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Chapter 4
Private Sector Five-Year Economic and Fiscal Projections

Highlights

• The Government is committed to sound financial management, including delivering balanced budgets or better, through prudent budget planning and reducing the burden of the federal debt.
• This Update maintains the annual $3-billion Contingency Reserve. It also includes an additional amount for economic prudence of $1 billion in 2006-07, rising to $4 billion by 2010-11.
• The fiscal projections in this Update have been prepared by four private sector forecasting organizations on a National Accounts basis of accounting, using the average of private sector economic forecasts. These projections have been converted by the Department of Finance to a Public Accounts basis of accounting-the basis on which the Government reports its financial position to Parliament (the detailed conversion is set out in Annex 3).
• Based on the average of the projections provided by the four forecasting organizations, and after subtracting amounts for the Contingency Reserve, economic prudence and the cost of initiatives proposed before this Update, the status quo surplus for planning purposes is estimated to be $8.2 billion for 2005-06, rising to $11.3 billion in 2010-11, for a total of $54.5 billion over the six-year period.
• Projected planning surpluses are significantly higher than those in the 2005 budget due to continued growth in corporate income tax revenues, partly resulting from much higher energy prices, mainly for natural gas prices; strong growth in personal tax revenues during the first part of 2005-06, reflecting recent growth in employment and earnings; and lower public debt charges, primarily reflecting lower interest rates than expected at the time of the 2005 budget.
• As is the standard practice, the Update releases some of the economic prudence built into the 2005 budget projections, which adds to the surplus for planning purposes.
• Initiatives proposed since the 2005 budget, including those in this Update toward implementing the Government's Plan for Growth and Prosperity, total $49.8 billion through 2010-11.
• The remaining planning surplus amounts to $1.6 billion in 2005-06 and ranges from about $2 billion to $3.5 billion annually over the next five years, totalling $15.5 billion.
• The debt-to-GDP (gross domestic product) ratio is projected to fall to about 29 per cent by 2010-11 (based on balanced budgets), putting the Government on track to meet the objective set out in the 2004 budget of reducing the ratio to 25 per cent by 2014-15. This Update announces a new objective of reducing the debt-to-GDP ratio to 20 per cent by 2020.
• Tax reduction measures proposed in the 2005 budget and in this Update are projected to reduce revenues as a share of GDP to 14.4 per cent by 2010-11, from 15.4 per cent in 2004-05.
• Program expenses as a share of GDP are projected to remain close to a postwar low of 12 per cent over the planning period.
• The Government has implemented virtually all of the recommendations proposed by Dr. Tim O'Neill in his review of the federal forecasting process.

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Approach to budget planning

• The Government's approach to budget planning involves four key steps. The first step involves using private sector economic forecasts for budget-planning purposes.

• The second step involves using the average private sector economic forecast to develop status quo fiscal projections for the fall Economic and Fiscal Update.

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

• The Government has proposed a fourth step, aimed at dealing with unanticipated federal surpluses at year end. Currently any unanticipated surplus at the end of the fiscal year is applied to reduce the federal debt. Under proposed legislation, any unexpected federal surplus over the $3-billion Contingency Reserve before closing the financial statements would be divided equally among tax relief, social and economic spending, and debt reduction. The $3-billion Contingency Reserve would continue to be applied to reduce the federal debt in the absence of unexpected shocks. For 2005-06 and 2006-07, amounts allocated under Bill C-48 (for affordable housing, post-secondary education, the environment and foreign aid) would be taken into account.

• The proposed approach for dealing with unexpected surpluses is one of a number of recommendations made by Dr. Tim O'Neill in his report, Review of Canadian Federal Fiscal Forecasting: Processes and Systems. The report was prepared at the request of the Minister of Finance to ensure that the Government continues to use the most up-to-date economic and fiscal-forecasting methods, and to benchmark Canadian practices against the best in the world. The Minister of Finance tabled Dr. O'Neill's report in the House of Commons on June 20, 2005. The report sets out 14 recommendations, 12 of which are in the Government's purview (the other two are related to the House of Commons Standing Committee on Finance). These recommendations and actions taken by the Government are provided at the end of this chapter.

Planning assumptions used to develop the five-year status quo fiscal projections

• The four private sector forecasting organizations derived projections of the major components of the federal budgetary balance on a National Accounts basis, using the economic forecasts outlined in Table 4.1. These projections were converted to a Public Accounts basis by the Department of Finance (details of this reconciliation by component of revenues and expenses are provided in Annex 3). The projections are based on the following assumptions.

Economic assumptions underlying the average private sector status quo fiscal projections

Table 4.1
Average of Private Sector Economic Forecasts: 
September 2005 Survey

	2005	2006	2007	2008-2010
	(per cent)
Real GDP growth	2.8	2.9	3.1	2.9
GDP inflation	2.4	2.2	1.6	1.7
Nominal GDP growth	5.3	5.2	4.7	4.7
3-month treasury bill rate	2.7	3.4	4.1	4.2
10-year Government of Canada bond rate	4.0	4.4	5.1	5.4
Note: The number of survey respondents declines from 16 in 2005 to 8 in 2010.

• The average private sector forecast of real GDP growth is 2.8 per cent in 2005, 2.9 per cent in 2006 and 3.1 per cent in 2007. The average growth forecast over the 2008 to 2010 period is 2.9 per cent.

• Short-term interest rates are expected to average 2.7 per cent in 2005 before rising to 3.4 per cent in 2006 and 4.1 per cent in 2007. Over the 2008 to 2010 period, short-term interest rates are expected to average 4.2 per cent. Private sector forecasters project a gradual rise in longer-term interest rates from 4.0 per cent in 2005 to 5.1 per cent by 2007, and averaging 5.4 per cent over the 2008 to 2010 period.

