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Annex 3
Private Sector Five-Year Economic and Fiscal Projections

Highlights

• The Department of Finance meets each fall with the chief economists of the major chartered banks and four private sector economic forecasting firms. The objective of this exercise, which was initiated in 1999, is to agree on a set of economic assumptions for planning purposes, which the four forecasting firms then use to develop status quo fiscal projections of the budgetary balance for each of the next five years.
• However, because of the greater degree of uncertainty associated with longer-term projections, budget decisions are made on a rolling two-year horizon.
• In order to arrive at an estimate of the fiscal surplus for planning purposes, the average fiscal surplus projections are typically adjusted to include prudence:

• an annual Contingency Reserve to guard against unforeseen developments. If it is not needed, this reserve goes to pay down the debt; and
• economic prudence to provide further assurance against going back into deficit

• Prudence is an essential element of budget planning. The purpose of prudence is to protect the annual balanced budget target against economic shocks and other unexpected developments. For example, in 2001 the unforeseen circumstances of both the global economic slowdown and the terrorist attacks of September 11th created exceptional fiscal pressures. As a result, the prudence absorbed the adverse fiscal impact of these developments and allowed the Government to meet its fiscal targets.
• In this update, the downward revisions to economic growth, and the resulting impact on budgetary revenues, will again require that some of the prudence established in the February 2003 budget be used to protect the balanced budget target.
• Based on the fiscal results for the first five months of 2003-04, and after accounting for the fiscal impact of the policy initiatives announced since the February 2003 budget, the surplus for 2003-04 is estimated at $2.3 billion. This amount has been allocated to the Contingency Reserve.
• Based on the average of the four private sector economic forecasting firms and including the fiscal impact of the policy measures announced since the February 2003 budget, but before any allocation for prudence, the surplus is forecast at $3.0 billion in both 2004-05 and 2005-06, $4.0 billion in 2006-07, $6.0 billion in 2007-08 and $9.5 billion in 2008-09. For the period to 2008-09 these surpluses are allocated to the $3 billion Contingency Reserve and an element of economic prudence.

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Approach to budget planning

• The Government's approach to budget planning involves a number of important steps. The first step involves using private sector economic forecasts for budget-planning purposes.

• The Department of Finance conducts surveys of private sector economic forecasters. In total, about 20 forecasters are surveyed on a regular basis.
• Each fall the Department of Finance conducts extensive consultations with an economic advisory group, which includes the chief economists of Canada's major chartered banks and leading economic forecasting firms.

• The second step involves using these economic assumptions to develop status quo fiscal projections for the regular fall Economic and Fiscal Update.

• Since 1999, for the fall update, major private sector economic forecasting firms develop detailed fiscal projections, on a National Accounts basis, based on tax and spending policies in place at that time, using the average of the private sector economic forecasts.
• These forecasts are then translated into Public Accounts projections, in consultation with the private sector economic forecasting firms, and presented in the fall Economic and Fiscal Update for budget-planning purposes. For the current fiscal year, year-to-date fiscal results are used to estimate the potential outcome, while forecasts for the next five years are based on the average of the fiscal projections provided by the four economic forecasting firms.
• The impact of policy decisions since the last budget is then subtracted from these fiscal projections.

• The third step adjusts the resulting fiscal projections for prudence to derive the fiscal surpluses for budget-planning purposes.

• An annual Contingency Reserve is set aside to guard against unforeseen circumstances. If not needed, it reduces the federal debt (accumulated deficit).
• An extra degree of economic prudence may be built in to provide further assurance against falling back into deficit.

• The Contingency Reserve is normally set at $3 billion annually, while the economic prudence is set at $1 billion in the first year of the five-year planning horizon, rising to $4.0 billion by year five.
• The Contingency Reserve and economic prudence are used to absorb the fiscal impact of short- and longer-term economic and other shocks. They provide a buffer to protect the annual balanced budget target, to avoid having to undo previous budget initiatives, and to avoid going back into deficit.
• It is the view of the private sector economic advisory group that for the purposes of public debate on policy options, a five-year time horizon is appropriate.
• However, it is also the view of the private sector economic advisory group that great caution is warranted in the use of long-term projections as a basis for budget decisions. Therefore, budget decisions continue to be made on a rolling two-year horizon.
• This prudent approach to budget planning has allowed the federal government to record six consecutive fiscal surpluses. In 2002 Canada was the only country among the Group of Seven (G-7) countries to record a budgetary surplus.

