Budget 2001 - Budget Plan
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Chapter 4
Private Sector Five-Year Economic and Fiscal Projections

Highlights

• The Department of Finance meets each fall with the chief economists of the major chartered banks and three private sector economic forecasting firms. The objective of this exercise is to agree on a set of economic assumptions for planning purposes, which the forecasting firms then use to develop fiscal projections of the budgetary balance for the current fiscal year and each of the next five years.

• However, because of the greater degree of uncertainty associated with longer-term projections, budget decisions are made on a rolling two-year horizon.

• In the absence of any policy decisions proposed in this budget, the average private sector projections of the surplus for fiscal-planning purposes are $7.3 billion in 2001-02, $3.8 billion in 2002-03, $5.7 billion in both 2003-04 and 2004-05, $9.7 billion in 2005-06 and $14.3 billion in 2006-07.

• These projections of the fiscal surplus reflect the effects of the slowdown in economic growth in both 2001 and 2002 and the rebound in the years thereafter. In addition, the agreements on health renewal and early childhood development reached by first ministers in September 2000 and the impact of the $100-billion Five-Year Tax Reduction Plan further restrain the surplus projections to 2004-05 – the year in which the tax reduction plan is fully implemented. Thereafter larger surpluses are projected.

• These fiscal projections are based on the October 2001 survey of private sector economists. Subsequently private sector economists have adjusted their short-term economic forecasts to incorporate more current data, including the third-quarter National Accounts results for Canada and the U.S., which were released on November 30, 2001 (they are described in Chapter 2). These adjusted economic assumptions were used in deriving the rolling two-year budget fiscal forecasts in Chapter 7.

Introduction

• Earlier this fall the Department of Finance conducted its regular consultations with its economic advisory group, consisting of the chief economists of Canada’s major chartered banks and leading economic forecasting firms.

• The objective of this exercise was to agree upon a set of economic assumptions for budget-planning purposes.

• The economic assumptions were based on a survey of 19 economic forecasters conducted in early October 2001. Based on their views of economic developments at that time, the advisory group agreed that the average of these economic forecasts constituted a reasonable basis to develop five-year fiscal projections, based on current tax and expenditure policies.

• The fiscal projections in this chapter are the average of the fiscal projections prepared by three economic forecasting firms, using the October 2001 survey of private sector economic forecasts. These fiscal projections have been adjusted to incorporate the fiscal impact of the policy initiatives announced before this budget, most of which were announced in the May 2001 Economic Update.

• These projections were prepared before the release of the third-quarter National Accounts for both Canada and the United States. As a result, private sector economists have revised their forecasts in light of the more recent economic data. The fiscal impact of the changed economic assumptions is reflected in the two-year budget projections contained in Chapter 7.

Assumptions Underlying Average of Private Sector Fiscal Projections

Table 4.1
Average of Private Sector Economic Forecasts:
October 2001 Survey

• As noted in Chapter 2, the average of private sector forecasts in the October 2001 survey projected economic growth of 1.5 per cent in both 2001 and 2002, down from 4.4 per cent in 2000. This slowdown in growth is accompanied by a fall in short-term interest rates.

• Over the medium term, the private sector forecasters expect economic growth to rebound back to a healthy pace. The average of private sector forecasts for real gross domestic product (GDP) growth over the 2003 to 2007 period is 3.3 per cent.

• GDP inflation is expected to average just under 2 per cent over the 2003 to 2007 period. As a result, nominal GDP growth is forecast to average 5.3 per cent over the same period.

• The average of private sector forecasts calls for relatively flat interest rates between 2003 and 2007, along with consumer price inflation slightly below the mid-point of the official target band of 1 to 3 per cent.

• Based on the October 2001 average of private sector economic forecasts, the three forecasting firms derived projections of the major components of the budgetary balance. These are based on the following assumptions:

• The projections include the impact of the $100-billion tax reduction plan as set out in the October 2000 Economic Statement and Budget Update and the $23.4-billion agreements on health renewal and early childhood development reached by first ministers in September 2000.

• The employment insurance (EI) premium rate assumptions are those used in the 2000 budget and the October 2000 Economic Statement and Budget Update – $2.20 (employee rate per $100 of insurable earnings) for 2002, $2.10 for 2003 and $2.00 thereafter.

• The 2000 budget assumptions for direct program spending – total program spending less major transfers to persons and major cash transfers to other levels of government – are used for 2001-02, adjusted for policy decisions announced in the October 2000 Economic Statement and Budget Update. Thereafter direct program spending is assumed to grow in line with the growth in the population and inflation.

