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Five-Year Fiscal Projections

Highlights

• The fiscal outlook has improved since the May 2006 budget, largely due to lower than expected program expenses and stronger than expected personal income tax revenues. After accounting for the cost of measures announced since the budget and the Government's minimum tax and debt reduction commitments, the Government projects a planning surplus of $4.2 billion for 2006-07, $3.5 billion for 2007-08, $2.4 billion for 2008-09, $2.0 billion for 2009-10, $3.6 billion for 2010-11 and $2.9 billion for 2011-12. These surpluses are available for new spending and debt and tax reduction initiatives.
• The Government believes that we should aim as a country to eliminate Canada's total government net debt in less than a generation. The federal government will do its part by continuing to plan for annual debt reduction of $3 billion. Further, it is advancing its commitment to reduce the federal debt-to-GDP (gross domestic product) ratio to 25 per cent by one year, to 2012-13, from 35 per cent today.
• Lower debt will mean lower taxes. To ensure that Canadians benefit directly from reductions in Canada's debt, the Government will dedicate the effective interest savings from federal debt reduction each year to personal income tax reductions. To the extent that the Government realizes unanticipated surpluses, it will accelerate debt and personal income tax reductions.
• The Government is committed to keeping the growth of program expenses below the growth of the economy over the medium term. The Government took an important step in meeting this objective in 2005-06, when program expenses fell for the first time in nine years. For 2006-07 and 2007-08, program expenses are projected to be lower than estimated in the May 2006 budget. Keeping the growth of spending below the rate of growth of the economy will contribute to further reductions in public debt and in taxes.
• Revenues as a share of GDP are projected to decline from 16.2 per cent in 2005-06 to 15.3 per cent in 2011-12, reflecting the ongoing implementation of tax reduction measures, including the reductions announced in the Tax Fairness Plan.
• The Canada Employment Insurance Commission has set the 2007 premium rate at $1.80 per $100 of insurable earnings, down from the 2006 rate of $1.87. The premium rate reduction, combined with an increase in the maximum insurable earnings to $40,000, will save employers and employees $420 million.
• This Economic and Fiscal Update builds on the changes made in Budget 2006 to improve the transparency and accountability of budget planning. It includes the Government's own estimate of the surplus as well as the estimates of four leading private sector forecasting organizations to allow comparison between different views on the fiscal outlook.
• The fiscal projections are subject to risks associated with the economic outlook and changes in the relationship between economic growth and tax revenues, particularly personal and corporate income tax revenues. For 2006-07, the level of departmental spending is also an important variable. The projections of the Government's fiscal position for the current and the next two fiscal years will be updated in the budget.

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New Approach to Budget Planning and Fiscal Forecasting

Budget 2006 introduced a new approach to budget planning. Under this new approach:

• The Government will plan on achieving annual debt reduction of $3 billion.
• The former practice of adjusting the budget projections for economic prudence has been discontinued.
• Quarterly updates of the fiscal outlook for the current year are now provided.
• The focus of budget planning will be on the near term, where uncertainties are fewer and the Government can reasonably be held to account.

This Economic and Fiscal Update builds on the changes made in Budget 2006.

• Canada's New Government believes that we should aim as a country to eliminate Canada's total government net debt by 2021 at the latest.
• The federal government will show leadership by continuing to plan on annual debt reduction of $3 billion.
• The federal government is also advancing its commitment to reduce the federal debt-to-GDP ratio to 25 per cent by one year, to 2012-13. This will bring the federal debt burden to its lowest level since the late 1970s.
• To ensure that Canadians benefit directly from reductions in the federal debt, the Government will dedicate the effective interest savings from debt reduction each year to personal income tax reductions.
• To the extent that the Government realizes unanticipated surpluses, it will accelerate debt and personal income tax reductions.
• For planning purposes and to show the medium-term implications of current policies, The Economic and Fiscal Update presents fiscal projections for the current and the next five years. However, since a short planning horizon is appropriate for budgetary decisions, the budget will continue to focus on a two-year horizon.
• In this Update, the Government's fiscal projection is presented alongside those of four private sector organizations. While the Government's projection is the basis for fiscal planning, presenting the four private sector fiscal projections separately allows comparison between different views on the fiscal outlook.
• To incorporate objective economic assumptions, the Government's fiscal projection is based on the average of private sector economic forecasts, consistent with past practice. A total of 15 economic forecasters responded to the latest survey by the Department of Finance. The four private sector organizations used their own economic assumptions to prepare their fiscal projections.

Changes in the Fiscal Outlook Since the May 2006 Budget

Table 2.1
Summary of Changes in the Fiscal Outlook Since the May 2006 Budget

	Actual	Projection
	2005-06	2006-07	2007-08
	(billions of dollars)
May 2006 budget underlying surplus	8.0	3.6	4.4
Impact of economic and  fiscal developments
Budgetary revenues
Personal income tax	0.7	2.9	2.9
Corporate income tax	-2.8	-2.6	-1.8
Goods and services tax	1.1	1.1	1.1
Other revenues	2.3	0.4	0.6
Total revenues	1.3	1.9	2.8
Program expenses
Transfer payments	0.0	0.2	0.0
Direct program expenses	3.9	2.2	1.2
Total program expenses	3.9	2.4	1.2
Public debt charges	-0.1	0.2	0.2
Total economic and fiscal developments	5.2	4.4	4.1
Impact of policy changes
Net impact of measures announced    since the budget1		-0.8	-1.2
Revised underlying surplus	13.2	7.2	7.3
Notes: A positive number implies an improvement in the budgetary balance. A negative number implies a deterioration in the budgetary balance. Totals may not add due to rounding. 1A detailed list of the measures is provided in Table 2.2.

Table 2.1 shows the changes to the Government's fiscal position as a result of economic and fiscal developments since the May 2006 budget. The Government's fiscal situation is now stronger than projected at the time of the budget, primarily due to lower than expected program expenses and higher than expected personal income tax revenues.

