Chapter 2
Fiscal Projections

Highlights

• The strength of the economy over the first half of 2007 has bolstered revenue growth and improved the overall fiscal position of the Government.

• The Government is directing these higher revenues to tax reduction and debt reduction.

• The Government plans to reduce the federal debt by $10 billion this year. This will bring total debt reduction since 2005–06 to over $37 billion, lowering the federal debt burden by about $1,570 per person. The Government will continue to plan on debt reduction of $3 billion in 2008–09 and each year thereafter.

• This also means that the target for reducing the debt-to-GDP (gross domestic product) ratio to below 25 per cent will be achieved by 2011–12, three years ahead of the original target date. This will mark the lowest debt burden since the late 1970s.

• The Government’s Tax Back Guarantee is ensuring that interest savings resulting from debt reduction are being returned to Canadians in the form of lower personal income taxes. Thanks to achieved and planned debt reduction, the Guarantee will reach $2.5 billion by 2012–13.

• At this time of global economic uncertainty, the Government’s strong fiscal position provides Canada with an opportunity that few other countries have—to put in place historic tax reductions that will bolster confidence and encourage investment, while at the same time remaining in a surplus position.

• The tax reductions proposed in this Economic Statement total almost $60 billion over this and the next five years. As a result, the federal tax burden, measured by total federal revenues as a share of the economy, will fall to 15.1 per cent by 2011–12, the lowest ratio in nearly 50 years.

• The Government is managing spending effectively through the new Expenditure Management System introduced this year, ensuring value for money and keeping program expense growth, on average, below the rate of growth of the economy.

• After taking into account the tax and debt reductions proposed in this Statement, the planning surplus is $1.6 billion this year, $1.4 billion next year, $1.3 billion in 2009–10, and then rises to $4.5 billion in 2010–11, $7.2 billion in 2011–12 and $9.8 billion in 2012–13.

Approach to Budget Planning and Fiscal Forecasting

The Government’s approach to budget planning involves a number of important elements.

• The Government plans on reducing the federal debt by $10 billion in 2007–08 and $3 billion in each year thereafter. Interest savings from federal debt reduction will be dedicated to permanent and sustainable personal income tax reductions through the Government’s Tax Back Guarantee.

• Any unplanned surpluses will be used to reduce federal debt, with the resulting interest savings directed towards further personal income tax reductions.

The economic assumptions that underlie the Government’s fiscal projections are based on the average of private sector forecasts.

While the Government’s projection is the basis for fiscal planning, the fiscal projections of four private sector organizations are presented separately, allowing a comparison between different views on the fiscal outlook. The four private sector organizations used their own economic assumptions to prepare their fiscal projections. Private sector projections are presented for the current and next five years.

Changes in the Fiscal Outlook Since the March 2007 Budget

Table 2.1 shows the changes to the Government’s fiscal position as a result of economic and fiscal developments since the March 2007 budget. The Government’s fiscal situation is now significantly stronger than projected at the time of the budget. This is primarily due to the recent unexpected strength of the economy, which is increasing revenues.

Table 2.1
Summary of Changes in the Fiscal Outlook Since the March 2007 Budget

In Budget 2007, the underlying surplus was estimated at $9.2 billion for 2006–07, $3.3 billion for 2007–08 and $3.0 billion for 2008–09. The final budgetary surplus for 2006–07, at $13.8 billion, was larger than expected, primarily because of higher-than-expected corporate income tax revenues.

Revenues are projected to be $12.0 billion higher in 2007–08 and $11.6 billion higher in 2008–09. Corporate income tax revenues, which represent about 16 per cent of total revenues, account for 35 to 45 per cent of the upward revision to the revenue projections. Projections for personal income tax, other income tax and goods and services tax (GST) revenues have also been revised upward significantly. All other revenues are expected to be $2.2 billion higher in 2007–08 and $2.0 billion higher in 2008–09 than projected in the budget.

Program expenses are expected to be $1.3 billion lower in 2007–08 than projected in the budget, largely reflecting lower-than-expected departmental spending. Higher spending in 2008–09 largely reflects the impact of higher inflation in 2007, which pushes up the cost of statutory transfers to individuals.