Assumptions underlying average private sector fiscal projections

Table 3.1
Average of Private Sector Economic Forecasts: September 2003 Survey

	2003	2004	2005	2006-2008
	(per cent)
Real GDP growth	1.9	3.0	3.4*	3.0
GDP inflation	3.3	1.4	1.9	1.8
Nominal GDP growth	5.3	4.4	5.3	4.9
3-month Treasury bill rate	2.9	2.9	4.1	4.6
10-year Government of Canada bond rate	4.8	5.0	5.4	5.7
	(percentage points)
Change from the February 2003 budget
Real GDP growth	-1.3	-0.5	0.2	0.11
Note: Based on a survey conducted by the Department of Finance in mid-September. The number of respondents declines from 18 in 2003 to 6 in 2008. 1 Annual average. *ERRATUM: In the print version of the update Real GDP growth for 2005 was shown as 3.2 per cent.  This was corrected in the electronic version on November 5, 2003 to show Real GDP growth of 3.4 per cent.  This correction did not change any of the rest of the table.

 

• The average private sector forecast of real gross domestic product (GDP) growth is 1.9 per cent in 2003, 3.0 per cent in 2004 and 3.4 per cent in 2005. The average growth forecast over the 2006 to 2008 period is 3.0 per cent.

• GDP inflation is expected to be 3.3 per cent in 2003, but then decline significantly to 1.4 per cent in 2004 and average around 1.8 per cent to 2008.
• As a result, nominal GDP growth is estimated at 5.3 per cent in 2003. However, it is forecast to slow to 4.4 per cent in 2004 before rebounding to 5.3 per cent in 2005. Over the 2006 to 2008 period nominal GDP growth is forecast to average 4.9 per cent.

• Short-term interest rates are expected to average 2.9 per cent in both 2003 and 2004, before rising to 4.1 per cent in 2005 and averaging 4.6 per cent over the medium term. Private sector forecasters project a gradual rise in longer-term interest rates between 2003 and 2008.
• Compared to the February 2003 budget, the real GDP growth forecasts have been lowered by 1.3 percentage points in 2003 and by 0.5 percentage points in 2004. However, the private sector economists do not expect that the Canadian economy will grow significantly above its potential growth rate over the medium term. As a result, the lower growth in 2003 and 2004 is not recovered in future years, and nominal income-the broadest measure of the Government's tax base-is forecast to be lower throughout the five-year projection period.

Planning assumptions used to develop five-year fiscal projections

• Based on these economic forecasts, four private sector forecasting firms derived projections of the major components of the federal budgetary balance on a National Accounts basis. These projections were then converted to a Public Accounts basis, on a full accrual basis of accounting, by the Department of Finance. The projections are based on the following assumptions.

• The projections include the impact of the policy initiatives announced in previous budgets. More specifically, they include the impact of the $100-billion Five-Year Tax Reduction Plan as set out in the October 2000 Economic Statement and Budget Update, as well as the further tax relief measures provided in the 2003 budget. They include the impact of the health care agreements reached by first ministers in 2000 and 2003, which will increase cash transfers to the provinces and territories by 7.3 per cent annually on average over the 2000-01 to 2010-11 period. As agreed under the 2003 First Ministers' Accord on Health Care Renewal, the federal government is prepared to put up to an additional $2 billion into health for the provinces at the end of the fiscal year if the Minister of Finance determines during the month of January that there will be a sufficient surplus above the normal Contingency Reserve to permit such an investment. These projections do not include a provision for this investment.
• In the 2003 budget the Government set the employment insurance (EI) premium rate for 2004 at $1.98 (employee rate per $100 of insurable earnings), down from $2.10 for 2003. Based on the private sector economic forecasts used in the 2003 budget, it was estimated that the rate of $1.98 would generate premium revenues sufficient to cover projected program costs. The four forecasting firms were asked to set forecast premiums equal to their projected program costs on an annual basis for 2005 to 2008.
• In the February 2003 budget the Government indicated that it would make reallocation from lower to higher priorities an integral part of the way it manages and that the Treasury Board would lead a systematic and ongoing examination of non-statutory government spending. These savings would be ongoing. As part of this commitment, the Government announced that it would reallocate a permanent $1 billion from existing spending beginning in 2003-04. The President of the Treasury Board announced in early October that the savings for 2003-04 have been secured. These projections assume that savings of $1 billion per year will be secured over the period 2004-05 to 2008-09 as well.
• The projections of public debt charges assume that the Contingency Reserve is not required and is applied each year to reducing the federal debt.

