GLOBAL ECONOMICS FISCAL PULSE

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1 March 22, 217 Canada s Federal Budget NO SURPRISES, NO MARKET IMPACT ANTICIPATED Stronger economic growth drives better underlying budgetary results through fiscal year (FY18) once the re-introduced adjustment for risk of $3 billion is taken into account. Slightly higher spending leads to marginally larger deficits relative to the Fall Update following that. Overall, the cumulative deficit from FY17 to FY22 is $1.7 billion less negative than the Fall Update forecast. CONTACTS Jean-François Perrault, SVP & Chief Economist Scotiabank Economics jean-francois.perrault@scotiabank.com Mary Webb Scotiabank Economics mary.webb@scotiabank.com Debt-to-GDP rises from 31.% as of March 216 to 31.4% this March 31, and remains at this level through FY19. Only in FY2 does the debt burden begin to edge lower, dropping below 31% by March 222. The government has not committed to a specific target for the debt-to-gdp ratio nor will it seek to achieve a balanced budget within its mandate. In his comments, Minister Morneau gave no indication that the government would consider a debt target or a balanced-budget objective in future Budgets. Potential developments in the United States loom large, though the Budget continues to focus on delivering the Liberal government s electoral platform with no notable surprises. The government has delayed its full review of tax expenditures, likely owing to the impending tax reform in the United States. The government is clearly considering significant changes to the taxation of private corporations, pointing to dividends and capital gains in particular. These changes are expected in two or three months. No mention is made of broader changes to the taxation of capital gains. The most significant changes on the tax side are an increase in EI premium rates from $1.63 per $1 of insurable earning in 217 to $1.68 in 218, the elimination of the tax credit on public transportation, and a further crackdown on tax evasion. The government now estimates the fiscal impact of the measures announced in the previous Budget will add.4 percentage points to growth in 217 and provides no guidance on impact in 218 and beyond. This is lower than what we and the Bank of Canada have built into our forecast. Given the stronger-than-expected growth in 217 relative to earlier forecasts, we do not think this will have a material impact on the Bank of Canada s policy stance. Key areas of focus in the Budget include innovation, with the government targeting six areas of particular focus: digital, clean technology, agri-food, advanced manufacturing, bio-sciences, and clean resources. Additional attention is directed towards the development of skills and training, early learning and childcare, and the national housing strategy, while also providing more details on how infrastructure spending will be directed. No new information is provided on the Canadian Infrastructure Bank but $3 million is devoted to the new Development Finance Institution under Export Development Canada. On housing, nothing specifically is done in relation to the Toronto or Vancouver housing markets, but $11.2 billion is set aside over 11 years in support of a National Housing Strategy that will be largely focused on affordable housing. Importantly, funding is provided to CMHC and Statistics Canada to improve the quality of housing statistics nationwide Federal Budget Balances... Balances, LHS % % of GDP, RHS -6 FY r and the Accumulated Deficit % of GDP, RHS 2 Accumulated Deficit, LHS % FY r Source for charts: Finance Canada, nominal GDP forecast: Scotiabank Economics