In Budget 2006, the underlying surplus was estimated at $8.0 billion for 2005-06, $3.6 billion for 2006-07 and $4.4 billion for 2007-08. The final budget surplus for 2005-06 was larger than expected primarily because of lower than expected program expenses. Program expenses were $3.9 billion lower while revenues were $1.3 billion higher than projected in the budget, largely reflecting one-time accounting adjustments. The surplus resulted in a corresponding reduction in the federal debt.

Going forward, revenues are projected to be $1.9 billion higher in 2006-07 and $2.8 billion higher in 2007-08. The increase in 2006-07 is largely driven by an upward revision to projected personal income tax revenues, which have grown at roughly twice the rate of growth in personal income in the first six months of 2006-07. The higher level of personal income tax revenues in 2006-07 carries forward to 2007-08.

In contrast, corporate income tax revenues in 2006-07 are projected to be $2.6 billion lower than projected at the time of the May 2006 budget. This revision reflects the carry-forward of the lower than expected 2005-06 outcome, when corporate income tax revenues grew more slowly than corporate profits. The impact of the lower 2005-06 outcome is expected to be mitigated somewhat in 2007-08, due to stronger forecast growth in corporate profits relative to the budget projection.

Goods and services tax (GST) revenues are projected to be higher than projected at the time of the budget, reflecting the carry-forward of higher than expected GST revenues in 2005-06.

Before the cost of measures announced since the budget, program expenses are expected to be $2.4 billion lower in 2006-07 and $1.2 billion lower in 2007-08 than expected at the time of the budget, largely reflecting the Government's commitment to implement new programs only when they are ready. Spending on a number of programs announced in the May 2006 budget, as well as programs announced by the previous government, will be lower than projected at the time of the budget. This is in addition to the $1 billion of savings this year and next announced in Budget 2006 and confirmed by the President of the Treasury Board in September.

In the 2005 budget, the previous government launched a reform of government procurement. Savings from this initiative were estimated at $204 million for 2006-07, rising to $888 million per year for 2009-10 and subsequent years.

After taking office, Canada's New Government undertook an assessment of the procurement reform initiative and has determined that the projected savings were significantly over-estimated. The Government currently estimates that the shortfall will be $1.4 billion over the 2007-08 to 2011-12 period. This revised fiscal target is reflected in the spending projections. Additional work is required and the Government will report on progress in the 2007 budget.

The net impact of new measures announced since Budget 2006 is $0.8 billion in 2006-07 and $1.2 billion in 2007-08. A detailed list of the measures is provided in Table 2.2. Spending measures include costs associated with extending Canada's mission in Afghanistan, the evacuation of citizens from Lebanon, as well as funding for the 2010 Olympic Games in Vancouver. On the revenue side, tax reduction measures include the increase of the age credit and pension income splitting announced as part of the Government's Tax Fairness Plan. The Canada-United States Softwood Lumber Agreement will lead to higher revenues and expenses, but it will have no net fiscal impact as the revenue and expense flows are offsetting.

These developments result in a revised underlying surplus of $7.2 billion in 2006-07 and $7.3 billion in 2007-08.

Table 2.2
Measures Announced Since the May 2006 Budget

	2006-07	2007-08
	(millions of dollars)
Spending measures
Afghanistan mission	206	515
Lebanon evacuation	94
2010 Olympic Games		50
Extension of employment insurance (EI) pilots-  additional five weeks1	14	92
Meteorological services in Newfoundland and Labrador	2	2
Older workers in vulnerable communities	21	38
Eastern Ontario Development Program	10
Extension of transitional measures for EI1	13	25
Recognition progams for ethnocultural groups		6
Transformational Plan-Department of   Fisheries and Oceans	57	59
City of Québec airport	15
Egmont Group secretariat		2
Subtotal	432	788
Less
Funding included in the fiscal framework	218	603
Revenue measures
Increase of the age credit	405	345
Pension income splitting	165	675
Beer and wine excise duty reduction	6	8
Subtotal	576	1,028
Canada-United States Softwood  Lumber Agreement (SLA)
Spending impact
Remittance to provinces of export charge revenue	482	516
Transfer of revenue to U.S. interests     under terms of SLA	500
Revenue impact
Export charge	-482	-516
Special charge	-500
Net cost	0	0
Net cost of measures announced since the May 2006 budget	790	1,213
Note: Totals may not add due to rounding. 1 Fully reflected in the EI rate.

Summary of Five-Year Fiscal Projection

Table 2.3
Summary Statement of Transactions

	Actual	Projection
	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11	2011-12
	(billions of dollars)
Budgetary revenues	222.2	229.4	238.0	245.4	253.9	264.6	276.8
Program expenses	175.2	187.6	196.1	204.4	213.1	220.7	228.6
Public debt charges	33.8	34.6	34.7	34.6	34.7	34.6	34.6
Total expenses	209.0	222.2	230.8	239.1	247.8	255.2	263.1
Underlying surplus	13.2	7.2	7.3	6.4	6.1	9.4	13.7
Government fiscal commitments
Planned debt reduction		3.0	3.0	3.0	3.0	3.0	3.0
Reduce GST to 5 per cent						1.5	6.4
Interest savings dedicated to  personal income tax reductions
$13.2-billion debt reduction    in 2005-06			0.7	0.7	0.7	0.7	0.7
$3-billion-per-year debt    reduction starting in 2006-07			0.2	0.3	0.5	0.6	0.8
Total			0.8	1.0	1.1	1.3	1.4
Planning surplus1		4.2	3.5	2.4	2.0	3.6	2.9
Federal debt2	481.5	478.5	475.5	472.5	469.5	466.5	463.5
Per cent of GDP3
Budgetary revenues	16.2	15.9	15.8	15.5	15.3	15.3	15.3
Program expenses	12.8	13.0	13.0	12.9	12.9	12.7	12.6
Public debt charges	2.5	2.4	2.3	2.2	2.1	2.0	1.9
Total expenses	15.2	15.4	15.3	15.1	15.0	14.7	14.5
Federal debt	35.1	33.2	31.6	29.9	28.4	26.9	25.6
Nominal GDP (billions of dollars, calendar year)	1,371	1,440	1,506	1,580	1,655	1,734	1,813
Note: Totals may not add due to rounding. 1 The remaining surplus of $4.2 billion in 2006-07 will be used to reduce federal debt and fund other priorities. 2 For planning purposes, federal debt is assumed to be reduced by $3 billion per year. 3 These calculations do not reflect the commitment to dedicate interest savings to personal income tax reductions and the reduction of the GST to 5 per cent.