2002-03 fiscal outcome

• On a full accrual basis of accounting, there was a budgetary surplus of $7.0 billion in 2002-03. This marks the sixth consecutive year the federal budget has been in surplus. Taken together, federal debt has been reduced by $52.3 billion over the last six years.
• The federal debt-to-GDP ratio is now 44.2 per cent, down sharply from its peak of 68.4 per cent in 1995-96. Market debt-the debt issued on credit markets-as a percentage of GDP has declined to 38.1 per cent from the peak of 57.0 per cent in 1996-97.
• Budgetary revenues increased only 3.4 per cent in 2002-03. As a result, the revenue-to-GDP ratio declined to 15.4 per cent. This reflects both the impact of the Five-Year Tax Reduction Plan and the weaker economy.
• Program expenses increased by 6.6 per cent in 2002-03. As a percentage of GDP, they were 11.5 per cent, up from 11.3 per cent in 2001-02 but well below the level of 15.7 per cent in 1993-94.
• Public debt charges declined by $2.4 billion to $37.3 billion in 2002-03. As a percentage of revenues, they were 21 per cent in 2002-03. In contrast, in 1997-98, the first year the federal budget was balanced and the Government began repaying debt, public debt charges were $43.1 billion and over 28 per cent of revenues.

Fiscal outcome for 200203 reflects weakening economy and one-time factors affecting program expenses

Table 3.2
Financial Highlights for 2002-03: Comparison to February 2003 Budget

	(billions of dollars)
February 2003 budget projected surplus	3.0
Changes1
Budgetary revenues	-1.2
Program expenses	5.2
Public debt charges	-0.1
Net change	4.0
Outcome for 2002-03	7.0
Note: Numbers may not add due to rounding. 1 A positive number implies an improvement in the budgetary balance.   A negative number implies a deterioration in the budgetary balance.

• The budgetary surplus for 2002-03 of $7.0 billion reflected lower-than-expected budgetary revenues due to weaker economic growth, but this was more than offset by lower-than-expected program expenses.
• Budgetary revenues were $1.2 billion lower than estimated in the February 2003 budget. The lower revenues in 2002-03 were attributable to much weaker-than-expected personal income tax revenues. Personal income tax revenues were $2.5 billion lower than expected, reflecting weaker-than-expected economic growth at the beginning of 2003. This lower-than-expected outcome for personal income tax revenues has carried forward into 2003-04, as witnessed by the fiscal results for the first five months of 2003-04.
• Program expenses were $5.2 billion lower due in large part to one-time factors, including adjustments to allowances for loans, revisions to accrual adjustments and data revisions which affected prior-year estimates of entitlements under the equalization program.

Status quo fiscal projections
Outlook for 2003-04 to 2008-09

Table 3.3
Surpluses for Purposes of Fiscal Planning

	Actual	Estimate
	2002-03	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(billions of dollars)
Average of private sector fiscal projections	7.0	3.5	3.2	3.2	4.3	6.4	9.7

• The weakness in economic growth in 2003 is reflected in the fiscal results for the first five months of 2003-04. The surplus for the April to August 2003 period was $1.3 billion, down $1.5 billion from the same period in 2002.

• The lower surplus to date primarily reflects the impact on revenues of the weakness in economic activity in 2003, largely due to a number of domestic shocks.
• Based on the above, the potential surplus for 2003-04 on a status quo basis is estimated at $3.5 billion.