• The projections of public debt charges assume that the Contingency Reserve is not required and is applied each year to reducing the net public debt.

Table 4.2
Status Quo Fiscal Outlook:
Changes Since October 2000 Economic Statement

• In the October 2000 Economic Statement and Budget Update, the private sector average budgetary surplus was projected at $15.2 billion for 2000-01, $14.9 billion for 2001-02, $16.5 billion for 2002-03, $17.3 billion for 2003-04 and $13.5 billion for 2004-05.

• The acceleration and enhancement of the tax reduction plan, coupled with the spending initiatives announced in the October 2000 Economic Statement and Budget Update, reduce these surpluses to $11.9 billion for 2000-01, $8.3 billion for 2001-02, $7.6 billion for 2002-03, $7.7 billion for 2003-04 and $6.7 billion for 2004-05. The lower surplus estimate for 2004-05 reflects the fact that the tax reduction plan is fully in place in that year.

• Prior to the 2001 budget a number of policy initiatives were announced, most of which were listed in the May 2001 Economic Update. The net impact of these initiatives amounts to $2.1 billion in 2000-01, $0.6 billion in 2001-02, $0.5 billion in 2002-03 and about $0.3 billion each year thereafter.

• As indicated in the 2000-01 Annual Financial Report of the Government of Canada, the final budgetary surplus for 2000-01 was $17.1 billion, compared to an October 2000 Economic Statement and Budget Update estimated surplus of $11.9 billion. Most of this better than expected outcome is attributable to higher than expected budgetary revenues, which were $4.9 billion higher than estimated in the October 2000 Economic Statement. Part of the better than expected outcome for 2000-01 is expected to carry forward into 2001-02 and later years, partially offsetting the adverse impact of the changes in the economic outlook. This is supported by the monthly financial results to the end of October 2001.

• The private sector projections of the budgetary surplus, based on the October 2001 survey of private sector economic forecasts, and before adjusting for the Contingency Reserve, economic prudence and the policy initiatives announced in this budget, amount to $7.3 billion for 2001-02, falling to $3.8 billion in 2002-03 and rising to $5.7 billion in both 2003-04 and 2004-05.

Table 4.3
Spending and Tax Initiatives Announced Since the October 2000 Economic Statement and Before the 2001 Budget

• In the May 2001 Economic Update a number of initiatives announced since the October 2000 Economic Statement and Budget Update were identified. These included: the Tobacco Control Strategy, major investments in Canadian culture, support for Olympic bids and amateur sports, incremental funding for Government On-Line, new funding to fight organized crime, investments in a number of environmental initiatives, and funding to launch the Commission on the Future of Health Care in Canada and revitalize Canada’s capital.

• Since the May 2001 Economic Update a number of additional initiatives have been announced. These include: funding for the Labrador Innu Healing Strategy, enhancements to EI benefits, making permanent the 1997 budget measure providing special tax assistance for donations of publicly traded securities to public charities, funding to support community crime prevention initiatives and assistance to airlines. In addition, incremental funding to the CBC and the Canadian Television and Cable Production Fund has been extended for one more year.

• Tobacco tax increases came into effect on April 6th and November 1st of 2001 and are expected to increase federal excise taxes and duties by $440 million per year on a full-year basis.

• As a result, the net impact of the policy initiatives announced before this budget amounts to $619 million in 2001-02, $496 million in 2002-03, falling to $39 million by 2006-07.

Table 4.4
October 2001 Status Quo Fiscal Outlook Summary Statement of Transactions: Average of Private Sector Fiscal Projections

Average of October 2001 Private Sector Projections

• Table 4.4 sets out the fiscal projections based on the October 2001 survey of private sector economic forecasts to 2006-07. They do not include the impact of changes to the economic outlook since that survey. In addition, they are not adjusted for either economic prudence or the Contingency Reserve and do not include the impact of policy initiatives proposed in this budget.

• On a status quo basis, a budgetary surplus of $7.3 billion is estimated for 2001-02. The impact of the slowdown in the economy reduces the surplus to $3.8 billion in 2002-03. Thereafter, given the projected rebound in economic growth, the surplus increases to $5.7 billion in 2003-04. It is not projected to increase in 2004-05, as this is the year in which the tax reduction plan is fully implemented. Thereafter the surplus rises to $9.7 billion in 2005-06 and $14.3 billion in 2006-07.

