Archived - Canada’s Economic Outlook and Policy Framework

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At his December 12th meeting with provincial and territorial finance ministers in Ottawa, Minister of Finance Jim Flaherty provided a presentation on the state of Canada’s economy.

The presentation provided an overview of the current economic situation and prospects, reviewed some key challenges the country is now facing, and discussed the policy framework Canada’s government has set out to address these challenges—the Advantage Canada economic plan. The attached document is an update of that presentation.

Highlights

The Canadian economy is currently in one of the strongest periods of economic growth in its history:

  • The labour market is in its best shape in a generation. The unemployment rate, at 5.9%, is near a 33-year low. In the first eleven months of 2007, the Canadian economy created close to 400,000 new jobs.
  • Household net worth and corporate profits are near record highs.
  • Canada was the only G7 country in surplus in 2006, and is expected to be in the strongest fiscal position of all G7 countries in 2007 and 2008.
  • All levels of government contributed to this strong fiscal performance. For 2007–08, provinces and territories are forecasting a combined surplus of $7.8 billion.
  • Federal transfers to provinces are rising significantly on both a cash and per capita basis.
  • Canada’s real income per capita has risen by more than 20% since the end of 2001, more than double that of the U.S. over this period.

This strong performance occurred while the Canadian economy was adjusting successfully to the rise in the dollar and increasing global competition.

The economic situation is positive, but our ability to sustain recent gains in our standard of living will largely depend on how well we manage the risks and challenges that lie ahead. These include:

  • The risk of a weaker-than-expected U.S. economy, which could be exacerbated by the ongoing financial market turmoil.,
  • The continued need to adjust to a higher dollar and increasing global competition.,
  • Labour shortages and the aging of the Canadian population.

While there is no single solution to these challenges, the key element of any solution is our productivity performance. This was the central focus of the Ggovernment’s long-term economic plan, Advantage Canada.

This plan was centered on building five key strategic advantages for Canada:

  • Knowledge.;
  • Infrastructure.;
  • Entrepreneurial.;
  • Tax.; and
  • Fiscal.

Facing these challenges and risks, the Government has taken bold action. The 2007 Economic Statement moved Canada into a new tax era with $60 billion in tax reduction.

The Economic Statement proposes to reduce the federal corporate income tax rate to 15% by 2012, the lowest statutory rate in the G7.

The Government is also seeking the collaboration of provinces and territories in reaching a 25% combined federal-provincial-territorial CIT rate. Provincial sales tax harmonization would further improve the competitiveness of Canada’s corporate tax system and give Canada a METR below the average for OECD countries.

The Government has also taken significant action in other Advantage Canada goals, and seeks further provincial cooperation in these areas, including:

  • Significant investments in post-secondary education and job training.;
  • $33 billion over seven years for infrastructure projects.; and
  • Launching a global capital markets plan.

Canada is reducing the debt burden to historic levels, with plans to for debt reduction of $10  billion in 2007–-08 and at least $3 billion a year after that. Interest savings from this lower debt are being channelled to personal income tax reductions.

These actions will help Canadians withstand uncertain economic times in the near term while providing the foundation for the economy in the long term.


Canada’ Economic Outlook and Policy Framework

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This document provides an overview of the current economic situation and prospects, reviews some key challenges the country is now facing, and discusses the policy framework Canada’s government has set out to address these challenges -- the Advantage Canada economic plan.

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We are currently experiencing one of the strongest periods of economic growth in Canadian history.

The labour market is in its best shape in a generation.

The unemployment rate, at 5.9%, is near a 33-year low.

Job creation has been very strong. In the first eleven months of 2007, the Canadian economy created close to 400,000 new jobs.

The share of Canadians currently employed, at 63.8%, is at a record high.

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The financial position of households is sound.

Household net worth measured relative to income is at a record high, and has continued to grow strongly. This contrasts with somewhat slower wealth gains in the U.S.

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The financial position of the corporate sector is very healthy.

Corporate profits as a share of GDP are near their record high, well above average historical levels.

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Similarly, the fiscal position of all orders of government in Canada is sound.

Canada’s fiscal situation has improved significantly since the mid-1990s as deficits were turned into surpluses and Canada’s debt burden declined from the second highest to the lowest among G7 countries.

On a National Accounts basis, Canada recorded a total government surplus amounting to 1 percent of GDP in 2006, compared to an average deficit of 2.5 percent for G7 countries.

According to the most recent OECD estimates, Canada is expected to be in the strongest fiscal position of all G7 countries in 2007 and 2008.

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An important reason for the recent strength of the Canadian economy is that world-wide economic growth has been very strong.

This has pushed up commodity prices significantly in recent years.

This rise has been compounded by supply constraints for agricultural commodities, base metals and crude oil.