• The fiscal surplus for the next five years is derived from the average of the private sector fiscal projections.
• The average of the four forecasting firms' fiscal projections, converted to a Public Accounts basis but prior to adjusting for the new policy initiatives, or any allocation for the Contingency Reserve and economic prudence, results in a fiscal surplus of $3.2 billion in both 2004-05 and 2005-06, $4.3 billion in 2006-07, $6.4 billion in 2007-08 and $9.7 billion in 2008-09.
• The relatively small surpluses are attributable to the slower-than-expected economic growth for 2003 and 2004, which have negatively affected federal revenues. Moreover, as the private sector economists do not expect that the Canadian economy will grow significantly above its potential growth rate over the medium term, this means that the weaker growth in the short term is not expected to be made up by stronger growth in the future. As a result, nominal income-the broadest measure of the Government's tax base-is expected to be lower throughout the entire five-year projection period.

Fiscal impact of policy initiatives since the 2003 budget

Table 3.4
Initiatives Announced Since the February 2003 Budget

	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(millions of dollars)
National Defence mission costs	193.0	15.0
Other international initiatives	27.3	12.6	3.7	3.7	3.7	3.7
Severe acute respiratory syndrome (SARS)
Offer to Ontario	150.0
SARS challenges	100.0
Other	110.0
Bovine spongiform  encephalopathy (mad cow disease)	440.0
Cod assistance package	49.8	15.8
Airline industry	15.0
Employment insurance changes	17.0	29.2	18.8	18.8	18.8	18.8
Hamilton Commonwealth Games	3.7	15.0	21.0	40.0	47.0	28.0
Canadian Television Fund	12.5	-12.5
World aquatics sports event		4.0	8.5
Whitehorse Canada Games	1.5	5.2	5.2	1.1
Drug strategy	20.0	41.3	59.0	59.8	59.9	59.9
Political financing	10.1	35.3	18.1	18.1	18.1	35.3
Aboriginal self-government			13.9	23.7	58.6	58.6
VIA Rail		45.0	56.0	190.0	206.0	203.0*
Other	11.4	4.0	3.4	3.4	3.4	3.4
Total	1,161.3	209.9	207.6	358.6	415.5	410.7*
*ERRATUM:  In the Print version of the Update the amount of $203 million in 2008-09 for the VIA Rail initiative was omitted.  It was added to the above table in the electronic version on November 5, 2003.  The new total for the year was consequently increased to $410.7 million from 207.7 million.

• Since the February 2003 budget the Government has announced a number of initiatives, primarily to respond to unexpected developments during 2003. These include:

• Incremental funding to National Defence to support Canada's international commitments.
• Funding in the fight against severe acute respiratory syndrome, including $250 million to help the province of Ontario in recognition of its extraordinary effort to protect public health.
• Assistance to help the Canadian cattle and beef industry to offset the impact of border closures following the discovery of a single cow with bovine spongiform encephalopathy (mad cow disease).
• Assistance to help fishers and fish plant workers affected by the closure of the cod fisheries.
• Incremental funding for sports and cultural initiatives, the drug strategy, Aboriginal self-government, VIA Rail and political financing.

• The fiscal cost of these initiatives amount to $1.2 billion in 2003-04, $0.2 billion in 2004-05, rising to $0.4 billion in 2006-07.

Average of private sector projections of the fiscal surplus

Table 3.5
Surpluses for Purposes of Fiscal Planning

	Estimate
	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(billions of dollars)
Average of private sector fiscal projections	3.5	3.2	3.2	4.3	6.4	9.7
Initiatives announced since the February 2003 budget	1.2	0.2	0.2	0.4	0.4	0.2
Average of private sector projections adjusted for policy initiatives	2.3	3.0	3.0	4.0	6.0	9.5
Allocation for prudence
Contingency     Reserve	2.3	3.0	3.0	3.0	3.0	3.0
Economic prudence				1.0	3.0	4.0
Surplus for planning purposes	0.0	0.0	0.0	0.0	0.0	2.5
Note: Numbers may not add due to rounding.

• Table 3.5 first adjusts the projections of the fiscal surplus to include the impact of policy decisions since the February 2003 budget.

• As a result, the surplus is reduced to $2.3 billion in 2003-04, $3.0 billion in both 2004-05 and 2005-06, $4.0 billion in 2006-07, $6.0 billion in 2007-08 and $9.5 billion in 2008-09.

• Second, the projections are adjusted to take into account the Contingency Reserve and some allocation for economic prudence.

