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Update of Economic and Fiscal Projections — 2012:
Part 3 of 3

Chapter 3 
Fiscal Outlook

While the Canadian economy has recovered from the global recession better than other Group of Seven (G-7) economies, the global economic environment remains fragile and the downside risks have started to weigh on global growth prospects and world commodity prices. Canada is not immune to these external developments. Indeed, reflecting lower commodity prices and the associated weakness in nominal gross domestic product (GDP), revenues are projected to be lower than forecast in Budget 2012, negatively impacting the fiscal track. However, by continuing to control growth in program spending, the Government remains on track to return to balanced budgets over the medium term. 

This chapter reviews the major fiscal developments since Budget 2012 and updates the Government’s fiscal projections for the 2012–13 to 2017–18 period.

Planning Assumptions 

To ensure objectivity and transparency in forecasting, the economic forecast underlying the Government’s fiscal projections is based on an average of private sector economic forecasts. This process has been followed for nearly two decades. This Update maintains that approach.

However, as described in Chapter 2, although the October 2012 private sector survey is considered to be a reasonable basis for fiscal planning purposes, the global economic outlook remains highly uncertain. As a result, the Government has judged it appropriate to continue to include a downward adjustment to the private sector forecast for nominal GDP. With this adjustment for risk, the revenue projections are reduced by $3.0 billion in each year from 2013–14 to 2017–18 (Table 3.1). The downward adjustment for 2012–13 is reduced to $1 billion, as actual economic data are now available for almost two thirds of 2012 (meaning the risk of a downward shock for 2012 as a whole has been reduced).

Table 3.1
Planning Assumptions for the Update of Economic and Fiscal Projections
billions of dollars

	2012–13	2013–14	2014–15	2015–16	2016–17	2017–18
Adjustment for risk to revenues	-1.0	-3.0	-3.0	-3.0	-3.0	-3.0

Reclassifications Reflecting the Adoption of the New Accounting Standard for Tax Revenues 

Beginning with the 2012–13 fiscal year, the Government has adopted the new accounting standard regarding tax revenues issued by the Public Sector Accounting Board of the Canadian Institute of Chartered Accountants. Notably, the new standard provides guidance as to whether payments made through the tax system or reductions in taxes payable should be classified as either reductions in tax revenues or as transfer payments. Under the new standard, some tax credits that were previously recorded as a reduction in tax revenues have been reclassified as transfer payments under direct program spending. These include the Working Income Tax Benefit, the Refundable Medical Expense Supplement, the Canadian Film or Video Production Tax Credit, the Film or Video Production Services Tax Credit, and that portion of the Atlantic Investment Tax Credit and the Scientific Research and Experimental Development Tax Credit that is eligible to be refunded.

As a result of the reclassification, both revenues and expenses will increase by an equivalent amount, resulting in no net impact on the budgetary balance. The fiscal outlook tables and charts in this Update reflect this reclassification. To enhance comparability, prior-year results have also been restated to reflect this reclassification. For 2011–12, this has the impact of increasing both revenues and expenses by $3.6 billion or 0.2 per cent of GDP (Table 3.2).

Table 3.2
2011–12 Reclassifications Resulting From the Adoption
of the New Accounting Standard for Tax Revenues
billions of dollars

	Before reclassification1	Adjustments	After reclassification2
Budgetary revenues
Personal income tax3	119.3	1.3	120.5
Corporate income tax4	31.7	2.3	34.0
Other revenues	94.2	0.0	94.2
Total budgetary revenues	245.2	3.6	248.8
Program expenses
Major transfers	125.2	0.0	125.2
Direct program expenses3,4	115.2	3.6	118.8
Total program expenses	240.4	3.6	244.0
Public debt charges	31.0	0.0	31.0
Budgetary balance	-26.2	0.0	-26.2
Note: Totals may not add due to rounding. 1 As reported in the Annual Financial Report of the Government of Canada—Fiscal Year 2011–2012 and Public Accounts of Canada 2012. 2 This is a preliminary estimate. Final figures will be reported in the Public Accounts of Canada 2013. 3 Reclassified tax credits include the Working Income Tax Benefit and the Refundable Medical Expense Supplement. 4 Reclassified tax credits include the Canadian Film or Video Production Tax Credit, the Film or Video Production Services Tax Credit, and that portion of the Atlantic Investment Tax Credit and the Scientific Research and Experimental Development Tax Credit that is eligible to be refunded.