At this time of global economic uncertainty, the Government is acting to bolster confidence and encourage investment by providing tax reduction measures totalling nearly $60 billion. These include:

• Reducing the general corporate income tax rate to 15 per cent by 2012.

• Reducing the small business tax rate to 11 per cent, effective January 2008, one year earlier than previously announced.

• Reducing the GST rate from 6 per cent to 5 per cent, effective January 1, 2008.

• Reducing the lowest federal personal income tax rate from 15.5 per cent to 15 per cent, effective January 2007.

• Increasing the basic personal amount to $9,600 in both 2007 and 2008.

The cost of these measures over the current and next five fiscal years is summarized in Table 2.2.

Taken together, the impact of economic and fiscal developments since the March 2007 budget as well as measures announced in this Economic Statement and planned debt reductions result in a planning surplus of $1.6 billion in 2007–08 and $1.4 billion in 2008–09.

Table 2.2
Proposed Tax Reductions

Summary of Fiscal Projections

Table 2.3 summarizes the Government’s fiscal projections for the current and next five fiscal years, taking into account the cost of the tax measures announced in this Economic Statement. The underlying surplus is projected to be $11.6 billion in 2007–08, $4.4 billion in 2008–09 and $4.3 billion in 2009–10. It rises to $7.5 billion in 2010–11, $10.2 billion in 2011–12 and $12.8 billion in 2012–13.

The Government plans to reduce the debt by $10 billion in 2007–08. Thereafter, it will plan to reduce the debt by $3 billion in each year as set out in Budget 2007.

Table 2.3
Summary Statement of Transactions
(Including Measures Announced in This Economic Statement)

Tax Burden Declines Due to Tax Relief Measures

One perspective on movements in tax revenues can be obtained by examining the revenue ratio—total revenues collected by the federal government in relation to total income in the economy (GDP). This ratio can be thought of as a proxy for the overall federal "tax burden" imposed on the economy.

The revenue ratio is projected to decline from 16.3 per cent in 2006–07 to 15.1 per cent by 2011–12—its lowest level in nearly 50 years—reflecting the impact of tax reduction measures announced in Budget 2006, the October 2006 Tax Fairness Plan, Budget 2007 and this Economic Statement.

Program Expense-to-GDP Ratio to Decline

As shown in Chart 2.2, program expenses as a share of GDP rose rapidly between 2000–01 and 2004–05. This trend was reversed in 2005–06, and program expenses are projected to remain slightly below 13 per cent of GDP for the next two years, with the program expense-to-GDP ratio falling to 12.7 per cent in 2011–12.

The Government is committed to limiting program expense growth, on average, to below the rate of nominal growth of the economy over the medium term. Overall program spending is projected to increase 5.4 per cent this year and on average 4.1 per cent annually over the remainder of the planning period.

Within this spending, transfers to persons, including elderly, children’s and Employment Insurance benefits, are projected to grow on average 3.9 per cent annually over the planning period.

Major transfers to other levels of government are projected to grow 4.7 per cent per year on average over the planning period, funding a comprehensive plan that restores fiscal balance. These transfers are now on a long-term principles-based footing.

Direct program expenses are expected to grow 4.4 per cent per year on average over the planning period, funding important investments in infrastructure, the Canada First Defence Strategy and other priorities.

Debt-to-GDP Ratio on Track to 25-Per-Cent Target by 2011–12

The Government is planning on reducing the federal debt by $10 billion in 2007–08. This will bring total debt reduction since 1996–97 to over $105 billion, with over 35 per cent ($37.4 billion) taking place in the last three years.

Canada Has the Best Fiscal Situation in the G7

According to the most recent projections from the Organisation for Economic Co-operation and Development (OECD), Canada is again expected to be the only Group of Seven (G7) country in surplus in 2007 and 2008. The OECD forecasts Canada’s surplus at 0.8 and 0.7 per cent of GDP in 2007 and 2008 respectively, compared to an expected average deficit of about 2.3 per cent of GDP in all G7 countries during that time.

