3

Building Canada

for the 21st Century --

Maintaining Sound Economic and Financial Management

Highlights

▪	The budget will be balanced in 1997-98 -- the first balanced budget since 1969-70.

▪	The budget will also be balanced in 1998-99 and 1999-2000 -- the first time in almost 50 years that the budget will be in balance for three consecutive years.

▪	Canada's debt burden will be put on a permanent downward track through sustained economic growth and a debt repayment plan.

▪	By international standards, Canada is the only Group of Seven (G-7) country to have balanced its budget.

▪	As a share of gross domestic product (GDP), program spending will fall to 11.5 per cent by 1999-2000 -- its lowest level in 50 years.

▪	Current inflation control targets, which keep inflation within a range of 1 per cent to 3 per cent, will be extended to the end of 2001.

Introduction

In 1993-94, Canada was caught in a vicious fiscal circle -- high deficits were pushing up interest rates and depressing economic activity which, in turn, worsened the fiscal situation. By that time, a national consensus had formed that Canada's deficit had to be eliminated and the burden of public debt reduced.

The government responded to that consensus. It set out a deliberate, measured and responsible plan to ultimately eliminate the deficit through program reforms that ensured permanent savings, while allowing Canadians and the economy time to adapt. Budget plans were based on two-year rolling deficit targets, using prudent economic planning assumptions and including a sizeable Contingency Reserve. Prudence in budget planning has meant that the Contingency Reserve has not been needed and deficit reduction targets have been consistently bettered in each and every year.

Today, Canada enjoys the benefits of a virtuous circle, where fiscal progress contributes to stronger economic and employment growth, which in turn is leading to an ever-improving fiscal climate.

This chapter reviews the progress achieved en route to a balanced budget. It introduces The Debt Repayment Plan -- the budget planning strategy that will guide the government in reducing its debt burden. It announces, jointly with the Bank of Canada, a three-year extension of Canada's inflation control targets. Finally, it provides a detailed discussion of the outlook for revenues and expenditures.

Balancing the Books --

The First Time Since 1969-70

In December 1997, the federal government recorded a budgetary surplus of $3.6 billion -- the largest monthly surplus ever recorded. As a result, for the first nine months of 1997-98, the government recorded a surplus of $5 billion. Based on these results, and coupled with expected developments over the balance of the fiscal year (including the traditional end-of-year accounting adjustments) and incorporating the fiscal impact of the initiatives announced in this budget, the budget will be balanced in 1997-98.

Achieving a balanced budget in 1997-98 means that the deficit has declined by $42 billion since 1993-94. The elimination of the deficit was due to a decline in program spending, largely as a result of the restraint measures introduced in the 1994 and 1995 budgets, and higher budgetary revenues, primarily from a growing economy. Partially offsetting these positive developments were somewhat higher public debt charges.

The reduction in program spending largely reflected the net impact of restraint measures taken since 1993-94. Program spending declined from $120 billion in 1993-94 to an estimated $106 billion in 1997-98 -- a reduction of $14 billion. This decline includes the impact of the initiatives funded in this budget, which increase program spending by $3.2 billion in 1997-98.

Reductions in program spending were the result of a fundamental review of all federal government programs. Beginning with the 1994 budget and followed up in the 1995 and 1996 budgets, all federal government programs were examined to ensure that limited resources would be directed to the highest priorities. This review was conducted in two parts. Most components of direct program spending -- total program spending excluding the major transfers to persons and other levels of government -- were subject to the Program Review exercises. As a result:

▪	the government reduced its role in numerous areas where it no longer has a discernible positive impact -- notably direct subsidies to business;

▪	services that were best delivered by the private sector were privatized or commercialized; and

▪	programs that could be best delivered by provincial governments were transferred, reducing overlap and duplication between the different levels of government.

In addition, the major transfer programs to persons and other levels of government were also reviewed to ensure that they would be sustainable over the long term. These transfers could not be exempt from overall program reduction, given their substantial share of overall program spending. Structural changes were made to the Employment Insurance (EI) Program. The Canada Assistance Plan and Established Programs Financing arrangements were replaced by the Canada Health and Social Transfer (CHST). The Equalization Program was not subject to restraint.

In 1993-94, total program spending as a percentage of the economy (GDP) stood at 16.6 per cent. By 1997-98, it is estimated to have declined to 12.4 per cent (Chart 3.1).

The federal government is not just smaller as a result of these reforms. It is also now more effective and efficient in delivering the programs and services that are central to its responsibilities and role in the Canadian federation. The government is announcing new spending in this budget, of which 80 per cent is being directed to two of the highest priorities of Canadians which will contribute to the building of a stronger economy and a more secure society.