Status quo fiscal projections on a National Accounts basis

Table 4.2
Private Sector Surplus Projections

	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(billions of dollars)
Conference Board of Canada	11.9	16.4	16.6	13.0	11.6	13.8
University of Toronto	11.4	17.4	18.4	15.6	15.2	18.0
Global Insight	10.5	15.2	15.9	13.8	13.7	18.5
Centre for Spatial Economics	10.4	15.7	17.4	16.2	17.2	21.3
Average	11.1	16.2	17.0	14.7	14.4	17.9
Forecast range	1.6	2.2	2.5	3.2	5.7	7.5

• The private sector forecasting organizations provided National Accounts-based projections of the Government's budgetary balance on a status quo basis and before subtracting amounts for the Contingency Reserve and economic prudence as well as the cost of initiatives announced since the February 2005 budget.
• On average, the four forecasting organizations project a status quo National Accounts surplus of $11.1 billion in 2005-06, $16.2 billion in 2006-07 and $17.0 billion in 2007-08, declining thereafter to $14.4 billion in 2009-10 before climbing to $17.9 billion in 2010-11.
• All four organizations project a decrease in the surplus in 2008-09. This largely reflects the implementation of tax cuts and spending initiatives announced in the 2005 budget.
• The differences in the projections among the four forecasters primarily reflect differing assumptions about the responsiveness of tax revenues to growth in the various income tax bases.

• The range in the projections is $1.6 billion in the first year of the planning period, rising to $7.5 billion in 2010-11. These differences are relatively small in relation to combined federal revenues and expenses of about $400 billion. For example, by 2010-11 the range represents 2.8 per cent of revenues and 1.4 per cent of combined revenues and expenses.

Status quo fiscal projections on a Public Accounts basis

Table 4.3
Average Private Sector Surplus Projection-Status Quo Underlying Surplus

	Actual	Projection
	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(billions of dollars)
National Accounts basis
Average of private sector     surplus projections	2.8	11.1	16.2	17.0	14.7	14.4	17.9
Adjustments for 2005-06     collections		-2.5	-2.6	-2.7	-2.9	-3.0	-3.1
Other adjustments	-1.2	4.8	1.4	2.1	3.9	5.1	5.0
Total adjustments	-1.2	2.4	-1.2	-0.7	1.1	2.1	1.9
Public Accounts status quo underlying surplus	1.6	13.4	15.0	16.4	15.7	16.5	19.8

• Table 4.3 reviews the key adjustments required to translate the National Accounts surplus projections to a Public Accounts basis. Detailed reconciliations are provided in Annex 3. The first adjustment is to incorporate the most recent fiscal data available. Estimates of government revenues and expenses on a National Accounts basis normally lag the Public Accounts estimates by several months and do not incorporate the final 2004-05 results.
• In total, the Department of Finance adjusted the private sector National Accounts projections by $2.5 billion in 2005-06, largely reflecting personal income tax collections to date. As explained in Annex 3, the National Accounts estimate year-over-year growth in personal income tax revenues of nearly 12 per cent in the second quarter of 2005, considerably above the estimated growth in the applicable tax base and the year-to-date growth in the Public Accounts-based data as reported in the September Fiscal Monitor of 8.6 per cent.
• The other key adjustments reflect differences in the accounting treatment of revenues and expenses between the two accounting systems. Notably:

• The status quo underlying surplus on a Public Accounts basis is $13.4 billion in 2005-06, rising to $19.8 billion by 2010-11.

Table 4.4
Surpluses for Purposes of Fiscal Planning

	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(billions of dollars)
Status quo underlying surplus	13.4	15.0	16.4	15.7	16.5	19.8
Initiatives proposed before the Update	2.3	1.8	1.8	1.9	1.6	1.5
Allocation for prudence
Contingency Reserve	3.0	3.0	3.0	3.0	3.0	3.0
Economic prudence		1.0	2.0	3.0	3.5	4.0
Total	3.0	4.0	5.0	6.0	6.5	7.0
Status quo planning surplus	8.2	9.2	9.5	7.9	8.4	11.3
Note: Totals may not add due to rounding.

• In order to derive the fiscal surplus for planning purposes, the cost of initiatives proposed before this Update (see Table 1.2), as well as allocations for the Contingency Reserve and economic prudence, must be deducted from the status quo surplus.
• Table 4.4 provides the estimates of the surplus for planning purposes. The surplus is projected to be $8.2 billion in 2005-06, $9.2 billion in 2006-07, rising to $11.3 billion by 2010-11, for a six-year total of $54.5 billion.
• The $8.2-billion increase in the status quo planning surplus for 2005-06 reflects a number of economic and fiscal developments, which are explained in detail in the following pages.

• Revenues in 2004-05, largely corporate income tax revenues related to the energy sector, came in $2.6 billion higher than projected in the 2005 budget, and this gain is expected to carry forward to future years, providing a permanent boost to the level of revenues as projected in the 2005 budget.
• Growth in corporate income tax revenues in 2005-06 is now expected to be much stronger than anticipated at the time of the 2005 budget, largely due to the increase in energy prices since the budget and the carry-forward for 2004-05. This has increased the status quo planning surplus by $3.1 billion.
• Growth in personal income tax revenues in early 2005 was extremely strong, and appears to be linked to much stronger-than-expected employment income growth. This has increased the status quo planning surplus by $1.7 billion.
• Public debt charges are projected to be lower than forecast in the 2005 budget due primarily to lower interest rates, adding about $1 billion to the status quo planning surplus.
• As is the norm, the Government has released the $1 billion of economic prudence set aside in the 2005 budget for 2005-06. A number of other factors have also increased the projected budgetary balance. Revenues of enterprise Crown corporations are expected to be somewhat higher. Expenses related to the new offshore arrangements with Newfoundland and Labrador and Nova Scotia (reflecting a change in accounting treatment) and employment insurance benefits are expected to be somewhat lower than at the time of the 2005 budget. Together, these factors add about $1 billion to the status quo planning surplus.
• The cost of new initiatives proposed before this Update has increased expenses by $2.3 billion.

