Archived - Update Economic and Fiscal Projections – 2013: Part 4 of 4
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Update of Economic and Fiscal Projections
This annex presents long-term economic and fiscal projections to 2050–51, using the medium-term forecast presented in this Update as the starting point. These projections follow the recommendation of the Auditor General of Canada to publish long-term fiscal sustainability analyses on an annual basis and update the Government’s first long-term fiscal sustainability report, Economic and Fiscal Implications of Canada’s Aging Population, published in October 2012.
Like any projection that extends over several decades, the demographic, economic and fiscal projections discussed in this annex are subject to considerable uncertainty. Rather than a forecast of the future, these projections are based on long-term developments that can be expected to occur based on current trends and policies and reasonable assumptions.
Long-Term Economic and Fiscal Projections
Since the publication of the Government’s first long-term fiscal sustainability analysis in October 2012, medium- and longer-term demographic, economic and fiscal trends have been relatively stable. Almost five years after the end of the global recession, Canada continues to fare relatively well on both the economic and fiscal fronts compared to other Group of Seven (G-7) countries. At the same time, Canada is still expected to age more rapidly than most other countries, meaning that Canadians and their governments will have to adjust to the economic and public finance implications of population aging sooner than many other advanced economies.
Over the past decade, Canada’s strong employment performance has been a key factor behind the country’s strong economic performance relative to other G-7 countries. Going forward, however, demographic changes will make it increasingly difficult to continue to improve Canada’s economic performance through increases in employment. Indeed, falling fertility rates since the end of the baby boom and continuously increasing longevity have resulted in the Canadian population gradually growing older. And with the baby boomers gradually moving into retirement, the pace of population aging will soon accelerate with important consequences for Canadians and their governments. Indeed, the number of working-age Canadians for every senior is expected to fall from close to 5 over the past decade to about 2.5 in less than 20 years (Chart A.1).
Population aging will result in an increase in the share of older age groups in the labour force. Because older workers have significantly lower rates of labour force participation than younger workers, an increasing number of older workers is expected to lead to a reduction in the overall rate of labour force participation (Chart A.2). In fact, the impact of the shift toward an older population is already being felt, as the overall participation rate has already likely reached its peak. Combined with slower growth in the population aged 15 and over and slightly declining average weekly hours worked per worker, reduced labour market participation is expected to reduce future growth in labour supply (i.e. the total number of hours worked by Canadians).
Economic growth stems from growth in either labour supply or labour productivity (real output per hour worked). Hence, unless labour market participation and productivity improve, population aging will negatively impact growth. With inflation expected to remain around 2 per cent per year, this impact on economic growth will be translated into lower growth in nominal gross domestic product (GDP), the broadest single measure of the tax base. Slower nominal GDP growth will reduce the growth rate of government revenues, thereby limiting the capacity of governments to continue to finance growth in public expenditures at rates as high as in the past. At the same time, population aging is also expected to put upward pressure on public expenditures, notably for age-related programs such as elderly benefits and health care.
In the context of this upcoming rapid demographic transition, the return to balanced budgets over the medium term is a first crucial and necessary step to guarantee long-term fiscal sustainability. The Government has taken a number of actions since Budget 2010 to eliminate the deficit and return to balanced budgets in 2015. These actions include controlling the direct program spending of federal departments, ensuring reasonable and affordable federal employee compensation, and closing tax loopholes. As shown in this Update, the success of these measures will be sufficient to ensure surpluses starting in 2015–16 without raising taxes or cutting important transfers in support of health care and social services, Equalization and the Gas Tax transfer to municipalities.
These actions, combined with actions to preserve social programs, are sufficient to put the federal debt-to-GDP ratio on a downward track and ensure the sustainability of public finances over the projection horizon (Chart A.3). These updated long-term fiscal projections are similar to the ones presented in the Government’s first long-term fiscal sustainability report published in October 2012. The slight improvement is essentially due to the better medium-term outlook for the budgetary balance.
