Chapter 8
Sound Financial Management in an Uncertain World

• After accounting for the fiscal impact of the proposed new spending initiatives and tax cuts, this budget projects balanced budgets or better in 2002–03—the sixth consecutive balanced budget—and in each of the next two fiscal years.

• These balanced budgets are backed by the normal annual Contingency Reserve of $3 billion, and economic prudence of $1 billion in 2003–04 and $2 billion in 2004–05. The Contingency Reserve, if not needed, will reduce debt.

• On an accrual basis, the federal debt (accumulated deficit) as a percentage of the economy is projected to fall to 44.5 per cent in 2002–03, down from its peak of 67.5 per cent in 1995–96. With the commitment to balanced budgets in each of the next two fiscal years, it is forecast to decline to about 40 per cent in 2004–05.

• Program spending is expected to increase by 11.5 per cent, or $14.3 billion, in 2002–03 and average about 4 per cent growth over the next two fiscal years. In 2002–03 health-related spending, increased transfers to the elderly and the unemployed and higher defence and security-related spending account for nearly three-quarters of the increase. As a percentage of gross domestic product (GDP), program spending averages about 12 per cent over the 2002–03 to 2004–05 period.

• Budgetary revenues are estimated at 15.7 per cent of GDP in 2002–03—the lowest share of the economy since the late 1970s. This reflects the impact of the Government’s Five-Year Tax Reduction Plan. This ratio is expected to continue to decline over the next two years, reflecting the Five-Year Tax Reduction Plan and further tax reductions proposed in this budget.

Introduction

Sound financial management has resulted in the Government recording five consecutive annual surpluses through 2001–02 and reducing the federal debt by $47.6 billion. At the same time, it has allowed the Government to implement the largest tax cut in Canadian history and to invest in key priorities of Canadians, such as health care, support for lower-income families with children, education, and research and development.

This sound financial management played an important role in helping Canada avoid a recession in 2001 despite the global economic downturn. It enabled fiscal and monetary policy to provide timely support to the Canadian economy through lower taxes and interest rates. The continual commitment to fiscal discipline allowed Canada to post a budgetary surplus in 2002, while all other G7 countries posted deficits. It also helped Canada record the best economic performance among the G7 countries in 2002, notwithstanding an uneven global recovery.

The Government is committed to maintaining this prudent approach to fiscal planning—an approach that has paid off and remains essential given the uncertain times. It includes a prudent approach to budget planning, with most budget decisions made over a rolling two-year horizon. To ensure the federal budget remains in balance or better, this budget restores the full $3-billion annual Contingency Reserve and economic prudence in the fiscal projections.

This chapter provides projections of the federal government’s finances for 2002–03 and the next two years of the Government’s budget plan. It updates the fiscal projections contained in the October 2002 Economic and Fiscal Update for:

• the impact of the revised economic outlook, reflecting the most recent survey of Canadian private sector economists, and recent financial developments;

• the impact of the implementation of full accrual accounting; and

• the impact of the spending and revenue measures proposed in this budget.

Canada’s fiscal performance stands out among the major industrialized countries. According to the Organisation for Economic Co-operation and Development (OECD), Canada is the only G7 country in surplus in 2002. It is also the only G7 country the OECD expects to be in surplus in 2003.

Approach to Budget Planning

• The Government’s approach to budget planning involves a number of important elements. The first element involves using private sector economic forecasts for budget-planning purposes.

• The Department of Finance conducts surveys of private sector economic forecasters. In total, about 20 forecasters are surveyed on a regular basis.

• Each fall the Department of Finance conducts extensive consultations with an economic advisory group, which includes the chief economists of Canada’s major chartered banks and major private sector economic forecasting firms.

• The second element involves using these economic assumptions to develop status quo fiscal projections for the regular fall update.

• Since 1999, for the fall Economic and Fiscal Update, major private sector economic forecasting firms have developed detailed fiscal projections, on a National Accounts basis, based on tax and spending policies in place at the time and using the average of the private sector economic forecasts. These forecasts are then translated into Public Accounts projections, in consultation with the private sector economic forecasting firms, and presented in the fall Economic and Fiscal Update for budget-planning purposes.

• The third element involves updating the projections for the budget:

• Based on the most current survey of the private sector economic forecasts and the most recent financial results, the fiscal projections are updated by the Department of Finance for the current fiscal year and each of the next two years.

• Although the private sector economic advisory group recommends that for the purposes of public debate on policy options, a five-year time horizon is appropriate, it recommends that caution is warranted in the use of long-term projections as a basis for budget decision. As a result, most budget decisions are made over a rolling two-year horizon and, hence, the budget fiscal plan is presented for the current and next two fiscal years.