Outlook for Budgetary Revenues

Table 2.4
Revenue Outlook

Table 2.4 sets out the Government’s projection for budgetary revenues. Taking into account the measures announced in this Economic Statement (see Table 2.2), budgetary revenues are expected to grow by 3.4 per cent in 2007–08 and by 0.8 per cent in 2008–09. Revenue growth is projected to average about 4.1 per cent starting in 2009–10. Over the planning period, revenues are expected to grow by less than growth in the overall economy. As a result, the revenue-to-GDP ratio is projected to fall from 16.3 per cent in 2006–07 to 15.1 per cent for 2012–13.

Personal income tax revenues—the largest component of budgetary revenues—are projected to increase by $3 billion, or 2.7 per cent, to $113 billion in 2007–08. This is much lower than the 6.3-per-cent projected growth in the personal income tax base, reflecting the impact of the increase in the basic personal amount and the reduction in the lowest personal income tax rate, announced in this Statement, as well as tax relief introduced in Budget 2007 and the October 2006 Tax Fairness Plan. Starting in 2008–09, personal income tax revenues increase somewhat faster than growth in GDP, reflecting the progressive nature of the income tax system combined with real income gains.

Recent growth in corporate income tax revenues has been well in excess of growth in profits. This likely reflects a decline in pools of losses and credits from prior periods available to apply against corporate tax liabilities. Detailed data to confirm whether or not these factors occurred will only become available with a two-year lag. Corporate income tax revenues, which grew 19 per cent in 2006–07, are expected to increase 10 per cent, to $41.5 billion, in 2007–08. Over the planning period, two primary factors affect the projection of corporate income tax receipts: ongoing growth in profits and tax relief measures. In 2008–09, in particular, corporate income tax revenues are projected to decline by 8.8 per cent, reflecting the reduction in the general corporate income tax rate, the elimination of the corporate surtax and the acceleration of the 1-percentage-point reduction in the small business rate, all effective January 1, 2008.

Other income tax revenues—largely withholding taxes levied on non-residents—are expected to increase by 20.2 per cent to $5.9 billion in 2007–08, reflecting strong collections through the first five months of 2007–08. Other income tax revenues are projected to remain relatively flat in 2008–09 and then decline in 2009–10 and 2010–11, reflecting the impact of the elimination of the withholding tax in respect of both arm’s-length interest and non-arm’s length interest with the U.S., implemented by the Canada-U.S. Tax Treaty, and the Budget 2007 initiative to eliminate the withholding tax in respect of arm’s-length interest paid to lenders resident in other countries.

GST revenues are expected to decline by 3.2 per cent to $30.3 billion in 2007–08, primarily reflecting the reduction in the GST rate to 5 per cent beginning on January 1, 2008. GST revenues are projected to decline further, by 9.6 per cent in 2008–09, once the full cost of the reduction in the GST rate to 5 per cent is fully reflected. GST revenues are projected to grow in line with the taxable consumption base starting in 2009–10.

Customs import duties are projected to increase 9.9 per cent to $4.1 billion in 2007–08, consistent with strong growth through the first five months of 2007–08. Over the remainder of the planning period, customs import duties are projected to grow at an average rate of about 5 per cent.

Other excise taxes and duties are projected to decline by 2.3 per cent in 2007–08, to $10.1 billion, after an increase of 5.2 per cent in 2006–07. The increase in 2006–07 largely reflected the introduction of an export charge on softwood lumber exports to the U.S. effective October 12, 2006, consistent with the Canada-United States Softwood Lumber Agreement, as well as a one-time charge on returned duty deposits under the Agreement. Other excise taxes and duties are projected to continue to decline, on average, over the remainder of the planning period.

Employment Insurance (EI) premium revenues are expected to decline 1.8 per cent to $16.5 billion in 2007–08, reflecting the decline in the premium rate from $1.87 to $1.80 per $100 of insurable earnings effective January 1, 2007. Consistent with the EI premium rate-setting mechanism, implemented in 2005, EI premiums are assumed to match projected EI program costs from 2008 to 2013. The projection assumes that the EI premium rate is reduced to $1.73 per $100 of insurable earnings in 2008. Accordingly, the rate for employers is assumed to drop by 10 cents per $100 of insurable earnings in 2008. These are the rates forecast by the Chief Actuary to generate just enough premium revenue in 2008 to cover the projected payments during the year.