These increases mean that the value of goods produced in Canada has increased considerably. In contrast, the prices of goods that we import have declined, mostly because the rise in the dollar has pushed down import prices.

This difference in prices of exports and imports -- our terms of trade -- is up by 20 per cent since 2002. This has added considerably to national income.

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The combination of strong economic growth and debt reduction has translated into a significant improvement in living standards.

Canada’s real income per capita has risen by over 20% since the end of 2001.

This reflects several factors. First, GDP per capita, a measure of the volume of Canadian production, has risen by more than 10% since the end of 2001. This is roughly similar to the increase in the U.S. over the same period.

Second, terms of trade gains mean that the value of Canadian production has also risen. This translates into a net income gain for Canadians, boosting living standards by a further 7.5 percentage points.

Finally, with governments in surplus and net foreign indebtedness falling, a growing share of income generated in Canada is staying here. This adds another 2.2 percentage points to living standards.

In contrast, the U.S. has suffered terms of trade losses and has run up foreign debt. After accounting for these factors, growth in Canadian living standards has been more than double that in the U.S. over this period.

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The economic situation is positive, but our ability to sustain recent gains in our standard of living will largely depend on how well we manage the risks and challenges that lie ahead.

These include:

  • The risk of a weaker-than-expected U.S. economy, which could be exacerbated by the ongoing financial market turmoil,
  • The continued need to adjust to a higher dollar and increasing global competition,
  • Labour shortages and the aging of the Canadian population.

While there is no single solution to these challenges, the key element of any solution is our productivity performance.

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The first major challenge for the Canadian economy is weakness in the U.S.

Private sector forecasters have revised down their economic outlooks for the U.S. since March. At the time of the Economic Statement, they expected U.S. growth to be well below trend this year.

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The weakness in the U.S. economy is primarily related to a major correction in housing markets.

Inventories of unsold houses have increased. New housing starts have dropped by almost half from their peak. Prices are now declining.

Over the coming months a large volume of variable-rate mortgages will be up for renewal. There is a significant risk that this will push the housing market even lower.

The primary risk in the U.S. now is that the falling housing market will lead to a retrenchment of consumer spending growth more generally.

There are two primary channels through which a slowing in U.S. consumption could occur.

The first is that purchases of many consumer products are influenced by housing investment.

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The second channel is through a potential tightening in lending standards that is occurring in the U.S. as a result of the impact on financial markets of the sub-prime mortgage crisis.

This chart provides one measure of the tightening in credit conditions, based on data from the US Federal Reserve’s survey of senior lending managers.

It indicates that over 40 per cent of US banks have tightened mortgage lending to their best customers.

Canada is significantly less exposed to sub-prime mortgage lending, but generalized financial market volatility is nonetheless having an impact.

Indeed, at the time of the last Fixed Announcement Date on December 4th, the Bank of Canada stated that "bank funding costs have increased globally and in Canada, and credit conditions have tightened further".

A recent positive step is the agreement in principle reached on December 23 by parties of the Montreal Accord to restructure Canada's $35 billion non-bank asset-backed commercial-paper market, which has been frozen since August amid the tightening in global credit markets. Going forward, it will be important that detailed information be made available to all investors and that arrangements be finalized at the earliest opportunity.

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The second key challenge for Canada is the rise in the dollar.

This partly reflects the strength of the Canadian economy and rising commodity prices.

However, the upward spike in late 2007 also reflected general U.S. dollar weakness which led to a fair amount of speculative activity in currency markets.

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The high dollar presents both challenges and opportunities.

It has lowered the price of imported machinery and equipment, supporting very strong growth in investment over the past five years -- in both the manufacturing sector and economy wide.

This will support Canadian productivity growth ahead.

In contrast, investment in equipment and software in the U.S. has grown at a much slower pace over the same period -- both in the overall economy and in the manufacturing sector in particular.

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The rise in the dollar, along with increasing global competition, is resulting in significant structural shifts in the Canadian economy.

Output and employment has shifted away from manufacturing and primary industries toward the service sector, while remaining strong overall.

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In terms of the decline in manufacturing, however, Canada is not unique. Manufacturing as a share of total output has declined in all G-7 countries over the past 35 years.

This trend reflects a shift in location to developing countries where labour costs are lower.

In Canada, this trend decline was temporarily reversed between 1993 and 2003, as the low dollar lent support to manufacturing.

Since then, the sharp appreciation of the dollar has put downward pressure on manufacturing exports and returned the sector's share of output to its longer-term downward trend.

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While manufacturing employment has fallen in Central Canada and parts of Atlantic Canada, these job losses have been more than compensated by strong employment gains in other sectors of the economy.

As a result, provinces have generally seen solid job gains over the past two years, with overall employment up 4.5% despite a 7% decline in manufacturing employment.

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In fact, the strength of the labour market is apparent in two developments.