The updated long-term fiscal projections also suggest that the Government is on track to meet the target of achieving a federal debt-to-GDP ratio of 25 per cent by 2021, as announced by Prime Minister Stephen Harper at the G-20 Leaders’ Summit in St. Petersburg, Russia, on September 5, 2013.
In Canada, health spending by the provinces, which have the primary responsibility for delivering health services to Canadians, has tended to increase at a faster pace than nominal GDP over the past decades. However, information from the latest provincial budgets and Public Accounts shows that health spending growth has fallen from 5.5 per cent in 2010–11 to 4.2 per cent in 2011–12 and, based on preliminary estimates, to 3.5 per cent in 2012–13. Using provincial budgets in which health spending information is available, health spending growth is expected to remain stable at 3.5 per cent in 2013–14 and further decline to 2.9 per cent over the following two fiscal years. If these slower growth rates materialize, they would generally be close to or lower than projected nominal GDP growth. As in many other advanced economies, sustained actions toward stabilizing public health spending in relation to nominal GDP, and therefore government revenues, will be required in Canada to ensure long-term fiscal sustainability.
|Note: 2010–11 and 2011–12 are actual figures, 2012–13 are actual figures or estimates, and 2013–14 to 2015–16 are forecasts.
1. For 2014–15 and 2015–16: includes provinces for which information is available (Quebec, Ontario, Alberta and British Columbia).
2. Growth rates are on a calendar-year basis. Figures for 2010 to 2012 are actual, while figures for 2013 to 2015 are forecasts based on the September 2013 survey of private sector economists.
According to the Canadian Institute for Health Information (CIHI), the recent slowdown in health spending growth is, unlike in the past, not about “cutting programs as much as looking at improving productivity, reducing overhead, controlling compensation and seeking value-for-money initiatives.” Indeed, over recent years, there have been greater, and sometimes concerted, efforts to control health spending growth on the part of the provinces through actions that will likely have a lasting dampening effect on health spending growth. For example, as a first step towards a more strategic, comprehensive and coordinated approach to pharmaceutical management, the new coordinated provincial approach to price setting for six widely used generic drugs should help maintain the recent trend in drug spending growth.
At the federal level, the legislation governing the Canada Health Transfer (CHT) was set to expire in 2013–14. There was no legislated growth path after that date. In December 2011 (and confirmed in Budget 2012), the Government announced the growth path of the CHT beyond 2013–14: it will continue to grow at 6 per cent per year until 2016–17, and then starting in 2017–18, it 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 new CHT growth path beyond 2013–14 will provide certainty and stability to the provinces and territories as they continue to take action to put their respective health care systems on sustainable spending paths.
However, it is important to note that, while useful to help assess the long-term impact of public policies based on “status quo” assumptions, long-term fiscal projections are not predictions. In particular, the projections in this annex assume sustained growth in economic activity and, as such, do not take into account the possibility that Canada could be hit by other recessions that would have long-lasting effects. They also do not include any new spending or tax measures beyond those previously announced and those included in this Update.
This is why continuing to restrain government spending and ensuring existing spending is as efficient as possible are necessary to maintain the Government’s flexibility to respond to unexpected economic shocks and emerging priorities of Canadians, while at the same time achieving a federal debt-to-GDP ratio of 25 per cent by 2021 and ensuring a sustainable track for Canada’s public finances over the longer term.
The Government’s commitment to sound and sustainable public finances is intimately related to its fundamental belief that the private sector is the engine of growth and wealth creation. The role of government is to provide the framework policies, programs and services for a prosperous economy and society at levels of taxation that are competitive and sustainable for the long term.
