance from Anna Wei. To these assistants and to all of the other persons too numerous to mention individually who provided us with encouragement and assistance at various times throughout the project I extend my sincere thanks. The contractée for the study was the Institute for Policy Analysis at the University of Toronto, which, as always, provided an excellent environment in which to carry out this research. The valuable contributions of various research associates and students, as well as the competence and understanding of Institute staff, contributed immensely to the study. Finally no project is possible without a contractor. The Ontario Economic Council kindly sponsored the study with guidance, enthusiasm, and patience not often encountered in a sponsoring agency. As project director, I extend my sincere appreciation to each of these institutions and their staffs, for without them this study would not have been commenced, let alone completed.

This page intentionally left blank

PART ONE INTRODUCTION

This page intentionally left blank

1 The postwar Ontario setting

THE N A T U R E OF THE STUDY Studies of public finance have traditionally focused on the many roles of the central government and its influence on domestic and foreign economic activity. Comparatively little attention has been devoted to the various roles of sub-national (or junior-level) governments and only recently have the implications of their budgetary processes been analysed in a quantitative framework. 1 This relative neglect of the impact of sub-national governments on economic activity has important implications in Canada where the combined expenditures of provincial and municipal governments on goods and services are now over twice those of the federal government. 2 Consequently it seems important that considerably more attention be devoted to studies of the various levels of sub-national governments in Canada. This includes the provincial governments and the recently created regional governments, as well as the many municipal governments.3

1 A useful summary of this work is presented in Bird (1970, 209-24). 2 In 1974, for example, total national or federal government expenditure on goods and services was $8.3 billion while total provincial and local government expenditures (excluding hospitals) was $20.4 billion. Total government expenditures including intergovernmental transfers were $22.6 billion and $27.8 billion respectively (Canadian Tax Foundation, 1975, 2). 3 The term local governments will be used to represent both regional and municipal governments throughout this study.

4 Provincial Public Finance in Ontario It is doubtful that much could be learned from a study of all sub-national governments combined since it is apparent that regional-specific influences are dominant in determining the financial priorities of each government and its relationships with other governments, both sub-national and national.4 By aggregating all sub-national governments together, the impact of the various regional effects will be lost. This will be true not only for the total of all sub-national governments, but also for the sub-aggregates of all provincial governments and all local governments. To incorporate the regional, as well as the relevant national, influences into a study of sub-national government public finance it is necessary to disaggregate the information, and consequently the analysis, to be able to consider homogeneous sub-national government entities; that is, entities that are subject to similar regional influences. This study focuses on the largest of all of the sub-national governments in Canada — the government of the Province of Ontario. 5 By the fiscal year 1975/6,6 the budget of the Government of Ontario exceeded $11 billion. In recent years this budget has represented approximately one-fifth of the gross provincial product of the province and about 7 per cent of the gross national product of Canada. Approximately four-fifths of this budget is obtained from Ontario's own sources, with transfers from the federal government making up most of the remainder. Consequently the public finances of this particular junior government are very important, both from the point of view of total public finances in Canada and from its impact on the economic activity of the province. It is the object of this study to analyse the finances of the Government of Ontario over the past twenty-five years in considerable detail within a quantitative framework (outlined in chapter two). The annual revenues and expenditures of the government are disaggregated into numerous consistent time series (see chapters three and four), which are then subjected to analysis using econometric techniques (see chapters five and six). For this purpose the government universe is defined to include not only ministries of the government, but also government-owned institutions, certain agencies, and a number of 4 Local government in Canada derives its authority from the provincial legislatures and consequently can have no dealings directly with the federal government. The powers, responsibilities and revenue sources of local government are laid down by provincial statute in accordance with the British North America Act of 1867. 5 In fiscal year 1972/3 the Government of Ontario accounted for 35.4 per cent of gross provincial spending. It was followed by Quebec (29.7 per cent), the Prairie provinces (15.7 per cent), the Atlantic provinces (9.9 per cent), and British Columbia (9.3 per cent) (Canadian Tax Foundation, 1975, 32). 6 This description of fiscal years will be used throughout the study; for example, 1975/6 covers the period 1 April 1975 to 31 March 1976.

The postwar Ontario setting 5 special operations whose funds are available to the provincial government. It does not cover the operations of provincial government enterprises. 7 It should be emphasised that the orientation of the study is on medium-term trend analysis. The data presented and analysed cover only one generation and consequently long-term analysis is not possible. On the other hand, the short-term analysis that is the preoccupation of those responsible for annual budget estimates requires careful consideration of the many variables subject to short-term variations. Although the annual changes in the appropriate legislation and in the provincial and national economies will be incorporated into the analysis wherever necessary, the goal of the analysis presented in this study will be to focus on the medium-term trends rather than the year-to-year movements in the underlying series. This also has the advantage of approximately coinciding with the traditional duration of the term of office of the government in the province. 8 THE POSTWAR ONTARIO ECONOMY9

Before examining the size and structure of the Government of Ontario in more detail it is useful to review briefly some of the indicators of the economy in which it has been operating. Table 1 presents some selected indicators of the Ontario economy for the postwar period. Over this period the total population of the province grew at an average annual rate of 2Vz per cent. By the middle of 1974 it had been estimated that there were over 8 million people in Ontario 10 . Of particular note is that, over the period, the growth of population in the province has exhibited more of a linear than an exponential trend. However, the same growth pattern has not occurred at all ages of the population (see Table 2), which has reflected Canadian immigration policies and the movement of the postwar 'baby boom' through the age structure of the population. Since the early sixties it is apparent that the average age of the population has been rising. This is reflected by the proportion of the population in the 0 to 4 years age group now being the lowest it has ever been over the period, while the proportion in the 65 years and over age group has returned to levels experienced 7 This definition and terminology is borrowed from Statistics Canada. A more detailed elaboration is outlined in the second section of chapter three (pp. 54-7). 8 Actually, during the period covered by this study, elections have taken place every four years; that is, in 1951, 1955, 1959, 1963, 1967, 1971, and 1975. The same political party has been elected to form the government in each of these elections. 9 For a more detailed discussion see Richmond (1974). 10 Census information is available for 1951, 1961, and 1971. All other population figures are estimates supplemented by intercensus surveys in 1956 and 1966.

6 Provincial Public Finance in Ontario TABLE 1 The Ontario economy, selected series, 1947-74

Year

Population 1 (millions)

1947 1948 1949

4.176 4.275 4.378

1950 19S1 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974

4.471 4.598 4.788 4.941 5.115 5.266 5.405 5.636 5.821 5.969 6.111 6.236 6.351 6.481 6.631 6.788 6.961 7.127 7.262 7.385 7.551 7.703 7.825 7.939 8.094

GPP 2 (Sbillion) 5.444 6.188

6.701 7.410 8.440 9.189 9.905 10.045 10.803 12.179 13.318 13.488 14.118 14.638 15.360 16.335 17.795 19.543 21.661 24.473 26.336 29.215 32.523 34.988 37.777 42.400 49.846 58.270

Personal income 2 ($ billion) 4.235 4.851 5.199 5.638 6.521 7.207 7.681 7.930 8.525 9.320 10.211 10.802 11.406 11.923 12.187 13.098 13.976 15.030 16.537 18.655 20.553 22.844 25.629 28.022 30.599 33.835 38.963 44.997

Consumer price index 3 (1961 =100) 65.6 75.1

77.4 79.6 88.0 90.2 89.4 89.9 90.1 91.4 94.3 96.8 97.9 99.1 100.0 101.2 103.0 104.8 107.4 111.4 115.4 120.1 125.5

129.7 133.4 139.8 150.4 166.8

Unemployment rate (%) 1.8 1.7 2.3 2.4 1.7 2.2 2.1 3.8 3.2 2.4 3.4 5.4 4.5 5.4 5.5 4.3 3.8 3.2 2.5 2.5 3.1 3.5 3.1 4.3 5.2 4.8 4.0 4.1

1 At 1 June. 2 Revised data for 1969-73 are presented in appendix A. 3 All items for all Canada. SOURCES: Ontario Statistical Review, various issues, and Ontario Statistics 1975.

at the beginning of the period. Barring any massive changes in fertility or immigration, these trends have been projected to continue into the next decade (Dallimore and Lampert, 1973). Over the 25 years prior to 1974, the gross provincial product (GPP) of Ontario increased over eight times. This rate of growth represents a doubling

The postwar Ontario setting 17 TABLE 2 The age structure of the population of Ontario, 1947-74 (percentage distribution) Year

0-4 years

5-19 years

20-44 years

45-64 years

65 years and over

1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974

9.5 10.1 10.5 10.6 11.2 11.3 11.4 11.5 11.6 11.6 11.7 11.9 11.9 11.8 11.9 11.8 11.8 11.5 11.2 10.7 10.2 9.7 9.1 8.7 8.3 8.2 8.0 7.9

23.2 23.0 22.8 22.7 22.6 23.2 23.6 24.0 24.4 24.7 25.2 25.8 26.2 26.8 27.3 27.8 28.4 28.9 29.2 29.6 29.7 29.9 29.9 29.9 29.7 29.2 28.8 28.3

38.1 37.9 37.9 37.8 37.7 37.5 37.3 37.0 36.7 36.3 36.4 35.9 35.4 34.8 34.3 33.7 33.3 33.1 33.0 33.2 33.4 33.6 33.8 34.2 34.6 34.9 35.3 35.9

20.6 20.4 20.2 20.1 19.8 19.4 19.2 19.0 18.9 18.7 18.5 18.3 18.4 18.4 18.4 18.4 18.4 18.4 18.4 18.4 18.5 18.7 18.9 19.0 19.1 19.3 19.4 19.4

8.5 8.6 8.7 8.7 8.7 8.6 8.5 8.5 8.5 8.6 8.2 8.1 8.1 8.1 8.1 8.2 8.2 8.2 8.2 8.1 8.2 8.2 8.2 8.3 8.3 8.4 8.5 8.6

NOTE: Row totals may not add to 100 per cent due to rounding SOURCES: Calculated from data contained in the Ontario Statistical Review, various issues, and Ontario Statistics 19 75.

approximately every eight years. The growth in personal income has exhibited an almost identical growth pattern, with personal income in Ontario reaching almost $45 billion by 1974. Per capita personal income therefore has risen from just over $1000 in 1947 to over $5500 by 1974. Of course not all of this increase represents 'real' gains because these figures also embody the effects of

8 Provincial Public Finance in Ontario price changes. Since price indices are not constructed at a provincial level11, the consumer price index (cPl) for all of Canada is included in Table 1 as an indication of the general trend in prices. Over the period, consumer prices rose on average by approximately 3J/2 per cent per year. Consequently, using the CPl as the deflator, per capita 'real' personal income (in 1961 dollars) rose from just over $1500 in 1947 to over $3300 by 1974; that is, more than doubling over the postwar period. These secular trends, however, were marked by short-term variations in economic activity in the province. Over the period the unemployment rate varied between a low of 1.7 per cent of the labour force (in 1948 and 1951 ) to a high of 5.5 per cent of the labour force (in 1961). It has exceeded 4 per cent of the labour force in two periods: 1958-61 and 1970-74, whereas it was below 3 per cent of the labour force for the entire period prior to 1954, again in 1956 and for the two years 1965-6. This indicates that, except for the slight interruptions associated with the Korean war, the period up to and including the mid-fifties presented a relatively buoyant economy which was in contrast to that of the late fifties and early sixties when unemployment rose to higher levels. From 1962 through 1965 unemployment rates steadily declined only to turn around in 1966 and rise to a peak in 1971 which was then followed by another trough in 1973. Finally it is useful to compare the performance of the economy of Ontario with that of the whole country. This information is presented in percentage form in Table 3. Over the past five decades the population of Ontario has accounted for approximately one-third of the population of Canada. However, over the postwar period there has been a trend towards an increasing proportion of the population of Canada resident in Ontario. With the exception of the 1961-2 period the rate of increase of the population of Ontario has exceeded the national average and for the period 1970-71 it was over twice that of the national average. By 1974 over 36 per cent of the population of Canada was resident in the province of Ontario. The GPP of Ontario as a percentage of the GNP of Canada has averaged a little under 40 per cent over the postwar period, being relatively lower during the early sixties and somewhat higher for 1968-74. Similarly, the personal income of Ontario has averaged around 40 per cent of the total Canadian personal income and since 1968 has been over 41 per cent suggesting a slightly increasing trend towards the end of the period. 11 They are, however, available for regional cities. In Ontario they are publicly available for the cities of Toronto, Ottawa, and Thunder Bay. The national series is used in this study because of the difficulties of selecting appropriate weights to combine the regional series and because it is available over a much longer time period.

The postwar Ontario setting 19 TABLE 3 The Ontario economy in relation to the Canadian economy, selected series, 1947-74 (per cent) Year

Populatior

Gross product 1

Personal income 1

1 Jnemployment 2

1947 1948

33.3 33.3 32. 6 3 32.6 32.8 33.1 33.3 33.5 33.5 33.6 33.9 34.1 34.1 34.2 34.2 34.2 34.2 34.4 34.6 34.8 35.0 35.1 35.2 35.5 35.7 35.8 35.9 36.1

40.4 39.9 39.9 40.1 39.0 37.4 38.3 38.8 37.9 38.0 39.7 38.8 38.3 38.2 38.7 38.1 38.7 38.9 39.1 39.6 39.7 40.2 40.7 40.9 40.4 41.0 41.9 41.8

38.8 38.5 38.8 39.5 38.8 38.8 39.3 40.2 40.1 39.6 40.6 40.5 40.6 40.3 40.5 39.9 40.1 40.3 40.3 40.5 40.6 41.0 41.5 42.0 41.7 41.3 41.5 41.1

().4 t).6 C).5 1 .2 C).7 C).7 ().9 ().8 1.2 0 1. 1.2 1.6 1.5 1.6 1.6 1.6 1.7 1.5 1.4 1.1 1.0 1.3 1.6 1.6 1.2 1.5 1.6 1.3

1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974

1 Revised data for 1969-73 are presented in appendix A. 2 Difference between Canadian and Ontario unemployment rates. 3 Newfoundland entered confederation. SOURCES: Calculated from data contained in Table 1 and the Canadian Statistical Review, various issues.

Over the same period the unemployment rate in Ontario has been consistently less than the national average ranging from a difference of slightly less than one-half of one percentage point to over 1% percentage points. Since 1955 it has always remained at least one percentage point below the national average. It is important to note that even though unemployment was high in

10 Provincial Public Finance in Ontario Ontario during the period 1958-61, it was still at least 1% percentage points lower than the national average and consequently, from this point of view, Ontario was still a comparatively attractive province in which to reside. In summary, the postwar economy of the province of Ontario has been a growing economy. Population, GPP, personal income, personal income per capita, and real personal income per capita have all increased substantially. However, there have been some noticeable fluctuations in this medium-term growth pattern with the age composition of the population changing significantly throughout the period and the unemployment rate reflecting the buoyant and relatively less buoyant periods in the postwar years. Relative to the rest of Canada, the economy of Ontario appears to have been very 'healthy,' with unemployment rates consistently below the national average and per capita incomes consistently above the national average (since roughly one-third of the people receive two-fifths of the personal income). This is the economy from which the Government of Ontario has received most of its revenues and into which it has directed its expenditures. The magnitude and organization of this involvement is briefly examined in the following two sections. THE SIZE OF THE P R O V I N C I A L G O V E R N M E N T The major source of information on the finances of the government of the province of Ontario is the Public Accounts.12 Published annually by the provincial auditor, usually at the beginning of the calendar year, it presents a complete account of the financial record of the government's activities for the previous fiscal year. Unfortunately over the postwar period a number of different accounting procedures have been followed making the construction of a consistent time series of government operations exceptionally difficult. Moreover, the scope of government activity has changed over the period with some functions being transferred to and from independent agencies that are not included in the accounts and with other functions being transferred to and from the private sector. Consequently, any financial measure of the size of the provincial government over time will incorporate a number of inconsistencies that are difficult to avoid. Traditionally the best measure of the size of government is given by the size of the budget. This represents the total amount of money disbursed by the government over the year under consideration. In Ontario, a budget statement is 12 The Statistics Canada publication Provincial Government Finance is based on the Public Accounts. This information source will be discussed in detail in the second section of chapters three (pp. 54-7) and four (pp. 75-7).

The postwar Ontario setting 11 presented by the government (to the legislature) towards the end of the fiscal year (usually in February) which outlines the planned public finances for the forthcoming fiscal year. It also includes figures for the previous year (or years) and the current year (based on the experience from April to December). This statement includes estimates of both revenues and expenditures, the difference being the estimated surplus or deficit. The details of the planned expenditures are outlined in a further publication entitled Expenditure Estimates. The first column of Table 4 presents the expenditure estimates of the Government of Ontario for the fiscal years 1950/51 to 1974/5. This provides an indication of the size and growth of the provincial government. Over the first decade expenditure estimates rose from around $350 million to reach $1 billion by 1960/61. Over the subsequent decade there was a five-fold increase so that by 1970/71 expenditure estimates amounted to over $5 billion. By 1974/5 they amounted to nearly $9 billion. For the first decade, year-to-year increases averaged out at considerably less than $100 million. This was followed by a period of four years (1961/2 to 1964/5) when annual increases averaged slightly over $100 million. Then in 1965/6 the increase jumped to over $400 million and only once since then has the annual budget increase been lower (column two, Table 4). Although the figures in the later years reflect certain accounting changes and changes in the scope of government activity, the general conclusion remains unchanged—since the mid-sixties there has been a very rapid growth in provincial government expenditures in the province. Moreover this growth apparently was not anticipated. 13 Some of this growth reflects a rising price level, so to obtain a more accurate evaluation of the growth in government expenditures it is necessary to deflate the expenditure estimates. No appropriate price deflator exists at present, so it is necessary to use a proxy deflator. The most appropriate proxy for this purpose is the implicit price index for government current expenditure on goods and services published as part of the National Income and Expenditure Accounts. 14 Moreover these data are available on a quarterly basis so that it is possible to calculate an index series appropriate to the fiscal year (by averaging the second, third, and fourth quarters of one year with the first quarter of the subsequent year). The results of these calculations are presented in Table 4. The final two columns of the table present the deflated expenditure estimates and annual changes (in 1961 dollars) with the former being plotted in Figure 1. The general 13 The report of the Ontario Committee on Taxation (1967) presented to the provincial government in August 1967 included a projection of public finances to 1975 (in chapter six) in which the rapid growth in expenditures was not anticipated. 14 See the Canadian Statistical Review, Table 1.8.