• As recommended by the Auditor General, the Government will adopt full accrual accounting as its accounting standard this year. The fiscal projections in this budget, as well as the fiscal results back to 1993–94, are being presented on a full accrual basis of accounting.

• The resulting fiscal projections are adjusted for prudence to derive the fiscal surpluses for budget-planning purposes. An annual Contingency Reserve is set aside to guard against unforeseen circumstances. If it is not needed, it reduces the federal debt (accumulated deficit). An extra degree of economic prudence, which rises over time, is built in to provide further assurance against falling back into deficit.

• Finally the proposed budget measures are substracted from the full accrual budgetary surplus for planning purposes to arrive at the budget balance.

Implications of the Revised Economic Outlook and Current Financial Developments

• Table 8.1 shows the impact of the revised economic outlook and the financial results to date on the fiscal projections presented in the October 2002 Economic and Fiscal Update. These updated projections are on a status quo basis, that is, before including the impact of moving to full accrual accounting and any of the measures proposed in this budget.

• In the October 2002 Economic and Fiscal Update, the budgetary planning surplus, net of the annual $3-billion Contingency Reserve and economic prudence, was forecast at $1.0 billion for 2002–03, $3.1 billion for 2003–04 and $3.5 billion for 2004–05. This was based on the average of the private sector forecasts. The budgetary surplus before allowances for the Contingency Reserve and economic prudence was estimated at $4.0 billion for 2002–03, $7.1 billion for 2003–04 and $8.5 billion for 2004–05.

• As noted in Chapter 2, the current average of private sector forecasts for 2002 and each of the next two years indicates relatively small changes from the October 2002 Economic and Fiscal Update. However, financial results for the period April to December 2002 show strong growth in goods and services tax (GST) revenues. GST revenues are now expected to be $1.6 billion higher for the year as a whole than forecast in the October 2002 Economic and Fiscal Update. In addition, employment insurance benefits are expected to be somewhat lower and other income tax revenues higher, given the stronger than expected employment performance in the second half of 2002. As a result, the budgetary surplus for 2002–03 is expected to be $6.4 billion, or $2.4 billion higher than estimated in the October 2002 Economic and Fiscal Update.

• For 2003–04 the surplus is projected at $8.2 billion, or $1.1 billion higher than forecast in the October 2002 Economic and Fiscal Update, again primarily reflecting higher GST revenues, as expected changes in the other components are largely offsetting.

• A surplus of $10.7 billion is forecast for 2004–05, up $2.2 billion from the October 2002 Economic and Fiscal Update. Most of the improvement also comes from higher GST revenues. Other contributing factors include higher corporate income tax revenues, reflecting the winding down of loss carry-forwards from the decline in profits in 2001, and higher other income tax revenues.

Table 8.1
Fiscal Outlook Before Accrual Accounting and Measures Proposed in 2003 Budget

Impact of Full Accrual Accounting on the Fiscal Projections

Table 8.2 presents the impact of implementing full accrual accounting on the revised fiscal projections. The Auditor General of Canada has strongly recommended full accrual accounting as superior to the Government’s previous accounting policies. Details on why the Government is adopting full accrual accounting, what it means and the impact on previously published financial results are presented in Annex 6, "Implementation of Full Accrual Accounting in the Federal Government’s Financial Statements."

Table 8.2
Fiscal Outlook: Incorporating Impact of Full Accrual Accounting

Full Accrual Accounting: Impact on Revenues

• Under the previous modified accrual method of accounting, tax revenues were accounted for on a cash basis in the year in which they were received. Refunds were recorded in the year in which they were paid. As a result, there were significant collection lags between the economic activity and the receipt of revenues or payment of refunds relating to that activity. For example, personal income tax revenues were extraordinarily high in 2001–02, reflecting taxes paid in April and May 2001 on large capital gains realized in 2000. Conversely, the decline in the stock market in 2001 resulted in higher refunds and lower settlement payments in April and May 2002.

• However, under full accrual accounting, personal income tax received and refunds paid are more appropriately allocated to the fiscal year to which they relate. As a result, personal income tax revenues in 2001–02 have been lowered and those in 2002–03 increased to more closely match economic activity in those years. Thereafter personal income taxes are slightly lower due to the reclassification of repayments of the Old Age Security benefit, which are now netted against elderly benefits.

• Corporate income tax revenues under full accrual are slightly higher in 2001–02 but lower in 2002–03 due to the reversal of the impact of the deferral of the small business tax instalment initiative announced in the 2001 budget. Under full accrual accounting, such deferrals have no fiscal impact in the years in which they are in effect.

• Classification changes between personal and other income tax explain the lowering of other income taxes. The increase in non-tax revenues is attributable to the reclassification of interest and penalties on personal and corporate income taxes, which previously were included in the respective tax components.