First, the unemployment rate in the manufacturing sector remains below the overall unemployment rate, which suggests that workers losing their jobs in the manufacturing sector are finding jobs in other sectors.

Second, manufacturers are increasingly facing labour shortages, especially for skilled workers.

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Today's labour market shortages provide us a glimpse of the tight labour markets that will likely result from population aging.

This represents a huge structural change for the Canadian economy.

The extraordinary growth in our labour supply over the last 50 years – due to the Baby Boom -- will fall off dramatically over the next 50 years.

This will slow labour-force and employment growth.

While this phenomenon is expected to occur in all developed economies, it will be especially pronounced in Canada.

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The challenges reviewed in this document suggest that the focus of economic policy should be on increasing productivity.

Over the last 10 years, our productivity growth has been among the lowest in the G-7, and the gap between Canada and the U.S. has continued to widen.

Improvements to our standard of living will increasingly depend on productivity growth.

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Last Fall, the Government released a comprehensive long-term economic plan – Advantage Canada.

This plan was centered on building five key strategic advantages for Canada:

  • Knowledge;
  • Infrastructure;
  • Entrepreneurial;
  • Tax; and
  • Fiscal.

Significant actions have already been taken in each of these areas.

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The 2007 budget took action to support a Knowledge Advantage in Canada by:

  • Investing an additional $800 million per year in post-secondary education.
  • Funding an additional 1,000 students through the Canada Graduate Scholarships.
  • Removing the contribution limits to registered education savings plans.
  • Investing $500 million per year in labour market training for those not eligible for employment-insurance-related training.
  • Providing $510 million to the Canada Foundation for Innovation to modernize research infrastructure at universities, colleges, research hospitals and other non-profit research institutions.
  • Supporting leading Centres of Excellence in Commercialization and Research with an investment of $350 million.

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On infrastructure, the federal government has provided $33 billion over seven years for long-term infrastructure projects.

The government wants to leverage this investment by using partnerships effectively, including greater reliance on public-private-partnerships.

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On Entrepreneurial Advantage -- the federal government has taken a number of steps to reduce the burden of regulation. This includes:

  • Creating a plan to succeed in global capital markets, including discussion of a common securities regulator;
  • Reducing the paper burden on small business;
  • Creating a new projects office to streamline the review of large resource projects.
  • Introducing policy to support new environmental and energy technologies.

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With respect to the Tax Advantage, the 2007 speech from the throne committed the federal government to a long-term plan of broad-based tax relief.

The Economic Statement is moving Canada into a new tax era with $60 billion of tax relief for this and the next five years, including:

  • Reducing the federal corporate income tax rate to 15 per cent by 2012. As a first step, it will be reduced by one percentage point – beyond scheduled reductions -- to 19.5 per cent in 2008. This helps move Canada towards a 25-per-cent combined federal-provincial tax rate. To reach this goal, we are seeking the collaboration of the provinces and territories.
  • Accelerating the reduction in the small business rate to 11 percent by one year, to 2008.
  • Reducing the GST by a further percentage point as of January 1, 2008, while maintaining the GST credit for low- and modest-income Canadians at its current level.
  • Reducing the lowest personal income tax rate to 15% from 15.5%, effective January 1, 2007.
  • Increasing the basic personal amount to $9,600 for 2007 and 2008, and to $10,100 for 2009.

While the Government has made tremendous strides in this area, it recognizes that there is more to do.

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Business investment is critical to long-term prosperity.

Since 1980, the federal corporate income tax rate has declined substantially -- from 37.8% to 15% by 2012.

This Government has taken action that will reduce the overall tax burden for Canadians and businesses. Canada’s general federal corporate income tax rate will fall to 15% by 2012.

Since 1980, there has been virtually no change in the average provincial corporate income tax rate. The Government is seeking the collaboration of the provinces and territories to reach a 25 per cent combined federal-provincial territorial statutory corporate income tax rate, to make Canada a country of choice for investment.

The federal government has also taken other important steps to improve tax competitiveness by, for example, eliminating its capital tax in 2006 and, in the 2007 Budget, providing an incentive for provinces to follow suit -- several provinces have taken steps to benefit from this incentive.

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With the 2007 Economic Statement in place, Canada will achieve the commitment set out in Advantage Canada, that is to have the lowest tax rate on new business investment (or METR) in the G7 by 2011. Canada will also have the lowest statutory tax rate in the G7 by 2012.

Canada will also have a substantial business tax advantage over the U.S. – a METR advantage reaching 9.1 percentage points in 2012, and a statutory tax rate advantage reaching 12.3 percentage points in 2012.

Achieving a combined Federal-Provincial CIT rate of 25% for Canada and provincial sales tax harmonization would further improve the competitiveness of Canada’s corporate tax system and give Canada a METR below the average for OECD countries.

This will require significant action by a number of provinces.

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This chart illustrates where and how progress can be achieved.