Changes in the Fiscal Outlook Since the March  2012 Budget 

Table 3.3 provides a summary of the changes in the fiscal projections between Budget 2012 and this Update of Economic and Fiscal Projections. The $26.2-billion deficit in 2011–12 was $1.4 billion higher than the $24.9-billion deficit forecast in Budget 2012. Revenues were $2.8 billion lower than projected, reflecting lower-than-expected tax revenues, which were affected by the slowing of nominal GDP growth at the end of the fiscal year. However, this outcome was partly offset by program expenses which were $1.5 billion lower than forecast. 

The table shows that the risk-adjusted budgetary balance has deteriorated across the forecast horizon as a result of lower expected revenues. Nevertheless, the projected budgetary deficit continues its downward track, reaching a small deficit of $1.8 billion in 2015–16 before turning into surpluses of $1.7 billion and $3.4 billion in 2016–17 and 2017–18, respectively. As a result, despite the weak global economic environment, the Government is on track to meet its commitment to return to balanced budgets over the medium term. 

Table 3.3 also shows the impact of the reclassification of certain tax credits resulting from the adoption of the new accounting standard for tax revenues. As previously described, the accounting reclassification increases both revenues and expenses by an equivalent amount, resulting in no net impact on the budgetary balance.

Table 3.3
Summary of Changes in the Fiscal Outlook Since Budget 2012
 billions of dollars

		Projection
	2011–12	2012–13	2013–14	2014–15	2015–16	2016–17	2017–18
Budget 2012 budgetary balance	-24.9	-21.1	-10.2	-1.3	3.4	7.8	n/a
Add: Adjustment for risk in Budget 2012		3.0	3.0	3.0	3.0	3.0
Budget 2012 budgetary balance before  adjustment for risk	-24.9	-18.1	-7.2	1.7	6.4	10.8
Impact of economic and fiscal  developments
Add: Budgetary revenues	-2.8	-6.3	-7.1	-7.8	-7.7	-7.3	0.0
Less: Program expenses	-2.0	0.8	0.6	1.5	0.5	0.5
Less: Public debt charges	0.1	-1.3	-1.3	-2.0	-2.9	-1.6
Total economic and fiscal developments	-0.9	-5.8	-6.3	-7.3	-5.3	-6.2
Policy decisions since Budget  2012
Less: Service Income Security    Insurance Plan  and Veterans    Affairs’ disability benefits	0.5	1.1	0.1	0.1	0.1	0.0
Less: Other	0.0	0.0	-0.1	-0.1	-0.1	-0.2
Total	0.5	1.1	0.0	0.0	-0.1	-0.1
Reclassifications—change in accounting  treatment of tax revenues
Add: Budgetary revenues	3.6	3.7	3.9	3.9	3.7	3.6	3.4
Less: Budgetary expenses	3.6	3.7	3.9	3.9	3.7	3.6	-3.4
Total	0.0	0.0	0.0	0.0	0.0	0.0	0.0
2012 Update budgetary balance  before adjustment for risk	-26.2	-25.0	-13.5	-5.6	1.2	4.7	6.4
Add: Adjustment for risk in Update 2012		-1.0	-3.0	-3.0	-3.0	-3.0	-3.0
2012 Update budgetary balance	-26.2	-26.0	-16.5	-8.6	-1.8	1.7	3.4
Note: Totals may not add due to rounding.

Coupled with lower-than-expected 2011–12 tax revenues, the downward revision to nominal GDP, the broadest single indicator of the tax base, drives a significant decrease in tax revenues over the 2012–13 to 2016–17 period (Chart 3.1). In addition, lower projected interest rates lead to a lower outlook for other revenues.

Total expenses over the 2012–13 to 2016–17 period are $5.2 billion lower than projected in Budget 2012. While program expenses are somewhat higher, public debt charges are considerably reduced due to lower expected interest rates.

The modest increase in program expenses is largely due to a change in the timing of when employee pension and benefit liabilities are expensed. Because long-term interest rates, which are used to discount those liabilities, are now expected to be lower than previously projected, relatively more of those liabilities must be expensed in the near term as opposed to the future. That said, the long-term total pension and benefit liability of the Government has not changed as a result of changes in interest rates.  