12 Provincial Public Finance in Ontario TABLE 4 Expenditure estimates for the Government of Ontario, 1950/51 - 1974/5 ($ million)

Fiscal year 1950/51 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1976/2 1972/3 1973/4 1974/5

Expenditure estimates

Annual changes'

353

383 414 461 510

569 648 820 933 990 1007 1135 1254 1369 1459 1871 2323 3084 3735 3990 5091 5876

7071 7987 8917

29 31 47 49

59 79 172 113 57 17 128 119 115 90 412 452 761

651 255 1101

785 1196 916 930

Prices 2 (1961 =100) 61.9 69.2

71.3 73.4 76.2 79.0 84.8 88.7 91.1 94.3 97.7 100.7 103.0 107.6 111.5 117.4 124.8 133.5 141.5 153.7 162.9 172.9

183.9 195.6 208. 1 4

Deflated expenditure estimates 570 553 581

628 669 720 764 924 1024 1050 1031 1127 1217 1272 1309 1594 1861 2310 2640 2596 3125 3398 3845 4083 4285

Deflated annual changes

-42 44 64 64 75 93 194 124 60 -17 129 116 107 81 351 362 570 460

-166 676

454 650 468 447

Expenditure estimates/ GPP3 (per cent) 4.8 4.5 4.5 4.7

5.1 5.3 5.3 6.2 6.9 7.0 6.9 7.4 7.7 7.7 7.5 8.6 9.5 11.7

12.8 12.3 14.6 15.6

16.7 16.0 15.3

1 Differences may reflect rounding. 2 Calculated from the quarterly data on the implicit price index for government current expenditure on goods and services in the National Income and Expenditure Accounts. 3 For example, fiscal year expenditures for 1950/51 divided by GPP for 1950. 4 Estimated. SOURCES: Ontario Expenditure Estimates, various issues, and Table 1.

conclusion remains unaltered-since 1965/6 there has been a rapid growth in government expenditure estimates in constant (1961) dollars, averaging a little under half a billion (1961) dollars per year (which represents approximately one billion dollars in 1974 prices). It is interesting to note that, according to these figures, the annual increases have not always been sufficient to compensate for

The postwar Ontario setting 3 Figure 1 Expenditure estimates - deflated and as a ratio to GPP, 1950/51 - 1974/ 75 Source: Table 4

inflation. In three fiscal years (1951/2, 1960/61, and 1969/70) the deflated expenditure estimates declined slightly although in each case they do not appear to be much at variance with the underlying medium-term trend. It is also interesting to note that these figures suggest that between 1972/3 and 1973/4 it would have been necessary to increase the estimated expenditures by slightly over $750 million just to keep up with inflation. The final column in Table 4 provides another indicator of the growth of government expenditures in the province. It shows the expenditure estimates expressed as a percentage of GPP (which is also included in Figure 1). An upward trend is evident for the decade and a half prior to the mid-sixties, but in 1965/6 the trend clearly accelerated confirming the conclusion reached above. However what is particularly interesting about this indicator is the turnaround over the last two years covered by the data, which suggests that government expenditure growth did not match the growth in the provincial economy over this period. The expenditure estimates show how much the government intends to spend, not how much it actually spends. During the fiscal year supplementary expenditure estimates may be released representing revisions to the original

14 Provincial Public Finance in Ontario TABLE 5 Gross expenditures by the Government of Ontario, 1950/51-1974/75 ($ million) Fiscal year

Net expenditures

Reimbursements of expenditures

Gross budgetary expenditures

Disbursements and charges

Gross expenditures

1950/51 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3

250 301 348 372 399 425 478 591 642 702 739 825 993 1078 1237 1442 1799 2297 2775 3249 3846 444S3 51853

9 12 14 15 18 19 20 23 25 39 38 39 46 51 54 73 132 257 340 4693 668 775 1295

259 313 362 387 418 443 498 614 668 741 777 864 1039 1129 1291 1515 1931 2554 3116 3718 4514 5223 6480

9 1211 65 1 146 1 - 2 452 602 129 1 ' 2 1012 1871'2 1022 65 42 60 86 125 294 470 618 674 818 797 890 842

268 434 427 534 463 503 626 715 855 843 841 906 1099 1215 1416 1809 2401 3172 3790 4537 5311 6113 7323

1 Includes advances to Ontario Hydro. 2 Includes payments into the Highway Construction Account. 3 Calculated. SOURCE: Public Accounts of Ontario, various issues.

estimates as deemed necessary for the appropriate management of the government. Moreover unforeseen circumstances may result in further changes and it is the final expenditures which incorporate all the changes during the fiscal year that are recorded in the Public Accounts. The method of recording these expenditures has been altered substantially over the years so that it is difficult to construct a consistent series. Table 5 presents the information contained in the Public Accounts in the following framework: net expenditures plus reimbursement of expenditures equals gross budgetary expenditures, plus disbursements and charges equals gross expenditures.

The postwar Ontario setting 15 Prior to 1968/9 gross budgetary expenditures were recorded as gross expenditures in the accounts while after 1970/71 net expenditures are not recorded. A related and much more serious limitation of these series arises from the changing interpretation of 'reimbursements.' Prior to 1967/8 many items now included in reimbursements were defined as 'refunds' and were netted out of expenditures but not included in reimbursements. Consequently gross budgetary expenditures up until this time excluded refunds. It took up to two years for this change to be incorporated and this is reflected in the sharp rise in the reimbursements series at that time. As a result, data prior to this period are biased downwards in comparison to the later years. A further complication arises in the disbursements and charges series where advances to Ontario Hydro and the use of the Highway Construction (or Reserve) Account affect the interpretation of the series in the earlier years. Finally, the increase in reimbursements for 1972/3 reflects reimbursements from the federal government for hospital care which formerly went to the (now defunct) Ontario Hospital Services Commission.15 For these reasons these series represent a somewhat less than satisfactory description of the expenditures of the government of the province. However, in spite of these limitations the same general conclusion emerges as previously - commencing in 1965/6 there was a rapid increase in the expenditures of the provincial government. Deflating the series or expressing it as a percentage of GPP does not alter this conclusion as the following summary figures indicate: Fiscal year

Deflated expenditures ($1961 million)

Expenditures/GPP (per cent)

1950/51 1955/6 1960/61 1965/6 1970/71

433 637 861 1541 3260

3.6 4.7 5.7 8.4 15.2

In summary, these figures generally indicate that deflated expenditures of the provincial government doubled over the decade of the fifties and then doubled again in each of the subsequent five-year periods. 15 For this reason recent publications of the Estimates have revised gross expenditures for the previous two years to be consistent with those of 1972/3. The figure for 1970/71 is $5944 million and for 1971/2 it is $6812 million. For further details see the third section of chapter four (pp. 78-83).

16 Provincial Public Finance in Ontario Before leaving these financial indicators of the size of the provincial government, three observations on the data are pertinent. Firstly, because of the accounting changes used in compiling the Public Accounts, particularly in the treatment of reimbursements, the Estimates perhaps give a more accurate indication of the growth of gross provincial expenditures. The Estimates have always been compiled in gross terms; that is, without netting out the reimbursements (or refunds). The obvious limitation of using the Estimates for this purpose is that they do not incorporate the supplementary changes in expenditures (both estimated and actual) that subsequently took place during the fiscal year. Secondly, by comparing the price indices presented in Tables 1 and 4, it is clear that the implicit government price deflator has increased much more rapidly than the CPI since 1961. This difference might arise from a fundamental difference in the rate of inflation in the two sectors, but it might also arise from a fundamental difference in the construction of the two index numbers. Basically the implicit price indices for the expenditure items in the National Accounts (from which the index in Table 4 is constructed) use current period quantities as weights, while the CPI uses base period (1961) quantities as weights. The former is called a Paasche index while the latter is called a Laspeyres index. These are probably the two most commonly used methods of index number construction and will, in general, give different results when applied to the same data. In a period of rising prices and increasing quantities (as has occurred over the postwar period) the Paasche index will often indicate a relatively higher rate of inflation compared to the Laspeyres index.16 Consequently the use of a Paasche index to deflate government expenditures above results in an even slower growth than if a Laspeyres index has been used. Thus, the conclusion is based on a price deflator which, if anything, is biased against it. As a third and final observation on the data it should be noted that the implicit price index for government expenditure on goods and services used above has 16 In general it can be shown (Karmel, 1957) that: Laspeyres Index / Paasche Index = 1 —(rxysxsy/ K)> where x is a vector of relative prices, y is a vector of relative quantities, V is a ratio of relative values, r is the correlation coefficient and s is the standard deviation. Therefore if relative prices or relative quantities remain unchanged between two periods (sx or s = 0 , respectively) or if there is no correlation between relative price and relative quantity movements (r = 0), the two indices are the same. However, if sx =£ 0, s =£ 0, and r > 0 (assumed in the text), the quotient on the right hand side of the above expression will be positive which implies that the Paasche Index is greater than the Laspeyres Index.

The postwar Ontario setting 17 TABLEÓ Employment by the Government of Ontario, 1959/60- 1974/5 Fiscal year

Government employment1

Government employment per real dollar of gross expenditure2

Per cent of Ontario Labour force employed by the government 3

1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

32,302 34,599 36,468 39,970 41,415 43,141 45,867 50,507 55,733 57,375 62,280 65,018 64,996 67,501 68,634 69,789

30.8 33.6 32.4 32.8 32.6 33.0 28.8 27.1 24.1 21.7 24.0 20.8 19.1 17.6 16.8 16.3

1.36 1.44 1.51 1.61 1.62 1.65 1.69 1.78 1.90 1.89 1.99 2.00 1.92 1.92 1.87 1.83

1 As at 31 March. 2 Persons per one million 1961 dollars (Table 6, column 1, divided by Table 4, column 4). 3 Labour force is the annual average for the calendar year (so there is an approximate 3-month difference in the two series). SOURCES: Ontario Civil Service Commission, Annual Reports, and Canadian Statistical Review, various issues.

risen more rapidly than all of the other implicit price indices for gross national expenditure. 17 Although this cannot be attributed to a different method of construction it does indicate that in choosing this proxy deflator for this study, it is unlikely that the conclusion concerning the rapid growth in real provincial expenditures is based on an understatement of the rate of inflation. A physical measure of the size of the provincial government is the amount of employment it undertakes. Unfortunately, this information is not available publicly prior to 1960, but since that date employment figures have been available from the annual reports of the Civil Service Commission. These are presented in Table 6 and Figure 2 where it can be seen that, over the period covered by the data, employment in the Government of Ontario more than 17 The implicit price indices for 1974 were: consumption, 158.8; investment, 177.5; government, 211.2; exports, 184.1; imports, 165.8, and GNE, 176.1.

18 Provincial Public Finance in Ontario Figure 2 Employment by the government of Ontario 1959/60 - 1974/75

Source: Table 6

doubled. Like the expenditure series, there was a rapid growth under way following the mid-sixties. However, unlike the expenditures, this pattern was broken in 1969 when a slower growth path was followed. Over the entire period the growth in employment has not kept up with the growth in real expenditures. The declining ratio of government employment to real estimated expenditures is indicated in Table 6 where it can be seen that the number of persons employed per one million (1961) dollars expended has almost halved over the period. Also included in Table 6 is the ratio of government employment to the total labour force in Ontario. From these figures it can be deduced that the provincial government gradually increased its proportion of labour force employment until it reached 2 per cent in 1971. Since then, however, the proportion has declined slightly. In summary, by all indicators, the size of the Government of Ontario has been growing quite rapidly over the postwar period. Total spending by the government has been rising in both current and deflated dollars, especially since the mid-sixties when the rate accelerated noticeably. Expenditures expressed as a percentage of GPP also grew over the period and especially since the mid sixties, although it is interesting to note that this indicator suggests that expenditure

The postwar Ontario setting 19 growth has not matched the growth of the provincial economy in recent years. Employment by the provincial government has also been rising, both in absolute numbers and as a percentage of the labour force of the province. However, the employment growth has not matched the expenditure growth with the result that persons employed per dollar spent has approximately halved since 1960. THE ORGANIZATIONAL STRUCTURE OF THE PROVINCIAL GOVERNMENT The organizational structure of the Government of Ontario is currently based on the concept of a 'ministry' (formerly called a department) which is in charge of administering certain defined and related programs in a functional area. In fiscal year 1973/4, the Government of Ontario created 'super-ministries' to coordinate the programs and policies in the fields of general government, justice, resources development, and social development. The orientation of these ministries is towards the co-ordination, not the administration, of programs and policies. Over the years the structure of the provincial government has been changed as new programs have been developed and existing programs eliminated or reformulated, or as existing organizational structures became outdated. Table 7 summarizes the changing organizational structure of the Government of Ontario since 1950/51. It should be emphasized that these changes in ministerial (or departmental) titles do not bear a unique correspondence to changes in the programs administered by the ministries (or departments). For example, many programs are initiated or changed without being reflected in a titular change. In 1950/51 there were twenty departments, whereas by 1974/5 the organizational structure had grown to twenty-nine ministries and offices. The structure of the Government of Ontario for the fiscal year 1974/5 is summarized in Table 8 where the division of the ministries into the four policy fields is apparent. General government embraces ten ministries, justice policy five, resources development eight, and social development policy five. By comparing Tables 7 and 8 it can be deduced that only five ministry titles have remained unchanged over the twenty-four years — Education, Health, Labour, Lieutenant Governor, and Provincial Auditor. Two others — Agriculture and Food and Premier - have been changed only slightly. Consequently, of the twenty-nine ministries at present existing, twenty-two either have been introduced or incorporate significant titular changes since 1950/51.18 1 8 It should be noted that Attorney General was renamed Justice which was then broken into Attorney General and Solicitor General.

20 Provincial Public Finance in Ontario

TABLE 7 The changing structure of the Government of Ontario, 1950/51 - 1974/5 Fiscal year

Number of ministries (or departments)

1950/51 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61

20 20 20 20 20 20 21 22 22 23 23

1961/2

22

1962/3 1963/4 1964/5

23 23 23

1965/6 1966/7

23 24

1967/8 1968/9

24 25

1969/70 1970/71

25 26

1971/2

25

Ministry (or department) changes

Provincial Treasurer renamed Treasury. Economics introduced. Transport introduced. Energy Resources introduced. Planning and Development renamed Commerce and Development. Provincial Secretary renamed Provincial Secretary and Citizenship. Commerce and Development and Economics amalgamated to Economics and Development. Civil Service introduced. Energy renamed Energy and Resource Management. Travel and Publicity renamed Tourism and Information. Insurance removed. University Affairs introduced. Agriculture renamed Agriculture and Food. Public Welfare renamed Social and Family Services. Financial and Commercial Affairs introduced. Reform Institutions renamed Correctional Services. Treasury, and Economics and Development renamed Treasury and Economics, and Trade and Development. Revenue introduced. Attorney General renamed Justice. Mines renamed Mines and Northern Affairs. Treasury Board introduced. University Affairs renamed Colleges and Universities. Energy and Resources Management renamed Environment. Highways and Transport amalgamated into Transportation and Communications.

The postwar Ontario setting 21 TABLE 7 (Cont'd) The changing structure of the Government of Ontario, 1950/51 — 1974/5 Fiscal year

Number of ministries (or departments)1

1972/3

23

1973/4

27

1973/4

28

1974/5

29

Ministry (or department) changes (Adoption of ministries in place of departments). Prime Minister renamed Office of the Premier. Civil Service renamed Civil Service Commission. Treasury Board renamed Management Board. Provincial Secretary and Citizenship and Public Works amalgamated into Government Services. Treasury and Economics and Municipal Affairs amalgamated into Treasury, Economics and Intergovernmental Affairs. Financial and Commercial Affairs renamed Consumer and Commercial Relations. Tourism and Information and Trade and Development amalgamated into Industry and Tourism. Lands and Forests and Mines and Northern Affairs amalgamated in Natural Resources. Social and Family Services renamed Community and Social Services. Justice divided into Attorney General and Solicitor General. Cabinet Office introduced. Office of the Speaker introduced. (Adoption of super-ministries). Justice Policy introduced. Resources Development Policy introduced. Social Development Policy introduced. Civil Service Commission removed. Housing introduced. Energy introduced. Office of Speaker renamed Office of the Assembly. Culture and Recreation introduced.

1 Excludes the Government Printer. NOTES: The changes outlined in this table do not imply similar changes in programs; that is, the introduction of a new department does not necessarily imply the introduction of new programs nor does the amalgamation of departments necessarily imply the amalgamation of exactly all of the programs previously existing in the separate departments. Conversely, no change in department titles does not necessarily imply that no changes in programs occurred. SOURCE: Public Accounts of Ontario, various issues

22 Provincial Public Finance in Ontario

TABLE 8 The 1974/5 structure of the Government of Ontario Policy Field

Number Ministries

Expenditure rank

1 General Government I II III IV V VI VII VIII

Office of the Lieutenant Governor Office of the Speaker Office of the Premier Cabinet Office Management Board Office of Provincial Auditor Government Services Housing Revenue Treasury, Economics and Intergovernmental Affairs

28 20 24 23 19 22 8 7 11 3

Justice Policy Attorney General Consumer and Commercial Relations Correctional Services Solicitor General

27 15 17 14 13

3 Resources development policy XVI Resources Development Policy Agriculture and Food XVII XVIII Energy Environment XIX Industry and Tourism XX Labour XXI Natural Resources XXII Transportation and Communications XXIII

26 12 21 9 16 18 10 5

IX X 2 Justice policy XI XII XIII XIV XV

4 Social development policy XXIV XXV XXVI XXVII XXVIII

Social Development Policy Colleges and Universities Community and Social Services Education Health

SOURCE: Ontario Expenditure Estimates, 1974-5.

25 4 6 2 1

The postwar Ontario setting 23 As an introduction to the importance of the different ministries — a subject covered in detail in chapter four — the expenditure rank based on the 1974/5 dollar Estimates is recorded in Table 8.19 Based on this information, it is apparent that the social development policy field is by far the most important, while the justice policy field is the least important from this viewpoint. Social development embraces the areas of education, health, and social services. To a large extent this relative importance reflects (not only the grouping of the ministries but also) the responsibilities accorded to the provinces under the British North America Act of 1867 and subsequent interpretations and clarifications.20 In summary, the organizational structure of the provincial government is based on ministries (formerly called departments) which administer and co-ordinate defined and related programs in functional areas. This structure has changed considerably over the years and is now arranged in four general policy fields, the most important of which is the social development field. To examine the relationships between the structure and the size of the government it is necessary to outline a complete model of the public finances of the province, examine the medium-term trends to be explained, and develop a methodology to analyse this information. This is the subject of the following chapter.

19 The new ministry of Culture and Recreation ranks twelfth in the 1975/6 expenditure estimates. This results in a slight reordering of the other ministries. 20 For a review of the development of social development policy in the province over the postwar period, see Lang (1974).

2 A model of provincial public finance

THE I N G R E D I E N T S OF A COMPLETE M O D E L

A complete model of provincial public finances should incorporate the three fundamental elements of any financial system — the revenues, the expenditures and, since in the case of provincial governments these need not be the same, the financial implications of the difference. If revenues are greater than expenditures, the surplus of funds must be invested somewhere (or used to retire accumulated debt). Conversely if expenditures are greater than revenues, the deficit must be financed from a cash reserve or by borrowing either from the public or from non-public sources. Unlike the federal government, the provincial governments do not have the option of printing money to finance their deficits, but unlike the local governments they are not required by law to equate current revenues and expenditures every year. The essential ingredients of a complete model of provincial public finances therefore are : (1) A revenue sub-model which explains the revenues received each fiscal year from all revenue sources including both budgetary and non-budgetary sources. Budgetary revenue encompasses all taxation sources plus revenue from fees, licences, royalties, etc. together with payments from the federal government and interest on investments. Non-budgetary revenue covers repayments of loans and advances and revenue from pension funds and other reserve accounts. (2) An expenditure sub-model which explains the expenditures each fiscal year by all government ministries. This includes both discretionary and statutory expenditures and all non-budgetary disbursements and charges. Since each

A model of provincial public finance 25 ministry is responsible for certain programs (including co-ordination of programs) expenditures could be further disaggregated by program. (3) A finance sub-model which explains how the government disposes of additional funds or raises needed funds. In the former case, additional funds can be used to pay back loans or retire the accumulated debt, both public and non-public. In the latter case, the cash requirements can be raised by depleting cash reserves, borrowing from the public (in the form of treasury bills and debentures) thus raising the public debt or borrowing from non-public sources such as superannuation and pension funds. Ideally these three sub-models should be constructed together since the decisions they represent are simultaneously determined. As a result of this simultaneity certain restrictions can be imposed on the construction of the submodels. Firstly, there is the accounting restriction which requires that:

R -E + F = 0,

(1)

where R is the sum of all revenues obtained from the revenue sub-model, E is the sum of all expenditures obtained from the expenditure sub-model, and Fis the total cash requirements (if positive) or surplus (if negative).1 This implies that the results of any two of the sub-models outlined above constrains the third according to identity (1). Since each sub-model will contain a number of different categories of finances to be explained, this identity serves the purpose of explaining one category somewhere in the public finance model. This might be conveniently called the residual category. For example, if all revenue and expenditure categories are explained in the revenue and expenditure sub-models and the financing decision centres on the composition of public and non-public borrowing (denoted Fp and FNp respectively), the financing of a deficit with the level of Fp determined in the financing sub-model requires that FNp becomes the residual in the public finance model determined from the identity:

Just where the residual category occurs in the model of public finances depends on an interpretation of the political process. There are three alternative, simplistic possibilities, (i) The government decides on revenues and expenditures which then constrain the financing decisions, (ii) The government decides on revenues and financing which then constrain the expenditure decisions, (iii) The government decides on expenditures and financing which then constrains the 1 A deficit will imply a positive F while a surplus will mean that F is negative.