Program spending will continue to be subject to ongoing review. The Expenditure Management System (EMS), first announced in the 1995 budget, will ensure that programs are permanently subject to strict cost control and evaluation. All necessary measures will be taken to ensure the effective management of human resources, with due regard for fiscal responsibility as well as for employees' needs. Under the EMS, departments must clearly set out their strategies through business plans, which are reviewed annually by Parliament. The EMS also provides ministers and departments with more flexibility to manage their resources efficiently, while subjecting them to increasing accountability. This structure will ensure that program spending remains strictly under control.

Chart 3.1 (See BP3-1E.WMF or .WPG)

Budgetary revenues are estimated to have increased by $31.5 billion between 1993-94 and 1997-98, with nearly $26 billion of this increase attributable to economic developments. Of this amount, about 85 per cent is due to the growth of the economy alone and about 15 per cent is due to the interaction between the tax system and rising incomes. Between 1993 and 1997, nominal income (the overall tax base for budgetary revenues) is estimated to have increased by $133 billion, with one million more Canadians employed. With a growing economy, more people are employed and paying taxes; increased consumer spending leads to higher sales tax revenues; while higher corporate profits result in increased corporate income tax collections.

One-time factors account for just over $3 billion of the total increase in budgetary revenues. Budgetary revenues were depressed in 1993-94 due to the transitional costs associated with the introduction of the Child Tax Benefit ($1.2 billion) and the faster processing of personal income tax returns in March 1994, resulting in higher personal income tax refunds ($1.2 billion). In contrast, budgetary revenues are somewhat inflated in 1997-98 by the inclusion of the Air Transport Tax ($0.7 billion) as part of budgetary revenues, whereas in previous years, it was netted against the cost of running the airports and, therefore, against program spending.

Only $2.6 billion of the estimated increase in budgetary revenues between 1993-94 and 1997-98 is attributable to the net impact of revenue-raising measures introduced since 1993. These measures were primarily designed to increase the fairness of the tax system and to remove or reduce a number of tax preferences. Since 1994, there have been no increases in personal income tax rates.

The Debt Repayment Plan

Canada's remaining fiscal challenge is to significantly lower the government's debt burden -- measured as the ratio of net public debt to GDP. Although the debt-to-GDP ratio has begun to decline, it is still too high, both by historical Canadian and international standards. It is important to ensure that the debt-to-GDP ratio is put on a permanent downward track.

A high debt burden means that a large portion of the revenue the government collects from taxpayers must go towards debt servicing payments rather than to valued programs and services, to reduce taxes or to pay down the debt. In 1997-98, about 30 cents of each revenue dollar received will be used to pay interest on the public debt -- double what was necessary in the mid-1970s.

Chart 3.2 (See BP3-2E.WMF or .WPG)

Reducing the high debt-to-GDP ratio will also lessen the exposure of Canada's fiscal situation to economic shocks, especially an increase in interest rates or prolonged slowdowns in economic activity.

Of even greater importance over time, reducing the debt-to-GDP ratio will ensure that future generations are left with a legacy of sound social and economic programs. To ensure that younger Canadians do not pay an unduly large portion of the debt, the debt-to-GDP ratio must be reduced while the generations that benefited most from its increase are still in the labour force.

The government intends to put the debt-to-GDP ratio on a permanent downward track by pursuing a two-pronged strategy of supporting long-term economic growth and achieving reductions in the absolute level of debt. First, as the fiscal situation permits, the government will undertake strategic initiatives to improve the growth potential of the Canadian economy. Second, the overall stock of public debt will be reduced through the government's Debt Repayment Plan.

The Debt Repayment Plan

The Debt Repayment Plan consists of three key elements:

▪	as before, two-year fiscal plans based on prudent economic planning assumptions; the current plan commits to balanced budgets in 1998-99 and 1999-2000;

▪	the inclusion in the fiscal plan of a Contingency Reserve of $3 billion in each year; and

▪	the use of the Contingency Reserve, when it is not needed, to pay down the public debt.

The Contingency Reserve is included in the budget projections primarily to cover risks arising from (i) unavoidable inaccuracies in the models used to translate economic assumptions into detailed budget forecasts, and (ii) unpredictable events. The Contingency Reserve also provides an extra measure of back-up against adverse errors in the economic forecast. The Contingency Reserve is not a source of funding for new policy initiatives.

The government will continue to use a two-year planning horizon for budget planning, which has proved extremely successful in eliminating the deficit. The short-term planning horizon ensures accountability and an immediate commitment to action to make sure that the targets are realized. However, the two-year budget planning horizon does not mean that the government cannot take action to address longer-term structural issues that could affect the Canadian economy and the fiscal situation. For example, the reforms to the Canada Pension Plan, agreed to by the federal and provincial governments, will ensure that it is secure for the future. The government has also proposed a new Seniors Benefit that will address the demographic pressures on the current Old Age Security and Guaranteed Income Supplement programs.