• For 2003-04 the Contingency Reserve is $2.3 billion, equal to the average private sector surplus, adjusted for initiatives since the February 2003 budget.
• For 2004-05 and beyond, the Contingency Reserve is set at its normal level of $3 billion per year.
• The economic prudence is $1.0 billion in 2006-07, $3.0 billion in 2007-08 and $4.0 billion in 2008-09.

Average of private sector fiscal projections

Table 3.6
Summary Statement of Transactions

	Actual	Estimate
	2002-03	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(billions of dollars)
Budgetary transactions
Budgetary revenues	177.6	180.5	186.3	195.5	204.4	213.9	224.6
Total expenses
Program expenses	-133.3	-142.1	-147.1	-155.3	-162.6	-170.4	-177.9
Public debt charges	-37.3	-36.2	-36.2	-37.2	-37.8	-37.6	-37.2
Total expenses	-170.6	-178.2	-183.3	-192.5	-200.3	-207.9	-215.1
Budgetary surplus	7.0	2.3	3.0	3.0	4.0	6.0	9.5
Prudence
Contingency Reserve		2.3	3.0	3.0	3.0	3.0	3.0
Economic prudence					1.0	3.0	4.0
Total		2.3	3.0	3.0	4.0	6.0	7.0
Planning surplus	7.0	0.0	0.0	0.0	0.0	0.0	2.5
Non-budgetary transactions
Pension and other accounts	0.4	-0.6	-1.4	2.6	2.5	2.2	2.0
Capital investing activities	-4.8	-4.8	-4.9	-5.1	-5.4	-5.7	-6.0
Other investing activities	0.8	-1.4	-1.5	-1.3	-1.2	-1.2	-1.2
Other activities	4.2	1.0	5.7	5.9	6.0	6.2	6.2
Total	0.6	-5.8	-2.1	2.0	1.9	1.6	1.0
Financial   source/requirement	7.6	-5.8	-2.1	2.0	1.9	1.6	3.5
Per cent of GDP
Budgetary revenues	15.4	14.8	14.7	14.6	14.6	14.5	14.6
Program expenses	11.5	11.7	11.6	11.6	11.6	11.6	11.5
Public debt charges	3.2	3.0	2.9	2.8	2.7	2.6	2.4
Total expenses	14.8	14.7	14.4	14.4	14.3	14.1	13.9
Planning surplus	0.6	0.0	0.0	0.0	0.0	0.0	0.2
Federal debt
Assuming balanced      budget	44.2	42.0	40.2	38.2	36.4	34.7	33.1
Assuming Contingency      Reserve applied      to debt reduction	44.2	41.8	39.8	37.6	35.5	33.5	31.5
Note: Numbers may not add due to rounding.

• Table 3.6 sets out the details of the fiscal projections to 2008-09 based on the September 2003 survey of private sector economic projections.
• The budgetary balance is presented on a full accrual basis of accounting, recording government liabilities and assets when they are incurred or acquired, regardless of when the cash payment or receipt is made. In contrast, the financial source/requirement measures the difference between cash coming in to the Government and cash going out. It differs from the budgetary balance as it includes the cash source/requirement resulting from the Government's investing activities through its acquisition of capital assets and loans, investments and advances, as well as from operating transactions, primarily through the federal employees' pension accounts and foreign exchange accounts. These transactions are recorded as non-budgetary transactions.

• There was a financial source of $7.6 billion in 2002-03, primarily attributable to the budgetary surplus of $7.0 billion.
• With projected budgetary balances, there is a projected financial requirement of $5.8 billion in 2003-04 and $2.1 billion in 2004-05, unchanged from the estimates at the time of the February 2003 budget. The requirement in 2003-04 reflects the cash transfers to the trust funds established in the February 2003 budget for the Canada Health and Social Transfer supplement of $2.5 billion and the Diagnostic/Medical Equipment Fund of $1.5 billion. The liabilities for these trust transfers were established in 2002-03 and affected the budgetary balance in that year. The proposed transfer of the Government's holdings in the Canada Pension Plan to the Canada Pension Plan Investment Board also impacts the financial requirements for 2003-04 and 2004-05. The Government will fund these cash requirements without raising new debt.
• In the absence of the special factors noted above, financial sources are projected for 2005-06 and beyond.