Table 2.3 summarizes the Government's fiscal projections for the current and the next five years.

Budgetary revenues are expected to increase by $7.2 billion in 2006-07, $8.6 billion in 2007-08, $7.4 billion in 2008-09 and $8.5 billion in 2009-10. Thereafter, revenues increase by $10.7 billion in 2010-11 and $12.2 billion in 2011-12. This takes into account the measures announced since the budget, including tax reductions announced in the Tax Fairness Plan.

In 2005-06, program expenses fell $1.1 billion, the first decline in nine years. With this decline, program expenses in 2005-06 were $3.9 billion lower than projected in the May 2006 budget. Reflecting the Government's diligent approach to expenditure management, program expenses in 2006-07 and 2007-08 are also projected to be lower than estimated in the budget by $1.2 billion and $0.5 billion respectively. This takes into account the cost of measures announced since the budget, including the Canada-United States Softwood Lumber Agreement, where the federal government acts as a financial intermediary, with incremental spending offset by additional revenues.

From 2008-09 to 2011-12, growth in program expenses is expected to average 3.9 per cent, well below average GDP growth over that period.

The increase in interest rates over the past year is expected to raise public debt charges by $0.8 billion in 2006-07. Thereafter, public debt charges are expected to remain relatively unchanged over the five-year horizon.

Accounting for planned annual debt reduction of $3 billion, the reduction of the GST to 5 per cent and the commitment to dedicate interest savings to personal income tax reductions (see box on interest savings from debt reduction) leaves a planning surplus of $4.2 billion in 2006-07, $3.5 billion in 2007-08, $2.4 billion in 2008-09 and $2.0 billion in 2009-10. The planning surplus rises in the following two years, to $3.6 billion and $2.9 billion. These surpluses are available for new spending and debt and tax reduction initiatives.

Interest Savings From Debt Reduction To ensure that Canadians benefit directly from reductions in the federal debt, the Government will dedicate the effective interest savings from debt reduction each year to personal income tax reductions. The effective interest savings resulting from debt reduction will be calculated as the annual reduction in federal debt multiplied by the average effective interest rate on the Government's unmatured debt, currently 5 per cent. Annual reductions in the federal debt are reflected in both decreases in the Government's interest-bearing debt, which directly reduce interest costs, as well as increases in the Government's net assets. Most of these net assets generate immediate returns or can be converted to cash in the future to pay down interest-bearing debt. The commitment will apply to debt reduction for 2005-06 and subsequent fiscal years. Combined with the interest savings from the $13.2-billion surplus realized in 2005-06, the Government's planned debt reduction of $3 billion per year will create room for personal income tax reductions of about $800 million in 2007-08, rising to $1.4 billion per year by 2011-12.

Revenue Ratio Declining Due to Tax Reductions

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

The status quo revenue ratio is projected to decline from 16.2 per cent in 2005-06 to 15.9 per cent in 2006-07, reflecting the impact of tax reduction measures, principally the 1-percentage-point reduction to the GST rate. Over the medium term, revenues are projected to grow more slowly than the economy, reflecting the ongoing implementation of tax reduction measures, including the reductions announced in the Tax Fairness Plan and increases to the basic personal amount. The commitment to dedicate interest savings to personal income tax reductions and the reduction of the GST to 5 per cent would lower the revenue ratio further to 14.8 per cent by 2011-12.

New Tax Reduction Measures Since Budget 2006 Since Budget 2006, the Government has demonstrated that tax relief is a priority by announcing and committing to tax reductions, totalling $22.2 billion over six years, that will benefit all Canadians. The Tax Fairness Plan, announced on October 31, will reduce taxes by restoring balance and fairness to the federal tax system. Under this Plan, the Government will: Enhance the age credit by increasing it by $1,000 to $5,066, effective January 1, 2006. Introduce a new mechanism for pension income splitting by allowing Canadian residents to allocate to their resident spouse (or common-law partner) up to one-half of income qualifying for the existing pension income tax credit. Introduce a distribution tax on distributions from publicly traded income trusts and limited partnerships. Reduce the general corporate income tax rate by one-half percentage point, to 18.5 per cent, beginning in 2011. In addition, the employment insurance (EI) premium rate will be reduced in 2007 to $1.80 per $100 of insurable earnings, from $1.87 in 2006. This premium rate is forecast by the Human Resources and Social Development (HRSD) Chief Actuary to generate just enough premium revenue in 2007 to cover EI program costs for that year. The HRSD Chief Actuary has also calculated the maximum insurable earnings (MIE) for 2007 as being $40,000, up $1,000 from its 2006 level. Taking into account the additional contributions associated with the rise in the MIE, the reduction in the rate will save employers and employees $420 million compared to the 2006 premium rate and MIE. To ensure that Canadians benefit directly from reductions in the federal debt, the Government will dedicate the effective interest savings from debt reduction each year to personal income tax reductions. Combined with the interest savings from the $13.2-billion surplus realized in 2005-06, the Government's planned debt reduction of $3 billion per year will create room for personal income tax reductions of about $800 million in 2007-08, rising to $1.4 billion per year by 2011-12. In addition, the Government will reduce the GST rate to 5 per cent starting no later than January 1, 2011, leading to additional savings for Canadians of about $7.9 billion.   2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Total   (millions of dollars) Tax Fairness Plan 570 1,020 1,065 1,105 1,240 1,545 6,545 EI premiums 125 420 420 420 420 420 2,225 Interest savings   810 960 1,110 1,260 1,410 5,550 GST         1,500 6,370 7,870 Total tax relief commitments   since Budget 2006 695 2,250 2,445 2,635 4,420 9,745 22,190

Program Expenses-to-GDP Ratio Lower Than Projected in Budget 2006

Following unsustainable increases between 1999-2000 and 2004-05, program expenses as a share of GDP declined significantly in 2005-06 to 12.8 per cent from 13.7 per cent in 2004-05. For 2006-07 and 2007-08, program expenses as a percentage of GDP are lower than projected in Budget 2006, reflecting tight control over the implementation of programs announced in the 2006 and previous budgets. In 2008-09 and beyond, program expenses are projected to decline as a proportion of GDP on a status quo basis.

