Budget 2001 - Budget Plan
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Chapter 7
Fiscal Management in Uncertain Times

"Managing an economy through tough times means striking the right
balance. This budget does that.... It builds on the strong fundamentals
Canadians have worked so hard to achieve."

Finance Minister Paul Martin
2001 budget speech

Highlights

• This budget projects balanced budgets or better for 2001-02 and for each of the next two fiscal years.
• The global economic outlook remains uncertain. However, even using the average of the four most pessimistic private sector forecasts, balanced budgets are still projected for each year of the budget plan.
• Program spending is projected to increase by 9.4 per cent in 2001-02. Over three-quarters of this increase is due to higher cash transfers to the provinces and territories for health care, funding to enhance security, and higher employment insurance (EI) and elderly benefits.
• Budgetary revenues are projected to decline in 2001-02, reflecting the impact of the second year of the Government’s tax reduction plan, the six-month deferral of monthly corporate tax instalment payments for small businesses, and the weakness in the economy.
• The debt-to-GDP (gross domestic product) ratio is expected to fall to under 50 per cent in 2002-03, its lowest level in 17 years.
• The unforeseen circumstances of both the global economic slowdown and the terrorist attacks of September 11th have created exceptional fiscal pressures. As a result, the Government will use the economic prudence and part of the Contingency Reserve for each year of the budget plan. The Contingency Reserve is set at $1.5 billion for 2001-02, rising to $2.0 billion in 2002-03 and $2.5 billion in 2003-04. It is the Government’s intention to rebuild the normal Contingency Reserve and economic prudence as soon as possible.
• In good economic times the Government paid down a substantial amount of debt – $35.8 billion in the last four years. Given the current economic weakness, it has decided not to pay down any debt this year. Any surplus at the end of fiscal year 2001-02 will be dedicated to the Strategic Infrastructure Foundation and the Africa Fund.

Introduction

• This chapter provides a full and detailed accounting of the federal government’s finances by incorporating into the private sector fiscal projections:
  • the impact of the changes in the economic outlook since the October 2001 survey of private sector forecasts; and
  • the impact of the spending and revenue measures proposed in this budget.
• Although private sector economists believe five-year fiscal projections are important for planning purposes and public discussion, they are of the view that budget decisions should be made within a rolling two-year horizon. This is because of the uncertainty inherent in long-term economic and fiscal projections. The Government agrees with this approach.
• This rolling two-year approach to budgeting, first introduced in the 1994 budget, has served Canadians well. The federal deficit, which stood at $42 billion in 1993-94, was eliminated in just 4 years, putting an end to more than 25 years of uninterrupted deficits. Surpluses have been recorded in each of the last 4 years, resulting in a paydown of net public debt of almost $36 billion.

Revised Economic Outlook

The five-year fiscal projections described in Chapter 4 are based on the October 2001 Department of Finance survey of private sector economic forecasts. Since that survey there have been a number of economic developments in both Canada and the U.S. The Department of Finance consulted the private sector economists again in early December to obtain their views on the adjustments required as a result of these developments. The revised economic assumptions in the table below reflect these consultations.

Table 7.1
Budget 2001 Economic Assumptions

• Private sector real GDP growth forecasts for Canada have been revised to an average of 1.3 per cent in 2001 and 1.1 per cent in 2002, down from 1.5 per cent in both years in the October survey. However, the economists still expect growth to pick up by mid-2002, leaving real GDP growth unchanged at 3.9 per cent in 2003.
• GDP inflation has also been revised downwards, with the result that nominal income, the applicable tax base for federal government revenues, is now expected to increase by 2.6 per cent in 2001 and 1.3 per cent in 2002, substantially less than in the October 2001 survey.
• Accompanying this weaker nominal GDP growth are substantially lower short-term interest rates. Private sector forecasters now expect short-term interest rates to average 2.4 per cent in 2002 and 4.0 per cent in 2003. Expectations for 10-year government bonds remain unchanged relative to the October survey.

Implications of the Revised Economic Outlook for the 2001 Budget Fiscal Projections

The lower outlook for both nominal GDP growth and short-term interest rates has differing impacts on the private sector projections of the fiscal surplus.