Much has been done in this regard by the Government. Recently, building on actions taken since 2006, Economic Action Plan 2013 included affordable initiatives that will further help to create jobs and secure economic growth—the Government’s top priorities—including:
- Connecting Canadians With Available Jobs by, among other things, creating the Canada Job Grant, the implementation of which is currently being negotiated with the provinces and territories; and creating opportunities for apprentices by reducing barriers to accreditation in the trades, and by supporting the use of apprentices in federal construction and maintenance contracts. Action was also taken to support groups that are under-represented in the job market by introducing a new generation of Labour Market Agreements for Persons with Disabilities by 2014 with an investment of $222 million per year, investing an additional $70 million over three years to support 5,000 more paid internships for recent post-secondary graduates, and proposing $241 million over five years to help ensure First Nations youth can access the skills and training they need to secure employment.
- Helping Manufacturers and Businesses Succeed in the Global Economy by extending by two years the temporary accelerated capital cost allowance for new investment in the manufacturing and processing sector; providing support of $1.4 billion over four years; and expanding and extending the temporary Hiring Credit for Small Business, allowing these businesses to reinvest approximately $225 million in job creation and economic growth in 2013.
- Creating a New Building Canada Plan, which will provide approximately $53.5 billion in new and existing funding over 10 years, starting in 2014–15, for provincial, territorial and municipal infrastructure such as roads, bridges and public transit.
- Investing in World-Class Research and Innovation by, for example, announcing $225 million to support advanced research infrastructure; providing $165 million to support world-leading genomics research; and allocating $325 million to continue support for the development and demonstration of new clean technologies.
- Supporting Families and Communities by, among other initiatives, providing $76 million in annual tariff relief on baby clothing and sports and athletic equipment to help reduce the gap in retail prices that Canadian consumers pay compared to those in the U.S; and investing $9 million over two years to expand the First Nations Land Management Regime to create further opportunities for economic development on reserve.
The Government is also acting to better position Canada as a strong competitor in the global economy. In mid-October, Canada and the European Union reached an agreement in principle on a comprehensive trade agreement that will significantly boost trade and investment ties, creating jobs and opportunities for Canadians.
The actions taken by the Government since 2006 have helped the Canadian economy to enjoy the strongest economic performance in the G-7 over the recovery and can be expected to continue to improve Canada’s economic and labour market performance over the longer term. Ultimately, the resilience of the Canadian economy, and its ability to thrive in the 21st century global economy, must be underpinned by a strong fiscal position. In that context, recent Government actions to ensure the sustainability of Canada’s public finances reduce the burden placed on future generations of Canadians, improve the environment for investment by keeping taxes and interest rates low, and maintain the ability of the Government to respond to unexpected economic shocks.
Methodology and Key Assumptions
The demographic projections used in this annex are based on medium-growth scenario projections produced by Statistics Canada. Using the latest population data available as a starting point, Statistics Canada projects the structure of the population by age and sex from one year to the next by adding births and net migrants and subtracting deaths. The demographic assumptions behind these projections are outlined in Population Projections for Canada, Provinces and Territories—2009 to 2036, published in 2010. The main assumptions are:
- Life expectancy at birth for females is expected to increase from 82.9 years in 2006 to 87.3 years in 2036. For males, the life expectancy at birth is expected to rise from 78.2 years in 2006 to 84.0 years in 2036.
- The fertility rate for Canada used for the entire projection period is 1.70 children per woman.
- Except for the first three years, where data used are drawn from the immigration plan as formulated by Citizenship and Immigration Canada, the annual immigration rate is assumed to represent 0.75 per cent of the total population. When accounting for emigration and returning emigrants, the net immigration rate for Canada is assumed to range between 0.60 and 0.66 per cent over the projection period.
For the purposes of this annex, the population projections produced by Statistics Canada have been adjusted to reflect the most recent population estimates.
Over the first six years of the projection (2013–2018), key economic indicators (e.g. real GDP growth and interest rates) are taken from the Department of Finance September 2013 survey of private sector economists, which forms the basis for the fiscal forecast presented in this Update.
These results are benchmarked to the Department of Finance long-term projection model. In this model, real GDP growth is assumed to depend on labour productivity growth and labour input growth. Labour input growth is determined by age- and gender-specific labour force participation and average hours worked using population projections from Statistics Canada by age and gender.