In addition to the interest rate impact, this Update reflects the expected savings from changes to federal employee pension plans included in the Jobs and Growth Act, 2012 as well as savings anticipated from changes to the Members of Parliament pension plan included in the Members of Parliament Retiring Allowances Act. In addition, this Update incorporates additional savings from the elimination of voluntary severance benefits first announced in Budget 2011, of which roughly $300 million in savings were recognized as of Budget 2012. Once fully implemented, these measures will generate annual savings of $1.4  billion as of 2017–18. Other fiscal developments include the deferral of transfers for infrastructure spending to future years in light of project delays.

With respect to new policy decisions, a significant portion of the expected increase in expenses for 2012–13 is related to the Government’s decision not to appeal the Federal Court of Canada decision regarding the offset of the Pension Act disability benefits from the Service Income Security Insurance Plan (SISIP). Following that decision, the Government discontinued the application of this offset to SISIP and decided to harmonize Veterans Affairs’ disability benefits with the changes to SISIP in order to ensure that servicemen and servicewomen who become disabled will receive full benefits and services. Under public sector accounting rules, the Government is obligated to record the full cost of these changes in its financial statements immediately as opposed to the moment these payments will be made to veterans, based on the existing population of veterans eligible for the additional benefits. In addition, the Government will accrue an additional small cost in subsequent years as new veterans become eligible for these benefits. The cost of these changes is estimated to be $1.9 billion over seven years, of which $0.5 billion was recorded in 2011–12. Of the remaining amount, $1.1 billion is expected to be recorded in 2012–13, with the remainder being recorded in subsequent years.

The costs of policy decisions since Budget  2012 are offset by lower-than-expected funding requirements for the Correctional Service of Canada in light of a lower-than-expected inmate population, which means that expected increases in costs for prisons have not materialized.

Even after taking into account the economic and fiscal developments and policy decisions since Budget 2012, projected program expenses are not significantly different from what was projected in the budget, and the difference decreases over time. Indeed, when the change in the timing of pension and benefit expenses due to interest rate changes is taken into account, program expenses are lower on average over the forecast horizon. This demonstrates the Government’s control of program spending growth in order to return to balanced budgets over the medium term.

Summary Statement of Transactions 

Table 3.4 summarizes the Government’s financial position over the forecast horizon. These projections are based on the average private sector forecast for the economy, with the adjustment for risk discussed above. As indicated in Chapter 2, the values expressed as a share of GDP incorporate the historical revisions to the Canadian System of National Accounts released on October 1, 2012 by Statistics Canada.

Table 3.4
Summary Statement of Transactions
billions of dollars

		Projection
	2011–12	2012–13	2013–14	2014–15	2015–16	2016–17	2017–18
Budgetary revenues1	248.8	254.4	267.2	281.6	296.1	308.8	319.8
Program expenses1	244.0	250.9	253.9	259.2	265.9	272.6	280.4
Public debt charges	31.0	29.6	29.8	31.0	32.0	34.5	36.0
Total expenses	275.0	280.4	283.7	290.2	297.9	307.1	316.4
Budgetary balance	-26.2	-26.0	-16.5	-8.6	-1.8	1.7	3.4
Federal debt2	582.2	609.4	625.8	634.4	636.2	634.5	631.1
Per cent of GDP
Budgetary revenues	14.1	14.0	14.2	14.3	14.4	14.4	14.3
Program expenses	13.8	13.8	13.5	13.2	12.9	12.7	12.5
Public debt charges	1.8	1.6	1.6	1.6	1.6	1.6	1.6
Budgetary balance	-1.5	-1.4	-0.9	-0.4	-0.1	0.1	0.2
Federal debt	33.0	33.6	33.4	32.3	30.9	29.5	28.1
Note: Totals may not add due to rounding. 1 Budgetary revenues and program expenses reflect the adoption of the new accounting standard for tax revenues. 2 The projected level of federal debt for 2012–13 includes an estimate of other comprehensive income.

As a result of the Government’s responsible management of public finances, the budgetary balance is projected to continue to improve from a deficit of $26.2 billion in 2011–12 to a surplus of $1.7 billion in 2016–17 (Chart 3.2). This projection includes the adjustment for risk. If the risks to the outlook do not materialize and the adjustment for risk is not required, a surplus of $1.2 billion is projected for 2015–16. As a percentage of GDP, the budgetary balance is projected to improve over the forecast period from a deficit of 1.5 per cent in 2011–12 to a surplus of 0.2 per cent in 2017–18, including the adjustment for risk.  

