Commentary

Big Returns, Big Spend

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Our Analysis of the 2022 Federal Budget

The federal government benefited from a significant improvement in its fiscal capacity in the short time since the December 14th Economic and Fiscal Update 2021 (EFU 2021). According to Budget 2022, the government’s fiscal position improved by roughly $85.5 billion, over the six-year projection horizon, because of improved revenues and lowered costs. Strong inflation coupled with a commodity price boom has bolstered government revenues. At the same time, a solid economic rebound over the second half of 2021 has given a boost to employment and economic activity, leading to lower underlying spending on employment insurance and other programs.

New tax measures, including taxes on big financial players, closing tax loopholes, vaping taxes and a few others, add roughly $16.5 billion to revenues over the 2022–23 to 2026–27 period. More effective government and other policy actions since EFU 2021, add another $11.5 billion in savings, for a total of $28 billion over the six-year planning horizon.

As such, the total amount of fiscal room-to-maneuver since EFU 2021 sums to a whopping $113.5 billion. Of that, Budget 2022 dedicates roughly $63 billion in new spending over 2021–22 to 2026–27, while the remaining $50 billion helps reduce deficits and upward pressures on debt.

The deficit for the fiscal year just ended 2021–22 is at $113.8 billion, a $30.7 billion improvement over EFU 2021. Including the two years of the pandemic, deficits totaled $441.5 billion over 2020–21 to 2021–22, and have added 16.9 percentage points to our net debt-to-GDP ratio. Over the forecast horizon, the federal government is forecasting deficits to ease from $52.8 billion in 2022–23, to $8.4 billion in 2026–27. This will help lower the net debt-to-GDP ratio from 50.6 per cent in 2021–22, to 45.1 per cent in 2026–27. (See Chart “Extended Fiscal Correction Ahead.”)

Extended Fiscal Correction Ahead

(surplus/deficit, $ billions; net debt-to-GDP, per cent)

Surplus/Deficit (−) (left) Net Debt−to−GDP (right) 2007−08 09−10 11−12 13−14 15−16 17−18 19−20 21−22e 23−24f 25−26f −350 −300 −250 −200 −150 −100 −50 0 50 20 25 30 35 40 45 50 55 60 Forecast

1. Including net acuarial losses
e = estimate
f = forecast
Source: Finance Canada

Budget 2022 spreads $63 billion of the fiscal windfall across a number of spending categories. By largesse, over the projection horizon, green economy initiatives get the most—$12.4 billion over the next five years. Investments to move forward on reconciliation total $10.5 billion, while $10.2 billion is put toward making housing more affordable. Other broad initiatives include: $9.4 billion to defense and leadership in the world; $7.1 billion to public health care; $6.0 billion to workforce initiatives; $5.5 billion to strengthening economic growth; and $1.6 billion to help build safe and inclusive communities.

Word of the (Budget) Day: Affordability

The word “affordable” features almost 100 times in the budget. However, in terms of substance, the budget did not have enough on tackling near-term inflationary pressures, which have been exacerbated by higher commodity prices and supply chain disruptions. For example, there was no mention of providing Canadians with some respite from inflation in the form of targeted and temporary tax cuts. Still, the government deserves credit for not giving in to the temptation of promising new big-ticket social spending items, which could add to inflationary pressure.

Most of the new spending is slated for areas such as workforce initiatives and public health care—that, if implemented well, are likely to enhance economic productivity and improve affordability. And since higher economic productivity is deflationary, it should put downward pressure on prices in the medium to long run. The budget also allocated billions in new spending toward housing affordability. Supply-side measures such as Ottawa’s promise to help build more homes will make housing affordable for the average Canadian. But demand-side measures such as offering more tax credits for first-time home buyers risk pushing house prices higher, making them even less affordable. The budget also talked about early learning and childcare as ways to tackle inflation. While it is true that these measures will increase supply-led growth, their cooling effect on prices would only be seen in the long run.

Budget Comes up Short on Boosting Capacity

February employment numbers surged in Canada, bringing the unemployment rate down to 5.5 per cent, essentially at rock bottom. At the same time, job vacancies have skyrocketed, and wage pressures are building. There’s no doubt that many industries across Canada are unable to meet demand because of labour constraints.