Table 7.2
Budget 2001: Fiscal Outlook Before Measures Proposed in 2001 Budget

• Financial results for the first six months of 2001-02 were used in deriving the October private sector fiscal projections. The monthly results already reflected much of the economic weakness confirmed by the release of the third-quarter National Accounts results, especially the impact of lower corporate profits on corporate income tax revenues. As a result, some of the deterioration in the fiscal outlook was already reflected in the October private sector fiscal projections.
• The revisions to the economic outlook are estimated to reduce the projected budgetary surplus by $1.1 billion in 2001-02, $1.7 billion in 2002-03 and $1.0 billion in 2003-04. Most of this deterioration results from lower corporate income tax revenues. Personal income tax revenues and other revenues, primarily excise taxes and duties, are also expected to be somewhat lower. In contrast, the outlook for lower short-term interest rates results in significantly lower public debt charges, especially in 2002-03 and 2003-04. In addition, program spending is slightly lower, reflecting the fact that fiscal transfers are assumed to grow in line with the growth in nominal GDP.
• As a result, the adjusted projections of the budgetary surplus, before taking into account the fiscal impact of the measures proposed in the 2001 budget, are $6.2 billion for 2001-02, $2.1 billion for 2002-03 and $4.8 billion for 2003-04.

Spending and Revenue Initiatives Proposed in the 2001 Budget

Table 7.3 presents the fiscal impact of the spending and revenue initiatives proposed in the 2001 budget. The net cost of the proposed actions is $4.7 billion in 2001-02, $111 million in 2002-03 and $2.3 billion in 2003-04.

Table 7.3
Spending and Revenue Initiatives Proposed in the 2001 Budget

Spending Initiatives

Enhancing Security for Canadians

A number of initiatives have been taken in the aftermath of the September 11th terrorist attacks to enhance security for Canadians and make the Canada-U.S. border more open and efficient. These amount to $1.1 billion in 2001-02 and $1.5 billion in each of the next two fiscal years.

Bridging to the Future

• Funding has been provided for strategic investments in the areas of health; skills, learning and research; strategic infrastructure and the environment; Aboriginal children; and international assistance. These amount to $1.0 billion in 2001-02, $0.7 billion in 2002-03 and $1.0 billion in 2003-04.

Funding Commitments to the Strategic Infrastructure Foundation and Africa Fund

• The Government proposes to establish the Strategic Infrastructure Foundation, with a minimum funding commitment of $2 billion, and the Africa Fund, with a commitment of $500 million.
  • The amounts to be transferred in 2001-02 will depend on the final outcome of the budgetary surplus for this year.
  • Any surplus in 2001-02 will be transferred to honour the Government’s commitments. This will be done through legislation and charged to the current fiscal year.
  • Should the available surplus at year-end not be sufficient to fully finance these commitments in 2001-02, funding will be made available in future years, depending on the fiscal flexibility at that time.

Government Operations

• In the February 2000 budget some federal departments and agencies received incremental funding in areas that were regarded as essential to the health and safety of Canadians or critical to the sustainability of high-quality public services. This was based on a major review by the Treasury Board Secretariat of the Government’s capacity to deliver existing programs. In this budget some additional funding has been provided including funding associated with the hosting of major international summits in 2001 and 2002 such as the G-8 Summit and, this year, funding to support the Vancouver-Whistler 2010 Olympic bid.

Revenue and Cost Recovery Initiatives

Measures to Assist Small Businesses

• The budget proposes that small businesses be able to defer for six months payments of their corporate income tax instalments for the months of January, February and March 2002, without payment of interest or the assessment of penalties. This deferral will provide an interest-free cash flow benefit to small companies for a six-month period. All corporations with taxable capital that does not exceed $15 million will qualify for this deferral.
• This deferral reduces federal corporate income tax revenues by $2 billion in 2001-02 and increases them by a similar amount in 2002-03.

Tax Expenditures

• This budget proposes a number of tax expenditures. These include an apprentice vehicle mechanics’ tools tax deduction; a tax deduction for tuition assistance for adult basic education; the extension of the education tax credit; improved tax incentives for renewable energy and energy efficiency; promotion of sustainable woodlot management; and changes to the deductibility of meal costs at construction work camps.

Air Travellers Security Charge

• To fund the new air security expenditures, the Government proposes to introduce an Air Travellers Security Charge, effective April 1, 2002. This charge will be paid by air travellers – the primary users of the enhanced security measures.
• This charge is estimated to result in revenues of $430 million in 2002-03 and $445 million in 2003-04. Over the next five years the charge is expected to generate revenue that will be roughly equivalent to the new air security expenditures. The rate of the charge will be reviewed over time to maintain revenues in line with these expenditures.