The federal debt-to-GDP ratio (accumulated deficit) stood at 33.0 per cent in 2011–12, down from 33.1 per cent in 2010–11 and less than half of its post World War II peak of 67.1 per cent in 1995–96. The debt ratio is projected to fall to 28.1 per cent in 2017–18, in line with the recent low in 2008–09. This will help to ensure that Canada meets its G-20 targets, as agreed to by G-20 leaders at their summit in Toronto in June 2010, to halve deficits by 2013 and to stabilize or reduce total government debt-to-GDP ratios by 2016. 

Indeed, the International Monetary Fund projects that Canada’s total government net debt-to-GDP ratio (including the net debt of the federal, provincial/territorial and local governments as well as the net assets of the Canada Pension Plan and the Québec Pension Plan) will remain the lowest, by far, of any G-7 country (Chart 3.3).

Outlook for Budgetary Revenues 

Table 3.5
Revenue Outlook
 billions of dollars

		Projection
	2011–12	2012–13	2013–14	2014–15	2015–16	2016–17	2017–18
Income taxes
Personal income tax1	120.5	125.5	132.1	140.4	148.7	156.3	164.2
Corporate income tax1	34.0	33.1	35.5	37.8	39.4	41.1	42.7
Non-resident income tax	5.3	5.3	5.7	6.0	6.5	6.9	7.3
Total income tax	159.8	163.9	173.2	184.2	194.6	204.3	214.2
Excise taxes/duties
Goods and Services Tax	28.4	29.4	30.8	32.3	33.9	35.6	37.3
Customs import duties	3.9	4.1	4.2	4.5	4.7	4.9	5.1
Other excise taxes/duties	10.9	10.9	10.7	10.8	10.7	10.5	10.5
Total excise taxes/duties	43.1	44.4	45.7	47.5	49.3	51.0	53.0
Total tax revenues	202.9	208.3	218.9	231.7	243.9	255.3	267.2
Employment Insurance  premium revenues	18.6	20.1	21.8	23.3	24.6	23.9	21.3
Other revenues	27.3	26.0	26.5	26.6	27.6	29.6	31.3
Total budgetary revenues	248.8	254.4	267.2	281.6	296.1	308.8	319.8
Per cent of GDP
Personal income tax	6.8	6.9	7.0	7.1	7.2	7.3	7.3
Corporate income tax	1.9	1.8	1.9	1.9	1.9	1.9	1.9
Goods and Services Tax	1.6	1.6	1.6	1.6	1.6	1.7	1.7
Total tax revenues	11.5	11.5	11.7	11.8	11.9	11.9	11.9
Employment Insurance  premium revenues	1.1	1.1	1.2	1.2	1.2	1.1	1.0
Other revenues	1.5	1.4	1.4	1.4	1.3	1.4	1.4
Total budgetary revenues	14.1	14.0	14.2	14.3	14.4	14.4	14.3
Note: Totals may not add due to rounding. 1 Figures reflect the adoption of the new accounting standard for tax revenues.

Table 3.5 sets out the Government’s projection for budgetary revenues after the adjustment for risk, which for planning purposes is applied to tax revenues and other revenues. Revenues are expected to increase by 2.3 per cent in 2012–13. Over the remainder of the forecast horizon, revenues are projected to grow at an average annual rate of 4.7 per cent.

Personal income tax revenues—the largest component of budgetary revenues—are projected to increase by $4.9 billion, or 4.1 per cent, to $125.5 billion in 2012–13. Over the remainder of the projection period, personal income tax revenues increase somewhat faster than growth in nominal GDP, averaging 5.5 per cent annual growth, reflecting the progressive nature of the income tax system combined with real income gains.

Corporate income tax revenues are projected to be $33.1 billion in 2012–13. Over the remainder of the projection period, corporate income tax revenues are forecast to grow at an annual rate of 5.2 per cent, largely in line with projected profit growth. 

Non-resident income tax revenues are income taxes paid by non-residents of Canada on Canadian-sourced income, notably dividends and interest payments. They are projected to grow at an average annual rate of 5.4 per cent over the forecast horizon.