In addition to securing a durable reduction in the public debt burden, the government has also reduced its exposure to increases in interest rates by restructuring the composition of public debt. In 1992-93, one-half of the stock of debt was at fixed rates (one-year maturities and over). Today, 65 per cent of the debt is at fixed rates. This means that a 100-basis-point increase in interest rates would now raise public debt charges by $1 billion in the first year; in the mid-1990s, the first year impact of a 100-basis-point increase was estimated at about $1.8 billion.

Preserving the Gains from Low Inflation

The objective of Canadian monetary policy is to contribute to sustainable economic expansion, high levels of employment and rising standards of living. The best contribution monetary policy can make to these goals is through preserving confidence in the value of money by providing an environment of stable average prices.

Targets for reducing inflation were first adopted in February 1991. In December 1993, the government and the Bank of Canada agreed to extend the targets from the end of 1995 to the end of 1998 with the objective of holding inflation inside the range of 1 per cent to 3 per cent. It was also agreed that the targets would be re-examined by the end of 1998 and a new long-term target range consistent with price stability would be set at that time.

Since the initial adoption of these targets, considerable progress has been made in reducing inflation and maintaining it at a low level. Economic decisions are increasingly being made on expectations of a continuation of low inflation, and Canadians are beginning to experience the benefits from such an environment. For example, low inflation, together with the progress made by all levels of government in Canada to restore fiscal balance, has resulted in substantial declines in interest rates, with medium- and long-term interest rates near their lowest levels in decades. However, over the past several years, the Canadian economy has been through a difficult period of private and public sector restructuring, and the full benefits for economic performance of low inflation have yet to be realized.

It would be helpful to have a longer period of time in which the economy demonstrated more fully its ability to perform well under conditions of low inflation before determining the appropriate long-run target consistent with price stability. Consequently, the Government of Canada and the Bank of Canada have agreed to extend the existing inflation control targets, which are to hold inflation inside the range of 1 per cent to 3 per cent, to the end of 2001. The government and the Bank of Canada plan to determine the long-run target for monetary policy before the end of 2001. Providing Canadians with a long-term commitment will help to secure the benefits that a stable price environment can bring to the growth of incomes and employment in Canada.

The extension of the inflation targets will help to keep Canada's inflation rate among the lowest in the world. It will provide Canadians with a medium-term guide in making economic decisions. As well, it will solidify Canada's international reputation as a low inflation country, enhancing the credibility of Canadian economic policies.

Fiscal Outlook to 1999-2000

Overview

At no time in the past 25 years has Canada's fiscal situation been so positive (Table 3.1).

▪	The budget for 1997-98, including spending and tax relief initiatives announced in this budget, will be balanced. This will be the first time since 1969-70 that the federal government has achieved a balanced budget.

▪	The government is committed to balancing the budget for 1998-99 and 1999-2000. This will mark the first time in nearly 50 years that the federal government will have balanced its books for three years in a row.

▪	These targets are based on prudent planning assumptions and include a Contingency Reserve of $3 billion each year. If the Contingency Reserve is not needed, it will be used to pay down the debt.

▪	In 1996-97, the debt-to-GDP ratio fell -- the first meaningful decline since 1974-75. With sustained economic growth and The Debt Repayment Plan, this ratio will continue to decline. By 1999-2000, it is projected to be at about 63 per cent of GDP, compared to almost 72 per cent in 1995-96.

▪	In 1996-97, a financial surplus of $1.3 billion was reported. This meant that the government took in more cash than was needed to pay for current operations and to pay interest on the public debt. With a commitment to balanced budgets in 1997-98 and in each of the next two fiscal years, the government will be in an ongoing net financial surplus position, or cash position. This will allow the government to steadily pay down its market debt. For the first nine months of 1997-98, the government paid down $12.9 billion of its market debt.

Table 3.1

Summary statement of transactions:

fiscal outlook with budget measures

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 (billions of dollars) Budgetary revenues 116.0 123.3 130.3 140.9 147.5 151.0 155.0 Program spending 120.0 118.7 112.0 104.8 106.0 104.5 107.0 Operating balance -4.0 4.6 18.3 36.1 41.5 46.5 48.0 Public debt charges 38.0 42.0 46.9 45.0 41.5 43.5 45.0 Underlying balance -42.0 -37.5 -28.6 -8.9 0.0 3.0 3.0 Contingency Reserve 3.0 3.0 Budgetary balance -42.0 -37.5 -28.6 -8.9 0.0 0.0 0.0 Net public debt 508.2 545.7 574.3 583.2 583.2 583.2 583.2 Non-budgetary

transactions 12.2 11.6 11.4 10.2 12.0 6.0 9.0 Financial requirements/

surplus -29.8 -25.8 -17.2 1.3 12.0 6.0 9.0 (excluding foreign exchange Transactions) Per cent of GDP	Budgetary revenues 16.0 16.2 16.3 17.2 17.2 16.9 16.7	Program spending 16.6 15.6 14.0 12.8 12.4 11.7 11.5	Operating balance -0.6 0.6 2.3 4.4 4.8 5.2 5.2	Public debt charges 5.2 5.5 5.9 5.5 4.8 4.9 4.9	Budgetary balance -5.8 -4.9 -3.6 -1.1 0.0 0.0 0.0	Net public debt 70.2 71.6 71.9 71.1 68.1 65.4 62.9	Financial

requirements/surplus -4.1 -3.4 -2.2 0.2 1.4 0.7 1.0

▪	Financial requirements/surplus are comparable to the measures of the budgetary balance used by other major industrialized countries, including the United States. Therefore, by internationally comparable measures, this means that the federal government had a surplus in 1996-97 and will continue to run surpluses -- the best performance among all other G-7 countries (see Annex 4 for more details on international fiscal comparisons).