26 Provincial Public Finance in Ontario revenue decisions. Different people will view the political process in different ways. Most writers, be they political scientists, economists, management, or organizational experts, appear to assume either explicitly or implicitly that the political process in North America is relatively stable over time.2 If this presumption can be applied in this case, the choice of the residual category is determined by the choice of the alternative which best characterises the political process under examination. Nonetheless it is quite possible that the alternative which best characterises the political process in any one fiscal year may not be the most appropriate for some other fiscal year. Consequently considerable research and documentation is required before it is possible to select one of these three alternatives as best characterizing the political process in Ontario over the entire postwar period. 3 The problem is compounded by the fact that the fundamental accounting restrictions might be implicitly rather than explicitly imposed. This can arise because of the considerable opportunity to 'trade-off between various categories, not only within each sub-model but also between the three sub-models. For example, it might be argued that it is impossible to raise the level of a particular expenditure program (denoted EN) without raising the level of a particular (and possibly unrelated) revenue program (denoted/?^). Under these conditions the accounting identity is being implicitly imposed. This can be illustrated by using a subscript '0' to denote the sum of all 'other' categories in the model and rewriting identity (1) as:

which shows that, given the totals on the right hand side of identity (3), all that is important is that the difference on the left hand side remain unchanged regardless of the levels of RM and E^. The accounting identity in this implicit form then explains a difference between categories rather than the absolute level of a category. 4

2 Hartle (1976) reviews the writings of a number of economists in which this assumption appears to be implicitly imposed usually as a result of a comparative statics approach to an essentially dynamic problem. 3 This issue was not considered by Hartle (1976), but information on it could result from an appropriate case study along the lines proposed by that author. See also n. 15 below and the associated text. 4 Of course, if either R,, or £"., is explained elsewhere in the public finance model then identity (3) becomes an example of identity (2).

A model of provincial public finance 27 Identity (3) can be reduced to a special case of identity (1) when an expenditure program must be self financing. In the previous notation this would require that

which when substituted into identity (3) requires that

which is identity (1) applied to the 'other' categories. Note however, that it is possible to include either identity (5) or identities (3) and (4) into the model of public finances - there would be a redundancy if all three identities were included. 5 Consequently political decisions of this type can be explicitly included (as with identities (3) and (4)) or implicitly included (as with identity (5)). All of the above results can be easily generalized to cover subsets of categories of expenditures, revenues, and finances. A much more difficult problem arises when two categories are related via a statistical rather than an identity relationship. For example, expenditures on a particular expenditure program may depend on Ontario-specific influences (such as total population) and revenues from the federal government in the general expenditure area of which the particular program is a part. This implies that increased revenues will induce increased expenditures. For other categories the reverse could be true. For any shared-cost program 6 increased provincial expenditures lead to increased revenues from the federal government. This simultaneous determination of the categories of each of the models can be illustrated simply by considering the aggregates and postulating that revenues depend on expenditures and vice versa:

5 In fact any two of (3), (4), and (5) would avoid the redundancy. 6 For an inventory of such programs see (Ontario) Ministry of Treasury, Economics and Intergovernmental Affairs (1972).

28 Provincial Public Finance in Ontario

where the a. and b¡ (i = 0, 1, 2) are parameters to be estimated and Xl and X2 are (matrices of) variables determined outside the public finance model. These three equations represent a model of provincial public finances determining three unknowns (R, E, and F), which in turn raises two related problems: (i) estimation - simultaneous estimation techniques would be required to obtain statistically consistent numerical estimates of the parameters in equations (6) and (7);7 (ii) solution - given parameter estimates, the model must be solved to obtain estimates of the three unknown variables.8 The problem of simultaneity can be extended even further since the provincial public finance system is only part of the over-all provincial economy. This means that the variables (in) X{ and X2 in equations (6) and (7), although determined outside the provincial public finance model, may be determined within an over-all model of the provincial economy. In addition, the levels chosen for the public finance variables will almost certainly have an impact on the remainder of the provincial economy. This two-way causation between the provincial public finance model and a model of the remainder of the provincial economy can be captured only if the public finance model is embodied in an over-all model and the linkages between all parts are incorporated. This raises the same two problems as previously mentioned - estimation and solution - although now in the context of a much larger model of the whole provincial economy. Finally the problem of a changing value of the dollar must not be overlooked. Within the context of the complete model of provincial public finances each of the three sub-models can be expressed in either nominal (or current) dollars or deflated (or constant or real) dollars. This permits the following eight possible alternative combinations. Model Number

R

E

F

1

N N N N D D D D

N D N D N

N N

2 3 4 5 6 7 8

D

N D

D D

N N D D

N = nominal; D = deflated. 7 See, for example, Johnston (1972, chap. 13). 8 Actually equations (6) and (7) can be solved to obtain R and E and these substituted into (1) to obtain F. This is an example of a block recursive model.

A model of provincial public finance 29 It is likely that some of these alternatives can be eliminated. For example, the financing (F) sub-model being concerned with cash will almost certainly be expressed in nominal dollars. Of the remaining four alternatives, it might be argued that since revenues are usually tied to nominal bases (for example, the value of retail sales) it is appropriate to estimate the revenue (R) sub-model in nominal dollars, whereas expenditure programs are usually determined by real or deflated variables (for example, total population) so that the expenditure (£") sub-model should be estimated in deflated dollars. These arguments would suggest alternative 2 as the most appropriate basis for construction of the provincial public finance model. Also there is nothing preventing the incorporation of deflated and nominal explanations within each of the three sub-models thus complicating the complete model even further. It is therefore apparent that the construction of a complete model of provincial public finances involves a number of distinct, but related ingredients. Not only should it embody separate revenue, expenditure, and finance sub-models which explain all of the various categories of public finance, but it should also take account of the relationships between the three sub-models. This includes the basic accounting identity together with any identity and statistical relationships that exist between the various categories. The latter type of relationships raise the additional problems of estimation and solution. Underlying this structure is a specific view of the political process since the role of the accounting identity is to determine a residual category in one of the three sub-models. Although it is likely that there is considerable stability in the political process, this should be confirmed by appropriate research and documentation. In addition, to use such a model for realistic simulation or forecasting experiments would require that it be satisfactorily linked with a model of the whole provincial economy so that all feedback effects could be incorporated. Finally, the problem of the appropriate choice of units (nominal or deflated) must be decided for each of the three sub-models (and perhaps within each sub-model) which adds a further array of complexities to the construction of a complete model of provincial public finances. As a prelude to this task for the Government of Ontario, the next three sections of this chapter examine the medium-term trends of the major categories within each of the three basic sub-models: revenue composition, expenditure composition, and financing composition. The scope of the present study, is then outlined. THE REVENUE TRENDS: The revenue sub-model explains the revenues received by the provincial government each fiscal year from all revenue sources. It has two major

30 Provincial Public Finance in Ontario components - budgetary and non-budgetary revenues. Each can be further subdivided as follows: budgetary revenue (taxation revenue, other revenue, payments from federal governments, interest on investments) plus nonbudgetary revenue (repayments of loans and advances, revenue from pension funds and other accounts, Province of Ontario savings deposits (net)) equals total revenue. Although this information is contained in the Public Accounts it is arranged by receiving ministry rather than by revenue source. However, the budget statements generally contain the information for the previous two years and from this source it is possible to construct series by revenue source for the Government of Ontario. These are presented in Tables 9 and 10 with the implied percentage distribution summarized in Table 11. From these tables it is clear that taxation revenue accounts for a little over half of total revenue, and that budgetary revenue accounts for approximately 95 per cent of total revenue. Also it is clear that, since the early sixties, payments from the federal government have become an important source of funds accounting for between 15 and 20 per cent of total revenues, while other budgetary revenues have accounted for between 20 and 30 per cent of total revenue. The relative shares of all these major categories are subject to some volatility and no clear trends can be deduced from these tables. However the data for the last two years do suggest an increase in the importance of taxation revenue relative to federal payments and other budgetary sources. Only time will confirm whether this is actually a temporary or permanent movement. The relative importance of the different sources of taxation and the other major revenue categories will become apparent in chapter three where a detailed disaggregation of revenues by revenue source is presented. THE EXPENDITURE TRENDS: The expenditure sub-model explains the expenditures by the provincial government each fiscal year by all government ministries.9 The growth in these expenditures has been examined in chapter 1 (pp. 10-17) where they were taken as an indication of the size of the provincial government in Ontario. The categories of the expenditure sub-model focus on the spending, by the different ministries, on the programs under their administration. Although the structure of the provincial government has changed considerably over the period under review 9 Expenditures can also be classified as budgetary and non-budgetary, where the latter includes loans and advances and payments out of pension funds and other accounts. However this distinction is not used for the expenditure side of this study.

A model of provincial public finance 31 TABLE 9 Total budgetary revenue, Government of Ontario, 1954/5 - - 1974/5 ($ million) Fiscal year

Taxation revenue

Other revenue

Payments from the federal government

Interest on investments

Total budgetary revenue

1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

284 294 330 427 458 500 536 615 773 835 966 1145 1487 1757 2027 2523 2754 2901 3414 4067 4953

115 136 153 169 192 281 290 301 310 344 410 454 487 531 770 946 1109 1109 1161 1219 1350

26 26 28 40 56 161 162 190 323 290 261 319 394 510 609 743 968 1103 1248 1267 1517

12 13 15 18 21 27 25 23 26 27 31 40 62 87 125 188 250 291 294 291 356

437 469 526 654 727 969 1013 1129 1432 1496 1668 1958 2430 2885 3531 4400 5081 5404 6116 6844 8176

SOURCES: Calculations by the (Ontario) Ministry of Treasury, Economics and Intergovernmental Affairs, and Ontario Budget, various issues.

(see pp. 19-23) it is useful to examine briefly expenditures on a ministry basis to appreciate the relative importance of the different ministries and implicitly of the programs they administer. 10 For this purpose it is useful to use the expenditure estimates presented in Table 4. These are disaggregated by ministry in Table 12 and the implied percentage distribution is presented in Table 13. It must be emphasized, however, that this breakdown is by ministry and not by program and, since programs get transferred between ministries, is only a very approximate indication of the importance of expenditure programs in the budget. Before examining the expenditure trends in Table 12, the apparent structural breaks in the series should be briefly explained." The entry of the provincial 10 Recall that Table 8 included expenditure ranks by ministry. 11 These changes are examined in considerably more detail in chapter four.

32 Provincial Public Finance in Ontario TABLE 10 Total non-budgetary revenue, Government of Ontario, 1954/5 - 1974/5 ($ million) Fiscal year

Repayments of loans and advances

Funds and accounts

Province of Ontario savings deposits

Total nonbudgetary revenue

Total revenue

1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

2 2 2 10 12 6 12 6 7 6 5 18 27 33 39 58 92 132 100 155 354

60 52 86 92 81 54 41 42 46 52 56 70 80 87 96 134 110 129 155 95 217

12 8 -1 1 1 _7 1 2 0 3 2 -2 0 13 10 2 12 29 13 28 46

74 62 87 103 94 53 54 50 53 61 63 86 107 133 145 194 214 290 268 278 617

511 531 613 757 821 1022 1067 1179 1485 1557 1731 2044 2537 3018 3676 4594 5295 5694 6384 7122 8793

SOURCES: Calculations by the (Ontario) Ministry of Treasury, Economics and Intergovernmental Affairs, and Ontario Budget, various issues.

government into universal medical insurance in October 1969 is reflected in an abrupt rise in the health series for 1970/71, while the absorption of the Ontario Hospital Services Commission into the Ministry of Health on 1 April 1972 is reflected in a further abrupt rise in that Ministry's budget for 1972/3. The department of University Affairs came into existence in 1965/6, but this does not introduce an apparent structural break into the education series. The Ministry of Revenue was created out of Treasury in 1969/70 which explains the apparent lack of growth in that year, while Trade and Development (previously included in the Treasury series) was incorporated into the Ministry of Industry and Tourism in 1972/3. This combined with a transfer of expenditures to the Ministry of Revenue explains the abrupt decline in the Treasury series in that year. The Transportation series contains no structural breaks and, except for 1952/3, neither does Social Services. The drop in 'all other' expenditures in

A model of provincial public finance 33 TABLE 11 Distribution of total revenue, Government of Ontario, 1954/5 - 1974/5 (percent) Fiscal year

Taxation revenue

Payments from the federal government

All other budgetary revenue

Non-budgetary revenue

1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

55.6 55.4 53.8 56.4 55.8 48.9 50.2 52.2 52.1 53.6 55.8 56.0 58.6 58.2 55.1 54.9 52.0 51.0 53.5 57.1 56.3

5.1 4.9 4.6 5.3 6.8 15.8 15.2 16.1 21.8 18.6 15.1 15.6 15.5 16.9 16.6 16.2 18.3 19.4 19.6 17.8 17.3

24.9 28.1 27.4 24.7 25.9 30.1 29.5 27.5 22.6 23.8 25.5 24.2 21.6 20.5 24.4 24.7 25.7 24.6 22.8 21.2 19.4

14.5 11.7 14.2 13.6 11.5 5.2 5.1 4.2 3.6 3.9 3.6 4.2 4.2 4.4 3.9 4.2 4.0 5.1 4.2 3.9 7.0

NOTE: Row totals may not add up to 100 per cent because of rounding. SOURCE: Tables 9 and 10.

1960/61 primarily reflects a decline in the budget of the Department of Public Works. From Table 13 it is apparent that these five expenditure categories (representing the six most important Ministries 12 ) now account for nearly 85 per cent of total provincial government expenditures. Health and education now account for over 50 per cent of the total which represents an almost doubling in the relative importance of these two categories over the period covered by the figures. Individually they have followed very different time paths with education rising rapidly in relative importance in the early sixties (to reach over 30 per cent by the late sixties), while the relative rise in health expenditures in the budget has only become apparent in the early seventies (now being as important as 12 Education covers two ministries - Education, and Colleges and Universities.

34 Provincial Public Finance in Ontario TABLE 12 Expenditure estimates by ministry, Government of Ontario, 1950/51 - 1974/5 ($ million) Fiscal year

Health

1950/51 33 1951/2 40 1952/3 45 1953/4 46 1954/5 49 1955/6 53 1956/7 58 1957/8 61 73 1958/9 1959/60 81 1960/61 92 1961/2 136 1962/3 149 137 1963/4 1964/5 156 1965/6 176 262 1966/7 359 1967/8 1968/9 396 1969/70 398 1970/71 895 1971/2 990 1972/3 2028 1973/4 2219 1974/5 2342

Education 1 56 63 72

79 80 92 108 140 181 206 234 266 337 396 422 517 699 889 1162 1297 1553

1821 1998 2182 2424

Treasury 2 46 49 68 78

93 93 113 164 163 152 199 227

248 292 258 479 555 806 1022 1020 1287

1483 1017 1115 1261

Transportation 86 93

99 124 148 177 204 254 280 284 259 276 273 285

312 342 388 422

483 506 524 570 594 676 794

Social Services 57

61 32 32 32 35 39 43 54 62 61 63 76 78 91 106 121 208 227 265

Ail other 75

77 98 102 108 119 126 158 182 205 162 167 171 181 220 251 298 400 445 504

275

557

355

657 1006 1311 1449

428 484 647

1 Includes Colleges and Universities. 2 Includes Treasury, Economics, Development and Municipal Affairs; excludes Revenue and Housing. 3 Includes Highways, Transport and Communications. SOURCE: Public Accounts.

education). This reflects the trend that had been experienced somewhat earlier in hospital expenses, but is not recorded in the Public Accounts until the transfer of programs in 1972/3. On the other hand there has been a noticeable decline in the relative importance of transportation expenditures over the period. After peaking at over 30 per cent in the mid-fifties there has been a gradual decline in relative importance so that they now account for under 10 per cent of total provincial government expenditures. There has been a relative con-

A model of provincial public finance 35 TABLE 13 Distribution of expenditure estimates by ministry, Government of Ontario, 1950/1 - 1974/5 (per cent) Fiscal year 1950/51 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

Health

Education

Treasury

Transportation

9.4 10.4 10.9 10.0 9.6 9.3 9.0

15.9 16.5

13.0

24.4 24.3

7.4

7.8 8.2 9.1 12.0 11.9 10.0 10.7 9.4 11.3 11.6 10.6 10.0 17.6 16.9 28.7 27.8 26.3

17.4 17.1 15.7 16.2 16.7 17.1 19.4 20.8 23.2 23.4 26.9 28.9 28.9 27.6 30.1 28.8 31.1 32.5 30.5 31.0 28.3 27.3 27.2

12.8 16.4 16.9 18.2 16.3 17.4

20.0 17.5 15.4

19.8 20.0 19.8 21.3 17.7 25.6 23.9 26.1 27.4

25.6 25.3 25.2 14.4

14.0 14.1

23.9 26.9 29.0 31.1 31.5 31.0 30.0 28.7 25.7 24.3 21.8 20.8 21.4 18.3 16.7 13.7 12.9 12.7 10.3 9.7 8.4 8.5 8.9

Social services

All other

16.2 15.9 7.7 6.9 6.3 6.2 6.0 5.2 5.8 6.3 6.1 5.6 6.1 5.7 6.2 5.7 5.2 6.7 6.1 6.6 5.4 6.0 6.1 6.1 7.3

21.2 20.1 23.7 22.1 21.2 20.9 19.4 19.3 19.5 20.7 16.1 14.7 13.6 13.2 15.1 13.4 12.8 13.0 11.9 12.6 10.9 11.2 14.2 16.4 16.2

NOTE: Row totals may not add to 100 per cent because of rounding. SOURCE: Table 12.

stancy in social service expenditures (at around 6 per cent) throughout the period, although a slight increase is estimated for 1974/5. The changes in the treasury series primarily reflect changes in government structure rather than changes in the relative importance of the associated programs. The declining percentage attributed to 'all other' expenditures suggests that there has been an increasing concentration of expenditures in spite of the rising numbers of ministries. 'All other' expenditures almost halved in relative importance over the first two decades, but this trend has been reversed in the early seventies (primarily as a result of the creation of the Housing and Revenue ministries out of Treasury).