Other revenues include those of consolidated Crown corporations, net gains/losses from enterprise Crown corporations, foreign exchange revenues, returns on investments and proceeds from the sales of goods and services. These revenues are volatile, owing partly to the impact of exchange rate movements on the Canadian-dollar value of foreign-denominated interest-bearing assets and to net gains/losses from enterprise Crown corporations. In 2007–08, other revenues are expected to increase by 6.3 per cent to $22.1 billion.

Outlook for Program Expenses

Table 2.5
Program Expenses Outlook

Table 2.5 provides an overview of the Government’s projections for program expenses. Program expenses are expected to grow by $10.1 billion, or 5.4 per cent, in 2007–08. Growth is expected to average 4.1 per cent over the remainder of the planning period.

Program expenses consist of three major components: major transfers to persons, major transfers to other levels of government and direct program expenses.

Major transfers to persons consist of elderly, EI and children’s benefits.

• Elderly benefits are projected to grow by $1.7 billion, or 5.8 per cent, to $32 billion in 2007–08, reflecting the $18-per-month increase in the Guaranteed Income Supplement in January 2007. In the following five years, elderly benefits are projected to grow by an average of 4.8 per cent per year, reflecting the growth in the elderly population and changes in consumer prices, to which benefits are fully indexed.

• EI benefits are projected to increase by 2.9 per cent to $14.5 billion in 2007–08 and by 3.5 per cent on average over the following five years. This growth is due to the indexation of maximum insurable earnings to the growth in the average industrial wage, which results in growth in the maximum weekly benefit. The projections are based on the average private sector outlook, under which the number of unemployed remains relatively stable.

• Children’s benefits, which consist of the Canada Child Tax Benefit (CCTB) and the Universal Child Care Benefit (UCCB), are expected to rise by $0.7 billion to $11.9 billion in 2007–08, reflecting the introduction of the UCCB in July 2006. Starting in 2008–09, the growth in children’s benefits is largely determined by the growth in the number of children, in addition to changes in consumer prices, to which the CCTB is indexed.

Major ongoing transfers to other levels of government are projected to increase by $4.4 billion or 11.2 per cent in 2007–08 (see Chart 2.5), reflecting a $2.7-billion increase in transfers in support of health and social programs and a $1.4-billion increase in fiscal arrangements. Once one-time transfers are taken into account, major transfers in 2007–08 are projected to be $1.0 billion, or 2.3 per cent, higher than in 2006–07. The one-time payments in 2006–07 total $3.4 billion and are in support of clean air and climate change, patient wait times, post-secondary education and training, and early learning and child care.

Over the next five years, major transfers to other levels of government are projected to increase from $43.5 billion in 2007–08 to $55.9 billion in 2012–13, averaging 5.1-per-cent growth per year.

This growth reflects the impact of rising transfers for health, Equalization and Territorial Formula Financing, as well as growing support for cities and communities. Revised Equalization figures for 2008–09 are based on data available at the time the forecast was prepared, and include the impact of recently announced measures related to the implementation of Budget 2007. Final estimates for 2008–09 Equalization entitlements will be released in December 2007. As the data required to calculate Equalization payments for 2009–10 to 2012–13 is not yet available, it is assumed that Equalization will grow at the rate of growth in the private sector forecast of nominal GDP, adjusted for changes in the share of recipient provinces’ population. Estimates of Equalization entitlements for those years will be made once the required data becomes available.

Direct program expenses include expenses for National Defence, Crown corporations, transfers administered by departments (for example, transfers for farm income support and Aboriginal programming) and departmental operating costs. In 2006–07, direct program expenses increased by 10.3 per cent largely as a result of one-time accrual adjustments for public sector pension liability and a change in the creditworthiness of outstanding tax debts owed to the Government. For 2007–08, the total amount of direct program expenses is $1.1 billion lower than expected at the time of the budget, reflecting tight control over the implementation of programs announced in previous budgets. Direct program expenses are expected to grow on average by 3.9 per cent over the following five years.