In some years, growth in program expenses may exceed the rate of growth of the economy, for example because economic growth is lower than expected or because unforeseen factors require a temporary increase in spending. In general, and as a matter of principle, the Government is committed to keeping the growth of program expenses below the growth of the economy over the medium term. The Government took an important step in meeting this objective in 2005-06, when program expenses fell for the first time in nine years. To the extent spending growth is kept below the growth in the economy, this will contribute to further reductions in public debt and in taxes given the commitment to dedicate interest savings to tax reductions.

Debt-to-GDP Ratio Falling

The federal debt-to-GDP ratio (accumulated deficit) stood at 38.3 per cent in 2004-05. As a result of the $13.2-billion surplus in 2005-06 the ratio dropped to 35.1 per cent, its lowest level in 24 years. For planning purposes, federal debt is assumed to be reduced by $3 billion each year. Taking into account planned debt reduction, along with the projected growth of the economy, the debt-to-GDP ratio is expected to fall to 25.6 per cent in 2011-12, on target to meeting the new medium-term objective of 25 per cent by 2012-13. This will bring the federal debt burden to its lowest level since the late 1970s and will contribute towards the elimination of total government net debt in less than a generation.

This goal of eliminating total government net debt can be achieved by 2021 if provincial-territorial governments maintain balanced budgets and the Canada Pension Plan/Quebec Pension Plan continue to build assets as currently projected. For its part, Canada's New Government will continue to plan for an annual debt reduction of $3 billion. Any surpluses recorded by provincial-territorial governments and federal surpluses in excess of $3 billion will contribute to accelerate the elimination of Canada's total government net debt.

The falling debt burden is expected to result in declines in the share of revenues devoted to public debt charges. To ensure that Canadians benefit directly from reductions in the federal debt, the Government will dedicate the effective interest savings from debt reduction each year to personal income tax reductions.

Federal Debt (Accumulated Deficit) and Total Government Net Debt Federal Debt (Accumulated Deficit) Since 2002-03, the financial statements of the Government of Canada have been presented on a full accrual basis of accounting. Under the previous accounting standard-modified accrual accounting-net debt and the accumulated deficit were identical. Under the new standard, net debt now includes a comprehensive costing for financial liabilities but excludes non-financial assets. The accumulated deficit includes both. It is the sum of all surpluses and deficits in the past. Federal debt, referred to in the budget documents and in the Annual Financial Report of the Government of Canada, is the accumulated deficit. It is the federal government's main measure of debt, as annual changes in this measure correspond to the budgetary balance. Total Government Net Debt The full impact of public debt on the economy includes not only the federal government's debt, but also debt of provincial-territorial and local governments, and the assets of the Canada Pension Plan and Quebec Pension Plan. That is why a standard measure of debt used by organizations such as the Organisation for Economic Co-operation and Development (OECD) is total government net debt. The OECD definition of total government net debt allows for comparisons across countries. It is calculated on a National Accounts basis. As such, the OECD definition is not directly comparable to federal debt (accumulated deficit) and excludes government employee unfunded pension liabilities, which are fully accounted for in federal debt (accumulated deficit). The annex contains more details.

Outlook for Budgetary Revenues

Table 2.4
Revenue Outlook

	Actual	Projection
	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11	2011-12
	(millions of dollars)
Tax revenues
Income tax
Personal income tax	103,691	111,630	117,390	123,355	129,260	136,850	144,405
Corporate income tax	31,724	32,780	35,005	33,890	33,720	33,690	35,400
Other income tax	4,529	4,340	4,315	4,545	4,680	4,655	4,420
Total income tax	139,944	148,750	156,710	161,790	167,660	175,195	184,225
Excise taxes/duties
Goods and services tax	33,020	30,970	30,895	32,150	33,595	35,320	37,005
Customs import duties	3,330	3,530	3,710	3,885	4,045	4,195	4,360
Other excise taxes/ duties	9,806	10,165	10,245	10,205	10,235	10,050	9,915
Total excise taxes/ duties	46,156	44,665	44,850	46,240	47,875	49,565	51,280
Total tax revenues	186,100	193,415	201,560	208,030	215,535	224,760	235,505
Employment insurance   premium revenues	16,535	16,155	16,140	16,655	17,105	17,730	18,370
Other revenues	19,568	19,860	20,335	20,745	21,280	22,110	22,925
Total budgetary revenues	222,203	229,430	238,035	245,430	253,920	264,600	276,800
Per cent of GDP
Personal income tax	7.6	7.8	7.8	7.8	7.8	7.9	8.0
Corporate income tax	2.3	2.3	2.3	2.1	2.0	1.9	2.0
Goods and services tax	2.4	2.2	2.1	2.0	2.0	2.0	2.0
Total tax revenues	13.6	13.4	13.4	13.2	13.0	13.0	13.0
Employment insurance     premium revenues	1.2	1.1	1.1	1.1	1.0	1.0	1.0
Other revenues	1.4	1.4	1.4	1.3	1.3	1.3	1.3
Total	16.2	15.9	15.8	15.5	15.3	15.3	15.3
Note: Totals may not add due to rounding

Table 2.4 provides an overview of the Government's fiscal projections for budgetary revenues. Budgetary revenues are expected to grow by 3.3 per cent in 2006-07, 3.8 per cent in 2007-08 and 3.1 per cent in 2008-09. Revenue growth averages 4.1 per cent per year in the three years to 2011-12. These growth rates are lower than average growth in the past two years of 5.8 per cent, reflecting the expected slowing in nominal GDP growth and the implementation of tax reduction measures.