• The revenue-to-GDP ratio was 15.4 per cent in 2002-03, down significantly from 17.0 per cent in 2000-01, primarily reflecting the impact of tax reduction measures. It is expected to decline to 14.8 per cent in 2003-04 and to 14.7 per cent in 2004-05, reflecting weaker economic growth and the impact of the Five-Year Tax Reduction Plan. The revenue ratio drops to 14.6 per cent in 2005-06, reflecting the tax reductions announced in the February 2003 budget, and remains relatively stable thereafter.
• The program expenses-to-GDP ratio was 11.5 per cent in 2002-03, well below the level of 15.7 per cent in 1993-94. It is projected to increase slightly in 2003-04, as some of the factors that reduced expenses in 2002-03 do not carry forward into 2003-04. It is projected to remain relatively stable thereafter.
• The federal debt-to-GDP ratio (accumulated deficit) stood at 44.2 per cent in 2002-03, down from its peak of 68.4 per cent in 1995-96. Assuming no incremental debt reduction, it would fall to about 33 per cent by 2008-09. If the Contingency Reserve is not needed and is used to reduce federal debt, the federal debt-to-GDP ratio would decline to 31.5 per cent in 2008-09.

Average private sector projections of budgetary revenues

Table 3.7
Average Private Sector Projections of Budgetary Revenues

	Actual	Estimate
	2002-03	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(millions of dollars)
Tax revenues
Income tax
Personal income tax	81,707	83,440	86,025	91,105	96,200	102,375	109,530
Corporate income tax	22,222	23,450	24,755	26,095	26,855	26,990	26,860
Other income tax	3,291	3,315	3,455	3,585	3,710	3,825	3,895
Total income tax	107,220	110,205	114,235	120,785	126,765	133,191	140,285
Excise taxes/duties
Goods and      services tax	28,248	29,260	31,170	32,865	34,585	36,425	38,475
Customs import duties	3,221	3,130	3,440	3,915	4,225	4,445	4,710
Energy taxes	2,496	2,525	2,585	2,650	2,700	2,735	2,775
Other      excise taxes/duties	6,971	6,920	7,080	7,235	7,380	7,550	7,815
Air Travellers      Security Charge	421	375	395	415	430	445	460
Total	41,357	42,210	44,670	47,080	49,320	51,600	54,235
Total tax revenues	148,577	152,415	158,905	167,865	176,085	184,790	194,520
Employment  insurance premium  revenues	17,870	17,500	17,135	16,965	17,420	18,035	18,730
Other revenues	11,115	10,575	10,250	10,700	10,850	11,100	11,330
Total budgetary revenues	177,562	180,490	186,290	195,530	204,355	213,925	224,580
Per cent of GDP
Personal income tax	7.1	6.9	6.8	6.8	6.9	7.0	7.1
Corporate income tax	1.9	1.9	1.9	2.0	1.9	1.8	1.7
Goods and      services tax	2.4	2.4	2.5	2.5	2.5	2.5	2.5
Other excise	1.1	1.1	1.1	1.1	1.0	1.0	1.0
Tax revenues	12.9	12.5	12.5	12.6	12.5	12.6	12.6
Employment    insurance premium    revenues	1.5	1.4	1.3	1.3	1.2	1.2	1.2
Non-tax revenues	1.0	0.9	0.8	0.8	0.8	0.8	0.7
Total	15.4	14.8	14.7	14.6	14.6	14.5	14.6
Note: Numbers may not add due to rounding.