36 Provincial Public Finance in Ontario THE FINANCING TRENDS The finance sub-model explains in what form the provincial government disposes of any surplus funds or borrows additional funds to cover a deficit. In the latter case, the difference between revenues and expenditures is referred to as net cash requirements which covers both budgetary and non-budgetary transactions.' 3 There are three primary sources of net funds — liquid reserves, public borrowing, and non-public borrowing — each having a borrowing (positive) and retiring (negative) component with the difference being the definition of net funds. The major categories in each are: non-public borrowing (Canada Pension Plan, funds and loans) plus public borrowing (treasury bills, debentures) plus decrease in liquid reserves equals total financing. The importance of each of these categories for recent years is summarized in Table 14 where the dominant position of non-public borrowing as the prominant source of funds is clearly evident. Borrowing from this source has enabled a reduction in the growth of public debt 14 which has been offset by a rise in debt to non-public sources. The main source of non-public funds is the Canada Pension Plan which has accounted for over 60 per cent of the non-public total over the period. However the Ontario Teachers Pension Fund and the Ontario Municipal Employees' Retirement Fund have also become important sources of funds to the Government of Ontario. On the other hand both treasury bills and debentures have been retired in the last two fiscal years covered by the data. This transfer of debt obligations appears as the most significant of the financing trends in recent years. THE M E T H O D O L O G Y AND SCOPE OF THIS S T U D Y

The trends outlined in the previous three sections underlie any model of public finances for the Government of Ontario over the postwar period. The revenue, expenditure and finance sub-models are the ingredients of a complete model of provincial public finances. However considerably more disaggregation is necessary if a detailed understanding of the various categories of revenues, expenditures, and finances is required. This disaggregation by revenue source, expenditure program and financing instrument is also necessary for a better understanding of the relevant determinants and for an examination of the possible interrelationships between the categories. 13 It does, however, exclude transactions on behalf of Ontario Hydro. 14 This appeared to be a matter of importance to the Treasurer of Ontario. See the Ontario Budget (1974, 26-7).

TABLE 14 Total financing, government of Ontario, 1969/70 to 1974/75 ($ million) Fiscal Year

Canada Pension Plan'

1969/70 1970/71 1971/2 1972/3 1973/4 1974/5

446 476 498 536 606 702

Funds and loans1 127

138 249 240 332 454

1 Net of Retirements. 2 Decrease (+) or Increase (-). SOURCE: Ontario Budget, various issues.

Total nonpublic 1

573 614 747 776 938 1156

Treasury bills1 0 0

190 70 -170

-90

Debentures 1 126 19 96

182 -58 -215

Total public 1

126 19 286 252

-228 -305

Liquid reserves2

Total financing

-261

438 640 1018 740

7 -15

-288

-126

2

708 977

38 Provincial Public Finance in Ontario Because of the various sources of data, changes in accounting conventions, changes in the structure of government, not to mention the introduction of new categories and the deletion and amalgamation of existing categories in each of the sub-models, it is a mammoth task to construct a complete and consistent disaggregated data base necessary for the development of a complete model of provincial public finances. Accordingly it has been necessary to limit the scope of this study to the revenue and expenditure sub-models as a major step towards the development of the complete model. This orientation is not necessarily intended to reflect the view of the political process that some form of financing is the residual category (although it is consistent with such a view), nor is it to say that the accumulation (or decumulation) of debt is not a matter of concern. 15 Rather it reflects the necessary allocation of priorities within the usual constraints and the decision that a detailed examination of the relevant capital markets was beyond the scope and resources of this study. However, as has been argued earlier, such a study is necessary to complete the model of provincial public finances. As outlined previously (see chapter one), the objective of this study is to explain the medium-term trends in the public finances of the province. Given a detailed data base, a methodology must be chosen that can satisfy this requirement. This requires the development of an appropriate theory and its empirical implementation. A discussion of the theory is presented in each chapter and its empirical implementation is accomplished by estimating the resulting relationships econometrically. By relating each of the categories (called the dependent variables) to a set of appropriate explanatory influences (called the independent variables) via a statistical relationship, an econometric equation can explain the medium-term trends in the dependent variable. Within this framework it is also possible to explore the statistical relationships between the various categories of revenues and expenditures as suggested above (p. 27). Consequently, subsequent to the construction of a detailed data base will be the development and estimation of appropriate econometric equations for each of the categories of revenues and expenditures as an aid to explaining their medium-term trends. It is important to remember that the provincial government does not operate in isolation from the rest of the provincial economy. By developing econometric equations for the categories of provincial public finance, links from the rest of

15 Since a few of the individual revenue and expenditure categories subsequently developed turn out to be exogenous in the theoretical and empirical sub-models presented in this study, the adopted approach is also consistent with either of the alternative views of the political process.

A model of provincial public finance 39 the provincial economy can be adequately incorporated into the explanatory variables. What will be missing, however, are the reverse links from the provincial government to the rest of the economy and the consequent feedback effects on provincial revenues and expenditures. The only way that these can be adequately incorporated is by constructing an econometric model of the whole Ontario economy of which the public finance sub-models are an integral part. 16 Unfortunately, because of the considerable disaggregation proposed, this additional task is also beyond the scope of this study, although the framework adopted in this study is entirely consistent with such an approach. The econometric approach can also provide a useful framework for obtaining projections of the trends into the future. By assuming that the estimated parameters remain appropriate descriptions of the underlying structure and by obtaining trend forecasts of the variables determined outside the public finance model, the equation can generate projections of the implied trend in the dependent variable. Different forecasted trend values of the independent variables in each equation will result in different projections of the dependent variables. Projections based on econometric equations are therefore conditional, not only on unchanging parameter estimates, but also on the forecasted trends of the exogenous variables. It is here that an economy-wide econometric model is both useful and essential. It is useful because variables that may be exogenous to the public finance model may be endogenous elsewhere in the over-all model and consistent medium-term forecasts will be available from that source. It is essential for forecasting medium-term trends because all the feedback effects must be captured. 17 For example, if an increase in the retail sales tax discourages retail sales which causes a decline in corporate profits, then corporate profits tax revenues will decline. This type of feedback effect cannot be captured in projections based on single equations and for this reason detailed projections will not be attempted in this study. However the approach is certainly consistent with such an application and it is hoped that this study will stimulate research along these lines. SUMMARY

This study is concerned with the medium-term trends in the public finances of the Government of Ontario in the postwar provincial setting. As a basis for the development of a complete model of provincial public finances, this study focuses on two of the three major ingredients — provincial government revenues 16 One such attempt has been made for the revenue sub-model (Haronitis, 1971). 17 The same arguments are also applicable to simulation experiments.

40 Provincial Public Finance in Ontario and expenditures. For a detailed examination of the medium-term trends, these are to be disaggregated into numerous categories by revenue source and expenditure program. Since all further work must rest on this basic information, considerable attention is devoted to the construction of a consistent data base. This is presented in chapters three (for revenues) and four (for expenditures). These time series are then employed as dependent variables in the econometric equations developed and estimated in the subsequent two chapters (five for revenues and six for expenditures) which form an appropriate framework for explaining the medium-term trends in these detailed categories. The econometric framework is also useful to facilitate the incorporation of the model of provincial public finances into an econometric model of the entire Ontario economy. This is important for any simulation or projection exercises where the feedback effects are potentially very important. A concluding chapter (seven) summarizes the findings of the study and outlines the further work that is necessary to finalize a complete model of provincial public finances for the Government of Ontario.

PART TWO DESCRIPTION

This page intentionally left blank

3

The revenue categories

AN I N T E R T E M P O R A L O V E R V I E W O F R E V E N U E S O U R C E S A summary of the growth of aggregate provincial government revenues has been presented in Tables 9 and 10, with the distribution of these aggregates presented in Table 11. From these sources it is apparent that taxation revenue accounts for over half of all revenue and that all budgetary revenue accounts for approximately 95 per cent of total revenue. This section is devoted to a brief review of the postwar historical development of the most important revenue categories in Ontario.1 It is followed by an examination of the relevant data sources and the development of detailed provincial revenues by source since the early fifties. An historical summary of the various rate changes can be found in chapter five. Of the taxation sources, two of the most important are the personal income tax (PIT) and the corporate income tax (CIT). Ontario entered the PIT field in 1936, but it was only in the postwar period that this became a major revenue source. With regard to both of these taxes, the postwar period in Canada has been characterized by a series of five-year fiscal arrangements between the provinces and the federal government. These followed the Wartime Tax Rental Agreement, which covered the period 1941/2 to 1946/7, under which the provinces agreed to vacate the PIT and CIT fields in return for annual rental payments so that the federal government could attempt to meet the financial 1 For a much more detailed historical review for the period up to the mid-sixties see Ontario Committee on Taxation (1967, vol. III).

44 Provincial Public Finance in Ontario burden associated with the involvement in the Second World War. Ontario did not enter into the first postwar tax rental agreement, which covered the fiscal years 1947/8 to 1951/2, and in 1950 enacted a PIT of 5 percent of the federal tax payable. However, the legislation was never proclaimed because of difficulties associated with collection. The second postwar federal-provincial agreement covered the fiscal years 1952/3 to 1956/7, but it was not until August 1952 that Ontario entered into the agreement thereby effectively renting the PIT and CIT fields to the federal government and receiving annual rental payments in return. Under the third set of arrangements, which covered the period 1957/8 to 1961/2, Ontario signed an agreement with respect to the PIT only and reintroduced its own CIT. In November 1957, the rental payment for the PIT was raised from 10 per cent to 13 per cent of the federal tax payable by individuals on income earned in the province. The Federal-Provincial Fiscal Arrangements Act of 1961, which covered the fiscal years 1962/3 to 1966/7, finalized the transition from tax rental to tax sharing, whereby the provinces could legislate their own PIT and CIT schedules and the federal government collected the taxes based on these schedules. This implied that the provinces accept the tax bases decided on by the federal government and that the federal government bear the cost of collection. The Act resulted in the federal government partially withdrawing from the PIT and CIT fields by making 'tax room' available to the provinces in the form of abatements amounting to 16 per cent of federal PIT payable in 1962/3 and rising one percentage point per year to 20 per cent in 1966/7. In addition, 9 per cent of corporate taxable income was to be made available throughout the period. Ontario imposed PIT rates equal to the amount of the abatement but, still not having signed an agreement with respect to the CIT, continued to administer and collect the tax itself based on an 11 per cent rate. Further 'tax room' for the PIT was made available under the agreement when the federal abatement was raised from 19 to 21 per cent for 1965/6 and from 20 to 24 per cent for 1966/7. Under the fifth set of federal-provincial arrangements covering the period 1967/8 to 1971/2, the provinces were granted four additional abatement points on the PIT as a substitute for conditional grants in support of universities and post-secondary technical education and one additional percentage point on the CIT. Ontario continued to impose PIT rates equal to the amount of the abatement and to collect its own CIT. The most recent five-year arrangement, covering the fiscal years 1972/3 to 1976/7, remains similar to the previous arrangement except that, because of a lower federal tax base resulting from tax reform, the federal government supplemented the rate payable on the PIT, increasing it from 28 to 30.5 per cent, in an attempt to ensure that payments to the provinces would not be any lower than previously. They also provided for special grants if the adjustment was

The revenue categories 45 insufficient. The principle underlying the supplementary rates scheme, therefore, is different to that underlying the previous abatement scheme. In December 1971, Ontario enacted PIT tax reductions for 1971 and 1972. Ontario continued to collect its own CIT, now based on a 12 per cent rate. It also has imposed its own special tax on profits derived from all mines and mineral workings throughout much of the period. The six postwar federal-provincial arrangements have also embodied agreements in other related areas, notably succession duties or estate taxes,2 equalization payments and opting out arrangements. The terms of the first postwar agreement required that the provinces refrain from inposing succession duties, but Ontario not being a partner to this agreement continued to impose succession duties as it had done since 1892. Under all of the subsequent arrangements Ontario has continued to impose succession duties with compensation from the federal government being reduced accordingly. In 1958 the federal government enacted an estate tax (an indirect tax) in place of its earlier succession duty (a direct tax). Since, for constitutional reasons the provinces cannot impose indirect taxes, the federal government continued to rent the estate tax field from those provinces not imposing a succession duty. The rental arrangement provided for 50 per cent of total duties based on a three-year average to be paid to the provinces. This was increased to 75 per cent effective 1964/5 and Ontario took the equivalent of the additional 25 per cent in a straight cash payment from the federal government. Since Ontario imposed succession duties, the federal government allowed Ontario estates a credit of 50 per cent of its estate tax and paid one-half of the 50 per cent portion that it collected to the province. Federal estate taxes were terminated in 1972 as a result of tax reform. Equalization payments were formally introduced with the third (1957) postwar agreement when the federal government agreed to pay to each province an unconditional grant of an amount that would bring the level of the per capita yield from the three standard taxes (PIT, CIT, and succession duties) up to the average yield of the two wealthiest provinces (Ontario and British Columbia). Since then the formula has been revised to use the national per capita yield and a number of additional taxes have been added to the base which now includes provincial taxation revenue of all kinds, nearly all other revenues the provinces derive from their own sources, taxation revenue imposed by the federal 2 Succession duties are taxes on beneficiaries (an inheritance tax), while estate taxes are levies on the estate of the deceased and consequently extract a share of the assets before they are distributed to the beneficiaries. See Ontario Committee on Taxation (1967, vol. I l l , 143).

46 Provincial Public Finance in Ontario government and shared with the provinces, and (since 1974) school purpose taxes (essentially property taxes levied by local governments).3 The period covered by the third postwar agreement also produced a substantial increase in conditional payments 4 (in the form of shared-cost programs) as a result, in part, of the introduction of a federally supported public health (hospitalization) plan. It also included the first solution to a province opting out of a federal program without suffering a financial penalty. The 1964/5 federal Established Programs (Interim Arrangements) Act sets up this opting-out procedure for certain federal or joint-cost programs, 5 but only the Province of Quebec chose to avail itself of the opportunity (primarily on constitutional grounds). 6 Since then there has been a tremendous increase of expenditures on shared-cost programs, primarily in the areas of health and social services, and, to a much lesser extent, in education. Many of the programs have been open ended with no maximum limits on expenditures. However there appears to have been a growing provincial dissatisfaction with conditional grants. In general, the provinces have argued that these grants enable the federal government to participate in areas of provincial jurisdiction thereby interfering with provincial planning and priorities. In addition, they argue, that it is not economically or politically practical to withdraw, especially as the residents of the provinces have already contributed to the programs in the form of federal taxes. Ontario has been no exception, and in November 1971 it requested to opt 3 By 1 975 the total number of separately defined revenue sources amounted to 22. The addition of school purpose taxes in 1974 brought the total to 20 (see Canada Gazette, part 2, 1973, 128, and 1974, 388 for precise definitions), while a federal amendment in 1975 redefined the revenue bases for oil and natural gas revenues bringing the total to 22 (ibid., part 2, 1975, 3346). 4 Conditional grants first appeared in Canada at the turn of the century. For a review see Carter (1971). 5 Such as hospital insurance, old age assistance, blind and disabled persons allowances, the welfare portion of the unemployment assistance (now Canada Assistance Plan), health and vocational training grants, and the Canada Pension Plan. See Strick ( 1973, 108-10) for further information. 6 The Province of Quebec had refused to use federal grants for universities, which had been available since 1951, on the grounds that they represented an invasion of political autonomy. In 1960 Quebec was granted a one percentage point tax room on the CIT in lieu of university grants. A similar case arose in 1964 when the federal government entered the field of youth allowances and Quebec was granted an additional three percentage points on the PIT. Again in 1965 Quebec availed itself of the opportunity under the Established Programs (Interim Arrangements) Act and opted out of hospital insurance and diagnostic services and a group of special welfare programs for which it received 14 and 4 percentage points on the PIT respectively. Following tax reform in 1972 these percentages have been modified.

The revenue categories 47 out of a number of shared-cost programs.7 This request was not granted by the federal government and Ontario continues to participate in the programs. In summary, two of the most important taxation sources for Ontario are the PIT and the CIT and these have been included under the six five-year federal-provincial agreements that have characterized the postwar period in Canada. Ontario entered the agreement with respect to the PIT in 1952, but it was not until the fourth agreement that tax sharing was instituted. Except for recent years, Ontario has always imposed a PIT rate equivalent to the 'tax room' provided by the federal government. However, Ontario has never signed an agreement with respect to the CIT which it has imposed, administered, and collected since 1957/8 with one rate change. Also, Ontario has never signed an agreement with respect to succession duties, which have also been covered under the federal-provincial arrangements. Instead, it has collected these revenues itself throughout the postwar period. Being a relatively rich province, Ontario does not receive equalization payments and, being a participant in a number of shared-cost programs, Ontario continues to receive numerous conditional revenues from the federal government. Another major taxation source for the provincial government is the retail sales tax. Introduced in September of 1961, Ontario was one of the last of the Canadian provinces to enter into this category of taxation revenue. 8 According to one source 'the rising costs of new hospital services and of the Province's responsibilities in education, coupled with the refusal of the federal government to grant greater income tax abatements requested by Ontario, led the Province to its decision to adopt a retail sales tax' (Ontario Committee on Taxation, 1967, vol. Ill, 213). The initial tax rate was 3 per cent, but this has since been increased to 5 per cent (in 1966/7) and 7 per cent (in 1973/4). There is a minimum level of sales necessary before this rate becomes effective and a number of items are exempt from this tax, the most notable of which are food purchases for human consumption, medical supplies, and children's clothing. In addition, a number of other items are excluded from the standard tax base to enable alternative tax rates to be applied. These include prepared meals, 7 For an inventory of these programs see Ontario Ministry of Treasury, Economics and Intergovernmental Affairs (1972). 8 Of the existing retail sales taxes, Saskatchewan entered in 1937, followed by Quebec (1940), British Columbia (1948), New Brunswick (1950), Newfoundland (1950), Nova Scotia (1959), and PEI (1960). Manitoba followed Ontario in 1964. Alberta, which was the first province to introduce a sales tax in 1936, repealed it in 1937 and now remains the only province without a retail sales tax. For comparative rates see Canadian Tax Foundation, Provincial and Municipal Finances, or Statistics Canada, Principal Taxes in Canada.

48 Provincial Public Finance in Ontario alcoholic beverages, motive fuel, and tobacco products. 9 Exemptions under the Retail Sales Tax Act have been changed periodically in an endeavour to achieve both greater equity and greater integration into the taxation system in Ontario. The payment of remuneration (or compensation) to vendors who collected the retail sales tax on behalf of the government was discontinued on 1 May 1972, but was subsequently reintroduced effective 1 July 1975 at a 3 per cent rate (with a certain minimum and maximum). The motive fuel tax predates the retail sales tax in all provinces in Canada. By 1928, all provinces had established a gasoline tax, Ontario having entered the field in 1925.10 Ontario, however, was the first province to introduce differential rates for gasoline and diesel fuel. In 1957, when gasoline was taxed at 13i/ a gallon, the rate on diesel fuel was raised to 204 a gallon, thus recognizing the greater fuel efficiency of diesel engines and the principle that tax paid per mile travelled should be equalized across similar vehicles. During the following year, a government study of the relative efficiency of the two fuels suggested a factor of 1.42 and the diesel fuel tax was lowered to 18.5 0 and where EX represents total dollar expenditures and POP the total population. 20 Calculation of the relevant partial derivatives will confirm these propositions.