Chart 3.3 (See BP3-3E.WMF or .WPG)

Changes since the 1997 budget forecast

The final deficit outcome for 1996-97 was $8.9 billion. This was $10.1 billion lower than the February 1997 budget estimate of $19 billion and $15.4 billion below the original deficit target of $24.3 billion. This better-than-expected performance reflected both lower program spending and higher revenues. This improvement has carried over into 1997-98.

Financial results for the first nine months of the 1997-98 fiscal year report a cumulative budgetary surplus of $5 billion (see The Fiscal Monitor for December 1997). Indeed, for the month of December 1997, the government recorded the largest monthly surplus ever. Over the remaining three months of the fiscal year and the end-of-year accounting period, it is expected that the federal government will run a small deficit. This is consistent with the flow of revenues and spending witnessed in previous fiscal years and takes into account adverse fiscal developments resulting from the January 1998 ice storm in eastern Canada. Incorporating the impact of the initiatives proposed in this budget, a balanced budget will be recorded in 1997-98. Final results will be published in the Annual Financial Report, which is released in the fall of each year.

Table 3.2

The fiscal outlook: changes since the 1997 budget

1996-97 1997-98 1998-99 (billions of dollars) Original deficit target 19.0 17.0 9.0 Impact of economic factors	Revenues:	Personal income tax -1.9 -1.7	Corporate income tax -1.2 -3.8 -3.4	Employment insurance	premium revenue -0.2 0.4 0.7	Sales and excise

taxes/duties

-2.1

-3.6

-3.4	Other revenues -1.9 -1.1 -0.7	Total -5.4 -10.0 -8.5	Program spending	Major transfers to persons -0.7 -2.4 -1.5	Major transfers to other	Levels of government 0.2 0.3 -0.1	Direct program spending -3.7 -0.9 0.6	Total -4.2 -3.0 -1.0	Public debt charges -0.5 -2.0 -0.5 Net impact of economic factors -10.1 -15.0 -10.0 Adjustment to public

debt charges

-2.5

-2.5 Net impact of policy changes 3.5 3.5 Contingency Reserve -3.0 Net changes since 1997 budget -10.1 -17.0 -9.0 1998 budget deficit track 8.9 0.0 0.0 Note: (-) indicates a reduction in deficit

(+) indicates an increase in the deficit

Based on the financial results to date and expected developments over the balance of the fiscal year, budgetary revenues, excluding the impact of policy initiatives, are expected to be $10 billion higher in 1997-98 than estimated in the February 1997 budget. Most of the increased revenues reflect higher corporate income tax and goods and services tax (GST) collections. Both corporate profits and consumer expenditures subject to the GST are much higher than estimated at the time of the February 1997 budget. Personal income tax collections are also expected to be somewhat higher, reflecting the strong employment growth witnessed in 1997.

The higher overall collections estimated for 1997-98 are expected to continue into 1998-99, although at a somewhat reduced pace. As indicated in Chapter 2, nominal income growth is expected to slow somewhat from 1997.

Excluding the impact of policy initiatives, program spending is expected to be $3 billion lower in 1997-98 and $1 billion lower in 1998-99, from the levels estimated in the February 1997 budget. Most of the lower spending is attributable to lower-than-expected employment insurance benefit payments, because of the drop in the number of unemployed. Direct program spending is lower in 1997-98 but somewhat higher in 1998-99 as a result of some reprofiling of funds between fiscal years. The reprofiling of funds is subject to Treasury Board approval, and promotes more efficient cash management practices.

Public debt charges are expected to be $2.0 billion lower in 1997-98 and $0.5 billion lower in 1998-99. Both short- and long-term interest rates in 1997 turned out to be significantly lower than those assumed for prudent planning purposes in the 1997 budget. Although short-term interest rates are now assumed, for planning purposes, to be somewhat higher in 1998, long-term interest rates are somewhat lower.

As a result, economic factors accounted for $10.1 billion of the lower-than-expected deficit outcome for 1996-97. For 1997-98, economic factors are estimated to account for $15 billion, while in 1998-99, these factors are estimated to account for $10.0 billion.