Goods and Services Tax (GST) revenues are projected to grow by 3.8 per cent in 2012–13 based on projected growth in taxable consumption and year-to-date results. Annual growth in GST revenues is projected to average 4.9 per cent over the remainder of the projection period, in line with growth in taxable consumption.

Customs import duties are projected to increase by $0.2 billion, or 4.9 per cent, in 2012–13, reflecting year-to-date results. Over the remainder of the projection period, annual growth in customs import duties is projected to average 4.8 per cent, in line with projected growth in imports. Based on year-to-date results, other excise taxes and duties are projected to be $10.9 billion in
 2012–13 and, in line with trends over the last five years, are projected to decline slowly over the remainder of the projection period.

Employment Insurance (EI) premium revenues are projected to grow by 8.3 per cent in 2012–13, in line with the growth in insurable earnings and the EI premium rate of $1.88 per $100 of insurable earnings in 2013. From 2013–14 to 2015–16, it is projected that the annual growth in EI premium revenues will average 6.9 per cent until the EI Operating Account is returned to cumulative balance in 2016. As announced in Budget 2012, once the EI Operating Account has achieved balance, the EI premium rate will be set annually at a seven-year break-even rate to ensure that EI premiums are no higher than needed to pay for the EI program. This new rate-setting mechanism leads to a lowering of the EI premium rate and a corresponding decline in EI premium revenues over the final two fiscal years of the forecast horizon.

Other revenues include revenues from consolidated Crown corporations, net income from enterprise Crown corporations, returns on investments, foreign exchange revenues and proceeds from the sales of goods and services. These revenues are generally volatile, owing principally to the impact of interest rates on returns on investments and the assets in the Exchange Fund Account, and the net gains or losses from enterprise Crown corporations. These revenues are also affected by the impact of exchange rate movements on the Canadian-dollar value of foreign-denominated assets as well as flow-through items that give rise to an offsetting expense and therefore do not impact the budgetary balance.

For 2012–13, other revenues are projected to decrease by 4.7 per cent to $26.0 billion due primarily to lower revenues from Crown corporations and the collection of lower offshore resource royalties on behalf of the provinces. This decline in other revenues only partially affects the budgetary balance as offshore resource revenues are transferred to the provinces, and this gives rise to an offsetting reduction in expenses. Growth in other revenues is expected to average 3.8 per cent over the remainder of the forecast horizon, based on the projected profiles of interest rates and nominal GDP.

Chart 3.4 shows that the revenue-to-GDP ratio has decreased from 16.0 per cent in 2006-07 to 14.1 per cent in 2011–12. Over the forecast horizon, the revenue-to-GDP ratio is projected to remain relatively stable at around 14.3 per cent.

Outlook for Program Expenses 

Table 3.6
Program Expenses Outlook
billions of dollars

		Projection
	2011–12	2012–13	2013–14	2014–15	2015–16	2016–17	2017–18
Major transfers to persons
Elderly benefits	38.0	40.4	42.7	44.9	47.3	49.9	52.6
Employment Insurance benefits1	17.6	18.2	18.9	19.4	19.5	20.0	20.4
Children’s benefits	12.7	12.9	13.2	13.5	13.8	14.0	14.2
Total	68.4	71.5	74.7	77.9	80.6	83.9	87.2
Major transfers to other levels  of government
Canada Health Transfer	27.0	28.6	30.3	32.1	34.0	36.1	37.7
Canada Social Transfer	11.5	11.9	12.2	12.6	13.0	13.3	13.7
Other health and social transfers2	0.2	0.3	0.3	0.0	0.0	0.0	0.0
Fiscal arrangements3	16.9	17.8	18.7	19.4	20.1	20.9	21.8
Canada’s cities and communities	2.2	2.1	2.0	2.0	2.0	2.0	2.0
Other major transfers4	2.3	1.2	0.4	0.4	0.3	0.2	0.2
Alternative Payments for    Standing Programs5	-3.2	-3.3	-3.5	-3.7	-3.9	-4.1	-4.4
Total	56.8	58.6	60.3	62.7	65.5	68.5	71.1
Direct program expenses
Operating expenses subject to freeze6	50.6	51.7	51.0	51.3	52.4	53.3	54.7
Other operating expenses	25.4	26.4	25.2	24.6	24.8	24.4	25.0
Transfer payments6,7	38.1	37.5	37.1	37.0	36.6	36.3	36.0
Capital amortization	4.6	5.2	5.4	5.8	6.0	6.3	6.5
Total	118.8	120.8	118.9	118.6	119.8	120.3	122.2
Total program expenses	244.0	250.9	253.9	259.2	265.9	272.6	280.4
Per cent of GDP
Major transfers to persons	3.9	3.9	4.0	4.0	3.9	3.9	3.9
Major transfers to other levels of government	3.2	3.2	3.2	3.2	3.2	3.2	3.2
Direct program expenses	6.7	6.7	6.3	6.0	5.8	5.6	5.4
Total program expenses	13.8	13.8	13.5	13.2	12.9	12.7	12.5
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 costs relate mainly to administration and are part of operating expenses subject to freeze. 2 Other health and social transfers include the Wait Times Reduction Transfer and other health-related transfers. 3 Fiscal arrangements include Equalization, Territorial Formula Financing, the Youth Allowances Recovery and statutory subsidies. 4 Other major transfers to other levels of government include transitional payments; transfer protection payments in 2011–12 and 2012–13; payments under the 2005 Offshore Accords; and assistance regarding sales tax harmonization. 5 The Alternative Payments for Standing Programs represent a recovery from Quebec of an additional tax point transfer above and beyond the tax point transfer under the Canada Health Transfer and the Canada Social Transfer. 6 Figures reflect the reclassification of the spending by Canada Mortgage and Housing Corporation for social housing from operating expenses to transfer payments under direct program spending. 7 Figures reflect the adoption of the new accounting standard for tax revenues.

