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Budget Analysis: March 21, 2013

Federal Budget 2013–14: A Minor Setback but Still on Track

In Budget 2013, the Conservative government remains committed to its deficit-elimination plan—to balance the books by 2015–16. With growth now predicted to be weaker than was projected in last year’s budget, the government had little room for new measures. However, by reducing spending in some areas and increasing revenues by eliminating so-called tax loopholes, the government has managed to dredge up enough funds for a few new initiatives. Intent on improving skills training for the low-skilled unemployed, the government announced its plan to take control of some of the funding it currently ships to the provinces for job training. The government is also trying to influence how money is spent on First Nations reserves. The budget proposes a new Aboriginal job training program that will fund personalized job training for Aboriginal young people living on reserves. However, funding will only be available to reserve communities that choose to implement mandatory participation in training for income assistance recipients. The government promised to continue funding to municipalities for infrastructure. The accelerated capital cost allowance for machinery and equipment for manufacturers was also extended for an additional two years. As well, the government will eliminate tariffs on imported baby clothes, ice skates, hockey equipment, skis, golf clubs, and exercise equipment. Tariffs on some of these goods are as high as 20 per cent and have been cited as a key factor in the higher prices Canadians pay for many consumer goods.

The government remains committed to last year’s medium-term deficit targets. However, the economic outlook has deteriorated significantly over the past year. The deficit for fiscal year 2012–13, which ends on March 31, now stands at $24.9 billion (excluding the adjustment for risk). That is almost $7 billion worse than was projected in last year’s budget. To stick to the target date for balancing its books, the government will hold program spending growth (including transfers) to an average of just 1.5 per cent over the next three years. To achieve this target, federal departmental spending will be cut by 2.4 per cent this fiscal year and by another 2.1 per cent in 2014–15.

Economic Outlook

The economic assumptions used by the Department of Finance for its budgetary projections rely on the consensus of 13 private sector forecasters. The Conference Board of Canada’s most recent economic forecast, however, is somewhat stronger than the consensus. As a result, we believe there exists some upside potential to the budget’s fiscal outlook.

Although key U.S. economic indicators, such as housing starts and jobless claims, have shown a marked improvement recently, political deadlock in Congress and the resulting uncertainty of future budgetary decisions will continue to pose a risk for the Canadian economy. Until very recently, it appeared that the European debt crisis was coming under control. However, it flared up again in recent days when it was revealed that the conditions of a proposed EU bailout of Cypriot banks included a tax on deposits. Cypriot banks are closed this week, but there are fears that bank runs could ensue; the greater menace is that bank runs could spread to other eurozone countries with distressed banks. Both the federal government and the Conference Board believe there remains substantial economic risk to the near-term growth outlook. As a result, growth is expected to be moderate over the near term. During the second half of 2012, real GDP growth was weaker than expected, and private forecasters expect this weakness to carry over into 2013. As a result, the consensus estimate for growth in 2013 has been revised down from 2 per cent to 1.6 per cent, followed by a 2.5 per cent gain in 2014.

Since the government’s 2012 Fall Update, the growth projections for nominal GDP (the broadest measure of a country’s tax base) have been adjusted down 0.7 percentage points, to 3.3 per cent, for 2013. This adjustment is largely due to a decrease in the forecast for commodity prices—which lowers income in Canada. The price of Canadian oil is playing a large role; while global oil prices remain strong, transportation bottlenecks due to increasing production are resulting in heavy discounts for North American production in general and Canadian production in particular. The heavy discount on oil sands crude is expected to persist over the near and medium terms because the construction of additional pipeline capacity is expected to take at least a few years. However, oil aside, the U.S. economic recovery, combined with strong demand from developing countries, will likely put upward pressure on commodity export prices over the forecast horizon. Despite this, the budget (prudently) assumes a largely flat profile for commodity prices. In addition, the Department of Finance decided to adjust downward the private sector forecast for GDP by $20 billion per year over the 2013–17 horizon. This adjustment for risk is equivalent to a decline of about 1 percentage point in nominal GDP, which translates to $3 billion less in revenue receipts.

The Conference Board’s economic outlook is stronger than the assumptions used in the budget, thanks to a stronger near-term outlook for growth in the United States and a brighter outlook for commodity prices. We forecast moderately stronger GDP growth for 2013, in both real and nominal terms. Our estimate for nominal GDP growth in 2013 is 0.3 per cent higher than that assumed in the budget. Roughly speaking, this increase in the tax base could translate into an additional $800 million of revenue for the federal government this year.