An empirical analysis of the expenditure categories 163 Data on these variables have already been presented and discussed in chapter one (see Tables 1 and 2). The population of the province has almost doubled since 1947 having grown at an average annual growth rate of 2'/4 per cent. Recently this rate has been declining as indicated by the average annual rate for the past five years of less than 2 per cent. The proportion of young people (0 to 4 years) peaked in the late fifties and early sixties when the proportion of senior people (65 years and over) was at a low. The school age proportion (5 to 19 years) peaked in the late sixties. These proportions are plotted in Figure 3. Whatever the exact specification of the functional form, this hypothesis suggests a positive relationship between desired provincial expenditures and the size and age distribution of the population of the province. A higher population and/or a higher proportion of people in a certain age group will lead to increased desired expenditures in the various categories. Incomes The second and third hypotheses are concerned with the economic determinants of desired expenditures. In almost all theories of government expenditures, an income variable has appeared as an important variable. In Wagner's 'Law' and subsequent interpretations it enters via the income elasticity of demand; in the revenue constraint theories it enters via the income elasticity of revenues; in the determinants studies it enters as one of the three 'classic' determinants; whereas in the more formal models it usually enters via the postulated budget constraint. As noted earlier, the exact interpretation of the role of this variable is not always clear. Interpreted via the micro-economic theory of consumption, it represents a demand influence, with rising real per capita incomes leading to increasing demands for public goods and services. However, interpreted through the revenue constraint theories, it proxies the fiscal capacity of the government to supply public goods and services, with rising incomes producing increasing revenues hence facilitating politically easier increases in expenditures than would be possible via tax increases. The evidence, as noted earlier, favours the former interpretation, and this is the interpretation adopted in this study, 21 but it must be remembered that the only safe interpretation is one of an indeterminate combination of both influences. Given that an income variable is an important variable in an expenditure model there is still an issue as to what exact form it should take. The determinants studies usually measure it in per capita terms, while those appealing to the micro-economic theory of consumption would use personal disposable

21 This agrees with the interpretation noted by Ohls and Wales (1972).

164 Provincial Public Finance in Ontario Figure 3 The âge structure of the Ontario population, 1947-74 (per cent)

Source: Table 2

An empirical analysis of the expenditure categories 165 income. In a time series application, such as in this study, the effects of a changing price level should also be removed. These considerations suggest that real personal disposable income per capita might be the appropriate income variable. An important implication of this income measure is that as personal tax rates are raised, desired government expenditures will be reduced, ceteris paribus. Including the alternative income measure of total personal income would mean that an explicit proxy for the relative price effect of Ontario goods and services to all other goods and services would have to be included to capture this influence. Since such a measure is not available, the former approach was adopted. This interpretation is consistent with the micro-economic theory of consumption which views tax rates as a proxy for the price of public goods and services, but it does not appear to accord with the revenue constraint theories which might postulate increased expenditures as a result of increased revenues. Of course, these are not necessarily inconsistent positions, since the former represents the demand response whereas the latter represents a possible supply response. This supply response is discussed in more detail under the determinant 'revenue led' below. A measurement of personal disposable income in the province is available from the provincial accounts from which the relevant per capita figures in both nominal and real dollars can be calculated. These calculations are set out in Table 37 where it is apparent that all series have grown strongly in the postwar provincial economy, especially the per capita series since the early sixties. Stabilization The third hypothesis is also concerned with economic determinants, but this time exclusively from the viewpoint of the supplier (that is, the government). The Provincial Treasurer has, from time to time, made reference to the provincial government's responsibility for fiscal policy management in the Ontario economy.22 This assumed provincial responsibility is based primarily on the premise of a regional dimension to the impact of economic decisions and to residents' needs. It has become particularly evident since the late sixties, commencing in 1968 with a detailed examination of the public finances of the provincial-municipal government sector and being extended to cover policies to deal with inflation and full employment in the early seventies. More recently the responsibility has also been extended to include policies to deal with certain sectors, such as housing and automobiles.

22 See, for example, Ontario Budget (1972, 49-73).

166 Provincial Public Finance in Ontario TABLE 37 Per capita personal disposable income, Ontario, 1950-73.

Year

1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972

1973

Population 1 (millions) 4.471 4.598 4.788

4.941 5.115 5.266 5.405 5.636 5.821 5.969 6.111 6.236 6.351 6.481 6.631 6.788 6.961 7.127 7.262 7.385 7.551 7.703 7.825 7.939

Personal disposable income ($ billion)

PDI per capita ($ 000)

Consumer price index 2 (1961 = 100.0)

Real PDI Real PDI per capita ($ billion) ($000)

5.208 5.916 6.467 6.860 7.090 7.644 8.273 9.066 9.745 10.167 10.529 10.720 11.533 12.320 13.106 14.301 15.850 17.233 18.855 20.696 22.248 24.220 26.929 31.175

1.165 1.287 1.351 1.388 1.386 1.452 1.531 1.609 1.674 1.703 1.723 1.719 1.816 1.901 1.976 2.107 2.277 2.418 2.596 2.802 2.946 3.144 3.441 3.927

79.6 88.0 90.2 89.4 89.9 90.1 91.4 94.3 96.8 97.9 99.1 100.0 101.2 103.0 104.8 107.4 111.4 115.4 120.1 125.5 129.7 133.4 139.8 150.5

6.543 6.723 7.170 7.673 7.887 8.484 9.051 9.614 10.067 10.385 10.625 10.720 11.396 11.961 12.506 13.316 14.228 14.933 15.699 16.491 17.153 18.156 19.263 20.714

1.463 1.462 1.497 1.553 1.542 1.611 1.675 1.706 1.729 1.740 1.739 1.719 1.794 1.846 1.886 1.962 2.044 2.095 2.162 2.233 2.272 2.357 2.462 2.609

1 At 1 June. 2 All items for all Canada. SOURCE: Ontario Statistical Review, various issues.

This responsibility for economic stabilization at both the provincial level and the sectoral level can directly affect expenditures in general and in specific programs. Perhaps the best measure of the stance adopted by the provincial government would be its surplus/deficit position each fiscal year. However, this can be misleading since it also includes changes in the revenues and expenditures which are not the result of government stabilization decisions but occur because of the observed state of the provincial economy. To measure the size of discretionary fiscal policy alone, the concept of the full employment surplus/deficit

An empirical analysis of the expenditure categories 167 has been proposed.23 This measures the surplus/deficit position that would occur at the full employment operation of the economy. Unfortunately, such a measure does not exist for the period covered by the time series of observations in this study and its calculation on a consistent basis would be a sizeable undertaking. Consequently, the provincial unemployment rate (see Table 1 ) was employed as a proxy variable to measure the state of the provincial economy. To the extent that the provincial government adequately recognizes and responds to this indicator in its choice of stabilization policy, a positive association is to be expected with the expenditure programs since the weaker the economy (as measured by a higher unemployment rate) the greater the expansionary effect required and hence the more likely the increase in expenditures.24 The use of this proxy variable does introduce some difficulties. It probably will not adequately capture the state of particular sectors of the provincial economy and consequently this feature of fiscal management will not be adequately accounted for in this measure. However, it captures only the expenditure response to fiscal policy management and ignores a possible revenue response. Also to the extent that this responsibility has not had widespread application throughout the entire sample period, the period over which it was not in effect might 'mask' the effects of the period when it was in effect, thus leading to an insignificant over-all relationship.25 Finally, there are some expenditure categories that might be directly affected by the state of the provincial economy regardless of a conscious stabilization policy. Some of the social assistance programs might fit into this group. In these cases stabilization policy may be defined to be 'automatically at work.' Urbanization The fourth expenditure hypothesis represents the third of the 'classical' determinants used by Fabricant (1952) and his followers. It was also referred to in the discussion of Wagner's 'Law.' The hypothesis is that greater urbanization leads to greater desired public expenditures even after the effects of population and income have been accounted for. The supporting argument for this hypothesis usually centres around the need for increased provision and quality of public 23 Solomon (1964) and Ontario Budget (1972, 52). 24 Of course, the alternative is a reduction of revenues. This could be reflected in the reduction of a tax rate in the revenue sub-model. 25 It is very difficult to divide the sample period into two such periods. If this were possible, it would be more appropriate to test for the effects of stabilization policy during the period when it was definitely in effect.

168 Provincial Public Finance in Ontario TABLE 38 Urbanization in Ontario, selected years, 1951-71 (millions of persons) Year 1951 1956 1961

1966 1971

Top 5 CMA population

Ontario population

Percentage1

2.011 2.447

4.598 5.405 6.236 6.961 7.703

43.74 45.28 49.86 52.26 53.54

3.109 3.638 4.125

1 Column two expressed as a percentage of column three. SOURCE: Ontario Statistical Review (1973, 23)

services in urban areas presumably as a result of greater 'awareness' or 'expectations' by urban dwellers. Often, however, the reference is to services which are the responsibility of municipalities (such as sidewalks, fire prevention, etc.) but it is also applicable to services which are the responsibility of the province (such as the Ontario Provincial Police). Consequently under this hypothesis increased urbanization is expected to lead to increased expenditures, all other things remaining equal. It is not an easy task to construct an adequate measure of urbanization for Ontario since census boundaries have been changed periodically and data are available only at five-year intervals. In addition, if an urban centre is defined too narrowly, its own growth will be constrained by its legislative boundaries even though the region it serves may continue to expand through the creation of surrounding 'suburban cities.' For this reason the census metropolitan area (CMA) was chosen as the best indicator of urbanized population growth and the top five CMAs, all with populations in excess of one-quarter of a million people in 1971, were chosen as the basis for the calculation. This included the following CMAs (with their 1971 populations measured in thousands of persons): Toronto (2628), Hamilton (499), Ottawa (453), London (286) and Windsor (259). Their combined population was then expressed as a percentage of the total population of the province for the years in which the CMA data were available (see Table 38). The resulting percentage was then interpolated to produce the urbanization series presented in Figure 4. This series shows a rapid increase in urbanization in the province during the late fifties after which the growth slowed considerably. It is interesting to note that over 50 per cent of the residents of the province now live in the five CMAs covered by this calculation.

An empirical analysis of the expenditure categories 169 Figure 4 Urbanization Index*, Ontario, 1950 - 73

Source: Table 38 (interpolated by the author)

* Population of the top five CMA's as a percentage of the total population

Elections The fifth hypothesis to be examined in this study is concerned with attempting to introduce the political factor into the explanation of government expenditures. Recent theories of politics and bureaucracy (see p. 158) have indicated this to be an important factor in expenditure determination. In a parliamentary system where voting is almost always along party lines, the degree of competition between the parties (as measured, for example, by the electoral majority at the previous election or the existence of a political decision-maker facing an elected body controlled by the opposition) is probably not nearly as important as it is under other political systems such as in the US. Moreover since there has been no change in the political party forming the government in Ontario over the period covered by this study, there is no point in introducing a variable to reflect the political dimension of the party in power. However it probably does make sense to see if the timing of election years has had any influence on the expenditure patterns in the province. The hypothesis is that expenditures are

170 Provincial Public Finance in Ontario likely to rise (at least above trend) in an election year as the government attempts to consolidate its political position by spending more money. This is the supply factor. To the extent that this increase in expenditures is anticipated and expected (or desired) by the electorate, there is a demand component as well. Since both work in the same direction the hypothesized sign on this variable is definitely positive. This hypothesis can be tested in a number of different ways. Elections have been held in the province once every four years since 1951. Consequently a dummy variable could be introduced that assumes the value one in 1951/2 and every subsequent fourth year and zero elsewhere, in an attempt to incorporate the possible impact of 'election year spending.' A possible disadvantage of this approach is that it imputes the same expenditure response to each election and it fails to capture the differential effects of by-elections in the non-election years which may also have an impact on government spending. Consequently, an alternative measure of the possible effects of elections was also tested. This included all the expenses incurred under the Elections Act each fiscal year as reported in the Public Accounts. This series, which is reported in current and constant dollars in Table 39, forms part of the expenditure series entitled 'other government services' (see Table 32) where the effects of the elections are readily apparent. Intergovernmental transfers A number of researchers, particularly in the United States, have investigated the impact of the transfers of funds from the federal government on the level and pattern of expenditures of the lower levels of government (see pp. 156-8). This is an equally relevant and important question in Canada, especially when the expenditure behaviour of a provincial government is under review.26 As has been noted, the core issue in this hypothesis is whether the federal transfers have stimulated provincial expenditures or have been a substitute for them, and a consensus in the empirical literature has not yet emerged. Since many of the federal transfers to Ontario have occurred under shared-cost programs,27 wherein the federal government contracts to pay a fixed percentage (often around 50 per cent) of the expenditures on certain programs, there is an automatic positive relationship. The core issues is whether provincial expenditures expanded by more or less than the amount required under the contractual formulae. Confirmation of the 26 The federal government is prohibited under the Canadian constitution to transfer funds directly to any other lower level of government (see chapter one, n. 4). 27 An inventory of these programs is presented in Ontario Ministry of Treasury, Economics and Intergovernmental Affairs (1972).

An empirical analysis of the expenditure categories 171 TABLE 39 Elections in Ontario, some descriptive variables, 1950/51 — 1972/3. Elections Act expenses Fiscal year

Election dummy

1950/51 1951/2 1952/3 1953/4 1954/5 1955/6 1956/7 1957/8 1958/9 1959/60 1960/61 1961/2 1962/3 1963/4 1964/5 1965/6 1966/7 1967/8 1968/9 1969/70 1970/71 1971/2 1972/3

0 1 0 0 0 1 0 0 0

1

0 0 0

1

0 0 0

1

0

0

0

1

0

$ millions

$1961 mil2

0.002 2.216 0.084 0.004 0.145 2.157 0.077 0.061 0.141 2.750 0.032 0.166 0.076 6.683 0.023 0.087 0.105 4.345 0.041 0.095 0.140 5.781 0.152

0.003 3.202 0.118 0.005 0.190 2.730 0.091 0.069 0.155 2.916 0.033 0.165 0.074 6.211 0.021 0.074 0.084 3.255 0.029 0.062 0.086 3.344 0.083

1 A one (1) indicates a general election year. 2 Deflated using the government deflator (see Table 4). SOURCE: Public Accounts of Ontario.

stimulation hypothesis in this context would require that provincial expenditures expanded by more than was covered under the various shared-cost formulae, whereas confirmation of the substitution hypothesis would require that they expended by less (presumably as a result of cutting back on closely related programs). It is not an easy task to test these hypotheses statistically. First it is important to obtain intergovernmental transfers disaggregated by different expenditure functions. Fortunately this was an essential part of the compilation of the revenue data in chapter three so that these transfers have already been presented in Table 23, where the federal transfers are divided into four main categories:

172 Provincial Public Finance in Ontario health, social welfare, education, and 'other' (primarily highways). It is important to note that these transfers now amount to well over $1 billion (see Table 15). Second, it is extremely difficult to establish the direction of causation. Since there is considerable room for negotiation in the establishment of shared-cost programs and since increased provincial expenditures can 'signal' the need for and often depend on the availability of further federal funds, it is difficult to be sure that the federal transfers determine the level and pattern of provincial expenditures and not vice versa. This problem of simultaneity can be handled in the context of a complete model of provincial public finances (see chapter two), because in the complete model there is nothing to prevent certain expenditures from being determined by certain revenues in the expenditure sub-model, while at the same time the same revenues are determined by the same expenditures in the revenue sub-model. However, it is important that the estimation procedure chosen to obtain parameter estimates for these equations takes account of this simultaneity. 28 In estimating the revenue sub-model in chapter five, no attempt was made to explain the medium-term trend in federal transfers, since this requires a theory of the intergovernmental negotiation process. Consequently, they can be considered to be determined exogenously to the model of provincial public finances presented in this study. However, all the necessary ingredients have been presented to enable a relaxation of this assumption - what is required is the development of an appropriate theory to explain the process determining the revenue categories representing intergovernmental transfers contained in Table 23. Revenue led The concept of a general revenue constraint on expenditures was reinforced by Peacock and Wiseman (1967), although the idea had been noted by earlier writers. The basic hypothesis was that the more income elastic revenues are, the easier it is politically to increase expenditures since the government does not have to confront the electorate with an increase in taxes to fund the increase in spending. However, tax increases are not the only way to fund increased provincial spending. As has been mentioned in chapter two, the province can also choose to fund some of the expenditure increase by increasing the size of its debt obligations. The obligations can be distributed over public and non-public sources (see Table 14). 28 Under these conditions ordinary least squares will produce biased and inconsistent parameter estimates and some simultaneous estimation technique, such as two-stage least squares, is required to obtain consistent parameter estimates (see pp. 27-8).

An empirical analysis of the expenditure categories 173 This additional source of funds may make the idea of there being a general revenue constraint on expenditures considerably less applicable in the present context. Indeed, a related but somewhat different interpretation of this hypothesis is possible. If this additional source of funds is available at acceptable borrowing rates, expenditures might be stimulated for exactly the same reasons as postulated by Peacock and Wiseman (1967) —only here it is hypothesized that it is the borrowing rates and not the income elastic revenues that are the politically less costly alternative to tax increases. This hypothesis presumes that the electorate perceives the increase in debt obligations to be somehow different from an increase in taxes. Since debt obligations can be distributed over both public and non-public obligations, this presumption may be postulated for either or both types of obligation. There is very little evidence as to how the electorate actually perceives these increases in financial obligations. However, there is some evidence that the provincial government may perceive increases in public and non-public debt obligations somewhat differently. As noted in chapter two, the Provincial Treasurer in recent years has been accumulating non-public debt obligations (by borrowing from the various pension funds) at a much faster rate than public debt obligations. This action would be consistent with the hypothesis that pension funds, and particularly borrowings from the Canada Pension Plan, are perceived by the government to be in some way different from increases in public debt obligations.29 If these various sources of funds are perceived, at least politically, to be different, then a change in their composition could affect expenditure growth. In particular, if non-public borrowing is perceived to be the politically least costly source of funds, then a shift in the portfolio composition towards nonpublic borrowing would ceteris paribus lead to an increase in expenditures under this reinterpretation of the general revenue constraint hypothesis. Displacement The eighth expenditure hypothesis is concerned with the displacement of private activity by public activity (or vice versa). If the provincial government assumes responsibility for activities formerly carried out in the private sector, then it is reasonable to expect government expenditures to rise.30 This implies a negative 29 There is some evidence of this in the Treasurer's announcement of the reduction of the level of public debt while ignoring the increase in the level of non-public debt (see chapter two, n. 14). Note that this action is also consistent with a lower interest rate being paid on non-public compared to public borrowing. 30 Note that net government expenditures will not necessarily increase because revenues may also rise. However, these have been considered in the revenue sub-model.

174 Provincial Public Finance in Ontario relationship between public expenditures and expenditures in the private sector on certain activities. Naturally this hypothesis also works in reverse — namely for the displacement of public activities by private activities. It is impossible to test this hypothesis statistically since measurements of private expenditures in all the sectors in which public activity takes place (such as agriculture, insurance, etc.) would have to be compiled. Such disaggregated data (by sector) are not publically available primarily because they might violate the confidentiality of private operators, especially in relatively concentrated industries. Nonetheless this is a potentially important explanation of the growth of government spending in the province and should not be ignored when other hypotheses are tested. Although it is not possible to confront this hypothesis with a direct statistical test, it is possible to highlight those expenditure categories where this hypothesis should be considered in the determinants of the spending levels and patterns. Since an explanatory equation which does not include such a variable when it should be included suffers from a specification error, the resulting parameter estimates are biased (e.g., Johnston, 1972, 169) and care should be exercised in interpreting any estimated results where this hypothesis is anticipated to account for an important part of the explanation. Leading sector The final expenditure determinant hypothesis to be considered is considerably more grandiose than the other hypotheses. By postulating that certain important functions of the provincial government have received concentrated attention over a medium-term development horizon (of say 5 to 8 years) and that these periods of "concentrated expenditures" have been co-ordinated so that no two functions are at their peak simultaneously, a 'development' approach to the growth of government expenditures can be obtained. This co-ordinated view of provincial public development is, for example, consistent with a series of S-shaped 'market acceptance type' curves each representing expenditures on a particular function of the provincial government. The idea can be viewed schematically in Figure 5. Curve 0 indicates a steady growth in expenditures on functions not covered by the other curves. Curve 1 indicates the combination of these expenditures with expenditures on function 1 which is the first function to receive concentrated attention; then as the growth rate of expenditures on function 1 slows attention can be turned to function 2 with the previous expenditures still being maintained or even increased but at a much slower rate (see curve 2). Over time this process can form a co-ordinated development pattern as every 5 to 8 years a new function receives the concentrated attention of the provincial government thus resulting in a rapid growth in expenditures until some 'desired' level of per capita expenditures is achieved for that function after

An empirical analysis of the expenditure categories 175 Figure 5 Schematic view of the 'development approach' to government expenditures

which the growth rate of expenditures on that particular function is curtailed and another function receives the concentrated attention of the provincial 'planners.'31 This pattern can easily arise because residents of the province can develop a desire for a certain per capita level of public expenditures in particular categories and communicate their desires through the usual channels. These desires may change over time, or what is more likely, as one desire gets more or less satisfied a new desire emerges. Consequently, the growth pattern of any one program may well be approximated by an S-shaped curve. Moreover, the government realizes that it cannot undertake all desired expenditures simultaneously and so responds to the wishes of a subgroup (which may or may not be the majority of the electorate) by concentrating on its current 'desires' but in a sequential 31 This can have important implications for the specification of the expenditure equations. To the extent that an explanatory variable grows over time, this hypothesis suggests a particular type of non-linear relationship between expenditures and the explanatory variable.

