Clean and Green but Not Very Lean: Our Analysis of the Federal Budget 2023

With the fiscal shadow of the COVID-19 pandemic fading into the background, the federal government is now repositioning itself to address some of the structural issues ahead. The themes this year centre around the green energy transition and offsetting inflation pressures on low and middle-income households—in a more challenging economic climate.

A slowing economy will prevent the federal government from being gifted with a major windfall this time around. The federal government expects an erosion of its fiscal capacity since last November’s Fall Economic Statement 2022 (FES 2022). According to Budget 2023, the government’s fiscal position has deteriorated by roughly $26.1 billion (over the six-year projection horizon) within just a few months. A weaker outlook for nominal GDP has pulled down income tax revenue projections, along with outlooks for corporate profitability and sales taxes.

Expenditures have also been revised down relative to FES 2022 due to lower major transfers to individuals, to other levels of government, and direct program spending. Expenditures, however, ramp up in later years, and end up outpacing FES 2022 estimates by almost $25 billion by 2027–28. (See Chart 1.)

Chart 1

Spending drifting up

($ billions)

*including net actuarial losses
e = estimate
f = forecast
Source: Finance Canada

Budget 2023’s revenue forecast is reduced significantly from FES 2022. Total budgetary revenues are down by $6.2 billion in the fiscal year just ending (2022–23) and that gap remains about the same over the projection horizon. Overall, a cumulative $34.4 billion in revenues is lost largely due to weaker personal and corporate income tax collections.

The weaker revenue profile stems from weaker economic activity. The consensus forecast used for the budget has real GDP growth of just 0.3 per cent in 2023. This is a prudent outlook, in which economic activity essentially grinds to a halt this year with a mild recession likely. Moreover, oil and other commodity prices have generally fallen back to pre-war levels in recent months and while this is a positive outcome for easing inflation, it has lowered the price of exports and reduced growth in nominal GDP to just 0.9 per cent in 2023.

Overall, the economic outlook used for Budget 2023 is prudent in comparison to our economic forecast at The Conference Board of Canada—on average, we have nominal GDP about $35 billion higher than what is in the Budget in 2023. This aligns more closely with the Budget’s “Upside” scenario, in which the deficit improves by close to $8 billion in 2023–24.

The result is a continuing string of deficits through the forecast period. The government will close out 2022–23 with a shortfall of $43.0 billion and post only modest improvements through the next five fiscal years—ending up at $14.0 billion in 2027–28. (See Chart 2.)

Chart 2

Deficits extended with new programs

(revenues less expenditures; $ billions)

e = estimate
f = forecast
Source: Finance Canada

The fiscal slippage will end up costing more in interest. By 2027–28, the cost of borrowing will more than double to $50.3 billion annually, compared to the $24.5 billion paid in 2021–22. Rising interest rates will push borrowing costs to the equivalent of 9.6 per cent of revenues in the next two fiscal years, before settling to 9.3 per cent for the remainder of the forecast. (See Chart 3.)

Chart 3

Making the future pay

(interest costs as a percentage of revenues)

e = estimate
f = forecast
Source: Finance Canada.

The Green Giant

A big push in the Budget is the attempt to shift Canada toward a cleaner economy. The task is indeed huge, as are the risks. Canadian businesses will be operating in a global environment supercharged by the U.S. Inflation Reduction Act’s nearly US $400 billion directed toward green energy production and related manufacturing south of the border.

The government’s priorities include greater investment in electricity production and distribution, clean manufacturing, critical minerals, emissions reductions and a push toward battery electric vehicle use and production. The government will use a variety of investment and tax incentive tools to aim for net-zero emissions by 2050.

The budget introduced a 15 per cent refundable tax credit for investments in non-emitting electrical generation like solar, wind, hydro, wave and nuclear, as well as for abatement of gas-fired generation. Significantly, crown corporations and publicly owned utilities will be eligible for the credits. The credit is expected to be worth approximately $1.6 billion per year for the next four years, before rising to $3.2 billion annually through 2034–35.

There will also be a new 30 per cent tax credit for investments in manufacturing machinery and equipment used in a broad range of production, extraction, processing and recycling activities. The total cost will be roughly $1 billion per year for the next 10 years. In addition, the Infrastructure Bank will be directed to invest $20 billion to support the building of clean growth infrastructure.

There are also a host of additional details on previously announced measures related to critical minerals, clean hydrogen, and biofuels.

G(rocery) S(ales) T(ax) Credit : A new measure to make things cheaper at the checkout

While affordability is often mentioned in this budget, there is little in the way of new money going to households, and as a result, will likely do little to raise inflation. However, this doesn’t mean households are not getting support, given the federal government has significantly expanded the amount of new money going to households since 2015. These new supports include the Canada Workers Benefit, the Canada Childcare Benefit, already in-place inflation relief, low-income support for renters, higher old age security payments and lower cost daycare. So, while the budget provides little new action, Canadians have seen significant new inflows in recent years.

The biggest new “affordability” measure comes from a 6-month extension to the GST rebate and veiled as the Grocery Rebate—which is in fact not tied to how much a household spends on groceries (which are largely tax exempt). The program is set to give around 11 million low-income households up to $467 as a one-time payment, at a total cost of $2.5 billion. While more government support is generally inflationary, the short-term nature of the program and the relatively modest amount will likely do little to push inflation upwards, especially over the medium-term.

Hidden Fees Virtually Gone

One interesting key area of policy action in this budget is to simplify and clarify the process of online shopping. The government intends to reduce hidden checkout fees through new regulation, and likely save Canadians money—especially on purchases made over peer-to-peer marketplaces, where prices are less likely to adjust.