Personal income tax revenues-the largest component of budgetary revenues-are projected to increase by $7.9 billion, or 7.7 per cent, in 2006-07, significantly higher than the 4.7-per cent growth in the underlying personal income tax base. This updated projection is consistent with the strong growth in personal income tax revenues recorded last year and through the first half of this fiscal year. The projection incorporates the cost of the recently announced increase in the age credit, retroactive to January 1, 2006, and the introduction of pension income splitting, effective January 1, 2007. In the following three years, personal income tax revenues are projected to grow more in line with GDP, reflecting the impact of tax measures offsetting the upward drift in tax revenues due to projected real income gains.

In 2006-07, corporate income tax revenues are expected to increase 3.3 per cent, following a gain of 5.9 per cent in the previous year. The more modest growth reflects smaller gains in profitability in 2006, the elimination of the corporate capital tax as of Janaury 1, 2006, and the ongoing reduction in the corporate surtax. Absent policy changes, corporate income tax revenues are projected to grow largely in line with profit growth over the remainder of the projection period. From 2008-09 to 2010-11, corporate income tax revenues are projected to decline, reflecting the elimination of the corporate surtax and the legislated reductions in the general tax rate, including the recently announced 0.5-percentage-point reduction in the general corporate income tax rate effective in 2011. The projection of corporate tax revenues reflects the tax on distributions from publicly traded flow-through entities, effective in 2011, introduced under the Government's Tax Fairness Plan, although this is offset in part by lower personal income taxes and lower non-resident withholding taxes.

Other income tax revenues-largely withholding taxes levied on non-residents-are expected to decline by 4.2 per cent in 2006-07, following a 27.2-per-cent increase last year, which was attributable to strong growth in dividend payments to non-residents. Other income tax revenues are projected to decline by 0.5 per cent in 2010-11 and by 5.0 per cent in 2011-12 with the introduction of the tax on publicly traded flow-through entities under the Tax Fairness Plan. Under the new regime, certain distributions of these entities will be subject to tax, thereby reducing distributions to non-residents.

GST revenues are expected to decline by 6.2 per cent in 2006-07, reflecting the 1-percentage-point reduction in the GST rate, effective July 1, 2006. GST revenues decline by a further 0.2 per cent in 2007-08, the first fiscal year in which the lower GST rate is fully reflected. Thereafter, GST revenues grow in line with the underlying consumption base.

After a decline of 2.0 per cent in 2005-06, other excise taxes and duties are projected to rise 3.7 per cent in 2006-07, largely reflecting the introduction of an export charge on softwood lumber exports to the U.S. effective October 12, 2006, consistent with the Canada-United States Softwood Lumber Agreement. The new export charge is determined in part by the price of softwood lumber, the volume of Canadian exports by region and the border measure that a province selects. The new export charge will have no net impact on the budgetary balance as export charge revenues collected by the Government of Canada, net of the costs of administering the agreement, will be distributed to provincial governments.

EI premium revenues are expected to decline 2.3 per cent in 2006-07, reflecting the decline in the premium rate from $1.95 to $1.87 per $100 of insurable earnings effective January 1, 2006, a further reduction to $1.80 per $100 of insurable earnings in January 2007, as well as the transfer to the province of Quebec of the responsibility for delivering maternity and parental benefits in that province along with the associated premium room, effective January 1, 2006. Consistent with the EI premium rate-setting mechanism, implemented in 2005, EI premiums are assumed to match projected EI program costs in the outer years of the projection.

Starting in 2007, insurable earnings covered by EI will increase because of the indexation of annual maximum insurable earnings to the growth in the average industrial wage. In 1996, the maximum level of insurable earnings, or the level of employment income on which EI premiums are payable, under the EI legislation was frozen at $39,000 until the average industrial wage reached that level. This will occur in 2007, with the result that annual maximum insurable earnings will increase to $40,000, rising thereafter in line with the average industrial wage. This change affects future growth in both premium revenues and benefits.

Other revenues include those of consolidated Crown corporations, net gains/losses from enterprise Crown corporations, foreign exchange revenues, returns on investments and proceeds from the sales of goods and services. These revenues are volatile, owing partly to the impact of exchange rate movements on the Canadian-dollar value of foreign-denominated interest-bearing assets and to net gains/losses from enterprise Crown corporations. In 2006-07, other revenues are expected to increase by 1.5 per cent. This weak growth reflects lower expected foreign exchange revenues, which were boosted last year by the change in the accounting treatment of the Government's subscriptions with the International Monetary Fund.

Outlook for Program Expenses

Table 2.5
Program Expenses Outlook

	Actual	Projection
	2005-06	2006-07	2007-08	2008-09	2009-10	2010-11	2011-12
	(millions of dollars)
Major transfers to persons
Elderly benefits	28,992	30,615	32,060	33,435	34,915	36,505	38,270
Employment insurance benefits1	14,417	14,375	15,075	15,565	15,980	16,560	17,150
Children's benefits	9,200	11,120	11,875	11,880	11,915	11,960	12,005
Total	52,609	56,110	59,010	60,880	62,810	65,025	67,425
Major transfers to other   levels of government
Federal transfers in support      of health and other programs	27,225	28,640	30,150	31,430	33,035	34,475	36,000
Fiscal arrangements	15,739	13,055	13,190	13,640	14,105	14,580	15,065
Alternative Payments for     Standing Programs	-2,731	-2,870	-3,010	-3,165	-3,325	-3,525	-3,750
Early learning and child care		650
Canada's cities and communities	582	600	800	1,000	2,000	2,000	2,000
Total	40,815	40,075	41,130	42,905	45,815	47,530	49,315
Direct program expenses	81,789	91,430	95,935	100,650	104,480	108,100	111,825
Total program expenses	175,213	187,615	196,075	204,435	213,105	220,655	228,565
Per cent of GDP
Major transfers to persons	3.8	3.9	3.9	3.9	3.8	3.8	3.7
Major transfers to other levels     of government	3.0	2.8	2.7	2.7	2.8	2.7	2.7
Direct program expenses	6.0	6.3	6.4	6.4	6.3	6.2	6.2
Total program expenses	12.8	13.0	13.0	12.9	12.9	12.7	12.6
Note: Totals may not add due to rounding. 1  EI benefits include regular, sickness, maternity, parental, compassionate care, fishing and work-sharing benefits, as well as employment benefits and support measures. These represent 90 per cent of total EI program expenses. The remaining EI program costs (amounting to $1.6 billion in 2005-06) relate to administration costs.