Changes in key variables since the February 2005 budget fiscal projections

• The outlook for corporate income tax receipts is significantly higher throughout the planning period, reflecting a number of factors.
• The final outcome for corporate income tax receipts in 2004-05 was $1.5 billion higher than projected in the 2005 budget, partly due to a doubling of tax receipts received from firms in the energy sector. This better-than-expected result carries forward into 2005-06 and future years.
• Prices of natural gas and crude oil increased significantly in 2005 and are now expected to be considerably higher than forecast at the time of the 2005 budget-50 per cent higher on average over the next three years. This has increased the outlook for corporate profits and associated tax receipts.
• The higher corporate profits also reflect the assessment of private sector economists that the share of corporate profits in GDP will remain close to the current historical peak over the planning period (see box entitled "Gross Domestic Product-Income-Based Components"). In the 2005 budget, the share of corporate profits in GDP was assumed to slowly return to its historical average.

Changes in key variables since the February 2005 budget fiscal projections

• In addition to strong growth in corporate income tax receipts, personal income tax collections have been very strong in early 2005. Over the first six months of 2005-06, personal income tax receipts grew 8.6 per cent, about twice the forecast growth of wages and salaries over the period, and much more rapidly than projected in Budget 2005. However, this is somewhat consistent with recent monthly labour force data, which show strong growth in total earnings in the third quarter of 2005. The unanticipated strength in personal income tax receipts is expected to result in significantly higher personal income tax receipts than projected at the time of the 2005 budget.
• Projections for short- and long-term interest rates have been lowered since the 2005 budget, translating into lower projected public debt charges.

The Fiscal Impact of Higher Oil and Natural Gas Prices The impact of higher oil prices on the budgetary balance is largely neutral, while the impact of higher natural gas prices is significantly positive. This difference is due to two primary factors. First, net exports of natural gas are about 21⁄2 times larger than net exports of crude oil-which means that the increase in corporate profits occasioned by an increase in gas prices is much higher than the increase occasioned by an equivalent increase in oil prices. Second, consumer expenditures on petroleum products are about five times as large as expenditures on natural gas, which means that an increase in oil prices increases the Consumer Price Index and the associated costs of indexed programs to a much greater extent than increases in natural gas prices. These programs include Old Age Security, the Guaranteed Income Supplement, the Canada Child Tax Benefit and the goods and services tax (GST) credit. Also, as the personal income tax system is fully indexed, higher inflation due to increases in oil prices reduces personal income tax collections.

 

Gross Domestic Product-Income-Based Components The income composition of nominal GDP plays a key role in the fiscal forecast because different components of income are taxed at different rates. In the February 2005 budget, the share of wages, salaries and supplementary labour income and that of corporate profits in GDP were assumed to converge toward their long-term historical averages. In the budget, the income shares of wages, salaries and supplementary labour income and corporate profits were assumed to be 51 per cent and 11.3 per cent, respectively, by 2010. However, the significant rise in energy prices, particularly natural gas prices, has raised the outlook for corporate profits this year and over the remainder of the outlook. Projected energy prices are on average about 50 per cent higher over the next three years compared to the budget outlook. Starting with this Update, the Department of Finance has expanded its survey of private sector economic forecasters to include forecasts of GDP income components. The September 2005 survey suggests the private sector forecasters expect that the share of corporate profits (before taxes) will rise from 14 per cent of GDP in the second quarter of 2005 and peak at 14.8 per cent in 2006 before stabilizing at around 14.1 per cent of GDP over 2008 to 2010-significantly higher than the historical average of about 10 per cent. The survey suggests that the share of wages, salaries and supplementary labour income in GDP will decline slightly, from almost 50 per cent in the second quarter of 2005 to average 49.1 per cent of GDP over 2008 to 2010. The change in the projected income shares of GDP is not neutral from a fiscal point of view. Corporate profits are taxed at a much higher effective rate than personal income (17.1 per cent in 2004-05, compared to 9.3 per cent for personal income) so the shift in the assumed income share of GDP results in a net fiscal gain. Gross Domestic Product, Income-Based Components   2004 2005 2006 2007 2008-2010   (per cent of nominal GDP) Wages, salaries and supplementary labour income 49.9 49.4 49.2 49.4 49.1 Corporation profits before tax 13.6 14.4 14.8 14.6 14.1 Interest and miscellaneous investment income 4.3 4.4 4.6 4.7 5.5 Taxes less subsidies, on factors of productions and products 11.5 11.5 11.4 11.3 11.2 Capital consumption allowances 13.4 13.3 13.3 13.4 13.5 Other 7.3 7.0 6.7 6.6 6.6 Total 100.0 100.0 100.0 100.0 100.0 Sources: Statistics Canada; September 2005 Department of Finance survey of private sector forecasters and Department of Finance assumptions.