Cost Recovery Measures

• Cost recovery measures directly related to enhancing security are also being proposed in this budget. These fees offset the costs of the new fraud-resistant Permanent Resident Card and the expedited pre-approved traveller pass programs at land border crossings and airports. This is expected to generate $50 million in additional revenues in both 2002-03 and 2003-04.

Fiscal Outlook: Summary

Table 7.4 summarizes the impact of the measures proposed in the 2001 budget on the adjusted fiscal projections.

Table 7.4
Budget 2001: Fiscal Outlook

• The net impact of the measures proposed in the 2001 budget reduces the adjusted budgetary surplus by $4.7 billion in 2001-02, $0.1 billion in 2002-03 and $2.3 billion in 2003-04.
• A Contingency Reserve of $1.5 billion in 2001-02, rising to $2.0 billion in 2002-03 and $2.5 billion in 2003-04, has been set aside, with the result that balanced budgets or better are projected for each year.
• However, any surplus at the end of fiscal year 2001-02 will be dedicated to the proposed $2-billion Strategic Infrastructure Foundation and the proposed $500-million Africa Fund. The actual allocation will be made when the final results for 2001-02 become available in the fall of 2002.

Budget Planning in the Current Environment

• The size of the Contingency Reserve and economic prudence included in this budget is smaller than in previous budgets. Previously the Contingency Reserve was set at $3 billion per year, with an additional amount for economic prudence.
• These amounts were included to cover risks arising from unforeseen circumstances, like those being experienced now.
• During 2001 the unforeseen circumstances of both the slowdown in the global economy and the September 11th terrorist attacks created a high degree of uncertainty and exceptional fiscal pressures.
• In these circumstances, this budget funds the substantial measures to enhance security for Canadians. As well, the Government is making strategic investments to support Canadians and the Canadian economy through the current period of weakness and uncertainty. These investments are based on two criteria:
  • they must be consistent with advancing the Government’s long-term plan to build a strong economy and secure society and to improve the quality of life for Canadians; and
  • they must fit within the prudent fiscal framework and, where possible, provide stimulus during the period of economic weakness and position Canada to take advantage of the economic recovery.
• Most economists would argue that, given the progress made in restoring fiscal health, the Government should not attempt to offset the impact of the weakness in the economy on its revenues and spending in the current circumstances. Rather, it should allow the "automatic stabilizers" to work.
• Therefore, for 2001-02 and for the next two fiscal years, the Government will not set aside any economic prudence and will use a portion of the Contingency Reserve.
  • For 2001-02 the Contingency Reserve is set at $1.5 billion. It increases in each of the next two years – rising to $2.0 billion in 2002-03 and $2.5 billion in 2003-04.
  • It is the Government’s intention to rebuild the normal Contingency Reserve and economic prudence as soon as possible.
• In good economic times the Government has paid down significant amounts of debt – $35.8 billion in just four years. Given the current economic weakness, debt paydown at this time is not appropriate. Therefore, any surplus at the end of fiscal year 2001-02 will be dedicated to honouring the Government’s funding commitment to the Strategic Infrastructure Foundation and the Africa Fund.

Summary Statement of Transactions: The Two-Year Planning Horizon

Balanced budgets or better are projected for 2001-02 and each of the next two fiscal years.

Table 7.5
Summary Statement of Transactions: Budget 2001

• Net financial requirements of $1.9 billion and $1.0 billion are estimated for 2001-02 and 2002-03 respectively due to the net requirement of funds for non-budgetary transactions. This reflects the one-time transfers of applicable pension assets to those Crown corporations setting up their own pension plans and borrowings associated with the Government assuming the administration of the Canada Student Loans program. The net financial requirements in these years can be sourced through the management of the Government’s cash balances. A net financial source is again expected in 2003-04.

Debt Burden Lowest in 17 years

Based on the adjusted economic forecasts, the debt burden – net public debt as a per cent of GDP – is projected to fall from 51.8 per cent in 2000-01 to under 50 per cent in 2002-03. This would be the lowest ratio in 17 years.