• The revenue-to-GDP ratio falls from 16.9 per cent in 2000-01 to 14.8 per cent in 2004-05. The major factor contributing to this decline is the implementation of the tax reduction plan. The revenue ratio remains stable thereafter.

• The program spending-to-GDP ratio increases in both 2001-02 and 2002-03, primarily reflecting the impact of a slowing economy, the fiscal costs of the agreements on health renewal and early childhood development, and changes to the EI program. Thereafter it falls to under 11 per cent by 2006-07.

• Assuming no debt payment over the planning period, the net debt-to-GDP ratio falls to under 40 per cent by 2006-07 – a decline of over 30 percentage points from its peak of 70.7 per cent in 1995-96.

Table 4.5
October 2001 Status Quo Fiscal Outlook
Budgetary Revenues: Average of Private Sector Projections

Average of October 2001 Private Sector Projections
of Budgetary Revenues

• The revenue projections in Table 4.5 do not include the impact of policy measures announced in this budget.

• In the October 2000 Economic Statement and Budget Update, budgetary revenues, based on the average of private sector economic assumptions at that time, were expected to increase only marginally from 2000-01 to 2001-02, reflecting the impact of the tax cuts that came into effect in 2000 and 2001. These included:

• restoration of full indexation of the personal income tax system;
• reductions in personal income tax rates for all taxpayers;
• elimination of the deficit reduction surtax;
• increases in the Canada Child Tax Benefit;
• a reduction in the capital gains inclusion rate; and
• a reduction in the corporate income tax rate.

• However, with the slowdown in economic growth in 2001, budgetary revenues are now expected to decline by $4 billion, in 2001-02.

• Only a slight increase in budgetary revenues is expected in 2002-03, reflecting the impact of continuing weak economic growth in 2002.
• Thereafter the profile of revenues reflects the impact of sustained economic growth and the ongoing impact of the tax reduction plan. Beyond 2004-05 revenue growth is somewhat stronger, as the tax reduction plan is fully implemented.

• Changes to the Employment Insurance Act give the Government the authority to set EI premium rates for 2002 and 2003. The employee rate for 2002 has been set at $2.20 per $100 of insurable earnings, unchanged from that assumed for planning purposes in the February 2000 budget and October 2000 Economic Statement and Budget Update. For planning purposes, the premium rates for 2003 and beyond are unchanged from what was assumed in the 2000 budget and October 2000 Economic Statement and Budget Update. However, in setting the rates for 2003, the Government will take into account the economic circumstances at that time.

Revenue Ratio Permanently Lowered Due to Tax Cuts

• A more revealing picture of movements in tax revenue can be obtained by examining the "revenue ratio" – total federal revenues in relation to the total income in the economy (or GDP).

• There is a cyclical element to the revenue ratio. It declines during economic downturns and tends to increase during recoveries, reflecting the progressive nature of the tax system and the cyclical nature of corporate profits. This was the primary factor underlying the increase in the revenue ratio between 1994-95 and 1997-98 as the economy recovered from the 1990-91 recession.

• Looking forward, the revenue ratio is projected to be significantly lower than in the past. This is attributable to the ongoing impact of the tax reduction plan, which has lowered the ratio on a structural basis.

• The revenue ratio is projected to decline from 16.9 per cent in 2000-01 to 14.8 per cent by 2004-05 – a level not seen since the early 1960s – and to stabilize thereafter.

Table 4.6
October 2001 Status Quo Fiscal Outlook
Program Spending: Average of Private Sector Projections

Average of October 2001 Private Sector Projections of Program Spending

• The projections of program spending in Table 4.6 include the impact of the agreements on health renewal and early childhood development reached in September 2000, the February 2000 budget and September 2000 enhancements to EI benefits, as well as initiatives announced before this budget, primarily those contained in the May 2001 Economic Update. They do not include the initiatives proposed in this budget.

• Program spending is divided into three major components: major transfers to persons, major cash transfers to other levels of government and direct program spending.

• Based on the average of the projections provided by three forecasting firms, total program spending is estimated to increase from $119.3 billion in 2000-01 to $128.0 billion in 2001-02.

• Nearly half of this increase is attributable to the impact of the September 2000 agreements on health renewal and early childhood development, which resulted in an increase of $3.8 billion in cash transfers under the Canada Health and Social Transfer.