Other governments are also experiencing stronger revenues

• The Government of Canada is not alone in experiencing stronger-than-expected revenue growth in 2005-06. Forecasts for the U.S. federal government made by the Office of Management and Budget (OMB) and the Congressional Budget Office (CBO) were also revised upwards for 2005-06, mainly as a result of higher revenues from personal and corporate income taxes and payroll taxes. This experience is quite similar to that of the Government of Canada.
• Moreover, most provinces that have revised their forecasts for 2005-06 are now expecting higher revenues than projected in their 2005 budgets. Revisions to provincial revenues are largest in Newfoundland and Labrador, Alberta, British Columbia and Saskatchewan, mainly reflecting higher royalties from oil and natural gas production. Personal and corporate income tax revenues are also higher than expected in most of these six provinces.
• These upward revisions generally followed better-than-projected outcomes for the 2004-05 fiscal year. For example, in the U.S., the final outcome for the budget balance was better than projected by both the OMB and the CBO largely because revenues turned out to be about US$100 billion, or almost 5 per cent, higher than projected last February.

Changes since the February 2005 budget fiscal projections

Table 4.5
Changes in the Fiscal Outlook Since the February 2005 Budget

	Actual	Projection
	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10
	(billions of dollars)
Budget 2005 planning surplus	3.0	0.0	0.0	0.0	0.0	0.0
Initiatives proposed before the Update		-2.3	-1.8	-1.8	-1.9	-1.6
Impact of economic changes1
Budgetary revenues
Personal income tax	0.2	1.9	1.2	0.5	-1.0	-2.3
Corporate income tax	1.5	4.6	6.6	7.3	8.6	10.7
Employment insurance premiums	0.2	0.1	-1.3	-1.4	-1.6	-1.7
Other revenues	0.6	0.6	0.7	0.1	-0.4	-0.9
Total	2.6	7.2	7.3	6.4	5.6	5.9
Program expenses
Major transfers to persons
Elderly benefits	0.1	-0.1	-0.1	0.1	-0.1	-0.2
Employment insurance benefits	0.5	1.1	1.2	1.5	1.7	1.8
Total	0.6	1.0	1.2	1.6	1.6	1.7
Major transfers to other levels     of government	-2.9	0.2	0.3	0.7	0.4	0.3
Direct program expenses	-2.3	0.0	0.0	0.0	0.0	0.0
Total	-4.5	1.1	1.5	2.3	2.1	2.0
Public debt charges	0.6	1.1	1.2	1.6	1.5	1.7
Release of prudence	-	1.0	1.0	1.0	0.5	0.5
Status quo planning surplus	1.6	8.2	9.2	9.5	7.9	8.4
Note: Totals 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.

• Table 4.5 provides a breakdown by revenue and expenditure component of the changes in the status quo planning surplus since the 2005 budget.
• The cost of new initiatives proposed before the Update is $2.3 billion in 2005-06 and ranges between $1.6 billion and $1.9 billion in other years.
• In 2005-06, corporate income tax receipts are projected to be $4.6 billion higher than forecast in the 2005 budget. This change accounts for a significant portion of the $8.2-billion improvement in the planning surplus projected for this year. This reflects the carry-forward of the better-than-expected 2004-05 outcome and the recent run-up in energy prices, which is boosting the profitability of a significant portion of the Canadian corporate sector.
• Over the 2005-06 to 2009-10 period, higher corporate income tax receipts account for most of the projected increase in the planning surplus compared to the 2005 budget. This increase also reflects an assumed shift in the composition of GDP away from wages and salaries to corporate profits. As discussed earlier, the September 2005 survey of private sector forecasters suggests that the share of corporate profits in GDP will stabilize at just over 14 per cent of GDP in the outer years of the planning period, significantly higher than the historical average of 10.1 per cent. The survey also suggests that the share of wages, salaries and supplementary labour income in GDP will stabilize at just over 49 per cent, below its historical average of 53 per cent. In contrast, in the 2005 budget, the shares of both corporate profits and wages, salaries and supplementary labour income in GDP were assumed to converge toward their long-term historical averages.
• Further boosting the surplus in the near term are personal income tax receipts, which have grown much more strongly than expected this year. Personal income tax receipts have risen 8.6 per cent over the first six months of 2005-06, or about twice the forecast growth of wages and salaries. Over the medium term, personal income tax receipts are weaker than projected in the 2005 budget, reflecting an assumed shift in the composition of GDP away from wages and salaries to corporate profits.
• EI revenues are lower, reflecting lower EI benefits. Lower EI benefits, in turn, are due to improvements in the labour market, savings from the expenditure review included in the 2005 budget and the transfer of some EI program elements to Quebec. The transfer of some EI program elements to Quebec has also reduced benefits by a corresponding amount, such that the impact of the transfer on the fiscal balance is neutral beginning in 2006-07.
• The other principal change from the budget to program expenses is a reduction in transfers to other levels of government, due primarily to the change in accounting for the new offshore arrangements with Newfoundland and Labrador and Nova Scotia.
• Public debt charges over the forecast period are expected to be between $1.1 billion and $1.7 billion lower than the Budget 2005 outlook due to lower projected interest rates since the time of the budget.
• The economic prudence included in the Budget 2005 projection has been eliminated for the 2005-06 fiscal year and reduced in the following years, as is the normal practice in the fall Update.
• Combined, these developments have resulted in a significant upward revision to projected status quo underlying surpluses over the 2005-06 to 2009-10 period compared to the 2005 budget.