176 Provincial Public Finance in Ontario fashion. In this way it can respond to demands of the various subgroups by pointing out that 'everything cannot be done at once.' To prevent this hypothesis being immediately dismissed as an overly simplified (or perhaps even sophisticated) view of the political process and the development of the provincial public sector over time, it is probably useful to present a brief glance at the evidence32 (although in general the hypotheses presented in this section are confronted with 'the evidence' (that is, data) later in this chapter). In figure 5, consider the functions included in curve 0 to include such categories as agriculture, justice, correctional services, government services, etc. In the postwar period the first function which received concentrated attention in Ontario might be identified as transportation (highways) where the growth rate in expenditures increased rapidly over the mid-fifties but had slowed down considerably by the following decade — this might be represented by curve 1. This expansion was followed by a rapid increase in the growth of expenditures on education during the early sixties as the postwar baby boom moved through the educational system — an increase which subsequently has been clearly moderated (curve 2). Then in the late sixties and early seventies expenditures on health have risen rapidly, although recent pronouncements have indicated that the pressure is building rapidly for a decrease in the observed rate of growth (curve 3). It is tempting to ask 'what is next'? The evidence seems to point to social services (curve 4), but this suggestion can be attributed only to conjecture at this time. The point of this brief discussion has been to attempt to prevent this expenditure determinant hypothesis from being instantly dismissed as being too naive or overly sophisticated. The successive development of highways, education, health, and now perhaps social services in the province seems to provide considerable support for this long-term, somewhat grandiose view. It is impossible to test this hypothesis in the context of annual econometric equations (which form the basis for the testing of most of the other hypotheses), but it does appear to be an interesting, relevant, and possibly useful hypothesis in any examination of the growth of provincial public expenditures. The following sections of this chapter are devoted to the detailed testing of the expenditure determinant hypotheses presented in this section. The next section is devoted to a brief review of the appropriate specifications of the equations including the development of a more formal expenditure model based on these hypotheses. The following section is devoted to a testing of the hypotheses, and the chapter is concluded by a summary of results. 32 What follows is a very brief discussion based on the intertemporal view of expenditure programs presented in chapter four. The reader is referred to pp. 69-75 for more detailed information.

An empirical analysis of the expenditure categories 177 EQUATION SPECIFICATION IN EXPENDITURE MODELS The expenditure model is a sub-model within a complete model of provincial public finances. It involves a series of econometric equations explaining each of the disaggregated expenditure categories in the complete model using the expenditure determinant hypotheses outlined in the previous section. This approach provides only a guide as to the relevant explanatory variables that might be included in each equation — it does not detail the appropriate model or functional relationship to be employed nor does it provide a guide to a number of other important specification issues. The hypotheses do, however, place definite sign expectations on the coefficients of each of the explanatory variables. One of the specification issues not covered by the hypotheses is whether the expenditure equations should be estimated in nominal or real (deflated) dollars. As has been argued in chapter two, the latter is probably to be preferred because, unlike revenues, expenditures are usually determined by real (not financial) variables. For example, population and urbanization do not reflect the value of the dollar in any way and the influences of elections and stabilization policy can also be considered to be real determinants of desired expenditures. For the empirical analysis in this study all financial variables (including the dependent variables) are expressed in 1961 dollars. The deflator used for this purpose was the implicit price index for government current expenditure on goods and services in the National Expenditure Accounts appropriately adjusted for fiscal year applications (see Table 4). All income variables were deflated by the Consumer Price Index (see Table 37). As previously mentioned, a further specification issue about which the expenditure hypotheses provide little guidance is whether the equations should be specified in levels (dollars) or per capita (dollars per person) terms. Both approaches were tested in this study, although most of the expenditure determinant hypotheses are postulated in per capita terms. As has been noted earlier in this chapter, the literature on regional government expenditures is notably silent on the development of formal models in which the time series trends in government spending can be analysed. In fact, very little has been published regarding the dynamic response of government expenditures to changing determinants over time. However, in other contexts this issue has received considerable attention, 33 and the general approach would seem naturally adaptable to the present context. 34 In particular, it could be 33 For example, see the reviews of the econometric literature on distributed lag models by Griliches (1967) and Wallis (1969). 34 I am grateful to R.M. Bird for this suggestion, although it was made in a somewhat different context.

178 Provincial Public Finance in Ontario argued that there exists a certain desired level of public expenditures (probably on a per capita basis) and that the provincial government is always attempting to adjust its expenditures towards this desired level. This hypothesis is consistent with the familiar partial adjustment model in economics (Wallis, 1969, 773). There are many reasons for only a partial adjustment towards the desired (sometimes called optimal) level of expenditures. Perhaps the government is ignorant as to exactly the desired level or, if it does have some idea of the level, the complexities of its organization structure produce an inertia in quickly moving to a new level. Alternatively there may be costs of adjustment which mean that a rapid adjustment is not possible, or perhaps there is a need to establish some permanence in the desired level before eliciting a response from the government. Whatever the reason, it is assumed that the government's reaction to or adjustment towards the desired expenditure level (denoted EXD) can be expressed as:

where EX? represents the actual expenditure level in period t. This formulation postulates that the government will change its actual expenditures (EX) from the previous period to move part of the way (since 0 < /u < 1) towards the change indicated by the difference between the previous expenditures and the present desired level of expenditures. A low value of ¿u (near zero) indicates a slow adjustment while a high value (near one) indicates a fast adjustment. To make this model operational it must be possible to determine how the 'desired' level of expenditures in any period (EXD f ) is determined. For illustrative purposes, suppose it is determined by some independent variable X according to the simple relationship:

Substituting this into the partial adjustment relationship yields

which can be empirically estimated since it does not involve the unmeasured variable EXD . Moreover, point estimates of each of the three parameters (JJL, °c and 0) can be obtained.35 This model can be easily extended to include more than one determinant of the desired level of expenditures, although the assumption of a single adjustment parameter (jji) will imply that the (constant) speed of adjustment is the same for 35 It should be noted that these point estimates will not be unbiased.

An empirical analysis of the expenditure categories 179 all determinants of EXDr. Exactly which variables should be considered can be found in the previous section since most of the expenditure determinants hypotheses referred to the existence of a desired level of public expenditures. Consequently, to test a partial adjustment model of provincial spending, the variables representing each of the expenditure determinants hypotheses can be included as explanatory variables of EXf together with the lagged value of the dependent variable. The coefficient on this lagged value then reflects the speed of adjustment by the provincial government to the desired level of expenditures. 36 One final comment. All of the explanatory variables have been entered linearly in the subsequent equations. This approach does not permit the possibility for a specified change in the value of one of the explanatory variables to have an impact of a certain magnitude on the dependent variable at one level of the explanatory variable, while the same change in the explanatory variable has a different impact on the dependent variable at a different level of the explanatory variable. The linear relationship imposes the same quantitative impact throughout the entire range of the explanatory variable which, without considerably more refined arguments under each of the expenditure hypotheses, provides one opportunity for testing the expenditure hypotheses. However, this restriction should be borne in mind when interpreting the subsequent results. In summary, the expenditure determinants hypotheses outline a set of explanatory variables to be considered in the following empirical analysis of expenditure categories. They also establish certain a priori sign expectations. Occasionally additional category-specific variables will be considered. The expenditure equations are estimated using deflated expenditure variables in both level and per capita specifications. Finally, a formal model of the expenditure process — the partial adjustment model — will be used as the basis for examining the effects of each of the expenditure determinants and for assessing the dynamic response of provincial expenditures over time. TESTING T H E E X P E N D I T U R E SUB-MODEL The previous two sections have outlined the equation specifications and the variables that must be considered in the empirical analysis of the expenditure 36 Note that the coefficient is (1 - M) so that a low value indicates a fast adjustment (M near 1) and vice versa. Also note that under these circumstances the DW statistic is biased towards not rejecting the null hypothesis of no significant first order autocorrelation (Nerlove and Wallis, 1966). This implies that if the null hypothesis is rejected, then significant first order autocorrelation definitely exists. In this way the DW statistic can still provide useful information. An alternative large sample statistic is the Durbin /¡-statistic (Johnston, 1972, 313), but its small sample properties are not known.

180 Provincial Public Finance in Ontario categories. It is useful to first review some general conclusions developed from the analysis to reduce the number of estimated equations that must be considered. Multicollinearity is a problem that often plagues the researcher working with time series data and it was not surprising to be confronted with the problem in testing the expenditure sub-model. In particular, it was not possible to separate statistically the influences represented by the first two expenditure hypotheses, namely population and income. For example, the simple correlation between total population and real personal disposable income in the province was 0.983 and between total population and real per capita personal disposable income it was 0.970. Their joint introduction into an expenditure equation invariably produced a very high positive coefficient on the income variable and a negative coefficient on the population variable. Breaking the population into its age components did not help (nor for that matter, did the introduction of alternative measures of income). Technically there is only one 'solution' to this problem, namely, the incorporation of additional information. This may be in the form of additional data, alternative measures of the relevant variables or the acquisition of extraneous parameter estimates from other research results. None of these possibilities presented a viable alternative in the present context. Additional information may also suggest the consideration of an alternative specification of the equation and consequently the levels form was discarded in favour of the per capita specification.37 This automatically results in the elimination of the above-mentioned multicollmearity problem. This is the specification that has generally been chosen by other researchers, presumably for the same reason. The second general conclusion developed from the analysis was that the per capita income variable tends to dominate all per capita expenditure equations. The other expenditure determinants definitely have a role to play, but their influence is much more selective, with different variables influencing different expenditure categories. This is not surprising if, as has been argued, the per capita income variable is interpreted to represent a basic demand for public services. A third general conclusion was very encouraging. In general, the partial adjustment model of provincial government expenditures performed remarkably well with very reasonable values being obtained for the adjustment coefficient.

37 This reasoning, although on statistical grounds, also accords with the theory where the desired levels of expenditures are hypothesized to be determined in per capita terms, which seems quite appropriate.

An empirical analysis of the expenditure categories 181 Moreover a possible multicollinearity problem between the per capita income variable and the lagged expenditure variable did not seem to be serious. As a result of these three general conclusions, the following preliminary equation was estimated for all expenditure categories:38

where EXPPC denotes real per capita expenditures, PDIPC denotes real per capita incomes, and t denotes the time dimension. In this preliminary specification, per capita incomes are the sole determinant of desired expenditures. The results for every expenditure category, which are reported in Table 40, provide a useful starting point for a general empirical analysis of the expenditure categories. The preliminary specification generally performs well, although there are some exceptions. For example, an incorrect negative sign on the income variable is recorded for education administration, development loans, highway maintenance, and highway construction. In addition, a poor degree of explanation is recorded for debt transactions and both categories of government services. These are not at all surprising results. Highway maintenance, for example, is undoubtedly determined by past construction expenditures rather than the postulated model; similarly, for debt transactions where the majority of the expenditures are determined by the size and composition of the public debt. For the remaining 26 categories, the equations are quite satisfactory. Of particular interest are the estimates of the 0 2 coefficient which reflects the speed of adjustment in expenditures by the provincial government. Table 40 contains the following unweighted distribution of magnitudes for this coefficient: Range

Number

1 2 7 0 6 Total

26

The unweighted modal range of this distribution is 0.6 < 0. < 0.8 which implies a modal range for the adjustment coefficient of 0 . 4 > / u > 0 . 2 . This 38 Recall that in this specification f i ~ = ( \ - M) where M is the adjustment coefficient.

182 Provincial Public Finance in Ontario TABLE 40 Results for the preliminary per capita expenditure equation1 Expenditure category

Estimation period

Health administration

1952-72

Mental health

1952-72

Public health

1952-72

Hospitals

1957-71

Assistance to school authorities Post-secondary education Special education

1952-72 1952-72

Cultural education

1952-72

Education administration Superannuation

1952-72 1952-72

Debt transactions

1952-72

Pensions

1952-72

Development loans

1961-72

Tax diminution

1953-72

TEIA administration

1952-72

Highway maintenance

1952-72

Highway construction

1952-72

Transportation administration Income maintenance

1952-72

1952-72

1952-72

£o (se)

-0.74 (0.33) -2.21 (1.26) -2.20 (0.97) -65.03 (5.96) -33.73 (19.3) -26.64 (10.8) -0.18 (0.15) -1.20 (0.46) 0.41 (0.47) -1.68 (1.82) 13.22 (18.8) -4.85 (1.67) 8.58 (38.9) -25.29 (7.81) -2.08 (1.04) 6.63 (3.28) 8.95 (4.39) -2.03 (1.53) -10.58 (4.61)

01 (se)

0.535 (0.224) 2.371 (1.301) 1.435 (0.608) 55.562 (3.134) 25.027 (13.86) 17.017 (6.559) 0.145 (0.110) 0.760 (0.281) -0.219 (0.401) 1.491 (1.309) 0.946 (8.430) 3.201 (1.078) -1.697 (21.04) 17.383 (5.175) 1.263 (0.600) -1.173 (0.872) -1.572 (2.458) 1.848 (0.959) 9.599 (3.741)

02

(se)

R2

SEE

DW 3

0.697 (0.150) 0.754 (0.160) 0.845 (0.106) 0.008 (0.049) 0.728 (0.185) 0.767 (0.124) 0.790 (0.188) 0.833 (0.099) 1.034 (0.170) 0.684 (0.230) 0.550 (0.201) 0.551 (0.183) 0.898 (0.238) 0.225 (0.247) 0.867 (0.157) 0.616 (0.149) 0.780 (0.134) 0.216 (0.119) 0.360 (0.240)

0.947

0.105

1.29

0.981

0.334

1.56

0.952

0.388

1.04

0.960

2.560

0.63

0.983

2.940

2.39

0.964

3.120

1.40

0.975

0.028

1.81

0.976

0.138

1.13

0.924

0.181

1.70

0.885

0.543

1.95

0.224 10.42

1.63

0.970

0.320

1.92

0.835

8.006

0.79

0.926

1.557

2.15

0.874

0.469

1.85

0.791

0.663

2.11

0.648

2.785

1.59

0.969

0.440

1.48

0.934

1.139

1.82

An empirical analysis of the expenditure categories 183 TABLE 40, continued Results for the preliminary per capita expenditure equation1 Expenditure category

Estimation period

Child and youth services Adult services Community services

1952-72

Rehabilitation services

1957-72

Housing

1952-72

Government accommodation Other government services Environment

1952-72 1952-72

Natural resources

1952-72

Revenue

1952-72

Agriculture

1952-72

OPP

1952-72

-2.51 (0.74)

Other justice

1952-72

Correctional services

1952-72

-1.93 (0.81) -1.61 (0.46)

00

0i

1952-72

-1.76 (1.00)

1952-72

-2.67 (0.85) -0.37 (0.10) -0.53 (0.18) -5.71 (2.76) 0.83 (1.50) -0.47 (0.48) -5.93 (1.79) -2.73 (0.87) -0.57 (0.28) -2.20 (0.96)

0.703 0.949 1.230 (0.650) (0.169) 2.031 0.359 0.905 (0.654) (0.269) 0.905 0.950 0.223 (0.064) (0.101) 0.703 0.990 0.317 (0.104) (0.141) 0.884 0.887 3.431 (1.568) (0.147) 0.846 0.676 0.590 (0.870) (0.153) 0.813 -0.219 0.244 (0.281) (0.217) 0.608 0.896 4.095 (1.238) (0.180) 0.485 0.917 3.155 (0.944) (0.192) 0.518 0.902 0.509 (0.225) (0.219) 1.764 0.747 0.940 (0.763) (0.154) 2.078 0.525 0.995 (0.615) (0.164) 1.312 0.838 0.937 (0.529) (0.111) 0.534 0.948 1.685 (0.468) (0.157)

1952-72

(se)

(se)

02

(se)

R2

SEE

DW3

0.255

1.43

0.263

1 .60

0.050

2 .55

0.021

2 .07

1.241

1.83

0.983

1 .72

0.319

2 .17

0.769

2 .28

0.463

2 .33

0.095

2.01

0.384

1 .88

0.082

2 .21

0.378

1.30

0.213

1.94

1 See the text for a description of this equation. 2 For example 1952-72 means 1952/3 to 1972/3 3 The DW statistic is biased towards accepting the null hypothesis so should be interpreted with caution. 4 Equation includes a dummy variable for the final year with a coefficient - 11.918 (1.822). 5 Equation includes a dummy variable for 1965/6 with a coefficient of 3.068 (0.461).

184 Provincial Public Finance in Ontario suggests that, in general, the provincial government adjusts its per capita expenditure towards a desired level in each category (which is determined by per capita disposable income) in such a way as to accommodate between 20 and 40 per cent of the difference between the actual per capita service level and the desired service level. As discussed above, there are a number of reasons that can account for this considerably less than immediate adjustment. 39 As is so often the case, it can be misleading to discuss generalities since an adjustment coefficient is estimated for each individual expenditure category. A relatively high value for j32 (or a relatively low value for ¿/) implies a slower adjustment than a relatively low value for 0 2 - However, before examining the estimated coefficients for the individual expenditure categories, the estimated equations must be extended to test for the remaining expenditure hypotheses discussed earlier in this chapter. It should be noted that since these hypotheses establish definite sign expectations on the coefficients of the explanatory variables, one-tail f-tests are required to test their significance.40 The preliminary per capita expenditure specification performs relatively well for all health categories except hospitals where the adjustment coefficient (¿¿) is unreasonably high. The inclusion of the other expenditure variables into the first three health categories did not prove to be significant; thus the impact of elections, urbanization, stabilization policy, or federal funds does not appear to be appreciable on health administration, mental health, or public health expenditures over the historical period. Expenditure on hospitals is another matter. Here the availability of federal health funds appears to have had a decided influence. Urbanization (URB) also appears to have some significance in determining desired per capita expenditures (see Table 41). For education expenditures again the preliminary specification performs relatively well for all categories except one — education administration. However, in these cases the additional expenditure hypotheses also contributed significantly to the determination of desired expenditures. Assistance to school authorities covers both primary and secondary education expenditures. The age structure of the population (that is, proportion in the school age (5 to 19) group denoted P519) and the availability of federal money for education both entered with correct signs, but the former was not significant. However its i-statistic was greater than one and inclusion of this variable could be justified on theoretical 39 A M = 0.4 implies that after three years the adjustment would be approximately 78 per cent complete, while a M = 0.2 implies that it would be approximately 49 per cent complete. 40 In most cases there are 17 degrees of freedom so that 95 per cent and 99 per cent significance levels are 1.740 and 2.567, respectively.