Consumer support also came in the form of “right to repair” legislation, that promises to make devices easier to fix and improve their longevity. While this program is mostly in the ideation stage, it could help save lower-income Canadians more money by increasing the availability of second-hand devices and, in theory, making devices last longer for those who wish to increase the lifecycle of their electronics.

To help support small businesses, the government has confirmed agreements with Visa and Mastercard to lower credit card fees for these entities. This will help small business owners bottom lines, which came under severe strain during the pandemic. The government expects this policy to save small businesses $1 billion over five years, with some of these cost savings potentially also ending up in the hands of consumers through lower prices.

Home Sweet … Home?

Housing has been a critical issue for the country in recent years, which only worsened with the run-up in house prices during the pandemic. Government policy, especially at the federal level, has typically been targeted on the demand side—freeing up more money to buy a house. While the thinking is that this should improve affordability, counterintuitively, it mostly just helps prices increase.  While governments continue to call for plans to build more houses, policy action in this space has been limited. The most notable measure recently has been the ban on non-resident, non-Canadian buyers, which shrinks the buyer pool, and thus saves Canada’s housing stock for Canadians, but it also causes some ownership issues for foreign developers that can hold back potential new building.

At a time of sky-high immigration, governments need to focus on how to increase housing supply, and this budget does little on that front. There are some measures for affordable housing, but the definition of “affordable” is unclear—with many Canadians, across most income spectrums, finding home ownership out of reach. And while it’s good that the National Housing Strategy will open up some housing stock, it pales in comparison to how much new housing Canada truly needs to support its population, especially in the face of higher immigration targets recently announced by the federal government.

Rx for Healthcare

If the pandemic taught Canadians anything, it’s that our public health system needs help. The federal government is stepping up for health by adding $46 billion in new health care transfers to provinces over the next 10 years (with the budget allocating an incremental $22 billion, mostly for a CHT top-up and new bilateral agreements). Much of this higher funding has already shown up in provincial budgets and will help ease some of the health care pressures the country faces, but it will by no means solve them all. While the higher transfers make up the bulk of new health care spending, the government has also allocated $505 million over five years for better health data, and more than $350 million over five years to help combat the opioid crisis.

Smiles for Canada’s Dental Benefit

There was also more news about Canada’s Dental Benefit, a key measure in government’s 2022 budget. The initial announcement of the program planned to provide dental care for uninsured Canadians making less than $90,000 per year, starting with children under 12. This was augmented in September 2022, with the Canada Dental Benefit, which gave parents up to $1,300 per child, over two years, to receive dental care.

The big news on the dental front comes in this latest budget, with over $13.0 billion allocated over the next five years, and $4.4 billion per year going forward, to implement the Canada Dental Care Plan. The plan will cover dental care for uninsured Canadians with a household income of less than $90,000 and no co-pay for families earning less than $70,000.

Defense Spending Shy of the Mark

Several new spending initiatives over the past decade have pushed up military spending from about 1 per cent of GDP in 2015 to 1.3 per cent of GDP in 2023. Budget 2022 allotted $7.2 billion in new defence spending over five years, with annual new spending peaking at $1.9 billion in 2026–27. Canada and all NATO members had committed at the 2014 NATO summit to spend 2 per cent of GDP annually on defence by 2025. According to NATO, by 2021, roughly ten member countries had achieved that goal, but Canada continues to lag. Canada’s spending reached $36.7 billion in 2023, or 1.29 per cent of GDP. To get to 2 per cent we would need to spend nearly $57 billion—essentially, military spending would need to increase by $20 billion annually to reach the NATO commitment.

Budget 2023 does little to move Canada towards its annual NATO commitments. The government had already allocated roughly $3 billion in new spending through 27–28 before the budget, which is progress towards its NATO commitment, but nowhere near enough. This budget has added only just over $700 million in new spending over the next seven years.

Friendshoring Taking Root

Budget 2023 includes a discussion about reducing supply chain vulnerabilities and reducing dependence on authoritarian regimes. This is an important consideration from an economic perspective. President Biden’s visit to Ottawa reinforced the U.S. government’s position that it will incent firms to move production closer to home. And Russia’s invasion of Ukraine has forced Europe to look to alternate sources to supply energy and other materials.

Moving supply chains will likely be costly for many developed economies but Canada could also benefit from a from a move by U.S. and European firms looking to secure supply chains. Canada is a trusted partner, we have a strong brand across our export categories, we have important bilateral and multilateral trade agreements, and we are a global exporter of energy, agrifood, and many other resources. These advantages alone have not sufficed since Canada severely lags other developed economies on attracting private non-residential investment. We need to be proactive and competitive to secure investment in areas where we have a comparative advantage but, in our view, Budget 2023 doesn’t do enough to significantly change our fortunes.

Tax Bites and Savings

Compared to the spending plans, the proposed tax changes are given much lower profile in the Budget and are geared to increasing the progressivity of the system.

The combined dollar amounts on the tax side of the ledger are significant though—particularly in the later part of the Budget forecast—amounting to about $4 billion per year in expected new tax revenue by 2027–28. There are also significant savings, about $12.7 billion total over six years, from less spending on consulting and cuts to departmental budgets. In total about $24 billion over six years is generated in departmental savings and additional taxes.

Risky Business

This Budget is dealing with more risks than usual. The economic environment is still unsteady and the dance between inflation and interest rates has not yet concluded. The war in Ukraine has been prolonged, and still has the potential to create uncertainty in the world economy. Finally, the technologies and pathways toward the greening of the economy are still relatively new and untested. Big investments have the potential to make a big difference in climate outcomes and Canada’s economic prospects, but they are still speculative. Budget forecasts rarely survive the future, but we can expect this year’s revenue and expenditure plans, given the risks identified, to shift even more dramatically in the coming years as conditions change.