Table 4.6
Initiatives Proposed Since the February 2005 Budget

	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11	Total
	(millions of dollars)
A Plan for Growth and Prosperity
Creating Opportunities for All Canadians	1,112	794	1,453	1,899	1,991	1,991	9,238
Advancing an Innovative Economy	530	299	382	384	385	365	2,344
At the Centre of Global Commerce and Networks		142	251	268	265	249	1,175
Building the Right Investment  Environment	5,385	5,070	4,716	4,118	4,318	6,848	30,455
Total	7,027	6,305	6,802	6,669	6,959	9,452	43,213
Government's Response to Higher Energy Costs	1,041	566	238	238	150	150	2,383
Canada-Ontario Agreement (excluding amounts included in thePlan for Growth and Prosperity, as well as the Government's response to higher energy costs)
Housing and infrastructure	150	150	100	100	100		600
Corporate tax collection and meat inspection	10	80	350	250	100	100	890
Total	160	230	450	350	200	100	1,490
Other Announced Post-Budget Funding Decisions
Airport rents reduction		48	72	97	132	176	525
Wage Earner Protection Program	4	32	32	32	32	32	164
Canadian Museum for Human Rights	10	10	10	20	20		70
Prince Rupert Port upgrade	10	20					30
Global Centre for Pluralism	30						30
International Fishing Governance	6	7	7				20
Quebec City's 400th anniversary celebrations	11	34	45	19			110
Measures to aid Darfur	120	78					198
Afghanistan (extended mission deployment)	286	286	50				622
Pakistan	57						57
Immigration measures	68	93	9	9	11	11	201
Other announced initiatives	165	205	265	248	182	171	1,236
Total	767	814	491	425	377	390	3,263
Less: Funding included in Budget 2005	168	106	55	65	75	92	560
Net cost	599	708	435	360	302	298	2,702
Total net costs	8,827	7,808	7,925	7,617	7,610	10,000	49,788
Note: Totals may not add due to rounding.

• The initiatives proposed since the 2005 budget total $49.8 billion over the planning period.
• These initiatives include $43.2 billion in support of the Plan for Growth and Prosperity, as well as funding to respond to higher energy costs, for the Canada-Ontario agreement and for a number of other announcements.

Average of private sector fiscal projections

Table 4.7
Summary Statement of Transactions (Including Measures Proposed Since the February 2005 Budget)

	Actual	Projection
	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(billions of dollars)
Budgetary transactions
Budgetary revenues	198.4	202.3	212.3	222.0	229.9	239.3	247.8
Total expenses
Program expenses	-162.7	-163.7	-170.7	-178.8	-187.2	-195.8	-203.6
Public debt charges	-34.1	-34.0	-34.4	-34.8	-34.6	-34.5	-34.4
Total expenses	-196.8	-197.7	-205.1	-213.6	-221.8	-230.4	-238.0
Budgetary surplus	1.6	4.6	7.2	8.4	8.1	8.9	9.8
Prudence
Contingency Reserve		3.0	3.0	3.0	3.0	3.0	3.0
Economic prudence			1.0	2.0	3.0	3.5	4.0
Total		3.0	4.0	5.0	6.0	6.5	7.0
Remaining planning surplus		1.6	3.2	3.4	2.1	2.4	2.8
Federal debt
Assuming balanced budget	499.9	499.9	499.9	499.9	499.9	499.9	499.9
Assuming Contingency     Reserve is applied to     debt reduction	496.9	493.9	490.9	487.9	484.9	481.9
Per cent of GDP
Budgetary revenues	15.4	14.9	14.9	14.8	14.7	14.6	14.4
Program expenses	12.6	12.1	11.9	12.0	12.0	12.0	11.9
Public debt charges	2.6	2.5	2.4	2.3	2.2	2.1	2.0
Total expenses	15.3	14.6	14.4	14.3	14.2	14.1	13.9
Planning surplus	0.1	0.1	0.2	0.2	0.1	0.1	0.2
Federal debt
Assuming balanced budget	38.7	36.8	35.0	33.4	32.0	30.5	29.1
Assuming Contingency       Reserve is applied to       debt reduction		36.6	34.6	32.8	31.2	29.6	28.1
Note: Totals may not add due to rounding.

• Table 4.7 summarizes the details of the fiscal projections to 2010-11, based on the average of private sector projections and adjusted for the fiscal cost of measures announced since the 2005 budget.
• After accounting for the cost of new measures and deducting the Contingency Reserve and amounts for economic prudence, there is a remaining planning surplus of $1.6 billion in 2005-06, $3.2 billion in 2006-07, $3.4 billion in 2007-08, $2.1 billion in 2008-09, $2.4 billion in 2009-10 and $2.8 billion in 2010-11.
• Budgetary revenues are expected to increase by $3.9 billion or 2.0 per cent in 2005-06. As a share of GDP, this represents a decline of 0.5 percentage point in 2005-06 and an additional 0.5 percentage point through to 2010-11. This reflects the impact of tax reduction measures proposed in the 2005 budget and in this Update.
• Program expenses as a share of GDP are expected to decline by 0.5 percentage point in 2005-06, reflecting significant one-time expenses in 2004-05. Over the planning period, program expenses are expected to grow in line with nominal GDP, averaging about 12 per cent of GDP, which is close to a postwar low.
• Public debt charges are expected to remain relatively unchanged in 2005-06, falling just $0.1 billion from 2004-05 to $34.0 billion. Thereafter, the projected increase in short-term interest rates and the refinancing of maturing long-term bonds at higher interest rates push up public debt charges by $0.4 billion in 2006-07 and a further $0.4 billion in 2007-08.
• Public debt charges as a share of total revenue were 17.2 per cent in 2004-05, a significant drop from the peak of 38.7 per cent in 1990-91. Public debt charges as a share of revenue are projected to continue to decline throughout the planning horizon, down to 13.9 per cent by 2010-11.
• Total expenses are projected to decline from 15.3 per cent of GDP in 2004-05 to 14.6 per cent in 2005-06 and then to decline gradually over the projection period, reaching 13.9 per cent of GDP in 2010-11.
• The federal debt-to-GDP ratio (accumulated deficit) stood at 38.7 per cent in 2004-05, down dramatically from its peak of 68.4 per cent in 1995-96. Assuming no incremental debt reduction, it would fall to 29.1 per cent by 2010-11, on track to meet the Government's objective of reducing this ratio to 25 per cent by 2014-15 set out in the 2004 budget. This Update announces a new objective of reducing the debt-to-GDP ratio to 20 per cent by 2020.