The Auditor General disagrees with the way that the government is reporting interest costs related to public service pension plans (see Annex 6). For accounting purposes, the Auditor General and the Public Sector Accounting and Auditing Board (PSAAB) have recommended since 1996 that such interest costs be calculated on the basis of the actuarial obligation of the pension plans rather than on the financial obligation. At present, the actuarial obligation is significantly lower than the financial obligation. Beginning in 1997-98, the government will change its accounting policies to conform with the recommendations of the PSAAB and the Auditor General. This will have the effect of reducing net public debt charges by about $2.5 billion per year. In addition, the President of the Treasury Board will be undertaking consultations with plan members regarding fundamental reform of the management and financing of public service pensions.

New initiatives totalling $3.5 billion are planned for 1997-98. These include $2.5 billion for the Canada Millennium Scholarship Foundation and the $350 million fund for a Healing Strategy to address the legacy of abuse of aboriginal students in residential schools. The government believes that transparency and accountability to Parliament and Canadians are best served by recording such liabilities in the year in which they are incurred (see Annex 6). In addition, the commitment to raise the cash floor of the Canada Health and Social Transfer to $12.5 billion results in an additional transfer of $0.2 billion to provinces in 1997-98. Also included is the impact of the reduction in employment insurance premium rates for 1998 from an assumed rate of $2.80 in the 1997 budget (employee rate per $100 of insurable earnings) to $2.70.

The fiscal impact of spending and tax initiatives is estimated at $3.5 billion for 1998-99 as well. Of this amount: $0.9 billion relates to general tax relief for Canadians; $0.5 billion relates to the reduction in EI premium rates; $0.9 billion for the raising of the CHST cash floor; $0.7 billion for the Canadian Opportunities Strategy; $0.3 billion to Building a Secure Society; and the remainder allocated for other commitments in Securing Our Future Together.

Given the improvement in the fiscal outlook for 1997-98, the Contingency Reserve of $3 billion included in the original deficit target of $17 billion is no longer required. However, under The Debt Repayment Plan, the $3 billion Contingency Reserve is included in the balanced budget target for 1998-99 and 1999-2000.

Outlook for budgetary revenues

The revenue outlook to 1999-2000 is summarized in Table 3.3.

In the first nine months of 1997-98, budgetary revenues were up 6.7 per cent over the same period last year. Strong gains were reported for personal and corporate income tax collections and for the GST. This pace of revenue growth is expected to slow over the balance of the fiscal year. For the year as a whole, budgetary revenues are expected to increase by 4.7 per cent. An increase of only 2.4 per cent is expected for 1998-99, primarily reflecting the impact of the general and targeted tax relief measures proposed in this budget. For 1999-2000, budgetary revenues are expected to increase by 2.6 per cent. As a percentage of GDP, revenues are expected to fall from 17.2 per cent in 1997-98 to 16.7 per cent in 1999-2000.

Table 3.3

The revenue outlook

1996-97 1997-98 1998-99 1999-00 (billions of dollars) Income tax revenue	Personal income tax 63.3 68.4 71.0 73.5	Corporate income tax 17.0 20.0 20.5 20.9	Other 2.8 2.4 2.3 2.4	Total 83.1 90.8 93.8 96.8 Employment insurance premium revenue 19.8 18.7 18.6 19.0 Sales and excise taxes/duties Goods and services tax 18.1 19.8 20.9 21.8 Customs import duties 2.7 2.7 2.5 2.5 Other 8.3 8.8 8.6 8.5 Total 29.1 31.3 32.0 32.7 Non-tax revenue 8.8 6.8 6.7 6.6 Total budgetary revenues 140.8 147.5 151.0 155.0 Per cent of GDP 17.2 17.2 16.9 16.7

Personal income tax revenues, the single largest source of federal revenues, are expected to increase by 3.8 per cent in 1998-99, following an expected advance of 8.1 per cent in 1997-98. The slower rate of growth in 1998-99 reflects the impact of the proposed increase in the amount of income that low-income Canadians can receive on a tax-free basis and the elimination of the 3-per-cent surtax for those Canadians with incomes up to about $50,000. These measures, coupled with the proposed increase in the Canada Child Tax Benefit, also affect personal income tax growth in 1999-2000.

Over the first nine months of 1997-98, corporate income tax collections are up 27.6 per cent. Collection growth is expected to slow considerably over the balance of the fiscal year and an increase of 17.6 per cent is expected for the year as a whole. For both 1998-99 and 1999-2000, collections are expected to increase only marginally, reflecting the assumed increase in corporate profits.

For 1998, the employment insurance premium rate has been lowered to $2.70 (employee rate) per $100 of insurable earnings, from $2.90 in 1997. The government is planning its budget on a premium rate of $2.70 for 1999 and $2.60 for 2000. This budget also proposes an employer employment insurance premium holiday for additional young Canadians hired in 1999 and 2000. This is expected to lower employment insurance premium revenues by about $100 million in 1999-2000. These measures are largely expected to offset any increase in premium revenues resulting from advances in overall job creation.