Table 2.5 provides an overview of the Government's projections for program expenses. Program expenses are expected to grow by 7.1 per cent in 2006-07 and 4.5 per cent in 2007-08. This growth reflects both lower expenses in 2005-06 and the slower than anticipated implementation of programs announced in the 2006 and previous budgets. Indeed, for 2006-07 and 2007-08, program expenses are lower than projected in Budget 2006. Growth in the following four years averages 3.9 per cent, well below growth of the economy over that period.

Program expenses consist of three major components: major transfers to persons, major transfers to other levels of government and direct program expenses-the latter includes subsidies and other transfers, as well as National Defence and all other departmental operating expenses.

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

• Elderly benefits grow by $1.6 billion, or 5.6 per cent, in 2006-07, reflecting the $18-per-month increases in the Guaranteed Income Supplement in January 2006 and January 2007. In the following five years, elderly benefits grow by an average of 4.6 per cent per year, reflecting the growth in the elderly population and changes in consumer prices, to which benefits are fully indexed.
• EI benefits are estimated to decline slightly in 2006-07, reflecting improved labour market conditions as well as the transfer to the province of Quebec of the responsibility for delivering maternity and parental benefits in that province under the new Quebec Parental Insurance Plan starting January 1, 2006. This is partly offset by the first full-year impact of the labour market pilot projects, relating to high-unemployment regions, announced in 2005-06. The projected increase in 2007-08 reflects a rise in the private sector forecast of the number of unemployed (see Chapter 1). Furthermore, starting in 2007, EI benefits are projected to increase because of the indexation of annual maximum insurable earnings to the growth in the average industrial wage in 2007.
• Children's benefits, including the Canada Child Tax Benefit (CCTB) and the Universal Child Care Benefit (UCCB), are expected to rise by $1.9 billion in 2006-07 and $0.8 billion in 2007-08, primarily reflecting the introduction of the UCCB on July 1, 2006. Starting in 2008-09, the growth in children's benefits is largely determined by the growth in the number of children and changes in consumer prices, to which the CCTB is indexed.

Major transfers to other levels of government in 2006-07 are $0.7 billion, or 1.8 per cent, lower than in 2005-06, reflecting one-time payments made to the provinces and territories for post-secondary education infrastructure, public transit and affordable housing. Over the medium term, transfers increase from just over $40 billion in 2006-07 to almost $50 billion in 2011-12, averaging 4.2 per cent growth per year. This growth reflects the impact of rising transfers for health, equalization and Territorial Formula Financing, as well as growing support for cities and communities. For planning purposes, this Update assumes the continuation of support for Canada's cities and communities of $2 billion for 2010-11 and 2011-12.

Direct program expenses include expenses for National Defence, Crown corporations, transfers administered by departments (for example transfers for farm income support and Aboriginal programming) and departmental operating costs. In 2005-06, direct program expenses declined by 1.6 per cent. For 2006-07 and 2007-08, including measures announced since the May 2006 budget, the total amount of direct program expenses is $1.0 billion and $0.5 billion lower than expected at the time of the budget, reflecting tight control over the implementation of programs announced in the 2006 and previous budgets. For planning purposes, this Update assumes that support for all infrastructure-related projects is maintained through 2011-12. Starting in 2008-09, growth in direct program expenses is projected to average less than 4 per cent per year.

Private Sector Five-Year Fiscal Projections

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

	2006-07	2007-08	2008-09	2009-10	2010-11	2011-12
	(billions of dollars)
Conference Board of Canada	5.3	4.4	7.2	7.6	10.8	15.3
University of Toronto	7.0	4.5	5.4	6.6	9.9	13.1
Global Insight	6.7	5.4	6.5	7.2	9.7	11.9
Centre for Spatial Economics	6.9	7.6	7.9	7.2	9.5	13.8
Average of private sector projections	6.5	5.5	6.8	7.2	10.0	13.5
Range of private sector projections	1.7	3.2	2.5	0.9	1.3	3.5
Government projection based   on private sector economic assumptions	7.2	7.3	6.4	6.1	9.4	13.7
Difference between government   projection and the average   of private sector projections	0.7	1.8	-0.4	-1.1	-0.6	0.2
Note: Numbers may not add due to rounding.

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

Under the new approach, the four organizations each provided their own fiscal projections on both a National Accounts and a Public Accounts basis. The process involved three key steps.

• Each of the four private sector forecasters developed projections of the federal budget balance on a National Accounts basis, based on their own economic forecasts and on tax and spending policies in place at the time of the May 2006 budget.
• These projections were then translated to a Public Accounts basis. The conversions were largely prepared by the Department of Finance, subject to review and approval by the private sector organizations.
• Finally, the Department of Finance adjusted the private sector Public Accounts projections to reflect the cost of initiatives announced since the budget and the updated projection of direct program expenses.

These figures can be directly compared to the Government's projection of the underlying surplus presented in Table 2.3. For reference, the projections on a National Accounts basis prepared by each organization are provided at the end of this chapter.

The four private sector organizations prepared their fiscal projections based on information publicly available as of the end of September. In preparing its fiscal projections, the Government had access to financial results for August and September 2006, which were not available to the four private sector organizations when they completed their projections.

Table 2.6 presents the four private sector forecasting organizations' projections of the underlying surplus. On average, the four private sector organizations project a surplus of $6.5 billion in 2006-07 and $5.5 billion in 2007-08, rising thereafter to $6.8 billion in 2008-09, $7.2 billion in 2009-10, $10.0 billion in 2010-11 and $13.5 billion in 2011-12.

The range between the lowest and highest projection is $1.7 billion in the first year of the planning period. It rises to above $3 billion in 2007-08 and falls to below $3 billion in the following three years. In the last year of the projection, where uncertainty is greatest, the range widens to $3.5 billion. Compared to the sum of revenues and expenses, (over $430 billion in 2005-06 and growing), the range of private sector projections is very small.