Table 3.6 sets out the main components of program expenses: major transfers to persons, major transfers to other levels of government, and direct program expenses.

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

Elderly benefits are comprised of Old Age Security, Guaranteed Income Supplement and Allowance payments to qualifying seniors, with Old Age Security payments representing approximately 75 per cent of these expenditures. Elderly benefits are projected to grow from $40.4 billion in 2012‑13 to $52.6 billion in 2017–18, or approximately 5.4 per cent per year—faster than nominal GDP, which is projected to grow on average by 4.4 per cent per year. This increase is due to consumer price inflation, to which benefits are fully indexed, and a projected increase in the seniors’ population from 5.2 million in 2012–13 to 6.2 million in 2017–18, or an average increase of 3.5 per cent per year.

EI benefits are projected to increase by 3.1 per cent to $18.2 billion in 2012–13 based on year-to-date results and projected growth in average benefits. Over the remainder of the projection period, EI benefits are projected to grow slowly, averaging 2.3 per cent annually, as projected increases in the average benefits paid to EI recipients more than offset the impacts of the reduction in the number of unemployed.

Children’s benefits, including the Canada Child Tax Benefit and the Universal Child Care Benefit, are projected to increase moderately over the forecast horizon, reflecting growth in the eligible population and adjustments for inflation.

Major transfers to other levels of government include transfers in support of health and social programs, Equalization and Territorial Formula Financing, among others. The Canada Health Transfer (CHT) will continue to grow from $28.6 billion in 2012–13 to $37.7  billion in 2017–18. Starting in 2017–18, the CHT will grow in line with a three-year moving average of nominal GDP growth, with funding guaranteed to increase by at least 3 per cent per year. The Canada Social Transfer will continue to grow at 3 per cent per year. Other major transfers to other levels of government include transfer protection payments to provinces in 2011–12 and  2012–13 as well as a provision for transitional assistance for Prince Edward Island, which has announced it will move to the Harmonized Sales Tax.

Direct program expenses include expenses of National Defence and other departments; expenses of consolidated Crown corporations; and transfers administered by departments for, among other purposes, farm income support, natural resource royalties paid to provinces, and student financial assistance. As the Government has adopted the new accounting standard regarding tax revenues, the Working Income Tax Benefit, the Refundable Medical Expense Supplement, the Canadian Film or Video Production Tax Credit, the Film or Video Production Services Tax Credit, and that portion of the Atlantic Investment Tax Credit and the Scientific Research and Experimental Development Tax Credit that is eligible to be refunded have been reclassified and are now included in the transfer payments category of direct program expenses.

Direct program expenses are broadly stable over the forecast horizon, with spending falling from $120.8 billion in 2012–13 to $118.6 billion in 2014–15, then rising to $122.2 billion in 2017–18. As a share of GDP, direct program expenses decline over the projection period from 6.7 per cent in 2012–13 to 5.4 per cent in 2017–18.