Budgetary revenues decline in 2001-02

Budgetary revenues are projected to decline by $7.3 billion in 2001-02, reflecting the impact of the second year of the tax reduction plan, the 2001 budget proposal to defer monthly income tax instalment payments for small businesses, and the weakness in nominal income growth. Most of the rebound in 2002-03 is attributable to the deferral of these payments. In 2003-04 budgetary revenues are expected to rebound somewhat.

Table 7.6
Budgetary Revenues

Increase in program spending in 2001-02

• Program spending is expected to increase by $11.2 billion, or 9.4 per cent, in 2001-02. Of this increase, over three-quarters, or $8.7 billion, is due to the following:
  • $3.8 billion in higher cash transfers under the Canada Health and Social Transfer (CHST);
  • $2.7 billion in higher EI benefits, attributable both to the program enhancements announced in previous budgets as well as an increase in the number of beneficiaries;
  • $1.2 billion in new measures to enhance security for Canadians and to ensure a secure, open and efficient border; and
  • $1 billion in higher elderly benefits, reflecting a growing number of individuals eligible for benefits and higher average benefits, which are indexed to inflation.
• Program spending is projected to increase by 4.7 per cent in 2002-03, primarily reflecting ongoing increases in major transfers to persons (both elderly and EI benefits) and in major transfers to other levels of government, primarily CHST cash transfers related to the September 2000 agreements on health renewal and early childhood development. In contrast, direct program spending is estimated to advance by only 2.6 per cent, in line with the projected increase in inflation and the population.
• An increase in program spending of only 2.6 per cent is projected for 2003-04, as an improving labour market due to the expected rebound in economic growth results in lower EI benefits, while the growth in direct program spending is projected to remain restrained.

Table 7.7
Program Spending

Sensitivity of the Fiscal Outlook to Economic Shocks

The fiscal projections are extremely sensitive to changes in economic assumptions – particularly to changes in real GDP growth, inflation and interest rates.

Table 7.8
Sensitivity of Fiscal Outlook to Economic Shocks

• A decrease in the growth of real GDP (through equal reductions in employment and productivity) would lead to lower federal government revenues through a contraction in various tax bases and an increase in spending, primarily due to higher EI benefits. Using the standard sensitivity analysis, a 1-per-cent decrease in real GDP for one year would lower the budgetary balance by $2.4 billion in the first year and by $2.6 billion in the second year.
• A 1-per-cent reduction in the growth in nominal GDP resulting solely from a one-year decline in the rate of GDP inflation would lower the budgetary balance by $1.4 billion in the first year and $1.3 billion in year two. Most of the impact would be on budgetary revenues, as wages and profits would be lower, as well as the price of goods and services subject to sales and excise taxes. The impact on expenditures would be largely reflected in those programs that are indexed to inflation, such as elderly benefit payments.
• A sustained 100-basis-point decline in all interest rates would improve the budgetary balance by $0.8 billion in the first year, rising to $1.4 billion in year two. This improvement comes solely from the reduction in public debt charges, which reduces overall budgetary expenditures. Expenditures would fall $1.1 billion in the first year and $1.9 billion in year two, as longer-term debt matures and is refinanced at the lower rates. Moderating this impact are somewhat lower interest earnings on the Government’s interest-bearing assets, which are recorded as part of non-tax revenues.

Balanced Budgets Even Under Lower Growth Scenarios

To assess the fiscal impact of differing views on Canada’s economic prospects, two alternative scenarios are presented for illustrative purposes: the recent International Monetary Fund (IMF) forecast and the average of the four most pessimistic economic forecasts in the December survey.

Table 7.9
Alternative Economic Assumptions: Lower Growth Scenarios

• The IMF forecasts real GDP growth of 0.8 per cent for 2002 and 3.6 per cent for 2003, while the average of the four most pessimistic forecasts results in real GDP growth of only 0.6 per cent in 2002, with a rebound to 3.9 per cent in 2003. These forecasts compare to the average of private sector forecasts of 1.1 per cent and 3.9 per cent, respectively.
• Using sensitivity analysis, the IMF economic outlook reduces the budgetary surplus to $1.3 billion in 2002-03 and $1.0 billion in 2003-04. Using the four most pessimistic growth forecasts, the budgetary surplus is reduced to $0.6 billion in 2002-03 and $0.9 billion in 2003-04.
• Under either of these lower-growth scenarios, there are still balanced budgets or better in both years.

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