Goods and services tax collections are up 13.1 per cent in the first nine months of 1997-98, reflecting the growth in consumer spending subject to the GST. For the year as a whole, GST collections are expected to be up 9.4 per cent. Other excise tax collections are expected to decline in 1998-99, largely due to the phase-out of the Air Transport Tax in 1998.

Non-tax revenues include return on investments, most notably Bank of Canada profits and exchange fund earnings, and other non-tax revenues such as user fees and charges. Revenues were exceptionally large in 1996-97 due to the inclusion of the proceeds from the sale of Transport Canada's air navigation assets.

Outlook for program spending

Table 3.4 provides the major elements of program spending through to 1999-2000. The profile of program spending reflects the impact of new initiatives announced since the 1997 budget.

For 1997-98, total program spending is expected to amount to $106 billion. This is only marginally higher than the February 1997 budget estimate of $105.8 billion, even though the current estimate includes the cost of the Canada Millennium Scholarship Foundation of $2.5 billion and the fiscal impact of other initiatives announced since the February 1997 budget. The elimination of the deficit has allowed the government to undertake additional strategic investments without materially affecting the level of program spending projected in the 1997 budget.

Program spending is estimated to fall to $104.5 billion in 1998-99. In the February 1997 budget, program spending was estimated at $103.5 billion. However, excluding the impact of the new initiatives ($2 billion) since the February 1997 budget, program spending would have been $1 billion lower than estimated in the 1997 budget.

By 1998-99, the Program Review restraint measures are fully reflected in the spending estimates. Although these measures are permanent, there are no incremental restraint measures beyond 1998-99. In 1999-2000, program spending increases to $107.0 billion, an increase of 2.4 per cent from 1998-99. This increase reflects, in part, the impact of rising transfers to persons (elderly and employment insurance benefits) and the spending initiatives funded in this budget. As well, after five years of steady decline in government operating budgets, an increase in departmental spending in line with the rate of inflation (1.5 per cent) has been factored into the program spending estimates to address wage and price increases and workload pressures.

Program spending falls into three components: major transfers to persons, major transfers to other levels of government and direct program spending -- referred to as departmental spending.

Major transfers to persons

Major transfers to persons consist of elderly benefits -- Old Age Security (OAS), Guaranteed Income Supplement (GIS) and Spouse's Allowance (SPA) -- and employment insurance benefits.

The increase in elderly benefits expected through 1999-2000 reflects a combination of rising maximum benefits (which are indexed to inflation) and growth in the senior population. The government intends to introduce legislation in the coming months to replace OAS and GIS with a new Seniors Benefit.

Employment insurance benefit payments are expected to continue to fall through 1997-98. EI benefits peaked in 1992-93 at $19.1 billion. The decline is due to improvements in the job market since 1993 and to structural reforms to the EI program. However, benefits payments are expected to rise modestly, starting in 1998-99. With an improving economy, the number of beneficiaries relative to the number of unemployed typically increases.

Major transfers to other levels of government

There are three major programs under which the federal government transfers funds to other levels of government. The largest of these is the Canada Health and Social Transfer (CHST), a block-funded transfer to provinces and territories to support health care, post-secondary education and other social programs.

Total CHST entitlements are determined through legislation. The CHST is delivered in the form of tax point transfers and cash transfers. Tax point transfers involved the transfer of federal "tax room" to the provinces, which allowed the provinces to increase their tax rates by an equivalent amount with no impact on taxpayers. The cash transfer is the difference between the total entitlement and the value of the tax point transfer.

Reflecting the commitment made in Securing Our Future Together, legislation was introduced in December 1997 to raise the cash floor to $12.5 billion beginning in 1997-98. The $12.5 billion cash floor means:

▪	in 1999-2000, provinces and territories are scheduled to receive an estimated $1.5 billion more in CHST cash transfers than they were to receive in the 1997 budget;

▪	over the period 1997-98 to 2002-03, there will be an additional $7 billion in CHST cash transfers; and

▪	CHST entitlements will start to grow in 1998-99. By 1999-2000, the estimated CHST entitlement will have increased more that 5 per cent over the 1997-98 level.

Equalization provides a further transfer in excess of $8.5 billion in cash to provinces with below-average per capita capacity to raise revenues. This enables these provinces to provide public services that are reasonably comparable to those available elsewhere in the country, without having to resort to above-average levels of taxation.

Between 1993-94 and 1996-97, Equalization payments increased significantly, reflecting the fact that this program was not subject to restraint. Over the fiscal planning horizon, provincial revenue growth, the strength of resource-based revenues in some of the Equalization-receiving provinces and shifts in population among provinces, will have an impact on Equalization payments. Statutory authority for Equalization expires March 31, 1999. For planning purposes, the estimates of Equalization transfers beyond 1998-99 assume a continuation of the current statutory formula.