Labour productivity is expected to grow at about its historical average over the 2013–2050 period. The unemployment rate over the 2013–2018 period is taken from the private sector forecast, which projects a gradual decline to 6.2 per cent by 2018, near its level prior to the 2008–2009 recession.
Over the medium term (2013–2018), growth in labour supply is projected to continue to contribute significantly to overall GDP growth, albeit somewhat less than over the last four decades. This in part reflects the positive effect of the ongoing recovery in labour markets from the 2008–2009 recession, translating into a falling unemployment rate (which contributes positively to labour supply growth). However, both labour force participation and average hours worked are projected to decline slightly each year (-0.1 percentage points for both) over the medium term, dampening labour supply growth.
Beyond 2018, the positive impacts of the current labour market recovery on labour supply are expected to disappear, while the unemployment rate is assumed to stabilize and average hours worked are projected to continue their trend decline. At the same time, an increasing rate of retirement among the baby boom generation is expected to result in a decline in labour force participation and the rate of growth of the working-age population. Combined, these factors suggest that the contribution of labour supply to real GDP growth will decline significantly to an average of just 0.5 percentage points per year over the 2019–2050 period. Given assumed trend productivity growth of 1.2 per cent per year, growth in real GDP would average 1.7 per cent per year over the same period.
|Real GDP growth||2.9||2.3||1.7||1.8|
|Contributions of (percentage points):|
|Labour supply growth||1.6||1.0||0.4||0.6|
|Labour force participation||0.3||-0.1||-0.5||-0.1|
|Average hours per worker||-0.2||-0.1||-0.1||-0.1|
|Labour productivity growth||1.2||1.3||1.3||1.2|
|Note: Contributions may not add due to rounding.
Sources: Statistics Canada; Department of Finance calculations.
Using the fiscal projections up to 2018–19 presented in this Updateas the starting point, the fiscal projections contained in this annex are obtained through an accounting model in which each revenue and expense category is determined independently and is modelled as a function of the underlying demographic and economic projections, with the relationships defined either by current and already-announced future government policies or assumptions. The model provides a detailed examination of the fiscal implications of population aging on government revenues and expenditures and provides an assessment of long-run fiscal sustainability by simulating long-run debt and deficit paths.
The principal assumptions underlying the fiscal projections from 2018–19 through 2050–51 are:
- The Canada Social Transfer increases by 3 per cent annually, and the Canada Health Transfer and fiscal transfers (i.e. primarily Equalization and Territorial Formula Financing) payments grow as per formulas linked to nominal GDP growth.
- Old Age Security program benefits grow with the targeted population (which is assumed to gradually change from 65 years old and over before 2023 to 67 years old and over in 2029) and inflation to reflect increases in the cost of living.
- Children’s benefits grow with the targeted population (less than 18 years old) and inflation to reflect increases in the cost of living.
- Direct program spending is linked to nominal GDP growth.
- Employment Insurance (EI) benefits grow in line with the projected number of beneficiaries and the projected growth in average weekly earnings.
- The EI premium rate grows according to current program parameters, i.e. EI revenues and expenditures (benefits and administration costs) break even over time.
- All tax revenues, including personal income tax, corporate income tax and Goods and Services Tax revenues, as well as other revenues, are assumed to grow in line with nominal GDP. The $3-billion adjustment for risk applied to revenues in 2018–19 is also assumed to grow in line with nominal GDP beyond that fiscal year.
- With respect to federal debt charges, the initial stock of debt is subject to an average interest rate that is assumed to gradually increase from about 4 per cent in 2018–19 to 5 per cent by 2027–28 (to account for the fact that maturing debt will have to be renewed at increasingly higher rates) and remain constant thereafter. Any additional stock of debt (net assets) resulting from the accumulation of projected deficits (surpluses) is assumed to bear a 5-per-cent effective interest rate. Investment returns on financial assets (which are included in other revenues) are assumed to equal the borrowing costs (which are included in public debt charges) associated with their purchase.