Full Accrual Accounting: Impact on Spending

• The recognition of post-employment and retirement benefits (primarily veterans’ disability costs) as liabilities results in a reduction in direct program spending with a roughly corresponding increase in public debt charges. As these liabilities have been recognized in previous years, current benefit payments no longer affect direct program spending. However, public debt charges are now higher, reflecting the increased interest costs associated with adjusting these liabilities to the current period. Direct program spending is also affected by the capitalization of assets (as the amortization adjustment is somewhat lower than capital acquisitions) and the inclusion of a provision for uncollectable taxes associated with the inclusion of tax receivables in the statement of assets and liabilities. These impacts are largely offsetting.

• The net impact of implementing full accrual accounting is to lower the budgetary surplus (before prudence and the measures proposed in the 2003 budget) by $0.7 billion in 2001–02 to $8.2 billion, and to raise it by $3.1 billion in 2002–03 to $9.4 billion. Thereafter it increases the projected budgetary surplus by $0.7 billion in 2003–04 to $8.8 billion and by $0.9 billion in 2004–05 to $11.5 billion

Fiscal Surplus for Planning Purposes

• Table 8.3 summarizes the impact of the revised economic outlook, financial developments to date and accounting changes on the October 2002 Economic and Fiscal Update projections of the budgetary surplus, and it subtracts the Contingency Reserve and economic prudence to arrive at the 2003 budget budgetary surplus available for planning purposes.

Table 8.3
Fiscal Outlook Before Measures Proposed in 2003 Budget: Summary

• As recommended by the private sector economic advisory group, most budget decisions are made over a rolling two-year horizon. The Government’s annual fiscal target over its two-year budget plan is a balanced budget or better each year. To ensure that this target is met, the Government has followed the prudent approach to budget planning set out above.

• In the October 2002 Economic and Fiscal Update, the Minister of Finance announced that the Government would restore the full $3-billion annual Contingency Reserve. This provides a buffer against unforeseen circumstances. If not needed, it will reduce the federal debt. The Minister also announced the restoration of the economic prudence in budget planning to help ensure that the Government will not return to deficit. The economic prudence is set as $1 billion for 2003–04 and $2.0 billion for 2004–05.

• As a result, the full accrual surplus for planning purposes is $6.4 billion for 2002–03, $4.8 billion for 2003–04 and $6.5 billion for 2004–05.

Impact of Measures in Budget 2003 on the Budgetary Balance

Table 8.4 summarizes the impact of the measures proposed in Budget 2003 on the fiscal surplus for planning purposes.

Table 8.4
Budget 2003: Fiscal Outlook With Measures

• The specific measures and their fiscal costs are described in Chapters 3, 4, 5, 6, and 7. The net impact of the measures proposed in the 2003 budget amounts to $6.4 billion in 2002–03, $4.7 billion in 2003–04 and $6.6 billion in 2004–05, for a total of $17.8 billion.

• After incorporating the measures proposed in this budget and maintaining the $3-billion annual Contingency Reserve and economic prudence, a balanced budget is projected this year and in each of the next two years.

• As agreed under the 2003 First Ministers’ Health Accord, the federal government is prepared to put up to an additional $2 billion into health for the provinces at the end of fiscal year 2003–04 if the Minister of Finance determines during the month of January that there will be a sufficient surplus above the normal Contingency Reserve to permit such an investment.

Summary Statement of Transactions

Table 8.5 provides the summary statement of transactions on a full accrual basis, including all the measures proposed in this budget.

Table 8.5
Summary Statement of Transactions: Budget 2003: Full Accrual With Measures

The Government’s Fiscal Progress

• With the surplus of $8.2 billion in 2001–02, the federal government recorded its fifth consecutive annual surplus, including surpluses of $2.8 billion in 1997–98, $3.1 billion in 1998–99, $13.1 billion in 1999–2000 and $20.2 billion in 2000–01. These surpluses incorporate the effect of moving to full accrual accounting.

• As a result of these surpluses, the federal debt (accumulated deficit) has been reduced by $47.6 billion since 1997–98.

• Balanced budgets or better are expected for 2002–03 and each of the next two fiscal years. To ensure that these targets are met, they are backed by the annual $3-billion Contingency Reserve and economic prudence.

Canada only G7 country to record surplus in 2002

• On a National Accounts basis, Canada’s total government sector financial balance has improved substantially over the last decade. The total government sector deficit peaked at 9.1 per cent of GDP in 1992, which was almost double the G7 average deficit-to-GDP ratio that year.

• By 1997, however, fiscal improvements at all levels of government enabled Canada’s total government sector to post a surplus. Canada has recorded six consecutive total government surpluses since that time.

