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Budget Analysis: February 11, 2014

Federal Budget 2014–15: Stay Tuned for Next Year

by Matthew Stewart and Daniel Fields  |  Version française

In Budget 2014, the Conservative government remains committed to its deficit-elimination target of balancing its books by 2015–16. With economic growth now predicted to be weaker than was projected in last year’s budget, the government has had to find ways to offset weakening revenue projections in order to stay on track. And by continuing to tighten its purse strings, the government has managed to improve its surplus projection. The lion’s share of tightening—$6.1 billion over the 2013–14 to 2015–16 fiscal years—comes out of the defence capital budget and from lower compensation costs through a reduction in retirement benefits for public sector employees. These cuts left room for a few small spending measures while still presenting a plan that could, in fact, allow it to balance its books in the coming fiscal year (2014–15) if the budget’s contingency fund of $3 billion goes unused. (See chart.) For 2015–16, the surplus is now expected to be as large as $9.4 billion (again, assuming the contingency for risk is not used). In short, there will be a fiscal dividend up for grabs.

Economic Outlook

The Department of Finance relies on the consensus of 14 private sector forecasters for the economic assumptions used in its budgetary projections. The consensus is that Canada’s economic performance is set to improve in 2014 and do even better in 2015, led by a pickup in exports. Still, the forecast for real GDP growth over the near term remains modest at 2.3 per cent in 2014 and 2.5 per cent in 2015. The Conference Board of Canada’s economic projections for real GDP growth are closely in line with that of the consensus. The government and the Conference Board both believe that economic growth in the United States will pick up. The long-awaited U.S. recovery seems to be solidifying. Private investment there is solid, household balance sheets are in good shape, labour markets are tightening, and governments will loosen (modestly) their purse strings in 2014. This will lead to a pickup in Canadian exports and business investment.

Since the consensus forecast was completed in December, the Canadian dollar has dropped another four cents versus its U.S. counterpart and is now hovering around the US$0.90 level. If it remains at that level, the lower dollar could spell some improvement for the much-beleaguered manufacturing industry and provide some upside risk to the numbers. However, when it comes to nominal GDP—the broadest measure of the government’s tax base—the Conference Board is still slightly less optimistic than the consensus of the private sector forecasters, due to our weaker projection for inflation. In particular, our outlook for nominal GDP is $10 billion lower in 2014 and $15 billion lower in 2015. If this weaker outlook proves accurate, the lower GDP would strip as much as $2 billion from the government’s projection for revenues.

Fiscal Outlook—Saving for Tomorrow

In Budget 2014, the government has intensified its efforts to return to fiscal balance by 2015–16 and leave as large a surplus as possible for next year’s budget. The continued deterioration in the economic outlook has made this job somewhat more difficult, as it has lowered the revenue projections. In its economic update released in November 2013, the federal government was forced to downgrade its revenue projection by an average of $2 billion per year over the 2013–14 to 2015–16 period. Now, just three months later, continued deterioration in economic growth (particularly for nominal GDP) has forced the federal government to further downgrade its revenue projections by an average of $1.5 billion per year over that period. But despite these downward revisions in revenues, cost-cutting and one-time revenue measures have allowed the government to improve on the overall balance.

Fortunately, some reductions in spending are expected as a result of the weaker economic projection. Thanks to a lower projection for inflation, the government expects to save on inflation-indexed transfers to the elderly and children’s benefits. It will also save some money on interest payments on the debt thanks to lower-than-projected interest rates.

New cost-cutting measures were also introduced. The government has cut $3.1 billion from the defence capital budget over fiscal years 2013–14 to 2016–17. Although the government states that these funds have been moved to future years, those years are outside of the current projection period. It has also reduced compensation costs by $4 billion over the 2013–14 to 2015–16 period through a reduction in retirement benefits for public sector employees. Retired employees will now have to pay 50 per cent of their public service health care plan—up from 25 per cent. These changes, together with an increase in excise duties on tobacco products, have created enough fiscal room to allow for relatively small new spending measures while still presenting a plan that will create a substantial surplus in 2015–16. Not including its adjustment for risk, the federal government now expects to essentially balance its books in 2014–15 and have a surplus as large as $9.4 billion in 2015–16.

The government has managed to significantly slow direct program spending over the last several years in an effort to balance its books, keeping the spending essentially flat since 2009–10. Direct program spending consists of departmental budgets and wages and salaries of government employees. Three-quarters of the federal government’s spending goes to transfer programs (such as employment insurance and Old Age Security), transfers to the provinces, and interest payments on the federal debt—all of which are formula driven and difficult to reduce. So most of the expenditure restraint has occurred in the category of direct program spending. Restraint will intensify this year, with direct program spending expected to decline by 4.8 per cent. Although this category has seen its slowest growth in spending since the late 1990s, direct program spending is still 19 per cent higher in this current fiscal year than it was in fiscal 2008–09 before the government began spending its way out of the last recession.

New Measures: Jobs, Bridges, and Broadband Internet

With the focus remaining squarely on balancing its budget by 2015–16, the Conservative government has little room for new program spending measures. Budget 2014 includes only a few new measures in three main areas: job creation and support for innovative research, resource development and investments in infrastructure, and assistance to families and communities. Overall, after accounting for funds already existing in the current fiscal framework, as well as for funds from internal reallocations, the new initiatives total just $700 million for this upcoming fiscal year and $1 billion in 2015–16.

Job creation (as well job matching) has been one of the main goals for this year’s new spending programs, with the government putting in place measures that should bode well for small businesses and innovative research institutes in Canada. The biggest chunk of spending comes in the form of support for advanced research and innovation. In particular, the government has set aside $500 million over the next two years for research in the auto industry, as well as $113 million for support for Atomic Energy of Canada in 2014–15. Furthermore, the government has set aside nearly $500 million over the next two years for construction of a new bridge between Windsor and Detroit.

The federal government has introduced its Training the Workforce of Tomorrow program, which aims to match Canadians with appropriate jobs and to combat youth unemployment. Spending in this area involves internships and apprenticeship programs, with the goal of helping young people who have been left out of the labour market of late. The budget also commits $75 million over the next three years to help support older workers in the labour market, as the aging of the population will greatly shift the landscape of the labour force over the next few decades. Also included is new funding for First Nations elementary school education, with a commitment of $120 million every year from 2015 to 2018, as well as a much larger $1.25-billion investment from 2016 to 2019 to support the new First Nations Control of First Nations Education Act.

Investments in infrastructure and transportation (mainly for improving and rehabilitating Montréal-area bridges) will account for almost $400 million in federal spending over the next two years. With regards to resource development, Canada has invested nearly $300 million. This money will be split between three main categories: responsible resource development (supporting First Nations’ fishing enterprises); mining, forestry, and agriculture (funding for junior mineral exploration and Canada’s forestry sector); and investments in the North (through the Canadian Northern Economic Development Agency and the Territorial Health Investment Fund).

Budget 2014 also added to funds aimed at supporting families and their communities. Including previous commitments, a total of $964 million is dedicated to families over the 2013–16 period. Additional funding was targeted at improving broadband Internet access in rural and Northern communities, and about $100 million was allotted for arts funding to support core cultural programs. The government also announced additional funding of $162 million in each of the next two years to ensure the safety of First Nations’ water systems on reserves. The funeral and burial program for modern-day veterans also received a sizable bump of over $100 million dollars.


Matthew Stewart Matthew Stewart
Principal Economist
David Rosé Daniel Fields
Economist

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