The most important measures to build our workforce were announced prior to Budget 2022 and included the government’s ambitious ramp up in immigration, and the affordable early learning and childcare program. Still, Budget 2022 includes nearly $6 billion in additional spending over the next five years to build our workforce. Four billion dollars of this is aimed at facilitating immigration—supporting students, asylum seekers and refugees with legal aid and other settlement services. Other spending is aimed at improving labour mobility, supporting foreign credential recognition in health, and improving the temporary foreign worker program.

In addition to workers, Canada is lagging in investment. Budget 2022 recognizes the problem but there is not enough in the budget to substantially improve Canada’s investment challenge. Canada’s non-residential private investment as a share of GDP is at 10 per cent, compared to 14–15 per cent in the United States and among many of our OECD competitors. To bring Canada’s private investment to comparable levels would require $140 billion annually in additional spending.

Budget 2022 puts limited funds towards this challenge. In all, $5.5 billion over five years is allotted to boosting economic growth through investment and innovation initiatives. Two arm’s length agencies, The Canada Growth Fund and the Innovation and Investment Agency, will help fund private investment initiatives across a broad range of industries. Small businesses will also enjoy a more gradual phase out from the small business tax rate as they grow, which the government hopes will help eliminate barriers to sizing up. These measures total roughly $1.7 billion over five years. Another nearly $3 billion will be spent on the Canadian Critical Minerals Strategy, recognizing the potential of Canada’s mineral resources in helping the world move to a green economy. Remaining measures target various industries, research, and transportation infrastructure.

It’s Not Easy Being Green

Green economy initiatives will add another $12.4 billion to federal spending over the next five years, though most of this spending was part of a separate announcement a week ago. Consumer-centered incentives like the $5,000 zero-emission vehicle incentive will be extended to the end of 2025 and the vehicle model range will be expanded.

The bigger shift in focus, however, is in supporting the greening of businesses, which had earlier been largely left out of the federal carbon levy rebate program. The energy-intensive agricultural sector will be getting a substantial part of those funds for gearing toward sustainability. The government will also be developing an investment tax credit to speed up the development of carbon capture technologies as well as giving help to fleet operators and commercial property owners. Substantial focus is also on infrastructure—expanding vehicle charging networks, improving regional interconnection of electricity grids and making room for new technologies like small modular nuclear reactors.

The government will try to mobilize private capital as well with a new $15 billion investment fund to encourage development and acquisition of clean, decarbonized technologies. The final emphasis is on preserving the natural environment. Protections for lands, lakes and oceans will receive $2.2 billion through 2026–27 for additional items like water clean-up, plastics waste reduction, wildfire management and recreational trails extensions.

The aim is to cut 2005-equivalent greenhouse emissions by 40 per cent by 2030, with an expectation of achieving net-zero emissions by 2050. These plans are ambitious and staked on new pathways and technologies not yet fully developed. Much will depend on the willingness and ability of Canadians to make the shift.

There’s No Place Like Home … If You Can Find and Afford One

The budget takes some steps to address the two main challenges Canada’s housing market faces: undersupply and poor affordability. Of course, poor affordability is partially the result of undersupply, but also of excess demand. The measures to increase housing supply are modest and will take time to implement. By contrast, the budget’s demand-limiting measures are tougher, largely fulfill Liberal campaign promises and address widely discussed proposals. Since sales of existing homes are roughly twice housing starts in any given year, measures targeting the resale market will do more to boost affordability than those hitting new construction, plus new construction takes time.

The budget hopes to incentivize homebuilders to double housing starts in the next few years. This might be challenging. Volumes of units under construction are near record highs and builders are having difficulty finding workers. The Housing Accelerator Fund plans 100,000 new housing units over the next five years, but the average 20,000 units per year appears modest set against current annual 250,000-plus housing start volumes. The roughly 10,000 units promised by smaller plans like the Rapid Housing Initiative and the National Housing Co-Investment Fund seem almost negligible. The same is true for plans to increase the volume of co-op housing by 6,000 units through a new Co-operative Housing Development Program. All told, budgetary measures seem unlikely to produce the starts ramp-up the government wants.