Fiscal Outlook 2015–16: Balance or Bust

Budget 2013 is almost entirely focused on returning to fiscal balance by 2015–16, as the government committed itself to do in last year’s budget. However, compared with last year, a weaker economic outlook has made that job somewhat more difficult by lowering the projection for revenues. Consequently, the federal government has been forced to tighten its purse strings. Fortunately, some reductions in spending are expected to occur naturally due to the weaker economic projection. Thanks to a lower projection for inflation, the government expects to save on transfers to the elderly and children’s benefits. Similarly, the federal government will save some money on transfers to the provinces (which are linked to the growth in the economy) and on interest payments on the debt thanks to lower interest rates. Interestingly, the federal government will also save on employment insurance benefits because of surprisingly strong employment gains over the past six months.

Nonetheless, the federal government still has to reduce its plan for direct program expenditures by approximately $5 billion over fiscal years 2014–15 and 2015–16 in order to stay on target. According to the budget plan, this will be achieved, in part because of lower-than-expected costs and also by reducing travel costs in the public service and improving efficiency in a few government departments. As well, the government announced changes to the tax code that are expected to generate an extra $3.8 billion by 2015–16. These measures created enough fiscal room to allow for some relatively modest new spending measures while still keeping to the plan to balance the books by 2015–16.

Although the government has succeeded in maintaining the target date for balancing its books, the situation has deteriorated substantially over the medium term. At $24.9 billion for 2012–13, it is almost $7 billion worse than projected in last year’s budget. And in this coming fiscal year, the deficit is expected to improve to $15.7 billion—but that is still much worse than the $7.2 billion projected for 2013–14 in last year’s budget. In fact, compared with last year’s budget, the government’s cumulative deficit from 2012–13 to 2015–16 (when the books are to be balanced) is roughly $23 billion higher. Although much of this higher deficit has to do with the weaker revenue profile, direct program spending did increase by 2.8 per cent in 2012–13 despite the fact that it was supposed to have been reduced. Moving forward, the government still plans to reduce direct program spending by 2.4 per cent this year and 2.1 per cent in 2014–15. However, even in 2014–15, spending will remain 18 per cent above pre-recession levels. (See chart.)

Chart: Direct Program Spending to Fall but Will Remain Above Pre-recession Highs

The string of deep deficits will add to the federal debt, which is expected to peak at $634 billion in 2014–15. Although this is an increase of $170 billion from 2008–09, interest payments on the public debt have remained essentially flat thanks to record-low interest rates. This will change as interest rates begin to rise toward the end of 2014. By 2017–18, debt financing costs will be almost $6 billion higher than they are today.

New Measures: Shining the Spotlight on Job Training

In light of the deterioration in Canada’s economic outlook, this year’s budget is once again focused on promoting economic growth and creating jobs. Broadly speaking, the new measures focus on three areas: improving labour market outcomes, supporting growth in the manufacturing sector, and directing funds toward infrastructure.

The government is concerned with skilled labour shortages, and this is reflected in new measures to better match unemployed Canadians with available jobs. The flagship measure is the renewal of the Labour Market Agreements with provinces and territories in 2014–15, with $300 million directed toward the creation of the Canada Job Grant. This grant is aimed at unemployed Canadians who are not eligible for Employment Insurance. The federal government will contribute up to $5,000 per person toward an approved training program, and the province/territory and an employer match the federal contribution. Additional measures are directed at skills training to help Aboriginal people, persons with disabilities, and young people access the labour market.

New support announced in the budget for manufacturers and other businesses will total $802 million over the 2012–15 period (with much of the funds coming from the existing fiscal framework). New measures include extending and expanding the hiring credit for small businesses, supporting junior mineral exploration, and assistance for manufacturers (in the form of tax relief for investment in new machinery and equipment and the renewal of the FedDev Ontario program in 2014). However, most of these measures will not be implemented this fiscal year.

Finally, the budget proposes over $47 billion in federal support for provincial, territorial, and municipal infrastructure investments over a 10-year period, starting in 2014–15. In the immediate term, however, the budget outlines just $123 million in new infrastructure funding.

Matthew Stewart Matthew Stewart
Principal Economist
David Rosé David Rosé
Economist, Provincial Forecasting

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