Toronto has a debt ceiling, too. But as the City gets close to its limit even without counting $23 billion of unfunded projects, council will face some tough choices.
This article is part of Torontoist’s special 2016 municipal budget coverage. If you value journalism like this and you’d like to see it year-round, then subscribe now and help fund a staff writer to hold City Hall accountable.
Remember the 2013 U.S. debt ceiling crisis? It was crazy. Texas Senator Ted Cruz forced a filibuster in the Senate, national parks shut down, the mail didn’t get delivered, and federally funded scientific studies were cancelled. The vote to increase the ceiling barely passed, and after many tweets and think pieces, the U.S. narrowly avoided a financial crisis, which would have had very significant consequences.
While the City of Toronto’s debt ceiling isn’t as well known, this little-discussed aspect of the budget affects which major projects the City funds. Capital projects range from building local community centres and libraries to replacing Toronto’s aging watermains—but council can’t take on infinite debt, and so it has to make choices to stay under its debt ceiling.
Here, we’ll outline how the debt ceiling works, and show what choices need to be made for the City to avoid their own Ted Cruz-style situation in a few years.
What is the debt ceiling, and how does it work?
The overall City budget is made up of smaller budgets, including the operating and capital budgets (there’s also the rate-supported budget, but we’ll leave that aside). The operating budget covers ongoing annual expenses, including staff salaries and day-to-day expenditures. The capital budget funds long-term projects, such as new fire stations or repairs to the Gardiner Expressway. Capital budget items are (mostly) tangible assets where the benefits accrue over time.
Unlike their federal and provincial counterparts, Ontario municipalities are legally required by the province to balance their operating budgets every year. This means that the City is legally prohibited from running a deficit, although it can issue debt to finance projects in the capital budget.
The idea behind the capital budget is that the City can take on debt to pay for long-term assets over the useful lifespan of the project. This gives the City flexibility for what projects it can fund, but comes with a cost. Every year, the City pays a certain amount of principal and interest against their total debt—the amount is partially based on interest rates and the City’s credit rating (essentially, how likely the municipality is to repay their debt). It’s kind of like taking out a mortgage on a house: you probably couldn’t afford to buy it upfront, but if you have a decent credit rating and salary, you can pay off the debt while you live in your home.
Just like there are rules for how financially leveraged individuals can be when they take on a mortgage, the City also has limits on how much debt it can assume relative to the revenue it takes in.
The Province requires Ontario municipalities to abide by a 25 per cent debt ceiling. But in 2007, Toronto City Council chose to set a more conservative debt ceiling: annually, its principal and interest payments cannot exceed 15 per cent of annual property tax revenues [PDF].
The equation looks like this:
In 2015, that worked out to:
According to projections from the 2015 budget, the City will come right up against its debt ceiling in 2019. That year will see the debt ceiling number reach 14.41 per cent of its 15 per cent limit, a big jump from 11.61 per cent in 2015. It could be even worse. Before capital projects were moved around last year, that number was 14.98 per cent. This means that if the City has projects that need urgent funding, or there are infrastructure needs that can no longer go ignored, Toronto might have to break through its ceiling.
Since the debt ceiling is self-imposed, it is possible for the City to breach it if circumstances require. However, this might concern credit rating agencies, which could lower the City’s AA rating, thus raising its borrowing costs, leading to a vicious financial circle where the City keeps delaying important infrastructure projects.
Property taxes are important and confusing
To better understand the ratio, let’s look at the denominator of that equation, which is the annual property tax revenue.
If you don’t have a firm understanding of property taxes, rest assured you’re not alone. Although it represents 40 per cent of the City’s annual revenue, property taxes are widely misunderstood, including by some members of council. Without getting into too many details, what’s important is that unlike income or sales tax, property tax revenue does not grow with the economy. This means that in order to maintain the City’s purchasing power, council must increase blended property tax revenue (combined residential and non-residential) by inflation.
Since the debt ceiling is 15 per cent of annual property tax revenue, if property taxes don’t increase with inflation, it creates additional pressure on the debt ceiling, which makes it more difficult to fund the projects Toronto needs. Over the next 10 years, the City assumes blended property tax revenue will increase 2.1 per cent annually, which is around the targeted inflation rate. If blended property tax revenue increased more than 2.1 per cent, it would help lower the debt ceiling ratio.
So is Toronto fiscally healthy?