The federal government also provides transfers to territorial governments, recognizing that these governments are in a unique situation due to the special challenges of providing public services in the north. These transfers are estimated at $1.1 billion in 1997-98 and 1998-99. In 1999, when Nunavut comes into existence, new arrangements will be required for the three northern territories. The federal government is consulting with northern parties to estimate reasonable incremental costs that will result from the division. For planning purposes, estimates of transfers to the territorial governments in 1999-2000 assume funding at current levels.

The economies of Canada's territories, like other regions, are undergoing significant change. Northern governments are pursuing the diversification of their economies in a variety of ways including the development of traditional economic activities, knowledge-based industries and a new diamond industry. The government is committed to working with territorial governments and other northern partners to develop a modern economic development strategy that recognizes the dynamics of the North and the need to establish more diversified economies.

The Alternative Payments for Standing Programs represent recoveries of federal tax point abatements under contracting-out arrangements. These arrangements allowed provinces to assume the administrative and financial authority for certain federal-provincial programs. In turn, the federal government provided provinces with tax points, the value of which are netted against total entitlements, and accordingly recovered from the cash transfers. Quebec was the only province to choose these arrangements when they were offered in the mid-1960s. The recoveries have no impact on net federal transfers or on Quebec's net receipts.

Direct program spending

Direct program spending consists of total program spending excluding the major transfers to persons and to other levels of government. It includes transfer programs administered by departments, expenditures related to Crown corporations and the operating, maintenance, and capital costs of departments, including defence.

Seven departments account for the majority of transfer payments.

▪	Transfers within the agriculture department largely consist of the agricultural safety net programs. The spending profile reflects the ongoing phase-out of the dairy subsidy and the reprofiling of funds within the agriculture safety-net envelope.

▪	Industry and regional development transfers support a wide range of programs, such as advanced research and technology adoption and diffusion and support for small businesses. Transfers will increase over the next two years reflecting the measures in this budget in support of advanced research and the information economy (i.e. funding for the granting councils and for the CANARIE, SchoolNet and Community Access programs) and the Technology Partnerships Canada Program introduced in the 1996 budget.

▪	A significant portion of the transfers administered by the Department of Foreign Affairs and International Trade consists of funding for international assistance. The international assistance envelope will be up slightly from the estimate at the time of the 1997 budget, reflecting the impact of one-time payments of $90 million in 1997-98 and $50 million in 1998-99.

▪	A significant portion of Health Canada's transfers is for First Nations and Inuit health services, as well as funding for the population health strategy and the Medical Research Council. Reflecting growth in the First Nations and Inuit populations and new initiatives since the 1997 budget, such as increased funding for HIV/AIDS and the Medical Research Council, health expenditures will increase over the forecast horizon.

▪	Growth in transfer programs adminstered by the Department of Indian and Northern Affairs was restrained in the 1995 and 1996 budgets. However, rapid growth of the on-reserve aboriginal population meant that this was one of the few program areas that did not experience an absolute decline in spending. Current spending levels incorporate a number of initiatives announced in Gathering Strength, which will raise the level of transfers to $4.1 billion in 1998-99 and 1999-2000.

The ongoing effects of restraint measures introduced since 1993 will continue to restrain Crown corporation expenditures over the next two years. Spending on Crown corporations will average $3.8 billion over the 1997-98 to 1999-2000 period compared with the $5 to 6 billion in the early 1990s. The government will continue to review its equity holdings in Crown corporations and other assets, divesting those that no longer serve a public policy objective.

Defence spending is also expected to decline through 1998-99 as past expenditure restraint decisions are fully implemented. The increase in defence spending in 1999-2000 largely reflects the effect of one-time savings of $150 million in 1998-99 that were put into effect in the 1996 budget as well as a carry-forward of capital expenditures from 1996-97 to 1999-2000.

All other spending includes departmental operating costs and centrally held funds to assist departments in managing unavoidable cost pressures during the fiscal year. The expenditure control measures implemented by the government since 1993-94 have significantly reduced operating budgets of departments. And the continued operation of the Expenditure Management System (introduced in the 1995 budget) will ensure that departments fulfill their mandates in the most efficient and cost-effective manner possible. This means that, to the greatest possible extent, new cost pressures will be funded by internal reallocation and increased efficiencies.

The public service of Canada is an essential institution with a long and proud record of outstanding contributions to national objectives and high quality service to citizens. In recent years, it has undergone difficult adjustments in response to severe fiscal pressures and the need for changing priorities. The ability to address future priorities will depend to a considerable degree on the continued strength of the public service. The government is committed to implementing measures that will ensure the revitalization of the public service and the capacity to work in partnership with other sectors in Canadian society to help build the Canada of the future.