Detailed Fiscal Projections
|Public debt charges||36.1||39.2||42.2||42.0||36.7||25.4||4.1||-31.8|
|1. On a calendar-year basis.|
|Public debt charges||1.6||1.5||1.4||1.2||0.9||0.5||0.1||-0.4|
|1. On a calendar-year basis.|
Because long-term projections and the range of possible results are inherently uncertain, the baseline projections presented in this annex are not intended to be exact forecasts. Rather, they provide a plausible baseline that follows from a reasonable set of demographic, economic and fiscal assumptions, which, as this sensitivity analysis shows, is fairly robust to a number of small changes to individual assumptions. On the other hand, larger changes or a combination of changes to some of these assumptions, a large change in the expected evolution of the medium-term economic and fiscal outlook, or a significant permanent shock to the Government’s revenue or spending would have more significant implications for the long-term economic and fiscal outlooks.
|Fertility rate (average births per woman)||+0.2 births||-0.2 births|
|Net immigration (per cent of population)||+0.1 p.p.||-0.1 p.p.|
|Life expectancy at 65||+3 years||-3 years|
|Total labour force participation rate (per cent)||+1.0 p.p.||-1.0 p.p.|
|Average weekly hours worked||+0.5 hours||-0.5 hours|
|Unemployment rate (per cent)||+0.5 p.p.||-0.5 p.p.|
|Labour productivity (per cent)||+0.1 p.p.||-0.1 p.p.|
|Interest rates (per cent)||+0.5 p.p.||-0.5 p.p.|
|Note: p.p. = percentage point.
1. These alternative assumptions are applied starting in 2019 except for changes in life expectancy, which are gradually applied over the projection horizon.
|Real Per Capita
|Real Per Capita
|Real Per Capita
|Life expectancy at 65||3.8||0.9||3.8||0.8||3.8||1.0|
|Total labour force participation rate||3.8||0.9||3.8||0.9||3.7||0.8|
|Average weekly hours worked||3.8||0.9||3.8||0.9||3.7||0.8|
|Real Per Capita
|Real Per Capita
|Life expectancy at 65||0.5||-2.1||-0.5||2.1|
|Total labour force participation rate||1.6||1.6||-1.6||-1.6|
|Average weekly hours worked||1.5||1.5||-1.5||-1.5|
|Life expectancy at 65||-2.8||-21.2||-2.4||-16.8||-3.2||-25.3|
|Total labour force participation rate||-2.8||-21.2||-3.0||-24.1||-2.6||-18.2|
|Average weekly hours worked||-2.8||-21.2||-3.0||-24.0||-2.6||-18.4|
1 The fertility rate in Canada rapidly decreased from a high of 3.9 children per woman in 1959 to 1.7 in 1979, and has stayed close to this level ever since. Canadians have seen their life expectancy increase by about 20 years since the 1920s.
2 The labour force includes non-institutionalized individuals aged 15 and over who are either working or actively seeking a job. Labour force participation rates are low when individuals are young (ages 15 to 24), reach peak levels between the ages of 25 and 54 and begin to decline starting at age 55. While participation rates of older individuals are expected to continue to increase, they are expected to remain well below rates seen among younger age groups.
3 Average annual hours worked by Canadians have gradually declined over the last four decades. This decline reflects several factors, including: rising post-secondary school enrolment, which limits the number of hours that younger individuals can work; the rise in part-time work, which is related to the increasing share of the service sector in the overall economy, characterized by a shorter and more flexible work week; and rising incomes, which have enabled the substitution of some work hours for some increased leisure time.
4 CIHI news release, “Canada’s health care spending growth slows: provincial and territorial government health expenditure expected to grow 3.1%, lowest since 1997,” October 30, 2012.
5 Statistics Canada produces three long-term population projections based on low-, medium- and high-growth scenarios.