Some of these expenses are subject to the operating freeze announced in Budget 2010. These include the wages and salaries of federal employees, professional services contracts, telecommunications, leases, utilities (heat and hydro), materials and supplies. Operating expenses subject to freeze are broadly stable over the forecast horizon, with spending increasing modestly from $51.7 billion in 2012–13 to $54.7 billion in 2017–18. Of note, $2.1 billion in spending by Canada Mortgage and Housing Corporation related to social housing has been reclassified as transfer payments under direct program expenses. This change took effect with the 2011–12 Public Accounts.

Other operating expenses include costs for employee pensions and other benefits, non-wage expenses of National Defence and accrual amounts for items such as the allowance for bad debt. Expenses in this category are projected to increase from $25.4 billion in 2011–12 to $26.4 billion in 2012–13 due to changes to the Service Income Security Insurance Plan and Veterans Affairs’ disability benefits. With the exception of 2012–13, other operating expenses are broadly stable.

Transfer payments administered by departments are projected to decline steadily over the projection period, with spending falling from $37.5 billion in 2012–13 to $36  billion in 2017–18. This reflects the reduction of activity under the Building Canada Fund and decreases in natural resource royalties paid to provinces.

Amounts for capital expenses are presented on an accrual basis. The amount of capital amortization is expected to increase modestly from $5.2 billion in 2012–13 to $6.5 billion in 2017–18 as a result of new investments and upgrades to existing capital.

As a share of GDP, program expenses are projected to decline from 13.8 per cent in 2011–12 to 12.5 per cent in 2017–18, which represents a return to pre-recession ratios (Chart 3.5).

Risks to the Fiscal Projections 

Risks to the economic outlook are the greatest source of uncertainty to the fiscal projections. To help quantify these risks, tables illustrating the sensitivity of the budgetary balance to a number of economic shocks are provided below.

Beyond the economic outlook, there remain upside and downside risks associated with the fiscal projections, as several key drivers of the fiscal outlook are not directly linked to economic variables (such as the relationship between personal income taxes and personal income or the extent to which departments and agencies do not fully use all of the resources appropriated by Parliament).

Sensitivity of the Budgetary Balance to Economic Shocks 

Changes in economic assumptions affect the projections for revenues and expenses. The following tables illustrate the sensitivity of the budgetary balance to a number of economic shocks:

• A one-year, 1-percentage-point decrease in real GDP growth driven equally by lower productivity and employment growth.
• A decrease in nominal GDP growth resulting solely from a one-year, 1-percentage-point decrease in the rate of GDP inflation (assuming that the Consumer Price Index (CPI) moves in line with GDP inflation).
• A sustained 100-basis-point increase 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, and are meant to provide a broad illustration of the impact of economic shocks on the outlook for the budgetary balance. Actual economic shocks may have different fiscal impacts. For example, they may be concentrated in specific sectors of the economy or cause different responses in key economic variables (e.g. GDP inflation and CPI inflation may have different responses to a given shock).

Table 3.7
Estimated Impact of a One-Year, 1-Percentage-Point Decrease in Real GDP Growth on Federal Revenues, Expenses and Budgetary Balance
billions of dollars

	Year 1	Year 2	Year 5
Federal revenues
Tax revenues
Personal income tax	-2.0	-2.1	-2.3
Corporate income tax	-0.3	-0.4	-0.4
Goods and Services Tax	-0.3	-0.4	-0.4
Other	-0.2	-0.2	-0.3
Total tax revenues	-2.9	-3.0	-3.4
Employment Insurance premiums	-0.2	-0.2	-0.2
Other revenues	0.0	0.0	0.0
Total budgetary revenues	-3.1	-3.3	-3.6
Federal expenses
Major transfers to persons
Elderly benefits	0.0	0.0	0.0
Employment Insurance benefits	0.8	0.9	1.0
Children’s benefits	0.0	0.0	0.0
Total	0.8	0.9	1.0
Other program expenses	-0.1	-0.1	-0.2
Public debt charges	0.0	0.1	0.3
Total expenses	0.8	0.8	1.2
Budgetary balance	-3.9	-4.1	-4.8
Note: Totals may not add due to rounding.