Mostly yes! “With a strong economy, solid credit ratings, low interest rates, and a manageable debt load, Toronto is in relatively good shape,” reads a 2014 report from the Munk School of Global Affairs entitled “Is Toronto Fiscally Healthy?” [PDF].
Toronto has a good credit rating—AA, the second highest tranche available. Relative to other cities of its age and size, that puts it in good stead.
When adjusted for inflation, the City’s spending has remained relatively stable since 2002. That inflationary adjustment is key, however. As we’ve established, property taxes don’t automatically grow with inflation, and even that might not be enough.
Here’s a look at Toronto’s property tax revenue growth since 2002, and how it closely tracks inflation (assessment growth has been excluded here).
But Toronto’s rapid growth means that the City has much more to address than inflationary needs. There are new community centres and libraries that need to be built alongside shiny new condos, and that doesn’t include the new plumbing and other unseen infrastructure that goes along with it.
Development charges don’t pay the full cost of that growth, and the City has to make up the difference. Nor do the extra units provide a boon to the property tax rolls because of the weird ways property tax is calculated (new units have the effect of reducing everyone else’s property tax bills—growth is revenue neutral). And the City also has aging infrastructure to replace (those 50-year old watermains don’t replace themselves). All of that is expensive, and goes beyond inflation.
It’s these infrastructure needs that drive the debt ceiling ratio up in 2019 and 2020. We’ll see a jump from 11.61 per cent to 14.41 per cent from 2015 to 2019. This is due to additional City debt charges, which sees an increase from $447 million in 2015 to $603 million in 2019, while projected property taxes increase at only 2.1 per cent a year.
And even with that increase, there’s still a lot of worthwhile capital projects that aren’t included.
The Value of Capital Projects
If you thought that all of the City’s capital needs were represented in the debt ceiling, you’d be wrong. The debt ceiling only includes funded projects, like the Scarborough subway extension, but not unfunded projects, like the George Street revitalization. Unfunded projects are ones that council has approved but can’t be worked into the capital budget. Some projects don’t have funding approval yet, while others get deferred beyond the current 10-year budget window.
To date, council has $23 billion worth of unfunded projects.
- Flooding protection for the lower Don River—Waterfront Toronto is seeking at least $276 million of funding from the City for the $1-billion project. The protection is necessary for any future building projects in the Port Lands, which would in turn unlock a lot of real estate value and economic development for the city. Both the Don Valley Parkway and Bayview extension regularly flood when storms hit the city.
- John Tory’s controversial SmartTrack transit plan is still without a price tag, but will not come cheap (during his campaign, he estimated it will cost the City $2.7 billion—it will likely be more).
- The TTC has $2.3 billion in unfunded needs over the next 10 years. This includes $616 million for 372 subway cars, $361 million for 60 streetcars, and $165 million to make the TTC accessible in compliance with provincial law.
- Toronto Community Housing has an unfunded repair backlog of $2.6 billion. With much of the existing housing having been built in the ’60s and ’70s, repairs are needed in many cases to make the spaces habitable. If funding for repairs isn’t found, by 2023 almost 20,000 residents will no longer be able to live in their home.
These are hardly frivolous items. But they’re not reflected in the debt ceiling, because they’re unfunded. If these projects were in there, the City would have punched through the debt ceiling long ago.
So what now?
With the debt ceiling where it currently sits, the City is simply unable to finance all the projects it needs to. There are three obvious solutions: raise property taxes, raise the debt ceiling, or continue deferring projects. In a crazy opposite world where up is down and city councillors actually read staff reports, the first two solutions could be enacted.
Raising property taxes over the rate of inflation would effectively give the City more room under its debt ceiling. It would also produce more revenue for the City’s operating budget. Peter Wallace, Toronto’s new city manager, gave a recent address in which he indicated the need for increased property tax revenue.
In an address to the Institute on Municipal Finance and Governance, Wallace said that council needs to think, “What are we trying to accomplish? How much does that cost, and at what point does that cost become unaffordable in our current model?” He went on to say that “in all likelihood” council would be “bouncing pretty hard” against the 15 per cent limit, and council would have to consider the implications.
Council should also consider that Toronto’s growing needs go beyond inflation, and funding must grow along with it. If we say that projects like flood protection, TCHC capital repairs, and TTC accessibility are worthy projects—and council has done so—then we need to be prepared to pay to accommodate that growth, and build the city we would like to see.
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