• EI benefits are expected to increase significantly by $2.7 billion, reflecting the impact of the slowdown on economic growth as well as the effect of program enhancements. In addition, elderly benefits are estimated to increase by $1 billion, reflecting increases in the number of people eligible for benefits and higher average benefits, which are indexed to inflation.

• Direct program spending is expected to be up $3.9 billion, primarily reflecting developments that lowered spending in 2000-01 as well as the impact of policy initiatives announced before this budget.

• Partially offsetting the impact of these factors are a number of one-time spending initiatives in 2000-01. These include the $1.5-billion Relief for Heating Expenses, $1.25-billion transfer to the Canada Foundation for Innovation, $1-billion payment to the Medical Equipment Fund and the liability of $0.8 billion related to the lifting of the equalization ceiling for 1999-2000.

Program Spending-to-GDP Ratio Continues to Decline

• Program spending as a share of GDP is expected to increase somewhat in both 2001-02 and 2002-03, reflecting the impact of higher cash transfers to the provinces and increased EI benefits, the latter reflecting both the impact of program enhancements as well as an increase in the number of people receiving benefits due to the slowdown in the economy.

• Beyond 2002-03 the ratio again declines as economic growth exceeds growth in program spending.

Table 4.7
October 2001 Status Quo Fiscal Outlook 
Major Transfers to Persons

• Major transfers to persons consist of elderly and EI benefits. The Relief for Heating Expenses is included in 2000-01.

• Elderly benefits consist of Old Age Security pensions, the Guaranteed Income Supplement and the spouse’s allowance.

• Growth in elderly benefits is largely determined by the growth in the elderly population and average benefits, which are fully indexed to quarterly changes in consumer prices.

• Growth in elderly benefits will be moderate until 2010-11, given the relatively small size of the generation born in the Depression years of the 1930s and during World War II.

• There are three components of the EI benefit program: regular benefits, which are primarily a function of the number of people unemployed and eligible to receive benefits; special benefits, which include maternity, parental and sickness benefits; and employment benefits and support measures, primarily active labour market measures delivered either by the federal government or provinces and territories. Certain provisions applying to special benefits will be modified to respond to issues arising from individual cases.

• The largest and most variable component, accounting for about two-thirds of EI benefits, is regular benefits. With the slowing in the economy and the accompanying increase in the number of unemployed, regular benefits are expected to increase significantly in both 2001-02 and 2002-03.

• The profile of EI benefits is also affected by the extension of and related changes to parental benefits and modifications to the intensity and clawback provisions.

Table 4.8
October 2001 Status Quo Fiscal Outlook
Major Transfers to Other Levels of Government

• The major programs under which the federal government transfers funds to other levels of government are the Canada Health and Social Transfer (CHST) and fiscal arrangements, which include equalization and Territorial Formula Financing.

• Under the agreements on health renewal and early childhood development reached by first ministers in September 2000, annual CHST cash transfers will increase from $13.5 billion in 2000-01, to $21 billion in 2005-06. For planning purposes, a continuation of the increase in 2005-06 is assumed for 2006-07.

• The largest component of fiscal transfers is equalization, whereby the federal government transfers funds to provinces with below-average revenue-raising capacities so that they can provide reasonably comparable levels of public services at reasonably comparable levels of taxation. The projection assumes that equalization transfers grow in line with the growth in nominal GDP. The final outcome for 2000-01 includes the liability related to the lifting of the equalization ceiling in 1999-2000.

Table 4.9
October 2001 Status Quo Fiscal Outlook
Direct Program Spending

• Direct program spending – total spending less major transfers to persons and other levels of government – consists of subsidies and other transfer payments, expenditures related to Crown corporations, defence spending, and operating and capital expenditures of non-defence departments and agencies.

• Many of these programs are quasi-statutory or demand-driven, such as support for Aboriginal people, veterans, correctional services, policing services and the justice system.

• There are also a number of programs that support economic growth and job creation or provide assistance to those in need. Such programs include student loan programs, the Canada Education Savings Grant, research and development (either through intramural activities or through transfers to universities, hospitals and the private sector), assistance to farmers and aid for developing countries.

• The projections for this component are consistent with those contained in the October 2000 Economic Statement and Budget Update, which were assumed to increase at an annual rate in line with the growth in the population and inflation. In addition to incorporating the effect of changes in the inflation outlook, adjustments were also made to include the impact of the policy initiatives announced in the October 2000 Economic Statement and Budget Update, as well as those announced before this budget.

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