• Budgetary revenues are projected to increase by only 1.6 per cent in 2003-04, primarily reflecting the weakness in the economy in 2003. Beyond 2003-04, the average of the private sector forecasts for revenue growth is broadly in line with the growth in nominal GDP, with variations largely due to the impact of tax reductions announced as part of the $100-billion Five-Year Tax Reduction Plan and in the 2003 budget.
• Personal income tax-the largest component of budgetary revenues-declines as a percentage of GDP to 2005-06, reflecting both the impact of the $100-billion Five-Year Tax Reduction Plan, which matures in 2004-05, and weakness in economic growth. Thereafter it increases slightly as a percentage of GDP, reflecting the progressivity of the income tax system.
• Corporate income tax revenues grow broadly in line with the growth in the economy to 2005-06, despite reductions in the general rate to 21 per cent from 28 per cent in 2000. Beyond 2005-06 they grow somewhat slower than the growth in nominal GDP, in part reflecting the impact of the tax reductions implemented in the February 2003 budget.
• Excise taxes and duties are expected to increase by only 2.1 per cent in 2003-04, following an increase of 11.4 per cent in 2002-03. The 2002-03 results were affected by the introduction of the Air Travellers Security Charge, tobacco tax increases and a strong increase in goods and services tax revenues. The slower pace expected for 2003-04 reflects the weakening in consumer demand. Thereafter they are expected to pick up somewhat and grow broadly in line with the growth in nominal GDP.
• The annual decline in EI premium revenues to 2004-05 reflects the impact of lower EI premium rates. Under current legislation, rates decline from $2.20 in 2002 (employee rate per $100 of insurable earnings) to $1.98 in 2004. Over the period 2005-06 to 2008-09 EI premium revenues are assumed to match EI program costs.
• Other revenues include revenues from enterprise Crown corporations, foreign exchange revenues, return on investments and sales of goods and services. These revenue sources are extremely volatile, determined in large part by changes in the value of the Canadian dollar and net gains/losses from enterprise Crown corporations. For planning purposes, they are assumed to grow slower than the growth in the economy.

• A more revealing picture of movements in tax revenue can be obtained by examining the "revenue ratio"-total federal revenues in relation to the total income in the economy (or GDP).
• This ratio primarily reflects the impact of policy decisions and economic developments. The ratio declines during economic downturns and tends to increase during recoveries, reflecting the progressive nature of the tax system and the cyclical nature of corporate profits.
• The decrease in the ratio in 2001-02 was largely attributable to the implementation of the $100-billion Five-Year Tax Reduction Plan. Thereafter the decline in the ratio reflects both the incremental impact of the Tax Reduction Plan and the tax reductions announced in the February 2003 budget and weaker economic growth than expected at the time of the February 2003 budget.
• The revenue ratio is projected to decline from 17.0 per cent in 2000-01 to 14.6 by 2008-09-a level not seen since the early 1960s.

Average private sector projections of program expenses

Table 3.8
Average Private Sector Projections of Program Expenses

	Actual	Estimate
	2002-03	2003-04	2004-05	2005-06	2006-07	2007-08	2008-09
	(millions of dollars)
Major transfers to  persons
Elderly benefits	25,692	27,015	27,940	28,975	30,120	31,355	32,740
Employment insurance    benefits	14,496	15,450	15,495	15,630	16,040	16,560	17,210
Total	40,188	42,465	43,434	44,605	46,160	47,916	49,950
Major transfers to  other levels of government
Federal transfers    in support of health and    other programs	22,600	20,300	21,900	24,500	26,100	27,700	28,900
Fiscal    arrangements	10,366	11,025	12,130	12,740	13,335	13,950	14,590
Alternative Payments for    Standing Programs	-2,321	-2,440	-2,550	-2,685	-2,820	-2,955	-3,100
Total	30,645	28,885	31,480	34,555	36,615	38,695	40,390
Other program expenses	62,490	70,700	72,150	76,150	79,800	83,750	87,550
Total program expenses	133,323	142,050	147,064	155,310	162,575	170,361	177,890
Per cent of GDP
Major transfers to persons
Elderly benefits	2.2	2.2	2.2	2.2	2.1	2.1	2.1
Employment     insurance    benefits	1.3	1.3	1.2	1.2	1.1	1.1	1.1
Total	3.5	3.5	3.4	3.3	3.3	3.3	3.2
Major transfers to  other levels of  government
Federal transfers    in support of    health and other    programs	2.0	1.7	1.7	1.8	1.9	1.9	1.9
Fiscal    arrangements	0.9	0.9	1.0	1.0	1.0	0.9	0.9
Alternative    Payments for    Standing    Programs	-0.2	-0.2	-0.2	-0.2	-0.2	-0.2	-0.2
Total	2.7	2.4	2.5	2.6	2.6	2.6	2.6
Other program  expenses	5.4	5.8	5.7	5.7	5.7	5.7	5.7
Total program  expenses	11.5	11.7	11.6	11.6	11.6	11.6	11.5
Note: Numbers may not add due to rounding.