When compared to the private sector average, the Government's projection of the underlying surplus is larger in the first two years but lower in subsequent years, with the exception of 2011-12, when the Government's projection is slightly higher. In 2006-07 and 2007-08, the Government projects budgetary surpluses that are $0.7 billion and $1.8 billion larger than the private sector average. While underlying assumptions for GDP growth are similar in the Government and private sector fiscal projections, the Government expects a higher tax yield in these years. The higher tax yield in the Government's projection reflects a view that the conditions that led to a high tax yield in 2005-06 and in the first half of the current fiscal year will persist over the near term.

The differences between the Government's projection and the average private sector projection are relatively small in relation to combined federal revenues and expenses. In 2007-08, the year in which the difference is largest, the $1.8-billion difference represents 0.4 per cent of the combined revenues and expenses projected by the Government for that year.

Given the inherent uncertainty underlying economic and fiscal projections, the differences between the five projections presented are remarkably small. This should not be interpreted as an indication that the underlying uncertainty is negligible. Rather, it should be viewed as a sign that, overall, the various views converge to similar outcomes, in spite of the underlying uncertainty. The following section discusses the risks and uncertainties underlying the fiscal projections.

Risks to the Fiscal Projections

Risks associated with the fiscal projections primarily relate to risks to the Canadian economic outlook and volatility in the relationship between fiscal variables and the underlying activity to which they relate.

Risks to the Canadian Economic Outlook

As detailed in Chapter 1, forecasts of the economic outlook contain an unavoidable level of uncertainty. Key economic concerns for the fiscal projections are provided below.

• Economic developments since September point to lower commodity prices, which could lead to slower than expected nominal GDP growth for the current year. Going forward, a larger than expected decline in commodity prices, which are currently well above their historical levels, would translate into lower than expected Canadian nominal GDP over the medium term and put downward pressure on budgetary revenues.
• The ongoing correction in the U.S. housing market could be greater than expected, leading to weaker than expected U.S. consumer spending and residential investment. This would have negative implications for Canadian economic growth.
• Global current account imbalances remain large and continue to pose a medium-term risk to the economic outlook. While several factors could help reduce imbalances, there is a risk that the main channel of adjustment could be a further depreciation of the U.S. dollar against floating currencies such as the Canadian dollar.

Tables illustrating the sensitivity of the budget balance to a number of economic shocks are provided later in this chapter. These tables are generalized rules of thumb that provide a guide to the impact of changes in economic assumptions on the fiscal projections.

Risks to the Fiscal Projections

Even if the economic outlook were known with certainty, there would still be risks associated with the fiscal projections because of the uncertainty in the translation of economic developments into spending and tax revenues. Growth in tax bases does not always translate in a predictable way into tax revenues.

The following are the key near-term risks to the projections.

• Growth in personal income tax revenues was almost twice the rate of growth in the personal income tax base through the first six months of 2006-07, a faster rate of growth relative to the tax base than would normally be expected. The sensitivity of personal income tax revenues to changes in the personal income tax base is summarized by a measure called the income elasticity of personal income tax revenues. This captures the change in tax revenues resulting from a 1-per-cent change in personal income. A 1-per-cent increase in personal income generally translates into an increase of more than 1 per cent in personal income tax revenues, due to the progressivity of the tax system-taxpayers pay progressively higher tax rates as their earned real income rises. In a "normal" year, where income gains are distributed evenly across income groups and all sources of income increase at roughly the same rate, the elasticity is about 1.2. However, in any given year this relationship may not hold. For example, during years when real income gains are particularly strong or capital gains realizations are high, the elasticity will be higher. Conversely, declines in real incomes and capital losses considerably lower the elasticity. In 2001-02, following the stock market correction, the elasticity was just 0.3. Every 0.1-percentage-point change in the elasticity translates into about a $500-million change in revenues. The personal income tax elasticity is assumed to be about 1.8 in 2006-07, before falling to its historical average of 1.2 in 2007-08. Given the recent slowing in nominal GDP growth from unusually high rates of growth in 2004 and 2005, the assumed drop in the personal income tax elasticity is warranted.
• Corporate income tax revenues for the first six months of 2006-07 are up 11.7 per cent, compared to profit growth of 7.9 per cent. Growth in corporate income tax revenues for a given year can differ substantially from growth in corporate profits for the same year due to provisions in the Income Tax Act that allow corporations to smooth taxable income from year to year by shifting losses backward or forward. In addition, reassessments, which generally pertain to past tax years, may contribute to a divergence between growth in corporate tax revenues and the tax base.  Furthermore, year-to-date profit growth in 2006-07 masks a divergence between very strong profit growth in the energy sector and a decline in manufacturing sector profits. The outcome for corporate income tax revenues in 2006-07 will depend heavily on energy prices and how these will affect profitability in the various sectors of the economy.
• On the expense side, the extent to which departments and agencies do not fully use all of the resources appropriated by Parliament varies from year to year and can materially affect the fiscal outcome. In addition, during the course of the fiscal year, departments and agencies often incur liabilities for which no payments are made. These liabilities are recognized throughout the year and are updated following the close of the fiscal year as part of the normal year-end accrual adjustments. Changes in estimates of liabilities can be significant.

Sensitivity of the Budget Balance to Economic Shocks

Changes in economic assumptions affect the size of projected tax bases and expenditures that are sensitive to economic factors, such as EI benefits and public debt charges.

The following tables illustrate the sensitivity of the budget balance to a number of economic shocks:

1. A one-year, 1-percentage-point decrease in real GDP growth driven equally by lower productivity and employment growth.

1. A decrease in nominal GDP growth resulting solely from a one-year, 1-percentage-point decrease in the rate of GDP inflation.

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

These sensitivities are generalized rules of thumb that assume any decrease in economic activity is proportional across income and expenditure components. EI premium rates are assumed to be fixed during the first calendar year in which the shock occurs, and to adjust for subsequent years, such that EI revenues exactly offset program expenses, consistent with the new EI rate-setting legislation introduced in 2005. Equal and opposite impacts would result from an increase of equal magnitude in real or nominal GDP growth and interest rates.