Average private sector projections of budgetary revenues

Table 4.8
Average Private Sector Projections of Budgetary Revenues
(Including Measures Proposed Since the February 2005 Budget)

	Actual	Projection
	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(millions of dollars)
Tax revenues
Income tax
Personal income tax	89,833	91,085	97,210	103,140	108,640	113,975	118,735
Corporate income tax	29,956	33,550	35,245	36,430	35,925	36,735	37,025
Other income tax	3,560	3,930	4,125	4,320	4,535	4,750	4,920
Total income tax	123,349	128,565	136,580	143,890	149,100	155,460	160,680
Excise taxes/duties
Goods and services tax	29,758	31,530	32,670	33,945	35,535	37,230	39,165
Customs import duties	3,091	3,270	3,450	3,610	3,685	3,805	3,815
Other excise taxes/duties	10,008	10,090	10,225	10,425	10,650	10,850	11,050
Total excise taxes/duties	42,857	44,885	46,345	47,980	49,870	51,885	54,030
Total tax revenues	166,206	173,450	182,925	191,870	198,970	207,345	214,710
Employment insurance premium revenues	17,307	17,285	16,340	16,675	17,215	17,815	18,490
Other revenues	14,907	11,570	13,020	13,495	13,730	14,170	14,595
Total budgetary revenues	198,420	202,305	212,285	222,040	229,915	239,330	247,795
Per cent of GDP
Personal income tax	7.0	6.7	6.8	6.9	6.9	7.0	6.9
Corporate income tax	2.3	2.5	2.5	2.4	2.3	2.2	2.2
Goods and services tax	2.3	2.3	2.3	2.3	2.3	2.3	2.3
Other excise	0.8	0.7	0.7	0.7	0.7	0.7	0.6
Tax revenues	12.9	12.8	12.8	12.8	12.7	12.7	12.5
Employment insurance premium revenues	1.3	1.3	1.1	1.1	1.1	1.1	1.1
Other revenues	1.2	0.9	0.9	0.9	0.9	0.9	0.9
Total	15.4	14.9	14.9	14.8	14.7	14.6	14.4
Note: Totals may not add due to rounding.

• Budgetary revenues are projected to increase by 2.0 per cent in 2005-06. As a share of GDP, revenues are projected to fall from 15.4 per cent in 2004-05 to 14.9 per cent this fiscal year, reflecting the significant tax reductions proposed in this Update.
• Personal income tax revenues-the largest component of budgetary revenues-fall as a percentage of GDP in 2005-06, reflecting the impact of the proposed reduction in the 16-per-cent rate to 15 per cent and the increase in the basic personal amount. Thereafter, personal income tax revenues increase somewhat as a percentage of GDP, reflecting the progressivity of the income tax system and real income gains. In 2010-11 personal income taxes fall as a share of GDP, reflecting proposed reductions in the two middle-income tax rates, the proposed increase to the top bracket and the maturing of the proposed Working Income Tax Benefit.
• In 2005-06 corporate income tax revenues are expected to increase 12.0 per cent, following a gain of 9.2 per cent in the previous year, reflecting ongoing strong growth in corporate profits. Expressed as a share of GDP, corporate income tax revenues are projected to decline starting in 2007-08, reflecting both the cost of the tax cuts proposed in the 2005 budget and a projected decline in the share of corporate profits in GDP.
• Excise taxes and duties are expected to rise by 4.7 per cent in 2005-06, following an increase of 3.6 per cent in 2004-05, reflecting higher GST revenues. Excise taxes and duties are projected to remain relatively stable as a percentage of GDP over the planning period.
• EI premium revenues are assumed to match EI program costs over the planning period. The EI revenue and expense projections also reflect the implementation of the Quebec Parental Insurance Plan in 2006, the cost of the labour market pilot projects announced in February 2005, as well as savings from expenditure review. This results in a decline in projected EI premium revenues in 2005-06 and 2006-07.
• Other revenues include net gains/losses from enterprise Crown corporations, foreign exchange revenues, return on investments and 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 2005-06 other revenues are projected to decrease 22.4 per cent, or $3.3 billion, largely due to the one-time gain from the sale of the Government's remaining shares in Petro-Canada in 2004-05.

Revenue ratio

• 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 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. Through 2004-05 the decline in the ratio largely reflects the incremental impact of the Five-Year Tax Reduction Plan.
• The revenue ratio is projected to decline steadily from 15.4 per cent in 2004-05 to 14.4 per cent by 2010-11. This decline reflects the impact of tax reduction measures announced in the 2005 budget and proposed in this Update.