Private Sector Five-Year Fiscal Projections

To provide context for the Government’s fiscal projections, four private sector organizations developed their own fiscal projections. The four organizations are the Conference Board of Canada, the Institute for Policy Analysis of the University of Toronto, Global Insight and the Centre for Spatial Economics.

The four private sector organizations prepared their fiscal projections based on their own individual economic forecasts and information publicly available as of the end of September. The forecasts for direct program expenses and transfers to other levels of government were provided by the Department of Finance. In preparing its fiscal projections, the Government had access to financial results for August and partial revenue results for September 2007, which were not available to the four private sector organizations when they completed their projections.

In addition, the private sector projections were adjusted to reflect the cost of measures proposed in this Economic Statement, which rise from $4.8 billion in 2007–08 to $14.7 billion in 2012–13 (Table 2.2). While these adjustments do not have an impact on the variation among the private sector projections, they lower the projected surplus levels.

The range of the private sector projections is larger than in the past. The range between the lowest and highest projection is $4.2 billion in the first year of the planning period and increases to $14.9 billion by 2012–13. This range is considerably higher than that presented in the 2006 Economic and Fiscal Update, when the high point of the range was only $3.5 billion by the final year of the projection. The significant range between projections in this Economic Statement reflects differences in both forecasts of GDP growth and the rate at which growth in GDP translates into tax revenues.

The range in the private sector fiscal forecasts provides an example of the uncertainty around the economic and fiscal forecasts. Small changes in revenues and expenses can lead to significant changes in the Government’s budgetary balance. For example, if both revenues and expenses differ by 1 per cent from what was projected, the impact on the Government’s budgetary balance would be $4.6 billion.

Chapter 1 describes the risks to the economic forecast. Changes in economic conditions have a direct impact on the Government’s budgetary balance. In addition, the translation of economic developments into changes in spending and tax revenues includes a degree of uncertainty. The following two sections provide an overview of the sensitivity of the fiscal situation to both of these sources of uncertainty.

Table 2.6
Private Sector Projections of Underlying Surplus on a Public Accounts Basis

Sensitivity of the Budget Balance to Economic Shocks

Changes in economic assumptions affect the projections for revenues and expenses. The following tables illustrate the sensitivity of the budgetary balance to a number of economic shocks:

• A one-year, 1-per-cent decrease in real GDP driven equally by lower productivity and employment growth.

• A decrease in nominal GDP resulting solely from a one-year, 1-per-cent decrease in the GDP deflator.

• A sustained 100-basis-point decrease in all interest rates.

These sensitivities are generalized rules of thumb that assume any decrease in economic activity is proportional across income and expenditure components. EI premium rates are assumed to be fixed during the first calendar year in which the shock occurs, and to adjust for subsequent years, such that EI revenues exactly offset program expenses, consistent with legislation governing EI rate setting. Equal and opposite impacts would result from an increase of equal magnitude in real or nominal GDP growth and interest rates.

Table 2.7
Estimated Impact of a One-Year, 1-Per-Cent Decrease in Real GDP on Federal Revenues, Expenses and Budgetary Balance

A 1-per-cent decrease in real GDP reduces the budgetary balance by $2.8 billion in the first year, $2.6 billion in the second year and $3.1 billion in the fifth year:

• Tax revenues from all sources fall by a total of $2.2 billion in the first year, $2.6 billion in the second year and $3.0 billion by the fifth year. Personal income tax revenues decrease as employment and wages and salaries fall. Furthermore, due to the progressivity of the tax system, as individuals earn lower real incomes, they pay proportionally less of their income in taxes. Corporate income tax revenues fall as output and profits decrease. GST revenues decrease as a result of lower consumer spending associated with the fall in employment and personal income.

• Since EI premium rates for a given year are set based on projections carried out in October of the previous year, EI premium revenues decline marginally in the first year of the shock (reflecting lower wages and salaries), but rise thereafter, reflecting the upward adjustment to the break-even rate necessary to meet increased program costs. For the purpose of the simulations, it is assumed that EI premium rates are increased as a result of the weaker economy. This is consistent with the legislation governing rate setting. However, the legislation also provides the Government with the option to leave rates unchanged if it believes this to be appropriate.