It illustrates the detrimental impact of provincial retail sales taxes on business investment.

Sales tax harmonization in provinces with retail sales tax would reduce Canada’s METR by about 7 percentage-points by removing taxes on business inputs.

The Government is ready to work with the five provinces that still have retail sales taxes to achieve this important goal.

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Since the Budget 2006, this Government has provided general and targeted support for the manufacturing industry, including:

  • Elimination of the corporate surtax
  • Bold, new reductions in the corporate tax rate
  • Acceleration of the elimination of the capital tax
  • Targeted temporary two-year accelerated capital cost allowance for manufacturing equipment.
  • Increase in the capital cost allowance rate for manufacturing buildings and computers to better reflect useful life

Together, these actions account for more than $8 billion in tax relief for the manufacturing sector for the 2007-08 to 2012-13 period.

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Canada already has a strong fiscal advantage, with both levels of government paying down debt.

The October federal fiscal plan calls for debt reduction of $10 billion in 2007-08 and at least $3.0 billion each year thereafter. The federal debt-to-GDP ratio is on track to fall below 25 per cent by 2011-12. Under the Tax Back Guarantee legislated in Budget 2007, the Government dedicates the effective interest savings from debt reduction each year to permanent and sustainable personal income tax reductions.

To achieve this debt reduction, the federal government has put in place a new system to better manage spending. An important part of that new system is a commitment to keep the rate of growth of program spending, on average, below the rate of growth of the economy.

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An improved fiscal situation has allowed the Government to channel savings from lower debt charges to tax reductions, while controlling growth in program spending.

The ratio of revenues to the total economy is expected to decline to its lowest level in nearly 50 years.

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This table provides a summary of the fiscal situation as of the October 2007 Economic Statement for the current and next five years.

Stronger economic growth in 2007 has boosted revenues.

Relative to the 2007 budget, the surplus was up $13.1 billion in 2007-08 and between $10 and $11 billion per year thereafter.

The Government has applied most of this upward revision in the surplus to fund the proposed tax reductions set out in the Statement.

In addition, the Government plans to reduce the federal debt by $10 billion in 2007-08 and $3 billion in each year thereafter.

After taking into account the impact of economic and fiscal developments since the March 2007 budget, as well as the tax and debt reduction proposed in this Statement, the revised planning surplus is about $1.5 billion in the current year and the next two years. Starting in 2010, surpluses rise substantially.

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In summary, Canada is currently enjoying very strong economic and fiscal fundamentals, but is entering into a period of uncertainty.

The Government has decided to act, and to act on key priorities as set out in Advantage Canada.

Given the challenges ahead, it will become increasingly important to focus on enhancing productivity.

This will mean choices will have to be made.

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Both levels of government are in sound fiscal position. Provinces and territories recorded an aggregate surplus in six of the last eight years.

Indeed, 2006-07 marked the third consecutive year in which the aggregate provincial-territorial surplus exceeded that of the federal government.

For 2007-08, provinces and territories are currently projecting a $7.8-billion surplus.

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For the first time in at least 60 years, all provinces and territories recorded a budgetary surplus in 2005-06. This is expected to be repeated in 2006-07, with all provinces and territories again recording or forecasting a budgetary surplus.

For 2007-08, 11 of the 13 provinces and territories are currently expecting balanced budgets or surpluses.

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This strong provincial fiscal position is supported by substantial increases in federal transfers over the last three years, including Budget 2007 investments. As a result, provinces are seeing significant overall growth in major transfers.

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Total Equalization payments have gone up from $10.9 billion in 2005-06 to $13.6 billion in 2008-09, and most receiving provinces have seen increases. For example, Quebec’s Equalization payments have risen from $4.8 billion to $8 billion.

Some provinces have experienced above-average economic growth, due largely to strong resource revenues, and as a result have seen their Equalization payments decline in recent years. This is consistent with the original intent of the Equalization program.

Note: NL and NS figures include offshore offsets.


$M NL PEI NS NB QC MB SK BC

2006-07 632 291 1,386 1,451 5,539 1,709 13 260
Offsets 329   57          
2007-08 477 294 1,465 1,477 7,160 1,826 226 0
Offsets 494   68          
2008-09 158 322 1,465 1,584 8,028 2,063 0 0
Offsets 742   106          

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Budget 2007 delivered on the commitment made in Advantage Canada by putting in place a long-term plan for infrastructure.

The Plan represents an unprecedented, long-term commitment to rebuilding Canada’s infrastructure totalling $33 billion over the next seven years.

This money is available to provinces for implementing growth-enhancing infrastructure projects.

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As well as providing immediate support to provinces and territories, Budget 2007 restored fiscal balance by putting all major transfers on a long-term, formula-driven and predictable footing.

With substantial new investments, total transfers are now at unprecedented levels, and will continue to grow.

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