An empirical analysis of the expenditure categories 185 grounds. Post-secondary education expenditures also reflected the same influences (although in this case it was the proportion of population in the 20 to 24 age group (P2024) that was relevant). Again, age structure and federal funds contributed significantly to the explanation. The preliminary equations for special and cultural education could not be improved. In these cases per capita incomes alone determine desired per capita expenditure levels. No satisfactory equation could be found for education administration. None could capture the noticeable downturn in per capita expenditures in this category since 1968/9.41 More research is needed for this category. Similar difficulties were encountered for education superannuation expenditures. One of the problems was a structural change introduced by the government in 1965/6 when expenditures jumped by almost $2 per capita. Presumably these expenditures could be better explained by a careful analysis of the superannuation program rather than by a general analysis of government expenditures. Attempting to explain the treasury (TEIA) categories really creates problems. So much of the expenses classified in the categories of debt transactions, development loans, and tax diminution are discretionary in nature and not as subject to the general determinants of desired expenditures contained in the expenditure determinants hypotheses being tested in this study. These include election expenses. However they are important expenditure categories and their analysis deserves considerable further examination. The preliminary equation for expenditures on pensions could not be improved, although presumably in this case the income variable is acting as a proxy determining not so much the desired demand for an expenditure, but a combination of the age structure of government employees and their salary levels. Again a closer look at this structure may produce better results for this category. The final category in this group is TEIA administration which, according to the figures assembled in this study, rose rapidly when government reorganization began in 1970-71. The preliminary equation captures the trend quite well but there is little theoretical explanation as to why this should be the case. The next group of expenditure categories is transportation and communications. The trend in highway maintenance in per capita terms has been downward throughout the historical period, having dropped from around $14 in the early fifties to around $10 by the early seventies (which accounts for the estimated 41 This is somewhat disturbing from a more general viewpoint since only the population structure can account for declining trends in the historical period — the coefficients on all other variables are expected to be positive and they have experienced positive trends. Note, however, that this need not necessarily be the case (for example, intergovernmental transfers).

TABLE 41 Extended per capita expenditure equation results Expenditure category Hospitals Assistance to school authorities Post-secondary education Highway maintenance2 Highway construction2 Income maintenance Child and youth services Adult services Rehabilitation services Other government services Revenue

Intercept

Income

-71.27 (19.2) -45.95 (18.4) -55.16 (21.0) 2.01 (1.07) 5.97 (2.94) -8.81 (4.06) -1.38 (1.45) -3.67 (0.40) -0.32 (0.16) -0.41 (0.20) -0.61 (0.12)

36.417 (4.850) 24.961 (11.77) 19.07 (7-54)

1 Variables are defined in the text. 2 Included for illustrative purposes only.

Lagged expenditures

0.589 (0.159) 0.468 (0.198) 0.802 (0.086) 0.758 (0.112)

0.750 (0.203) 2.857 (0.212) 0.168 (0.097) 0.599 (0.107) 0.651 (0.071)

0.634 (0.114)

Federal funds

Other variables

0.231 (0.095) 0.363 (0.149) 0.273 (0.165)

0.757 URB (0.421) 56.051 P519 (52.6) 382.2 P2024 (197.0) 0.633 DEL (0.328) 2.382 DEL (1.335) 0.314 URB (0.090) 3.943 P019 (3.913)

0.712 (0.067) 0.056 (0.050)

0.012 (0.004) 0.653 DEL (0.069) 0.265 D61 (0.040)

ti?

SEE

DW

0.984

1.620

1.56

0.989

2.434

2.68

0.969

2.878

1.60

0.809

0.633

2.48

0.694

2.596

1.29

0.979

0.633

2.24

0.951

0.250

1.28

0.901

0.269

1.34

0.994

0.017

1.53

0.865

0.135

1.53

0.963

0.059

1.66

An empirical analysis of the expenditure categories 187 negative sign on the income variable in Table 40). This downward trend is somewhat surprising, especially since highway construction has remained at high levels even on a per capita basis. Since deterioration and hence maintenance are usually dependent on the size of the relevant capital stock it is not surprising that the included expenditure determinants do not satisfactorily explain these expenditures. However one interesting conclusion that did emerge from the analysis of this category was the continuing significance of the elections on highway expenses. To illustrate the point, the results for the equations with just the lagged expenditure variable and an election dummy (DEL) are presented in Table 41. These results suggest that highway maintenance rises by 63 cents per person (in constant dollars) in an election year while expenditures on highway construction rise by $2.38 per person (in constant dollars). However these estimates must be treated with obvious caution because of the poor specification of the equations. The unemployment rate appeared to enter positively and significantly in highway maintenance, perhaps suggesting that highway construction may have been used historically as a provincial fiscal policy instrument. The introduction of federal funds into the construction equation proved to be significant when introduced with the income variable and reduced the significance of the elections, but the degree of explanation was quite poor (R2 = 0.41). Transportation administration can be explained by the preliminary specification. The next group of expenditure categories centres on community and social services. For these categories it might be expected that the population structure and the availability of federal funds and perhaps urbanization might be important. The availability of federal funds and urbanization proved to be important variables for explaining expenditures on income maintenance. For child and youth services urbanization was not significant and the availability of federal funds and the proportion of the population under nineteen (P019) appeared with the correct signs, but had f-statistics only slightly above unity. However, what was really surprising was the lack of significance of the 'over 65' population proportion in the adult services equation. In fact, only per capita income was a significant explanatory variable for this category. The preliminary equation could not be improved for community services, while the introduction of a federal funds variable improved the equation for rehabilitation services (see Table 41). The preliminary equation could not be improved for housing expenditures. No satisfactory equation could be obtained within the context of this study for expenditures on government accommodation, but other government services can be adequately explained by per capita income and an election dummy which captures the expenses under the Elections Act. Its estimated coefficient (see Table 41) suggests that elections have, on average, cost the province about 65

188 Provincial Public Finance in Ontario cents per person (in constant dollars). None of the other expenditure variables proved to be significant for environment or natural resources. The basic per capita expenditure equation for revenue is not affected by the introduction of other variables. However there appears to be a structural change in the series for 1961/2 (presumably associated with the introduction of the retail sales tax) and the introduction of a dummy variable (06!) significantly improved the explanatory power of the regression (but eliminated the significance of j32 —see Table 41). The basic equations for agriculture and OPP remained unaffected by the introduction of the remaining explanatory variables, and the introduction of a dummy variable into the 'other justice' equation to capture the transfer of responsibilities from the municipalities proved to be a significant improvement (and lowered the (3- coefficient considerably). Finally, all of the other explanatory variables proved to be insignificant when entered into the preliminary equation for correctional services. A review of the results for the per capita expenditure equations shows that: 16 expenditure categories can be explained by the simple preliminary equation; 8 expenditure categories cannot be explained by the expenditure determinant hypotheses outlined in this study; 9 expenditure categories needed to be reestimated in light of the significant influence of the variables representing the other expenditure determinant hypotheses. Of these, 4 retained the lagged dependent variable in the specification. Before summarizing the results it is probably useful to review, once again, the adjustment pattern of the provincial government for those categories for which the partial adjustment model is substantiated by the empirical results. The estimates of the unweighted j3, coefficients follow the following distribution: Range

Number 0 1 2 < 0.6 6 2 < 0.8 2 < 1.0

Total

7 6

20

The same general conclusion emerges as previously - that the modal range for the adjustment coefficient is 0.2 < p. < 0.4. Taking the mid-point of this range for illustrative purposes, suggests that the provincial government takes approximately 2 years to complete 50 per cent of the desired adjustment and 4 years to complete 75 per cent of the desired adjustment determined by the

An empirical analysis of the expenditure categories 189 TABLE 42 Tests of the long-run stimulation-substitution hypothesis Expenditure category

Long-run coefficient

Assistance to school authorities Post-secondary education Child and youth services Rehabilitation services

0.883 0.513 0.224 0.033

explanatory variables representing six of the nine expenditure hypotheses outlined above. Where a federal funds variable enters into the explanation of an expenditure category, a test of the stimulation-substitution hypothesis is possible. The parameter estimates for these coefficients, presented in Table 41, are all less than unity, thus suggesting some substitution by the provincial government. However, in the equations where the lagged dependent variable appears, these parameter estimates only represent the impact effect of the federal funds. The long-run effect is obtained by dividing the parameter estimate by the measure of the adjustment coefficient. This results in the estimates shown in Table 42. Even the long-run effects are all below unity, which suggests that the provincial government expanded expenditure in these broad categories by less than matching the amounts of the federal funds. These results all correspond to the interpretation that there has been some substitution in provincial expenditures in response to the federal transfer payments. Before summarizing the findings of the empirical analysis of expenditure categories, the three remaining expenditure determinant hypotheses outlined earlier should be briefly examined. The revenue led expenditure hypothesis can be empirically tested by referring back to Table 14, where it is readily apparent that there has been a dramatic increase in the obligations to the Canada Pension Plan. To the extent that the provincial government finds these sources of funds the politically least costly, then this hypothesis would predict a rapid rise in expenditures. Such an increase was noted in chapter one (see Figure 1) where a rapid rise in aggregate real government expenditures after 1965/6 is apparent. This rapid rise is also apparent in per capita terms. In surveying the historical development of the expenditure categories (in chapter four) it was noted that the CPP was introduced in 1966 and these funds were made available to the provinces as a new source of borrowing. Consequently, the evidence examined appears to be very supportive of this view, although considerably detailed

190 Provincial Public Finance in Ontario analysis of the financing sub-model would be necessary before this hypothesis could be considered largely substantiated. The displacement hypothesis cannot be empirically tested because of the lack of relevant private sector measures of the activities. However the one expenditure category where this has clearly been a dominant factor is in health (hospital and medical) insurance, where the province took over basic insurance from private companies in 1969. Extended coverage is still available in the private sector. Because of data difficulties it has not been possible to construct a time series for this important expenditure category so no parameter estimates are biased by the exclusion of this influence (see p. 174). Finally, the evidence on the leading sector hypothesis is presented in Figure 6. Because of certain data difficulties the analogy is not perfectly realized but a noticeable pattern along the lines outlined under that hypothesis (see Figure 5) clearly emerges. First, highways received concentrated attention; this was followed by education, then health (and perhaps municipal assistance and other treasury programs), and now it is interesting to ponder the next sector for concentrated development. A conjectural response might suggest that the evidence points to social services, but by examining Figure 6 the reader can be the final judge. SUMMARY

This chapter has presented the results of an empirical analysis of the expenditure categories of the Government of Ontario. For this purpose, econometric equations were developed in an attempt to account for the medium-term growth of expenditures for the various categories developed in chapter four. The formal model used was a partial adjustment model, where the desired per capita level of expenditures was determined by nine possible expenditure determinant hypotheses. Elements of all hypotheses were found to have explanatory power, but the income hypothesis was generally the most powerful. The provincial government was found to take about 2 years on average to complete 50 per cent of the desired adjustment. The conclusion suggested by these results is that it is probably a desired demand for public expenditures, which is determined by population and income levels, that determines expenditures in the various categories. However other influences are also quite important. The availability of federal funds has clearly been an important determinant of hospital, education, and some social welfare expenditures and, since these are very large categories, much of the growth since the mid-sixties (in addition to the basic demand determinants) can be traced to this source. Generally, it appears as though these have been a substitute for

An empirical analysis of the expenditure categories 191 Figure 6 Evidence for the leading sector hypothesis Key: See Figure 5 and associated textual discussion

provincial expenditures. Provincial stabilization policy does not seem to have been active over the historical period covered by these results. Any effects of urbanization are only apparent in two expenditure categories, namely hospital expenditures and expenditures on income maintenance. A quick glance at the relevant figures (1 and 4) suggests that the effects of urbanization must work with roughly a ten-year lag for this to be a significant general determinant of most provincial expenditures. Clearly this is not impossible and the lag may be shorter for some individual expenditure categories, but the conclusion that emerges from these results is that urbanization has generally not been a significant determinant of provincial expenditures. The influence of elections seems to

192 Provincial Public Finance in Ontario have been felt in two main categories — in expenses under the Election Act and in expenditures on transportation (highway construction and maintenance). This may not be a surprising finding,42 but it is useful to document it quantitatively. The revenue led expenditure hypothesis certainly deserves further analysis, particularly along the lines developed in this chapter. Displacement of private by public activity has clearly been important in health insurance, but it has not been possible to test for displacement in other areas of activity. The existence of a leading sector explanation of the development of the public sector of the province appears plausible and this view of the expenditure process cannot be easily dismissed in light of the evidence presented in this chapter. The conclusion that emerges from the specification of the econometric equation used in the analysis of provincial expenditures is that the government does not adjust rapidly to increases in the desired level of per capita expenditures. There are probably many reasons for this partial adjustment and the results of this chapter suggest an average partial adjustment of between 20 and 40 per cent per year.

42 Munro (1975) reported a similar finding for British Columbia.

PART FOUR CONCLUSIONS

This page intentionally left blank

7

Summary and conclusions

SUMMARY

This study has been directed at a relatively neglected area in public finance — an analysis of the activities of a junior government over time. The study focuses on the largest of all of the junior governments in Canada — the government of the Province of Ontario. The objective has been to analyse the finances of the Government of Ontario over the postwar period in considerable detail within a quantitative framework. To achieve this objective, the annual revenues and expenditures of the government were reviewed (part one) and disaggregated into numerous consistent time series (part two), which were then subjected to analysis using econometric techniques (part three). Each part contained two chapters. Following a brief review of the relevant historical experience in the province (chapter one), the basic ingredients of a complete model of provincial public finances were outlined (chapter two). This study was limited to the revenue and expenditure sub-models with the financing sub-model receiving comparatively little attention. Historical time series for detailed revenue and expenditure categories were compiled from public sources (chapters three and four). A revenue sub-model was developed based on a rate-base approach. It separated discretionary from automatic revenue changes and provided both structural and reduced form specifications for all tax and a number of non-tax revenue categories. The equations were estimated in current dollars (chapter five). An expenditure sub-model was developed based on a set of independent hypotheses regarding the determinants of a desired level of public expenditures. These then entered into a partial adjustment model of government expenditure behaviour. The equations were estimated in constant dollars expressed on a per capita

196 Provincial Public Finance in Ontario basis (chapter six). The resulting estimated equations, for both the revenue and expenditure sub-models, can help to explain the medium-term growth trends in the various categories and provide an illustration of the application of the theoretical models to the activities of a governmental unit over time. Not all of the provincial revenues and expenditures are accounted for in this study. Only the expenditure programs of the most important ministries were considered, although these account for a large proportion of total government expenditures. Moreover not all of the medium-term trends in the various categories could be adequately explained by the econometric equations estimated in this study. This indicates that additional research is required for these particular revenue and expenditure categories. CONCLUSIONS This study has demonstrated the feasibility of disaggregating the public finances of a sub-national level of government and analysing their behaviour over time. It has shown that it is important to separate the effects of discretionary changes (such as tax changes) from automatic changes when analysing revenue patterns and that a partial adjustment model performs well for analysing expenditure patterns. A general result from the revenue analysis is that a three equation rate-base approach provides a useful theoretical basis for examining mediumterm revenue growth in the Province of Ontario. It provides sufficient flexibility to accommodate the analysis of a wide range of specific revenues. A general result from the expenditure analysis is that the provincial government adjusts reasonably slowly to new levels of desired per capita expenditures which appear to be determined primarily by demand variables. More specific results indicate that economic stabilization and urbanization have not been significant determinants of expenditure patterns in Ontario, whereas the availability of federal funds has been an important determinant for some categories. For these categories the substitution hypothesis is confirmed. Elections, in general, have had little effect. There is also evidence that there has been some transfer of expenditures between the private and public sectors and that the hypothesis of revenue-led expenditure growth cannot be dismissed. Also the evidence suggests that the expenditure programs of the province have followed a pattern that is consistent with a leading sector interpretation. It is hoped that the description, analysis, and conclusions in this study will encourage others to engage in the quantitative examination of the medium-term trends of the public finances of sub-national governments. This relatively neglected approach can yield interesting and useful results for all of those concerned with an assessment and analysis of the changing patterns of provincial public finances.

APPENDIX A

Revised data

TABLE Al The Ontario economy, selected series, 1969-74

Year

GPP

Personal income

1969 1970 1971 1972 1973 1974

32.638 35.314 38.212 43.230 49.846 58.270

25.629 27.974 30.857 34.623 38.963 44.997

Personal disposable income

Per capita PDI

CPI (1971 = 100)

20.696 22.189 24.465 27.687 31.189 35.655

2802 2939 3176 3538 3929 4405

94.1 97.2 100.0 104.8 112.7

NOTE: See Tables 1 and 37 for further details.

125.0

Real per capita PDI ($71 bil) 2978 3024 3176 3376 3486 3524

TABLE A2 The Ontario economy in relation to the Canadian economy, selected series, 1969-74 (per cent) Year 1969

1970 1971 1972 1973 1974

Gross Product

Personal Income

40.9 41.2 40.6 41.3 40.7 40.3

41.5 42.0 41.6 41.3 40.0 39.2

NOTE: See Table 3 for further details.

APPENDIX B

Growth rate calculations

Growth rate calculations1 Growth rates g for any time series, denoted yf , are usually calculated as

When y = yt_^ a condition of zero growth is recorded. Equation (B.I) can be written as y-y- = «v_. or

This is a homogeneous first order difference equation which has the general solution:

where the value of the parameter A is determined from an initial (t = 0) condition

1 For a similar presentation see Kelejian and Oates (1974, 99-102).

200 Provincial Public Finance in Ontario Equations (B.3) and (B.4) completely describe the behaviour of a time series with a constant growth rate g. Since growth rates in actual time series usually vary from period to period, # can be interpreted as an average annual growth rate for the entire series. There are two alternative methods of estimating g under these circumstances (1) End point estimates Equation (B.4) defines the initial value of the series (when t = 0). The terminal value of the series (when t = T) can be obtained from equations (B.3) and (B.4) as

Consequently the ratio of the terminal to the initial value is

By taking logs of equation (B.5) and rearranging terms

and since all information on the right hand side of equation (B.6) is available an estimate of g (denoted g) can be obtained as

Note that this method only uses the first and the last observations in the time series and hence ignores all the intervening observations. Consequently, the calculated growth rates can be quite sensitive to the choice of the initial and terminal values. (2) Regression estimates An alternative method of calculating growth rates which uses all of the observations in the time series, and therefore is not as sensitive to any particular subset of observations, is to apply regression analysis to a semilog transformation of equation (B.3); that is, using log^ = \ogA which might be written more familiarly as

Growth rate calculations 201

where a = log A and 0 = log (1 + #). Since actual growth rates vary around the average, a random error term can be introduced into equation (B.8) which then becomes a simple regression of log yf on time (/)• An estimate of the average annual growth rate (g) is obtained from the estimate of the slope (/3) as2

Since this procedure uses all of the information in the time series yf it is usually the preferred method of calculating growth rates. Tables B.I and B.2 summarize the results of applying this method to the revenue and expenditure categories of chapters three and four. Results for both current and constant dollar calculations are presented. For the constant dollar calculations, the National Accounts implicit price deflator for government current expenditure on goods and services adjusted to a fiscal year basis is used as the deflator (see Table 4). For each revenue and expenditure category the coefficient of multiple correlation (R2) is also presented as a summary measure of the 'goodness of fit' of these equations. In general, a high R2 suggests that the time series has closely followed a smooth exponential growth over the estimation period, while a low R2 suggests that the recorded growth should be interpreted with caution. In addition, these results also serve as a benchmark against which to assess the econometric specifications analysed in chapters five and six.3 The growth rate (g) and R2 associated with the estimation of equation (A8) for each of the revenue and expenditure categories are summarized in Tables B.I and B.2 respectively for both current and constant dollar calculations. The ordering of the categories closely follows the ordering in chapters three and four respectively, where a description of the data can be found.

2 It can be shown that,? will be a consistent but not unbiased estimator oí g (Kelejian and Dates, 1974, 102). Note that the two methods will usually give different estimates of g. 3 The reader is reminded that a simple comparison of R1 is often not possible since the dependent variables in the regressions will usually be different. In all regressions reported in this appendix the dependent variable is the natural logarithm of the figures in the category.