• Expenses rise, mainly reflecting higher EI benefits (due to an increase in the number of unemployed) and higher public debt charges (reflecting a higher stock of debt due to the lower budgetary balance).

Table 2.8
Estimated Impact of a One-Year, 1-Per-Cent Decrease in the GDP Deflator on Federal Revenues, Expenses and Budgetary Balance

A 1-per-cent decrease in nominal GDP resulting solely from lower GDP inflation (assuming that the Consumer Price Index moves in line with GDP inflation) lowers the budgetary balance by $2.2 billion in the first, second and fifth years:

• Lower prices result in lower nominal income and, as a result, personal income tax, corporate income tax and GST revenues all decrease, reflecting declines in the underlying nominal tax bases. For the other sources of tax revenue, the negative impacts are similar under the real and nominal GDP shocks.

• EI premium revenues decrease marginally in the price shock in response to lower earnings. However, unlike the real GDP shock, EI benefits do not rise since unemployment is unaffected by price changes.

• Partly offsetting lower revenues are the declines in the cost of statutory programs that are indexed to inflation, such as elderly benefit payments and the Canada Child Tax Benefit, as well as federal wage and non-wage expenses. Payments under these programs are smaller if inflation is lower. Public debt charges rise due to the higher stock of debt.

Table 2.9
Estimated Impact of a Sustained 100-basis-Point Decrease in All Interest Rates on Federal Revenues, Expenses and Budgetary Balance

A decrease in interest rates raises the budgetary balance by $0.8 billion in the first year, $1.3 billion in the second and $1.5 billion in the fifth. The improvement stems entirely from decreased expenses associated with public debt charges. The impact on debt charges rises through time as longer-term debt matures and is refinanced at lower rates. Moderating the overall impact is a fall in revenues associated with the decrease in the rate of return on the Government’s interest-bearing assets, which are recorded as part of non-tax revenues. This becomes significant in the fifth year, rising to almost $1 billion.

Risks to the Fiscal Projections

Additional uncertainty also arises from the translation of economic forecasts into spending and tax revenue projections, as growth in tax bases does not always translate in a predictable way into tax revenues.

The following are the key sources of uncertainty:

• The sensitivity of personal income tax revenues to changes in personal income is summarized by a measure called personal income tax elasticity, which is the ratio of personal income tax growth to the growth in personal income. Budget 2007 projected that underlying personal income tax elasticity—excluding the impact of policy changes—would be 1.4 in 2007–08, before declining to 1.3 in 2008–09 and subsequent years. Based on somewhat weaker growth in collections relative to personal income thus far in 2007–08, underlying elasticity is now projected to be 1.3 in 2007–08, and is projected to remain at that level over the planning period. In other words, growth in underlying personal income tax revenues is assumed to be 30 per cent faster than growth in personal incomes. While this is in line with the average observed over the last decade, personal income tax elasticity can be very volatile on a year-to-year basis, ranging from 0.7 to 2.0 over the same period. A change of 0.1 in the elasticity translates into an increase or decrease in revenues of approximately $700 million.

• Projected corporate income tax revenues over the planning period have been revised up significantly since Budget 2007, reflecting growth in corporate income tax revenues that has been well in excess of growth in profits. This likely reflects a decline in pools of losses and credits from prior periods available to apply against corporate tax liabilities. For planning purposes, underlying corporate income tax revenues (i.e. before taking into account tax reductions announced in this Economic Statement) are expected to grow in line with corporate profits, leaving underlying average effective tax rates close to their current levels. In the short term, corporate income tax revenues could come in higher than projected if loss pools continue to decline. Over the medium term, however, there is some risk that average effective tax rates could return to closer to their pre-2006 levels.

• On the expense side, the extent to which departments and agencies do not fully use all of the resources appropriated by Parliament varies from year to year and can materially affect the fiscal outcome. In addition, during the course of the fiscal year, departments and agencies often incur liabilities for which no payments are made. These liabilities are recognized throughout the year and are updated following the close of the fiscal year as part of the normal year-end accrual adjustments. Changes in estimates of liabilities can be significant.

 

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