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Budget 2000 - Budget Plan, Chapter 3: Maintaining Sound Financial Management - 2
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Fiscal Outlook: The Two-Year Planning Horizon to 2001-02

Introduction and Overview

During the spring and fall of 1999, the Department of Finance Canada engaged in an unprecedented consultation process with the chief economists of Canada’s major chartered banks and four leading economic forecasting firms. The private sector economists recommended that the prudent approach to budget planning contained in the Government’s Debt Repayment Plan be continued. This entails:

• continuing to use the average of private sector economic forecasts for budget planning purposes;
• continuing the practice of setting aside an annual $3-billion Contingency Reserve, which is used primarily to cover risks arising from unavoidable inaccuracies in the models used to translate economic assumptions into detailed fiscal forecasts and unpredictable events. It also provides an extra measure of backup against adverse errors in the economic forecasts. It is not a source of funding for new policy initiatives. If not needed, it will be used to pay down the public debt; and
• continuing to add an extra degree of economic prudence to provide further assurance against falling back into a deficit. In past budgets, this prudence was included in revenue and expenditure projections. As a result, its fiscal impact was not explicitly identified, which made it difficult to judge the credibility of the key components of the fiscal projections. This extra prudence is now clearly and explicitly shown. In the years when this extra prudence is not required, it will become part of future planning surpluses.

The Economic and Fiscal Update, presented on November 2, 1999, contained five-year fiscal projections based on the above approach. It was the view of the private sector economists that, for the purposes of public debate on policy options, a five-year time horizon was appropriate. However, the economists agreed that great caution is warranted in the use of long-term projections for budget decisions.

As a result, budget decisions will continue to be made within a rolling two-year planning horizon, reflecting the difficulties in forecasting economic events over a longer time period. As such, spending initiatives and tax cuts will be introduced only when the Government is reasonably certain that it has the necessary resources to do so. This protects against the risk of having to make hasty, and potentially damaging, corrections to the budget plan.

The fiscal projections to 2001-02 are presented in Table 3.1. The Government is committing to balanced budgets or better in 1999-2000, 2000-01 and 2001-02. These targets are based on the average of private sector economic forecasts, include a Contingency Reserve of $3 billion each year as well as economic prudence – $1.0 billion in 2000-01 and $2 billion in 2001-02 – and include all the proposed budget actions.

On the basis of balanced budgets in 1999-2000 and in each of the next two years, the absolute stock of public debt remains unchanged at its 1998-99 level. However, as was the case in each of the past two years, to the extent that the Contingency Reserve is not needed, it will be used to pay down the public debt. As a percentage of GDP, net public debt is projected to fall to about 55 per cent in 2001-02, down 16 percentage points from the post-war peak of 71.2 per cent in 1995-96 (Chart 3.4). Assuming nominal GDP growth averages 3.5 per cent annually and an annual balanced budget, the debt-to-GDP ratio would fall to below 50 per cent in 2004-05.

A financial surplus of $8 billion is expected in 1999-2000, marking the fourth consecutive year that the Government has taken in more cash than is needed to pay for current operations and interest on the public debt. However, the impact of public sector pension reform and payments related to the pay equity settlement and the Canada Health and Social Transfer (CHST) supplement are expected to result in a financial requirement of $5.0 billion in 2000-01. With the ending of these special payments, a financial balance is projected for 2001-02. The ongoing impact of public sector pension reform has resulted in a permanent lowering of the net cash available to the Government to finance its current operations from what it was in the past.

Table 3.1
Summary Statement of Transactions: The Two-Year Planning Horizon

Outlook for 1999-2000

The 1999 budget projected balanced budgets – or better – for 1998-99, 1999-2000 and 2000-01 and included an annual $3-billion Contingency Reserve in each year.

For 1998-99, a budgetary surplus of $2.9 billion was recorded. Budgetary revenues were $0.8 billion lower than estimated in the 1999 budget, primarily because of transfers to the Tax Collection Agreement Accounts (an "off-budget" account), reflecting underpayments with respect to the 1997 and 1998 taxation years. In contrast, program spending was $0.7 billion lower than expected, primarily reflecting lower direct program spending.

As a result, there was a drawdown of the Contingency Reserve of $0.1 billion, resulting in an audited surplus for the year of $2.9 billion.

The economy grew much faster in 1999 than forecast by the private sector economists at the time of the February 1999 budget. Nominal income growth for the year is now estimated at 5.4 per cent, double that anticipated in February 1999. The impact of this stronger-than-expected growth is reflected in the financial results for the first nine months of 1999-2000.

The budgetary surplus to the end of December 1999 is estimated at $10.9 billion (see The Fiscal Monitor for December 1999). However, with developments over the balance of the fiscal year, including the impact of the initiatives proposed in this budget, a balanced budget or better is forecast for the year as a whole. To the extent that the Contingency Reserve is not needed, it will be used to pay down the public debt.

During the balance of the fiscal year, including the end-of-year accounting period, but before the actions in this budget, a deficit of $3.4 billion is expected. This is due to the effect of higher Equalization transfers, the normal revenue profile during the final quarter of the fiscal year, the impact of spending initiatives announced before the 2000 budget (but not reflected in the results to December), the reduction in employment insurance (EI) premium rates effective January 1, 2000, and the income tax reductions announced in the February 1999 budget (Table 3.2). Revenues are typically depressed in January due to payment of the quarterly goods and services tax (GST) credit and again in March due to personal income tax refunds pertaining to the processing of tax returns. These factors should reduce the surplus before the Contigency Reserve from $10.9 billion to $7.5 billion.