Average private sector projections of program expenses

• The projections of program expenses in Table 3.8 include the impact of the health care agreements reached in September 2000 and February 2003, as well as initiatives announced in the February 2003 budget. They also include initiatives announced since the 2003 budget, which are shown in Table 3.4.
• Program expenses are divided into three major components: major transfers to persons, major cash transfers to other levels of government and other program expenses-the latter include subsidies and other transfers, and expenses of Crown corporations, defence and all other departmental operating expenses.
• Program expenses are expected to increase by 6.5 per cent, or $8.7 billion, in 2003-04, with most of the increase due to higher other program expenses, reflecting in part the impact of initiatives announced in the February 2003 budget, including incremental funding for National Defence, affordable housing, infrastructure, research and innovation, and climate change, as well as the initiatives announced since the 2003 budget. Thereafter, based on the average of the projections provided by the four forecasting firms, total program expenses are estimated to increase broadly in line with the increase in nominal GDP.
• Major transfers to persons, consisting of elderly benefits and EI benefits, are expected to increase by $2.3 billion in 2003-04. The growth in elderly benefits is largely determined by the growth in the elderly population and average benefits, which are fully indexed to quarterly changes in consumer prices. The growth in EI benefits reflects the lagged impact of the economic slowdown and increases in average benefits.
• Cash entitlements to other levels of government in 2002-03 include one-time funding totalling $4.0 billion, of which $2.5 billion was for the Canada Health and Social Transfer cash supplement and $1.5 billion for the Diagnostic/Medical Equipment Fund. The inclusion of these one-time transfers accounts for the drop in cash entitlements in 2003-04. Cash transfers in support of health and other social programs reflect the planned levels for total cash entitlements to 2008-09 as set out in the February 2003 budget. Fiscal arrangements include equalization entitlements, transfers to the territories, statutory subsidies and recoveries under the Youth Allowance Recovery Program. Renewal of the equalization program is currently under discussion with the provinces. Until a new five-year legislated program is enacted, it is assumed for planning purposes that equalization entitlements will grow in line with nominal GDP.
• Other program expenses are projected to grow by 13 per cent in 2003-04. This increase is attributable to the impact of one-time adjustments, which lowered spending in this component in 2002-03, and the impact of the February 2003 budget initiatives, which came into effect in 2003-04. Thereafter this component is projected to grow in line with the growth in nominal GDP.

Program expenses-to-GDP ratio continues to decline

• Program expenses as a per cent of GDP, on a status quo basis, are expected to increase slightly, from 11.5 per cent in 2002-03 to 11.7 per cent in 2003-04.
• The ratio has declined significantly from the levels of the 1980s and early 1990s. This is primarily attributable to the expenditure reduction measures implemented in the 1995 and 1996 budgets, which structurally lowered program expenses.
• Since 1996-97 the ratio has been relatively stable and is expected to remain so over the outlook period.

Sensitivity of the fiscal outlook to economic shocks

Table 3.9
Estimated Change in Fiscal Position

	Year 1	Year 2
	(billions of dollars)
1-per-cent decrease in real GDP growth
Revenue impact	-1.9	-1.9
Expenses impact	0.6	0.7
Deterioration in fiscal balance	-2.5	-2.6
1-per-cent decrease in GDP inflation
Revenue impact	-1.9	-1.8
Expenses impact	-0.5	-0.5
Deterioration in fiscal balance	-1.4	-1.3
100-basis-point decrease in interest rates
Revenue impact	-0.4	-0.5
Expenses impact	-1.2	-1.8
Improvement in fiscal balance	0.8	1.3

• The fiscal projections are extremely sensitive to changes in economic assumptions-particularly to changes in real economic (GDP) growth, inflation and interest rates. To ensure that such developments do not adversely affect the achievement of the Government's balanced budget target, the Government follows a prudent approach to budget planning, as described earlier in this annex.
• 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 expenses, primarily due to higher EI benefits. Using standard sensitivity analysis, a 1-per-cent decrease in real GDP for one year would lower the budgetary balance by $2.5 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 expenses 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 $1.3 billion in year two. This improvement comes solely from the reduction in public debt charges, which would reduce overall budgetary expenses by $1.2 billion in the first year and $1.8 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 other revenues.

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