Average private sector projections of program expenses

Table 4.9
Average Private Sector Projections of Program Expenses (Including Measures Proposed Since the 2005 Budget)

	Actual	Projection
	2004-05	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11
	(millions of dollars)
Major transfers to persons
Elderly benefits	27,871	29,245	30,575	31,895	33,365	34,935	36,585
Employment insurance benefits1	14,748	14,660	15,030	15,355	15,885	16,430	17,040
Energy Cost Benefit	565
Total	42,619	44,470	45,605	47,250	49,250	51,365	53,625
Major transfers to other levels of government
Federal transfers in     support of health and     other social programs	27,831	28,225	28,640	30,150	31,680	33,590	35,325
Fiscal arrangements	16,170	12,345	12,685	13,110	13,560	14,030	14,505
Alternative Payments for    Standing Programs	-2,746	-2,835	-2,995	-3,165	-3,300	-3,445	-3,625
Early learning and child care	700	0	700	1,200	1,200	1,200	1,200
Canada's cities and communities		1,000	1,000	800	1,000	2,000	2,000
Total	41,955	38,735	40,030	42,095	44,140	47,375	49,405
Direct program expenses	78,098	80,500	85,095	89,495	93,835	97,105	100,525
Total program expenses	162,672	163,705	170,730	178,840	187,225	195,845	203,555
Per cent of GDP
Major transfers to persons
Elderly benefits	2.2	2.2	2.1	2.1	2.1	2.1	2.1
Employment insurance benefits	1.1	1.1	1.1	1.0	1.0	1.0	1.0
Total	3.3	3.3	3.2	3.2	3.1	3.1	3.1
Major transfers to other levels of government	3.3	2.9	2.8	2.8	2.8	2.9	2.9
Direct program expenses	6.1	5.9	6.0	6.0	6.0	5.9	5.9
Total program expenses	12.6	12.1	11.9	12.0	12.0	12.0	11.9
Note: Totals may not add due to rounding. 1 EI benefits include regular EI benefits, sickness, maternity, parental, compassionate care, fishing and work-sharing benefits, and employment benefits and support measures. These represent 90 per cent of total EI program expenses. The remaining EI program costs (amounting to $1.3 billion in 2004-05) relate to administration costs.

• Table 4.9 provides an overview of the projections for program expenses, including the cost of measures announced since the 2005 budget. Program expenses are divided into three major components: major transfers to persons, major transfers to other levels of government and direct program expenses-the latter include subsidies and other transfers, expenses of Crown corporations, and defence and all other departmental operating expenses.
• Major transfers to persons, consisting mainly of elderly and EI benefits, are expected to increase by $1.9 billion in 2005-06.

• Major transfers to other levels of government in 2005-06 are $3.2 billion lower than in 2004-05, reflecting the one-time payments referred to earlier, somewhat offset by the proposed Post-Secondary Education Innovation Fund. Over the medium term, transfers increase from $38.7 billion in 2005-06 to $49.4 billion in 2010-11, averaging around 5.0 per cent growth per year, reflecting the impact of First Ministers' agreements on health, equalization and Territorial Formula Financing as well as growing payments under early learning and child care and support for Canada's cities and communities. The 2005 budget committed funds to the latter two programs through 2009-10. The amounts for 2010-11 reflect the continuation of these programs. Decisions on their enhancement will be the subject of future budgets. The amounts related to cities and communities include funding for public transit infrastructure, as proposed as part of the Government's response to the impact of higher energy costs.
• Direct program expenses are projected to increase by $2.4 billion in 2005-06 and are expected to grow roughly in line with nominal GDP growth over the rest of the projection period, reflecting increased spending on foreign assistance and defence and the cost of initiatives announced since the 2005 budget, including those proposed in this Update.

Funding Commitments Made Under Bill C-48 Under Bill C-48-An Act to authorize the Minister of Finance to make certain payments-the Government committed to make payments in a number of priority areas from any surplus over and above $2 billion in 2005-06 and 2006-07. The funding set out in the Act is as follows: $900 million for the environment, including assisting public transit and a low-income housing energy retrofit program. $1.5 billion to enhance access to post-secondary education and support training. $1.6 billion for affordable housing. $500 million in foreign aid. The following table reviews the funding allocated since the 2005 budget that meets the commitments set out in Bill C-48. Over the planning period, the initiatives proposed by the Government in the policy areas set out in Bill C-48 total $9.4 billion, more than double the amount committed to in the Act. Further, the Government is committed to extend and deepen spending in these areas, particularly for affordable housing and on foreign aid. These expenses will be funded from the remaining planning surplus identified in Table 4.7. Initiatives Announced as Part of Bill C-48  Spending in Update    C-48   2005-06 2006-07  2007-08 to 2010-11 Total   (millions of dollars) Environment           Public transit 400 400   800   Energy-efficient retrofit program 50 100 400 550   Total 450 500 400 1,350 900 Training and Post-Secondary Education           Canada Access Grants   110 440 550   Post-Secondary Education Innovation Fund 1,000     1,000   Improvements to student financial assistance     2,190 2,190   Workplace skills development 77 476 2,969 3,522   Canada Graduate Scholarships   17 193 210   International education   20 130 150   M.B.A. scholarships   2 16 18   Research internships   2 19 21   Total 1,077 627 5,957 7,661 1,500 Affordable Housing           Canada-Ontario agreement-housing 150 150   300   Total 150 150   300 1,600 Foreign Aid           Pakistan 57     57 500 Total program spending proposed in the Update 1,734 1,277 6,357 9,368 4,500

Program expense-to-GDP ratio

• Program expenses as a share of GDP have 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 lowered program expenses. The increase in 2004-05 is due to one-time payments related to the Wait Times Reduction Fund ($4.3 billion), the new offshore arrangements with Newfoundland and Labrador and Nova Scotia ($2.8 billion) environmental liabilities related to Atomic Energy of Canada Limited ($2.3 billion) and the Medical Equipment Fund ($0.5 billion). Over the five-year planning period program expenses are projected to remain at 12 per cent, close to a postwar low.