202 Appendix B TABLE B.I Regression estimates of growth rates for revenue categories Current $

Constant 3>

Revenue category

Estimation period

R2 g (per cent)

R2 g (per cent)

Taxation revenue categories: Personal income Corporation income (total) Ordinary incorp. income Premium income Other corporation All other Succession duties Retail sales (total) Retail sales Tobacco Amusements (hospitals) Motive fuel Race tracks Land transfer Property

1964-73 1958-73 1958-73 1958-73 1958-73 1952-73 1952-73 1968-73 1963-73 1967-73 1952-69 1952-73 1952-73 1952-73 1952-73

25.7 8.9 8.4

18.1 3.7 3.2

Other revenue categories Health premiums Motor vehicle licenses and permits LCBO profits Liquor licenses and permits Natural resource revenues Fish and game Forests Mines Oil and gas Water power Fines and penalties Sales and rentals Interest on investments Pension contributions WBC contributions

34.2 6.5 7.2 20.8 19.6 33.2 2.6 9.5 10.7 11.3 8.0

0.969 0.947 0.939 0.927 0.617 0.778 0.981 0.959 0.961 0.819 0.178 0.991 0.950 0.901 0.898

2.8 27.8 1.8 2.5 13.8 12.6 24.8 -1.5 4.6 5.8 6.4 3.3

0.938 0.836 0.752 0.621 0.542 0.229 0.792 0.918 0.919 0.733 0.078 0.965 0.869 0.793 0.526

1960-72

13.0

0.935

7.3

0.870

1952-73 1952-73 1952-73

10.0 9.5 7.1

0.969 0.978 0.957

5.2 4.7 2.3

0.872 0.935 0.759

1952-73 1952-73 1952-73 1952-73 1952-73 1952-732 1952-73 1952-71 1952-73 1952-73

5.8 1.5 7.3 14.3 9.5 8.7 11.7 17.1 14.7 9.5

0.936 0.419 0.755 0.852 0.903 0.980 0.854 0.937 0.944 0.981

1.1 -3.00 2.6 9.3

0.459 0.726 0.263 0.699 0.653 0.969 0.726 0.910 0.864 0.905

8.0

4.7 4.4 6.8 12.2 9.7 4.7

Growth rate calculations 203 TABLE B.I continued Regression estimates of growth rates for revenue categories Current $

Constant $

Revenue category

Estimation period

~R2 g (per cent)

R1 g (per cent)

Payments from other levels of government Health Social welfare Education Other federal Total local

1952-733 1953-73 1952-73 1952-73 1963-73

16.3 22.1

10.5 16.6 28.3

34.2 6.5 10.0

0.991 0.984 0.866 0.425 0.430

1.8 3.6

1 Fiscal year ending. For example, estimation period 1952-73 means from fiscal year 1951/52 to fiscal year 1972/3. 2 Includes a dummy variable from 1968. 3 Includes a dummy variable from 1960.

0.990 0.971 0.816 0.051 0.088

204 Appendix B TABLE B.2 Regression estimates of growth rates for expenditure categories' Current $'s

Constant $ 's

R2 g (per cent)

Expenditure category

Estimation period 1

R2 g (per cent)

Health administration Mental health Public health Hospitals Health insurance School authorities Post-secondary education Special education Cultural education Administration and other education Superannuation (education) Debt transactions Pension funds Development loans Tax diminution Administration (TE1A) Highway maintenance Highway construction Administration (MTC) Income maintenance Child and youth welfare Adult services Community services Rehabilitation Day nurseries Housing Provision of accommodation Other government services Environment Natural resources Revenue Agriculture OPP Justice Correctional services

1951-73 1951-73 1951-73 1956-712

16.2 12.2 16.8 14.3

0.957 0.994 0.864 0.995

11.1

11.6 9.1

0.936 0.993 0.789 0.997

NA

NA

1 2 3 4

7.2

NA

NA

NA

1951-75 1951-75 1951-75 1951-75

16.9 23.4 15.3 23.5

0.994 0.968 0.989 0.960

11.5 17.7

0.982 0.955 0.979 0.945

1951-75 1951-75 1951-73 1951-75 1958-75 1953-75 1951-75 1951-75 1951-75 1951-753 1951-75 1951-73 1951-74 1951-73 1958-73 1951-74 1951-74 1951-74 1951-73 1951-75 1951-75 1951-754 1951-75 1951-75 1951-75 1951-75

12.1 16.2 6.5

0.983 0.963 0.672 0.988 0.610 0.964 0.932 0.948 0.908 0.996 0.986 0.963 0.966 0.774 0.990 0.721 0.804 0.899 0.859 0.926 0.965 0.987 0.962 0.995 0.887 0.976

7.0 10.9 1.7 16.2 36.0 12.9 17.4 1.0

21.8 43.2

18.4 23.1 5.8 9.5

14.4 14.9 19.0 16.7

14.0 31.8 18.2 25.0

10.2 11.6 14.9 11.2 13.8 12.8 14.3 14.1 11.6

See footnotes to Table B.I. Last two fiscal years are from the Estimates. Calendar years. Includes dummy variables for 1956 to 1964 and from 1965. Excludes GAINS allocation for 1974/5.

10.0 17.8

4.5 8.8 9.6

13.7 11.5

9.0 25.3 12.8 19.4

5.2 6.5 9.6 6.1 8.5 7.6 9.0 8.8 6.5

0.931 0.910 0.144 0.980 0.534 0.930 0.908

0.511 0.660 0.995 0.964 0.943 0.939 0.627 0.987 0.600 0.738 0.732 0.670 0.864 0.934 0.961 0.936 0.992 0.801 0.960

APPENDIX C

Weighted tax rates on a calendar year basis

206 Appendix C TABLE Cl Ontario weighted tax rates for selected revenue categories, calendar year basis, 1951-73 (per cent)

Year

1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973

Personal income

Ordinary incorp. income

Paid-up capital

Retail sales

Cigarettes

16.0 17.0 18.0 21.0 24.0 28.0 28.0 28.0 28.0 27.5 29.585 30.5

11.0 11.0 11.0 11.0 11.0 11.0 11.0 11.0 11.0 11.0 12.0 12.0 12.0 12.0 12.0 12.0 12.0

5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 9.0 10.0 10.0 10.0 17.2

1.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 4.5 5.0 5.0 5.0 5.0 5.0 5.0 6.3

8.75 10.00 26.07 38.27 40.00 40.00 44.56 46.00

NOTE: See notes to Tables 35 and 36.

Weighted tax rates on a calendar year basis 207 TABLE C l , continued Ontario weighted tax rates for selected revenue categories, calendar year basis, 1951-73 (per cent) 1 Motive fuel Year

Gasoline

Diesel

1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973

11.00 11.00 11.00 11.00 11.00 11.00 12.72 13.00 13.00 13.00 13.00 13.00 14.77 15.00 15.00 15.75 16.00 17.61 18.00 18.00 18.00 18.75 19.00

11.00 11.00 11.00 11.00 11.00 11.00 17.99 18.88 18.50 18.50 18.50 18.50 18.50 21.15 21.50 21.88 22.00 23.61 24.00 24.00 24.00 24.75 25.00

Race tracks

Land transfer

12.16 10.69

0.2 0.2

8.61 7.25

7.00 6.25 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.80 7.00 7.00 7.00 7.00 7.00

0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.275 0.3 0.3 0.3 0.3 0.3 0.39 0.45

Health premiums

Vehicle licence fees

2.10 2.10 2.10 2.10 2.10 2.675 3.25 5.75 8.25 9.825 11.40 11.40 11.40 11.10 11.00

13.00 13.00 13.00 13.00 13.00 18.20 18.20 18.00 18.00 20.00 20.00 20.00 20.00 20.25 23.00 23.00 23.00 23.75 32.00 32.00 32.00 32.60 36.80

This page intentionally left blank

Bibliography

Adams, R.F. (1966) 'The fiscal response to government transfers in less developed areas of the United States.' Review of Economics and Statistics 48, 308-13 Auld, D.A.L. (1971) 'Automatic fiscal stabilizers: problems of identification and measurement.' Public Finance 26, 513-31 Bahl, R.W. and R.J. Saunders (1965) 'Determinants of changes in state and local government expenditures.' National Tax Journal 18, 50-57 - (1966) 'Factors associated with variations in state and local government spending.' Journal of Finance 21, 523-34 Balopoulos, E.T. (1967) Fiscal Policy Models of the British Economy (Amsterdam: North-Holland) Berney, R.E. (1970) Tax Structure Variations in the State of Washington (Washington: Pullman) Bird, R.M. (1970) The Growth of Government Spending in Canada (Toronto: Canadian Tax Foundation) Bishop, G.A. (1964) 'Stimulative versus substitutive effects of state school aid in New England.' National Tax Journal 17, 133-43 Bodkin, R.G. and D.W. Conklin (1971) 'Scale and other determinants of municipal government expenditures in Ontario: a quantitative analysis.' International Economic Review 12, 465-81 Brazer, H.E. (1959) City Expenditures in the United States. Occasional paper no. 66 (New York: National Bureau of Economic Research) Breton, A. (1974) The Economic Theory of Representative Government (Chicago: Aldine)

210 Bibliography Canada (bi-weekly) The Canada Gazette. Parts 1 and 2 (Ottawa: Queen's Printer for Canada) Canadian Tax Foundation (biennial) Provincial and Municipal Finances, formerly called Provincial Finances (Toronto: Canadian Tax Foundation) Carter, G.E. (1971) Canadian Conditional Grants Since World War II (Toronto: Canadian Tax Foundation) Clark, C. (1945) 'Public finance and the value of money.' Economic Journal 55, 371-89 Dallimore, D.C. and B. Lampert (1973) 'Demographic trends in Ontario: some policy considerations.' Ontario Economic Review 11, 1-12 Fabricant, S. (1952) The Trend of Government Activity in the United States (New York: National Bureau of Economic Research) Fisher, G.W. (1961) 'Determinants of state and local government expenditure: a preliminary analysis.' National Tax Journal 14, 349-55 - (1964) 'Interstate variation in state and local government expenditure.' National Tax Journal 17, 57-74 Gramlich, E.M. (1968) 'Alternative federal policies for stimulating state and local expenditures: a comparison of their effects.' National Tax Journal 21, 119-29 - (1969) 'State and local government and their budget constraint.' International Economic Review 10, 163-82 - and H. Galper (1973) 'State and local fiscal behaviour and federal grant policy.' Brookings Papers on Economic Activity 4, 15-58 Griliches, Z. (1967) 'Distributed lags: a survey.' Econometrica 35, 16-49 Hagan, E.E. (1968) The Economics of Development (Homewood: Irwin) Haronitis, D. (1971) 'An econometric model for the Ontario economy.' Ontario Economic Review. Special supplement Harris, R. ( 1966) Income and Sales Taxes: The 1970 Outlook for States and Localities (Chicago: The Council of State Governments) Hartle, D.G. (1976) A Theory of the Expenditure-Budgetary Process (Toronto: Ontario Economic Council) Helliwell, J.F., R.G. Evans, F.W. Corbet, R.F.S. Jarrett, and D.R. Stephenson ( 1969) Government Sector Equations for Macroeconomic Models. Staff Research Studies no. 4 (Ottawa: Bank of Canada) Henderson, J.M. (1968) 'Local government expenditures: a social welfare analysis.' Review of Economics and Statistics 50, 156-63 Horowitz, A.R. (1968) 'A simultaneous-equation approach to the problem of explaining interstate differences in state and local government expenditures.' Southern Economic Journal 34, 459-76 Johnston, J. (1972) Econometric Methods. 2nd ed. (New York: McGraw-Hill)

Bibliography 211 Karmel, P.H. (1957) Applied Statistics for Economists (Melbourne: Pitman) Kee, W.S. (1965) 'Central city expenditures and metropolitan area.' National Tax Journal 18,337-53 Kelejian, H.H. and W.E. Dates ( 1974) Introduction to Econometrics: Principles and Applications (New York: Harper and Row) Lang, V. (1974) The Service State Emerges in Ontario (Toronto: Ontario Economic Council) Legler, J.B. and P. Shapiro (1968) 'The responsiveness of state tax revenue to economic growth.' National Tax Journal 21, 46-56 McGuire, M. (1975) 'An econometric model of federal grants and local fiscal response.' In W.E. Gates, éd., Financing the new Federalism, Revenue Sharing, Conditional Grants and Taxation (Washington: Johns Hopkins University Press for Resources for the Future) Michas, N.A. (1969) 'Variations in the level of provincial-municipal expenditures in Canada: an econometric analysis.' Public Finance 24, 597-613 Morss, E.R. (1966) 'Some thoughts on the determinants of state and local expenditures.' National Tax Journal 19, 95-103 - J.E. Friedland, and S. H. Hymans (1967) 'Fluctuations in state expenditures: an econometric analysis.' Southern Economic Journal 23, 496-517 Munro, J.M. (1975) 'Highways in British Columbia: economics and politics.' Canadian Journal of Economics 8, 192-204 Nerlove, M. and K.F. Wallis (1966) 'The use of the Durbin-Watson statistic in inappropriate situations.' Econometrica 34, 235-8 O'Brien, T. (1971) 'Grants-in-aid: some further answers.' National Tax Journal 24, 65-77 Ohls, J.C. and T.J. Wales (1972) 'Supply and demand for state and local services.' Review of Economics and Statistics 54, 424-30 Ontario (annual) Expenditure Estimates (Toronto: Ontario Government) - (annual) Public Accounts of Ontario (Toronto: Queen's Printer for Ontario) Ontario Civil Service Commission (annual) Annual Report (Toronto: Ontario Civil Service Commission) Ontario Committee on Taxation (1967) The Ontario Committee on Taxation Report. Vols. I, H , a n d III (Toronto: Queen's Printer for Ontario) Ontario Hospital Services Commission (annual) Annual Report (Toronto: OHSC) Ontario Ministry of Health (1974) OHIPPractitioner Care Statistics. Fiscal 1973/4 (pre-audit) (Toronto: Ontario Ministry of Health) Ontario Ministry of Treasury, Economics, and Intergovernmental Affairs (annual) Ontario Budget (Toronto: Ontario Ministry of TEIA) - (annual) Ontario Statistical Review (Toronto: Ontario Ministry of TEIA) - (quarterly) Ontario Finances (Toronto: Ontario Ministry of TEIA)

212 Bibliography - ( 1972) Federal-Provincial Shared-Cost Programs in Ontario. Ontario Tax Studies no. 8 (Toronto: Ontario Ministry of TEIA) - (1973) 'Government reorganization and treasury, economics and intergovernmental affairs.' Ontario Economic Review 11, 3-9. - ( 1974) The Dynamic Impact of Indexing the Personal Income Tax. Ontario Tax Studies no. 9 (Toronto: Ontario Ministry of TEIA) - (1975) Ontario Statistics 1975 (Toronto: Ontario Ministry of TEIA) Osman, J.W. (1966) 'The dual impact of federal aid on state and local government expenditures.'National Tax Journal 19, 362-72 - (1968) 'On the use of intergovernmental aid as an expenditure determinant.' National Tax Journal 21, 437-47 Peacock, A.T. and J. Wiseman (1967) The Growth of Public Expenditure in the United Kingdom (London: Allen and Unwin) Pidot, G.B. (1969) 'A principal components analysis of the determinants of local government fiscal patterns.' Review of Economics and Statistics 51, 176-88 Pogue, T.F. and L.G. Sgontz (1968) The effect of grants-in-aid on state-local spending.' National Tax Journal 21, 190-99 Prest, A.R. (1962) 'The sensitivity of the yield of personal income tax in the United Kingdom.' Economic Journal 72, 576-96 Renshaw, E.F. (1960) 'A note on the expenditure effect of state aid to education.' Journal of Political Economy 68, 170-74 Revenue Canada (annual) Taxation Statistics (Ottawa: Revenue Canada) Richmond, D.R. (1974) The Economic Transformation of Ontario: 1945-73 (Toronto: Ontario Economic Council) Sacks, S. and R. Harris (1964) The determinants of state and local government expenditures and intergovernmental flows of funds.' National Tax Journal 17, 75-85 Sahota, G.S. (1961) Indian Tax Structure and Economic Development (London: Asia Publishing House) Sharkansky, I. (1967) 'Some more thoughts about the determinants of government expenditures.' National Tax Journal 20, 171 -79 - (1968) 'A reply to Professor Harlow.' National Tax Journal 21, 217-19 Singer, N.M. (1968) The use of dummy variables in estimating the incomeelasticity of state income-tax revenues.' National Tax Journal 21, 200-4 - (1970) 'Estimating state income-tax revenues: a new approach.' Reveiw of Economics and Statistics 52, 427-33 Solomon, R. (1964) 'A note on the full-employment budget surplus.' Review of Economics and Statistics 46, 105-8

Bibliography 213 Statistics Canada (annual) Principal Taxes in Canada, formerly Principal Taxes and Rates. Cat. no. 68-201 (Ottawa: Statistics Canada) - (annual) Provincial Government Finance, Revenue and Expenditure, formerly Financial Statistics of Provincial Governments. Cat. no. 68-207 (Ottawa: Statistics Canada) - (annual) Tobacco Product Industries. Cat. no. 32-225 (Ottawa: Statistics Canada) - (monthly) Canadian Statistical Review. Cat. no. 11-003 (Ottawa: Statistics Canada) - ( 1966a) A Review of Dominion Provincial Conferences on Provincial Financial Statistics 1933-1960. Cat. no. 68-504 (Ottawa: Dominion Bureau of Statistics, now Statistics Canada) - ( 1966b) Historical Review: Financial Statistics of Governments in Canada: The Government of Canada, Provinces and Municipalities 1952-1962. Cat. no. 68-503 (Ottawa: Dominion Bureau of Statistics, now Statistics Canada) - ( 1972) The Canadian System of Government Financial Management Statistics. Cat. no. 68-506 (Ottawa: Information Canada) - (197'4) Population Projections for Canada and the Provinces 1972-2001. Cat. no. 91-514 (Ottawa: Information Canada) Strauss, R.P. (1974) 'The impact of block grants on local expenditures and property tax rates.' Journal of Public Economics 3, 269-84 Strick, J.C. (1973) Canadian Public Finance (New York: Holt, Rinehart and Winston) Struyk, R.J. (1970) 'Effects of state grants-in-aid on local provision of education and welfare services in New Jersey.' Journal of Regional Science 10, 225-35 Wallis, K.F. (1969) 'Some recent developments in applied econometrics.' Journal of Economic Literature 1, 771-96

This page intentionally left blank

Ontario Economie Council Research Studies

1 Economie Analysis of Environmental Policies D.N. DEWEES, C.K. EVERSON, and W.A. SIMS 2 Property Crime in Canada: an econometric study KENNETH L. AVIO and C. SCOTT CLARK 3 The Effects of Energy Price Changes on Commodity Prices, Interprovincial Trade, and Employment J.R. MELVIN 4 Tariff and Science Policies: applications of a model of nationalism D.J. DALY and S. GLOBERMAN 5 A Theory of the Expenditure Budgetary Process D.G. HARTLE 6 Resources, Tariffs, and Trade: Ontario's stake J.R.WILLIAMS 7 Transportation Rates and Economic Development in Northern Ontario N.C. BONSOR 8 Government Support of Scientific Research and Development: an economic analysis D.G. McFETRIDGE 9 Public and Private Pensions in Canada: an economic analysis J.E. PESANDO and S.A. REA jr 10 Speculation and Monopoly in Urban Development: analytical foundations with evidence for Toronto J.R. MARKUSEN and D.T. SCHEFFMAN 11 Day Care and Public Policy in Ontario M. KRASHINSKY 12 Provincial Public Finance in Ontario: an empirical analysis of the last twenty-five years O.K. FOOT 13 Extending Canadian Health Insurance: an evaluation of policy options for pharmacare and denticare R.G. EVANS and M.F. WILLIAMSON