The Year 2000 preparedness presents a global challenge -- for individuals, for businesses and for governments. The recent report of the Task Force on Year 2000 set out a variety of actions that business will have to undertake to ensure that they meet the challenge of continuing operation of computer-supported systems in the next millennium. The initiatives taken by securities commissions and stock exchanges to ensure full disclosure by publicly traded companies of their state of readiness in this regard represent a further welcome step in preparing Canada to meet this challenge. The government is also clarifying the tax treatment of Year 2000 expenditures. Expenditures that are made to ensure functionality in the Year 2000 will be fully deductible in the year incurred.

For its part, the government will ensure that all of its critical computer-based systems will continue to function at the turn of the millennium. To this end, the government is reallocating resources within its own information technology budget to focus on solving the Year 2000 problem.

Table 3.4

The outlook for program spending

1996-97 1997-98 1998-99 1999-00 (billions of dollars) Major transfers to persons	Elderly benefits 21.6 22.2 22.9 23.6	Employment insurance

benefits

12.4

12.0

12.6

13.2	Total 34.0 34.2 35.5 36.8 Major transfers to other

levels of government	CHST	Total entitlements 26.9 25.3 26.0 26.6	Tax point transfer -12.1 -12.8 -13.5 -14.1	Cash payment 14.8 12.5 12.5 12.5	Equalization 8.7 8.8 8.5 8.7	Transfers to territories 1.1 1.1 1.1 1.1	Other fiscal transfers -0.4 -0.4 -0.4 -0.5	Alternative Payments

for Standing Programs

-2.0

-2.1

-2.2

-2.3	Total cash transfers 22.2 19.9 19.5 19.5 Reference:	Total entitlements 36.0 34.2 34.7 35.4 Direct program spending	Departmental transfers	Agriculture 1.1 1.0 1.0 0.9	Industry and

Regional

Development

1.6

1.9

2.0

1.8	Foreign Affairs 2.1 2.2 1.9 1.9	Health 0.9 0.9 1.1 1.1	Human Resources

Development

2.1

2.1

2.2

2.0	Indian and Northern

Development

3.9

4.0

4.1

4.1	Other 6.1 7.6 4.7 5.1	Total 17.9 19.6 17.0 16.8	Crown corporations 3.6 3.9 3.8 3.8	Defence 8.5 8.4 7.9 8.2	Other 18.7 20.0 20.9 21.9	Total direct program

spending

48.7

52.0

49.5

50.7 Total program spending 104.8 106.0 104.5 107.0 Per cent of GDP 12.8 12.4 11.7 11.5 Numbers may not add due to rounding.

Public debt charges

Public debt charges are expected to fall to $41.5 billion in 1997-98, reflecting the impact of the decline in interest rates and the change in accounting for pension interest. The higher interest rates, embedded in the prudent budget planning assumptions, result in an increase in public debt charges over the planning horizon.

Table 3.5

Public debt charges

1996-97 1997-98 1998-99 1999-00 (billions of dollars) Public debt charges 45.0 41.5 43.5 45.0

Financial surplus

The financial balance (requirements/surplus) provides a measure of net cash requirements to fund the government's programs and debt charges. In 1996-97, the financial balance was in surplus by $1.3 billion. The financial surplus is expected to be $12 billion in 1997-98, $6 billion in 1998-99 and $9 billion in 1999-2000.

The difference between the financial balance and the budgetary balance is due to a number of non-budgetary transactions that provide funds to the government. Non-budgetary transactions convert the cash-based financial requirements to the accrual-based spending and revenue concepts in the deficit. The largest of the non-budgetary transactions are the government employees' pension accounts. Other smaller sources of funds include loans, investments and advances, cash in transit and accounts payable.

Non-budgetary transactions are expected to be up significantly in 1997-98, down significantly in 1998-99 and then return to more normal levels in 1999-2000. This pattern reflects the impact of the Canada Millennium Scholarship Foundation. The Foundation will affect the budgetary balance in 1997-98, but it will affect the financial balance only in 1998-99 -- the year the government actually advances the $2.5 billion to the Foundation.

Financial requirements (excluding foreign exchange transactions) are a proxy for the amount of net new debt that the government issues on financial markets. However, in any single month, changes in the government's cash balances and foreign exchange reserves will also have an impact on the level of market debt.

Reflecting the increased flows and volatility in foreign exchange markets, the government plans to continue to increase foreign exchange reserves. This will bring Canadian reserves more in line with other comparable countries.

Table 3.6

Budgetary balance, non-budgetary transactions and financial surplus

1996-97 1997-98 1998-99 1999-00 (billions of dollars) Budgetary balance -8.9 0.0 0.0 0.0 Non-budgetary transactions	Loans, investments

& advances

0.3

1.0

1.3

0.4	Pension and other

accounts

6.9

3.7

5.0

5.7	Other 3.0 7.3 -0.3 2.9	Total 10.2 12.0 6.0 9.0 Financial surplus

(excluding foreign exchange

transactions) 1.3 12.0 6.0 9.0 (-) implies a requirement for funds / (+) implies a source of funds.