Budget items mainly targeting the resale market have the potential to curb price growth and perhaps cut prices. Many of these measures address non-productive and price-boosting housing market activity. The proposal to end blind bidding on resale homes will help buyers make more accurate price offers. The suggestion to restrict foreign ownership of non-recreational, residential property in Canada for two years could trim prices, if the experience in Vancouver and Ontario’s Greater Golden Horseshoe be a guide. Business taxation of capital gains on a property held for less than 12 months might similarly curb investor enthusiasm. The budget’s proposal to investigate money laundering in real estate looks welcome and long overdue, based on regulatory and media findings. If it is as widespread as many believe, this could significantly reduce housing demand and thus prices. The ultimate effect of an “Underused Housing Tax” targeting underused or vacant units held by non-resident, non-Canadians homeowners will depend on how it is implemented.

Direct support to homebuyers through a proposed Tax-Free First Home Savings Account, that would give prospective first-time home buyers the ability to save up to $40,000 should help but seems small set against Canada’s average existing housing prices which have now approached nearly $800,000. The budget’s $500 one-time payment to those facing housing affordability challenges is tiny.

Smile: Dental Care Highlights Package for Canadian Families

Of the $7.1 billion committed to health, $5.3 billion over five years will fund dental care, with an ongoing annual spend of $1.3 billion thereafter. While the policy’s purpose is to support better health outcomes, it will also have a positive impact on the economy. The program is targeted at lower income households, who are less able to afford dental care. There is clear evidence between oral health, overall health, and employability, which could help boost labour force participation. The budget also includes other health spending measures, such as investments in pandemic surveillance, support for mental health and an effort to reduce the backlog for surgeries.

The budget includes other smaller spending items such as $625 million for a Child Care Investment Fund to support capacity in childcare, which, when coupled with the Child Care Program signed on to by the provinces, will help enable women’s participation in the labour market. With little detail, the budget also includes mention of changing Canada’s EI system, which is worth keeping an eye on, as it could have major implications for the labour force.

Further Steps Towards Reconciliation

The federal government has also committed another $10.6 billion to support reconciliation, with $4 billion of that to help First Nations children access health, social and educational services through Jordan’s Principle. The budget commits another $5.5 billion to improve health care, education and housing in First Nations communities and $500 million to support various Indigenous business ventures. While the aim of these initiatives is undoubtedly to forge a pathway towards reconciliation, Canada’s economy, and especially the economies of local Indigenous communities, stand to benefit from ensuring that Indigenous youth receive the proper supports to achieve prosperity.

Defense Spending Misses the Mark

Budget 2022 commits $9.4 billion to defense and leadership in the world over the next five years. The lions’ share, $7.2 billion is on defense with the annual increase in spending starting at just $100 million in 2022-23, ramping up to nearly $1.9 billion in 2026–27. However, this is well shy of meeting our 2 per cent NATO commitment, which would require roughly $17 to $20 billion in additional spending annually. Additional measures provide direct humanitarian aid to Ukrainians and COVID funding for less developed nations.

Government Drops Anchor

Prior to the pandemic, the government shifted away from a decade’s old stance of balanced budgets as a fiscal anchor. Instead, the government opted to target a falling net debt-to-GDP ratio as the mark of sustainable fiscal policy. Plummeting revenues and historic support measures over the past two years led to a temporary abandonment of this fiscal anchor however, as the ratio soared to a 20–year high of 52 per cent in 2020–21. Budget 2022 brought forth a return to the pre-pandemic stance of decreasing net debt-to-GDP targets, with the share steadily falling to 45 per cent by 2026–27.

Thanks to an improved revenue outlook, the government expects to have the fiscal room to increase spending while also still decreasing the net debt-to-GDP ratio. Going forward it will be critical that the government sticks with this fiscal goal. Mounting fiscal pressures at the provincial level, who currently face structural deficits over the long-term, as well as continued uncertainty pertaining to the pandemic and situation in Ukraine, could all lead to an unexpected uptick in net debt. Thus, the government should continue to be cautious over the medium term. Otherwise, we could see debt repayment charges eating up an even bigger share of revenues than currently expected. (See Chart “Borrowing Becoming More Costly.”)

Borrowing Becoming More Costly

(Interest share of total revenues, per cent)

2007−08 09−10 11−12 13−14 15−16 17−18 19−20 21−22e 23−24f 25−26f Actual 2022 Budget Forecast 0 2 4 6 8 10 12 14

e = estimate
f = forecast
Source: Finance Canada


Read the full 2022 federal budget  |  Lire la totalité du budget fédéral 2022

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