A 1-percentage-point decrease in real GDP growth reduces the budgetary balance by $3.9 billion in the first year, $4.1 billion in the second year and $4.8 billion in the fifth year (Table 3.7).

• Tax revenues from all sources fall by a total of $2.9 billion in the first year and by $3.0 billion in the second year. Personal income tax revenues decrease as employment and wages and salaries fall. 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.
• EI premium revenues decrease as employment and wages and salaries fall. In order to isolate the direct impact of the economic shock and provide a general overview of the fiscal impacts, the EI premium revenue impacts do not include changes in the premium rate that would be necessary to bring the EI Operating Account back into balance, as the rate changes would be very sensitive to the timing of the shock and cumulative balance in the Account.
• Expenses rise, mainly reflecting higher EI benefits (due to an increase in the number of unemployed) and higher public debt charges (reflecting a higher stock of debt due to the lower budgetary balance). This rise is partially offset by lower other program expenses (as certain programs are tied directly to growth in nominal GDP).

Table 3.8
Estimated Impact of a One-Year, 1-Percentage-Point Decrease in GDP Inflation
on Federal Revenues, Expenses and Budgetary Balance
billions of dollars

	Year 1	Year 2	Year 5
Federal revenues
Tax revenues
Personal income tax	-2.0	-1.6	-1.5
Corporate income tax	-0.3	-0.4	-0.4
Goods and Services Tax	-0.3	-0.4	-0.4
Other	-0.2	-0.2	-0.3
Total tax revenues	-2.9	-2.5	-2.6
Employment Insurance premiums	-0.1	-0.2	-0.2
Other revenues	-0.1	-0.1	-0.1
Total budgetary revenues	-3.1	-2.8	-2.9
Federal expenses
Major transfers to persons
Elderly benefits	-0.3	-0.5	-0.5
Employment Insurance benefits	-0.1	-0.1	-0.1
Children’s benefits	-0.1	-0.1	-0.1
Total	-0.4	-0.7	-0.8
Other program expenses	-0.2	-0.3	-0.8
Public debt charges	-0.4	0.0	0.2
Total expenses	-1.1	-0.9	-1.4
Budgetary balance	-2.0	-1.9	-1.5
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 $2.0 billion in the first year, $1.9 billion in the second year and $1.5 billion in the fifth year (Table 3.8).

• Lower prices result in lower nominal income and, as a result, personal income tax revenues decrease, reflecting declines in the underlying nominal tax base. As the parameters of the personal income tax system are indexed to inflation and automatically adjust in response to the shock, the fiscal impact is smaller than under the real shock. For the other sources of tax revenue, the negative impacts are similar under the real and nominal GDP shocks.
• EI premium revenues, absent any change in the premium rate, decrease marginally in response to lower earnings. In order to isolate the direct impact of the economic shock and provide a general overview of the fiscal impacts, the EI premium revenue impacts do not include changes in the premium rate that would be necessary to bring the EI Operating Account back into balance, as the rate changes would be very sensitive to the timing of the shock and the cumulative balance in the Account. EI benefits decline slightly due to lower average benefits.
• Other revenues decline slightly as lower prices lead to lower revenues from the sales of goods and services.
• 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, and downward pressure on federal program expenses. Payments under these programs are smaller if inflation is lower. In addition, other program expenses are also lower as certain programs are tied directly to growth in nominal GDP.
• Public debt charges decline in the first year due to lower costs associated with Real Return Bonds, then rise due to the higher stock of debt.

Table 3.9
Estimated Impact of a Sustained 100-Basis-Point Increase in All Interest Rates
on Federal Revenues, Expenses and Budgetary Balance
billions of dollars

	Year 1	Year 2	Year 5
Federal revenues	1.2	1.5	2.1
Federal expenses	1.8	3.0	4.2
Budgetary balance	-0.6	-1.4	-2.1

An increase in interest rates decreases the budgetary balance by $0.6 billion in the first year, $1.4 billion in the second year and $2.1 billion in the fifth year (Table 3.9). The decline stems entirely from increased expenses associated with public debt charges. The impact on debt charges rises through time as longer-term debt matures and is refinanced at higher rates. Moderating the overall impact is an increase in revenues associated with the increase in the rate of return on the Government’s interest-bearing assets, which are recorded as part of other revenues. The impacts of changes in interest rates on public sector pension and benefit expenses are excluded from the sensitivity analysis.

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