Risks to the fiscal projection for 2005-06

• Fiscal projections are inherently uncertain. Annex 1 provides an overview of the three key sources of uncertainty in the projections. This section reviews the key near-term risks to the 2005-06 budgetary outcome.
• Personal income tax receipts are projected to grow by 1.4 per cent in 2005-06. This outlook reflects the strong 8.6-per-cent growth in personal income tax receipts recorded during the first six months of the year, offset by the cost of the personal income tax reduction measures proposed in this Update. Growth over the April-to-September period was considerably higher than the growth in personal income of about 41⁄2 per cent. In August and September, however, personal income tax growth slowed to an average of just 4.6 per cent year over year. The outlook for the full year is based on a projected easing in the growth of personal income tax receipts over the remainder of the year. Given the variability of personal income tax receipts over the first six months of the fiscal year, the outcome for the year is subject to considerable uncertainty. A 1-percentage-point difference equals about a $1-billion swing in revenues.
• Growth in corporate income tax revenues is highly variable. Results for the first six months of 2005-06 bear this out. To date receipts are up 25.9 per cent. However, absent timing factors related to monthly corporate tax remittance procedures, the year-to-date growth of corporate income tax receipts is estimated to be about 10 per cent, more closely in line with the projected growth in corporate profits in 2005 of 12 per cent. The current projection is for corporate income tax receipts for the year as a whole to rise 12.0 per cent. The actual outcome will be influenced by underlying profit growth, the composition of that profit growth by sector, as well as the tax-planning activities of corporations, particularly the extent to which corporations can use past losses to reduce current-year tax liabilities.
• For corporate income tax in particular, a disproportionate percentage of full-year receipts are collected in the December-to-March settlement period. This is the period when firms must pay any outstanding tax liabilities that were not met through their monthly instalment payments. If the final outcome for corporate income tax receipts in 2005-06 is higher (or lower) than projected, this would likely only be reflected in the Government's financial data in the settlement period, information which will not become fully available until May 2006, with the release of the March 2006 Fiscal Monitor.
• 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 following the close of the fiscal year as part of the normal year-end accrual adjustments. These liabilities can be large.
• A more detailed exploration of the key risks and uncertainties in the fiscal forecast is one of a number of recommendations made by Dr. Tim O'Neill in his report on the forecasting practices of the Department of Finance. The recommendations in the report and the actions taken by the Government are detailed below.

Review of Canadian Federal Fiscal Forecasting: Processes and Systems
Recommendation Action	Action
The Need for Transparency
1) In the Budget and the Economic and Fiscal Update, fully explore the key risks and uncertainties in the economic forecast and discuss their implications for fiscal projections.	Chapter 4 of Update
2) In the Budget and the Economic and Fiscal Update, provide details on the rules of thumb used to estimate the impacts on revenue and (certain) expenditure categories of key economic variables.	Annex 1 of Update
3) In major fiscal documents, spell out the details of the reconciliation between the National Accounts and Public Accounts fiscal forecasts.	Annex 3 of Update
4) In the annual Budget, provide documentation of the long-term (e.g. ten-year) track record of Finance's fiscal forecast accuracy.	Annex 2 of Update
5) Provide, as part of every third Fiscal Monitor, an analysis of fiscal developments in the current year and the risks to the projected fiscal outcome. Where possible, a complete update of the current year fiscal projections should be done.	There is insufficient new information available during the first quarter of the fiscal year to provide a meaningful update of the Government's projected fiscal position for that year. However, updates are provided at the six-month stage (the Economic and Fiscal Update) and nine-month stage (the budget) of the fiscal year. Any significant changes from the projected outcome for the year will also be discussed in the March Fiscal Monitor.
6) Increase the number of formal briefings by Finance to the House of Commons Finance Committee by at least one to be provided in the early summer.	Briefings occur at the discretion of the Finance Committee.
Improving Accuracy & Timeliness of Data
7) Statistics Canada and the Department of Finance jointly examine the causes of the significant GDP data revisions and explore options for mitigating them.	The Department of Finance and Statistics Canada will examine these issues, seeking areas for improvement.
8) Undertake research into changes over time in the relationship between the economy's performance and major revenue categories.	The Department of Finance-along with many other federal departments-conducts significant research on Canada's economy and economic and fiscal performance. Research results are readily available on the departmental websites.
9) Improve the in-year monitoring of Crown corporations' earnings and of departmental spending.	The Department of Finance has begun a more formal consultation process with Crown corporations regarding their financial results.
Fiscal Rules-Options
10) Shift from the no-deficit target to a fiscal rule of achieving a surplus, on average, over the economic cycle.	The Government recently tabled unanticipated surplus legislation (Bill C-67).
11) If the no-deficit rule is retained, provide, in each Budget, for contingent allocations of surplus surprises among tax cuts, spending initiatives and debt reduction.
12) Set the debt-to-GDP target, to be reached within ten years, lower than the current 25 per cent (i.e. 15 per cent-20 per cent) to ensure that future fiscal challenges can be met.	The objective for the debt-to-GDP ratio has been extended to below 20 per cent by 2020.
Possible Institutional Changes
13) The House of Commons Finance Committee discontinue the hiring of economic forecasters to provide quarterly fiscal projections.	This recommendation was made with respect to the House of Commons Finance Committee and is at the Committee's discretion.
14) Create an agency within government with a mandate to focus on the medium- to long-term fiscal implications of structural economic and demographic factors.	The Department of Finance-along with many other federal departments-conducts significant research on Canada's economy and economic and fiscal performance. Research results are readily available on the departmental websites.

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