2 March 22, 217 FURTHER PROGRAM SPENDING DETAILS The program spending path outlined in Budget 217 is very similar to the Fall Statement forecast. The surge in program expenditures remains concentrated in FY16 FY18, with annual increases averaging 6.4%. Program spending is still expected to climb 5% in FY18 following an estimated 7.5% jump this fiscal year. For the following four years to FY22, the planned rise in program spending is just 2.6%, representing, for now, a modest decline on a real per capita basis. New initiatives in Budget 217 climb from $1.2 billion in FY17 to $8.2 billion by FY22. Over the six years to FY22, they total $31.8 billion. However, freed-up departmental resources and projected revenues are expected to sum to about $27 billion, trimming the net fiscal impact of the Budget measures over the six years to just $4.8 billion. Program Spending Growth 18 annual % change 14 1 Budget Historical Budget FY r 19b 21b Source: Finance Canada. Early learning and child care receives significant funding of $7 billion over ten years, adding to last year s $.5 billion injection. This is one of several measures intended to encourage broader labour force participation going forward. On skills and training, a number of measures are proposed including an increased allocation for the Labour Market Development Agreements. As a result, Employment Insurance (EI) premiums, now set according to a seven-year break-even mechanism, are expected to rise to cover these expanded benefits. Infrastructure outlays for FY17 in this Budget are $.6 billion below the plans outlined in Budget 216 and the Fall Statement. In FY18, outlays on the Budget 216 infrastructure are expected to be $275 million lower, with the catch-up from both years now expected in FY19. Reprofiling of the Fall Statement infrastructure investment also loads additional spending into FY19 and particularly FY2. Thus, an extended path is now anticipated for this stimulus. Pursuing a trade and transportation focus, a National Trade Corridors Fund will be created with $2 billion over 11 years targeted at relieving congestion at the Vancouver and Montreal ports and improving the rail and highway corridors around Canada s cities. Attention to Montreal reflects the increased trade anticipated from CETA. The Canadian Infrastructure Bank is still expected to be operational by late this Fall and enabling legislation is promised shortly. As indicated prior to the Budget, the issue of possibly privatizing some or all of Canada s largest airports or ports is still under consideration. REVENUE GROWTH PICKS UP Total revenues, after an estimated 1.2% decline in FY17, are expected to rebound by 4.3% in FY18, propelled by tax revenues, and specifically the personal income tax. From FY19 through FY22, solid increases averaging 4.% annually are forecast. Adding to the support provided by a relatively healthy economic outlook are multiple initiatives to make Canada s tax system more efficient and oriented towards the middle class. The government s tax expenditure review to eliminate low-impact measures has been extended, but in this Budget, this effort increases revenues by $.2 billion in FY18, and a cumulative $1.3 billion over the next five years, with the end of the Public Transit Credit dominating the revenue change. Closing tax loopholes raises revenues by an average $6 million annually, while reducing tax evasion and tax avoidance is expected to raise receipts by $1.9 billion through FY22, after a further investment of over $5 million over five years to step up enforcement. In addition, federal fees going forward will be indexed to inflation. 2

3 March 22, 217 Tax increases this year include higher excise taxes on alcohol and tobacco (with the manufacturers surtax on tobacco products removed) and adjustments to ensure that ride-sharing services operate under the same GST/HST framework as taxis. For the oil & gas sector, expenses related to discovery wells must now be deducted gradually over time as an expense on an enduring asset and are only immediately deductible if the well is deemed unsuccessful. Tax relief for families amounts to just $.3 billion, focused on an overhaul of the caregiver credit. The Budget indicates that a number of legislative amendments to enhance the resiliency of the financial system will be forthcoming. These include amendments that will seek to strengthen the bank resolution regime, modernize and enhance the Canadian deposit insurance framework, and strengthen the oversight of financial market infrastructures. Comparing Federal Deficit Projections FY16 FY17r FY18r FY19r FY2r FY21r FY22f FY17-FY21r FY17-FY22r 1(a) Budget 216: Deficits n.a n.a. (b) Deficits Ex $6bn Risk Adjustment n.a n.a. 2. Fall Statement*:Deficits (No Risk Adjustment) (a) Budget 217*: Deficits (b) Deficits Ex $3bn Risk Adjustment Change**: Fall Statement vs Budget 216 (2 vs 1b) n.a n.a. Budget 217 vs Fall Statement (3b vs 2) Budget 217 vs Budget 216 (3b vs 2b) n.a n.a. * Final FY16 deficit in Fall Statement and 217 Budget. ** A negative difference indicates a wider deficit. Source: Finance Canada. 3