Table 3.2
Fiscal Outlook for 1999-2000

The Contingency Reserve is maintained at $3 billion in order to ensure that the budgetary target for 1999-2000 of a balanced budget or better will be realized. To the extent that the Contingency Reserve is not needed, it will be used to pay down the public debt. This leaves a planning surplus after the Contingency Reserve of $4.5 billion.

This remaining surplus has been allocated to priorities such as health care, higher education, access to knowledge and skills and innovation. This includes the $2.5-billion CHST cash supplement and another $1.3 billion for initiatives to make the economy more innovative, such as the $0.9-billion transfer to the Canada Foundation for Innovation.

Final audited financial results will be published in the Annual Financial Report of the Government of Canada, which is released in the fall of each year.

Changes Since the 1999 Budget Forecast

The changes in the major fiscal estimates since the 1999 budget are shown in Table 3.3. Because of stronger-than-expected economic growth, revenues for 1999-2000 are now significantly higher than anticipated at the time of the 1999 budget, and this is expected to carry forward into 2000-01. In addition, economic growth is also expected to be much stronger in 2000 than forecast at the time of the February 1999 budget, thereby leading to even higher revenues.

A strong economy and falling unemployment rates have resulted in lower-than-expected EI benefit payments. This has more than offset increases in transfers to other levels of government. The latter reflects a change in the planning assumption, as outlined in The Economic and Fiscal Update. In the past few years, Equalization entitlements have been subject to significant upward adjustments. To minimize the impact of such changes on the planning surplus, these entitlements are assumed to be at their legislated ceiling in 1999-2000 and to grow in line with the growth in nominal income thereafter. The increase in direct program spending in 2000-01 is attributable to the reprofiling of funds to that year, as well as to higher expenditures under the Canada Education Savings Grant program. The reprofiling of funds is subject to Treasury Board approval and promotes more efficient cash management practices.

The lower public debt charges reflect two factors. As explained in The Economic and Fiscal Update, unlike in previous budgets, the interest rate assumptions no longer include an adjustment for prudence. Interest rates in 1999 were somewhat lower than those used in the February 1999 budget. In addition, on the recommendation of the private sector economists, it is now assumed that the Contingency Reserve will not be needed in calculating public debt charges. Therefore, the stock of debt used to calculate public debt charges is lower than assumed in the 1999 budget.

The net impact of the economic developments and technical factors has been to increase the budgetary balance by $6.2 billion in 1999-2000 and $8.7 billion in 2000-01.

Initiatives announced since the 1999 budget, including those in this budget, total $6.2 billion for 1999-2000 (Annex 1), of which about $0.6 billion (primarily reflecting incremental funding related to the conflict in Eastern Europe) has been reflected in the monthly results to the end of December 1999. The rest – $5.6 billion – includes the proposed CHST cash supplement of $2.5 billion, funding to support the Canada Foundation for Innovation and incremental funding for defence and to meet other international commitments and obligations. For 2000-01, the fiscal cost of the policy initiatives amounts to $7.7 billion, the majority of which – $4.6 billion – is for general tax relief.

This results in an underlying surplus of $3.0 billion for 1999-2000 and $4.0 billion for 2000-01. From these amounts, prudence – the Contingency Reserve of $3 billion and economic prudence – must be subtracted. As indicated earlier, economic prudence is now shown separately, whereas in previous budgets it was incorporated in the projections of revenues, program spending and public debt charges. The economic prudence for 2000-01 has been set at $1.0 billion. For planning purposes, therefore, the Government is committing to balanced budgets in both 1999-2000 and 2000-01. To the extent the Contingency Reserve is not needed, it will be applied to reducing the public debt.

Table 3.3
The Fiscal Outlook: Changes Since the 1999 Budget

Changes Since The Economic and Fiscal Update

In The Economic and Fiscal Update, the fiscal surplus for planning purposes – that is, after allowance for economic prudence and the Contingency Reserve – was projected at $2.0 billion in 1999-2000, $5.5 billion in 2000-01 and $8.5 billion in 2001-02.

For 1999-2000, the planning surplus has been revised up by $3.5 billion, to $5.5 billion. Of this increase, about half is attributable to one-time factors – transfers from the Tax Collection Agreement Accounts relating to overpayments with respect to the 1998 taxation year, and reprofiling of funds from 1999-2000 to future years. The remainder reflects the impact of stronger-than-expected economic growth, resulting in higher revenues and lower EI benefits.

For 2000-01, the planning surplus has been revised up by $0.8 billion, to $6.2 billion. This reflects the impact of stronger-than-expected economic growth on revenues and EI benefits, dampened by the reprofiling of funds from 1999-2000 and higher public debt charges reflecting somewhat higher interest rates than those assumed in The Economic and Fiscal Update. For 2001-02, the planning surplus has been revised up by $2.3 billion, to $10.9 billion, reflecting the impact of stronger-than-expected economic growth, partially offset by somewhat higher public debt charges.

The net impact of the policy initiatives since the 1999 budget amounts to $6.2 billion in 1999-2000, $7.7 billion in 2000-01 and $12.0 billion in 2001-02. However, The Economic and Fiscal Update planning surplus projections already incorporated the decline in EI premium rates from $2.55 (employee rate per $100 of insurable earnings) in 1999 to $2.40 in 2000 and assumed that they would be held at that level for 2001 and 2002. In addition, the projections included expenditures committed at that time ($0.5 billion in 1999-2000 and $0.3 billion in 2000-01) associated with Canada’s international peacekeeping activities. The net impact of these adjustments was $0.8 billion in 1999-2000, $1.4 billion in 2000-01 and $1.0 billion in 2001-02. As a result, the net impact of the policy decisions since The Economic and Fiscal Update is $5.5 billion in 1999-2000, $6.2 billion in 2000-01 and $10.9 billion in 2001-02.

Table 3.4
The Fiscal Outlook: Changes Since The Economic and Fiscal Update

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