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

	Year 1	Year 2	Year 5
	(billions of dollars)
Federal revenues
Tax revenues
Personal income tax	-1.0	-1.3	-1.6
Corporate income tax	-0.4	-0.4	-0.5
Goods and services tax	-0.3	-0.3	-0.4
Other tax revenues	-0.2	-0.2	-0.2
Total tax revenues	-1.9	-2.3	-2.7
Employment insurance premium revenues	-0.1	0.7	0.8
Other revenues	0.0	0.0	0.0
Total budgetary revenues	-2.1	-1.6	-1.8
Federal expenses
Major transfers to persons
Elderly benefits	0.0	0.0	0.0
Employment insurance benefits	0.6	0.6	0.8
Total	0.6	0.6	0.8
Other program expenses	-0.1	-0.1	-0.3
Public debt charges	0.0	0.1	0.4
Total expenses	0.6	0.7	0.9
Budgetary balance	-2.6	-2.2	-2.7
Note: Totals may not add due to rounding.

A 1-percentage-point decrease in real GDP growth reduces the budgetary balance by $2.6 billion in the first year, $2.2 billion in the second year and $2.7 billion in the fifth year.

Tax revenues from all sources fall by a total of $1.9 billion in the first year, $2.3 billion in the second year and $2.7 billion by the fifth year. Personal income tax revenues decrease as employment and wages and salaries fall. Furthermore, due to the progressivity of the tax system, as individuals earn lower real incomes, they pay proportionally less of their income in taxes. Corporate income tax revenues fall as output and profits decrease. GST revenues decrease as a result of lower consumer spending associated with the fall in employment and personal income.

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

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

Table 2.8
Estimated Impact of a One-Year, 1-Percentage-Point Decrease in GDP Inflation on Federal Revenues, Expenses and Budgetary Balance

	Year 1	Year 2	Year 5
	(billions of dollars)
Federal revenues
Tax revenues
Personal income tax	-1.3	-1.3	-1.4
Corporate income tax	-0.4	-0.4	-0.5
Goods and services tax	-0.3	-0.3	-0.4
Other tax revenues	-0.2	-0.2	-0.2
Total tax revenues	-2.3	-2.3	-2.5
Employment insurance premium revenues	-0.1	-0.1	-0.1
Other revenues	-0.1	-0.1	-0.1
Total budgetary revenues	-2.4	-2.4	-2.7
Federal expenses
Major transfers to persons
Elderly benefits	-0.2	-0.3	-0.4
Employment insurance benefits	-0.1	-0.1	-0.1
Total	-0.3	-0.4	-0.5
Other program expenses	-0.3	-0.3	-0.7
Public debt charges	0.0	0.1	0.3
Total expenses	-0.5	-0.6	-0.9
Budgetary balance	-1.9	-1.8	-1.8
Note: Totals may not add due to rounding.

A 1-percentage-point decrease in nominal GDP growth resulting solely from lower GDP inflation (assuming that the Consumer Price Index moves in line with GDP inflation) lowers the budgetary balance by $1.9 billion in the first year and $1.8 billion in the second and fifth year.

Lower prices result in lower nominal income and, as a result, personal income tax, corporate income tax and GST revenues all decrease, reflecting declines in the underlying nominal tax bases. Compared to the impacts of the real GDP shock, the effects on personal income tax revenues are more pronounced in the initial year, due to the lag with which changes in the inflation rate are reflected in the tax system (tax brackets are indexed to the percentage change in the Consumer Price Index for the 12-month period ending September 30 of the previous year). For the other sources of tax revenue, the negative impacts are similar under either the real or nominal GDP shocks. EI premium revenues decrease marginally in the price shock in response to lower earnings. However, unlike the real GDP shock, EI benefits do not rise since unemployment is unaffected by price changes.

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

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

	Year 1	Year 2	Year 5
	(billions of dolllars)
Federal revenues	-0.4	-0.5	-0.8
Federal expenses	-1.4	-2.0	-2.7
Budgetary balance	1.0	1.5	1.8
Note: Totals may not add due to rounding

A decrease in interest rates raises the budgetary balance by $1.0 billion in the first year, $1.5 billion in the second and $1.8 billion in the fifth. The improvement stems entirely from decreased expenses associated with public debt charges. The impact on debt charges rises through time as longer-term debt matures and is refinanced at lower rates. Moderating the overall impact is a fall in revenues associated with the decrease in the rate of return on the Government's interest-bearing assets, which are recorded as part of non-tax revenues.

Private Sector National Accounts Projections

Table 2.10
Private Sector Surplus Projections on a National Accounts Basis

	2006-07	2007-08	2008-09	2009-10	2010-11	2011-12
	(billions of dollars)
Conference Board of Canada	-5.5	-0.6	3.0	3.5	5.9	10.9
University of Toronto	-3.8	-0.5	0.9	2.1	4.4	7.7
Global Insight	-3.9	0.4	2.2	3.2	4.6	7.2
Centre for Spatial Economics	-3.9	2.6	3.4	2.8	4.0	8.7
Average	-4.3	0.5	2.4	2.9	4.7	8.6

Table 2.10 provides the private sector fiscal projections on a National Accounts basis. The projections are based on their own economic forecasts and on tax and spending policies in place at the time of the May 2006 budget.

On average, the four forecasting organizations project a deficit of $4.3 billion in 2006-07. Thereafter, they project a surplus of $0.5 billion in 2007-08 and $2.4 billion in 2008-09, rising to $8.6 billion by 2011-12.

To translate the National Accounts surplus projections to a Public Accounts basis, several adjustments are required. These include adjustments to reflect:

• Differences in the definition of the government sector in the two accounting systems.
• Inclusion of certain revenues in the Public Accounts that are not accounted for in the National Accounts, such as revenues from asset sales and the impact of revaluations of financial assets, as well as some payables and receivables.

Making these adjustments and incorporating the cost of initiatives announced since the budget and the updated projection of direct program expenses leads to the fiscal projections on a Public Accounts basis presented in Table 2.6.

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