4 March 22, 217 OTTAWA S FISCAL PLAN Federal Budget Economic Assumptions annual % change except where noted Scotiabank Economics, March 7, f 218f Canada: Real GDP Nominal GDP CPI - All Items Unemployment Rate*,% month T-bills*,% year Bonds*,% Cdn Dollar*, US U.S.: Real GDP WTI Oil Price*, US$/bbl Finance Canada March 217 Budget** f 218f f Canada: Real GDP Nominal GDP CPI - All Items Unemployment Rate*,% month T-bills*,% year Bonds*,% Cdn Dollar*, US U.S.: Real GDP WTI Oil Price*, US$/bbl *Annual averages. ** Based on private-sector survey, Dec Source: Finance Canada, Statistics Canada, BEA, Scotiabank Economics Ottawa s Ottawa's Updated Fiscal Plan Plan % of GDP Revenue Program Spending 1 FY r Source: Finance Canada; Statistics Canada; nominal GDP forecast: Scotiabank Economics. Federal Budget Arithmetic except where noted FY16 FY17 FY18 FY19 FY22* Final Rev. Bud Bud Bud Personal Income Tax (PIT) Corporate Income Tax (CIT) Goods & Services Tax (GST) Total Tax Revenue Employ. Insurance (EI) Premiums Other Revenue Total Revenue Elderly Benefits Employ. Insurance (EI) Benefits Children's Benefits Major Transfers to Persons Transfers to Other Levels of Gov't Direct Program Spending Total Program Spending Debt Service Total Expenditure Reserve Budget Balance Non-Budgetary Transactions Fin.Source(+) / Requirement(-) Accumulated Deficit Net Debt Annual Change, % Personal Income Tax (PIT) Corporate Income Tax (CIT) Goods & Services Tax (GST) Total Tax Revenue EI Premiums Total Revenue Elderly Benefits Employ. Insurance (EI) Benefits Children's Benefits Major Transfers to Persons Transfers to Other Levels of Gov't Direct Program Spending Total Program Spending Total Expenditure Memo Items, % Tax Revenue / GDP Total Revenue / GDP Total Program Spending / GDP Budget Balance / GDP Accumulated Deficit / GDP Net Debt / GDP Debt Service / Revenue *Average annual growth for FY2-FY22. Source: Finance Canada; Statistics Canada; nominal GDP forecasts: Scotiabank Economics. 4

5 March 22, 217 Appendix: Debt Management Strategy The $21 billion FY17 financial requirement is significantly lower than expected due to the narrower deficit and non-budgetary transactions that net to a small $2. billion source of funds rather than a significant requirement. FY18 financial requirements surge to $39 billion, and subsequently average just over $3 billion annually through FY22. Parliamentary approval of the government s borrowing program will be restored with legislation, aiming to increase the transparency and accountability of this process. Gross bond issuance, after a $42 billion jump to $135 billion in FY17, is expected to climb a further $7 billion to $142 billion in FY18. The net increase in Canadian dollar bonds outstanding rises from $16 billion in FY16 to an estimated $33 billion in FY17 and $39 billion in FY18. As of March 218, bonds outstanding are expected to total $575 billion. The debt strategy for FY18 will continue to be tilted towards short- and medium-term bond issuance (2-, 3- and 5-year). This is intended to meet the market s liquidity needs for core existing sectors, while providing stable, lowcost funding. The number of planned bond auctions for FY18 is 16 for two-year bonds, eight for three- and five-year issues, five for ten-year bonds and four for Real Return Bonds. For the 3-year bond in response to feedback, issuance is now allocated over three auctions instead of two. Over the mid-term, the average term to maturity of the domestic market debt is projected to remain relatively stable at roughly years. Ultra-long bond issues may be issued on a tactical basis. Similar to last year s Strategy, they will only be issued if market conditions are favourable and they are believed to add to the government s objective of stable, low-cost funding. To accommodate the higher bond issuance in FY17 FY18, Treasury bills outstanding are expected to end March 217 lower by $8 billion at $13 billion, and similarly finish FY18 close to that level. The sales of new Canada Savings Bonds will be discontinued in 217 given the significant administrative costs of the program, its declining popularity, and the many alternative investment vehicles available for consumers Federal Treasury Bills Outstanding FY Federal Financial Source (+) / Requirement (-) r Gross Federal Bond Issuance* FY * Includes Real Return Bonds. Source for top three charts: Finance Canada. General Government Net Debt % of GDP G7 Canada Germany Australia US * Calendar year. Source: IMF, October

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