• In 2002 Canada recorded a surplus estimated at 0.6 per cent of GDP, compared to an average deficit of 3.7 per cent in the G7 countries. Canada was the only G7 country to record a surplus in 2002, according to OECD estimates.

Federal debt-to-GDP ratio on downward track

• The federal debt-to-GDP ratio is the most appropriate measure of the debt burden, as it measures the federal debt (the accumulated deficit) relative to the ability of the Government and the nation’s taxpayers to finance it.

• On an accrual basis, the federal debt-to-GDP ratio fell to 46.5 per cent in 2001–02. It has come down nearly 20 percentage points from its peak of 66.4 per cent in 1995–96.

• With balanced budgets or better and sustained economic growth, it is expected to decline to about 40 per cent by 2004–05.

• The Government is committed to keeping the federal debt-to-GDP ratio on a downward track.

Canada has achieved the largest decline in the debt burden among the G7 countries

• Since the mid-1990s Canada’s total government sector has achieved the largest decline in its debt burden of all the G7 countries. Between 1995 and 2002 Canada’s debt-to-GDP ratio was reduced by 26.8 percentage points.

• As a result, Canada’s total government debt burden is now below the G7 average and only the UK and the U.S. are expected to have lower debt burdens than Canada in 2003.

• Based on OECD projections of continuing fiscal surpluses in Canada and large deficits in the U.S., Canadian and U.S. total government debt burdens are expected to converge by 2004. See Annex 4 for more details.

Details of the 2003 Budget Plan: Outlook for Revenues

• Table 8.6 presents the major components of budgetary revenues for the period 2001–02 to 2004–05. It includes the impact of the move to full accrual accounting as well as the cost of the measures proposed in this budget.

• Budgetary revenues declined by 5.8 per cent in 2001–02, largely due to the Five-Year Tax Reduction Plan, the global economic slowdown in 2001 and the decline in the stock market.

• Economic growth rebounded in 2002, with the result that budgetary revenues are expected to increase by $7.0 billion, or 4.1 per cent, in 2002–03. Thereafter the projected growth in budgetary revenues is somewhat slower than the growth in nominal income—the applicable tax base for budgetary revenues—due to the impact of the tax reduction measures proposed in this budget as well as those implemented in the Five-Year Tax Reduction Plan.

• Personal income tax revenues are the largest component of budgetary revenues and the component most affected by the switch to full accrual accounting. They are estimated to have declined by 6.2 per cent in 2001–02 due to the Five-Year Tax Reduction Plan, the global economic slowdown and the decline in the stock market. Thereafter personal income tax revenues are projected to increase broadly in line with the growth in personal income.

• The decline in corporate income tax revenues in 2002–03 is attributable to losses incurred in 2001, resulting in higher refunds pertaining to previous years’ taxes paid. In the period April to December 2002, corporate income tax revenues were down 18.1 per cent from the same period the previous year. The data to convert corporate income tax revenues to accruals are not available in order to present the financial statements in a timely manner. As such, cash is used as a proxy for the accrual numbers.

• Excise taxes and duties are up in 2002–03 by 11.5 per cent primarily due to higher GST revenues, the impact of the tobacco excise tax increases announced in late 2001 and early 2002, and the introduction of the Air Travellers Security Charge in April 2002. The increase in GST revenues reflects both the strong growth in the applicable tax base as well as a decline in refunds. Over the next two fiscal years, growth in this component is expected to mirror more closely the growth in the applicable tax bases.

• Non-tax revenues include return on investments and other non-tax revenues. Under full accrual accounting, the latter now include interest and penalties accrued on income taxes owing.

Outlook for Budgetary Revenues

Table 8.6
The Revenue Outlook

Revenue ratio lowered due to tax cuts

• A picture of movements in budgetary revenues can be obtained by examining the "revenue ratio"—federal revenues in relation to 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 1990–1991 recession.

• The revenue ratio dropped significantly in 2001–02 due primarily to the tax reductions that came into effect in January 2001 as part of the $100-billion Five-Year Tax Reduction Plan. The revenue ratio is expected to continue to decline over the budget-planning period due to the ongoing impact of the Five-Year Tax Reduction Plan as well as further tax cuts proposed in this budget.

Details of the 2003 Budget Plan: Outlook for Program Spending

• The program spending projections presented in Table 8.7 include the impact of the move to full accrual accounting, the February 5, 2003 First Ministers’ Accord on Health Care Renewal, as well as the spending initiatives proposed in this budget.

• As a result of the measures proposed in this budget, coupled with economic and demographic factors, program spending is expected to increase by $14.3 billion, or 11.5 per cent, in 2002–03. Nearly three-quarters of the increase is due to the following:

• $7.2 billion is attributable to health-related transfers and equalization entitlements to the provinces, including $3.8 billion under the Canada Health and Social Transfer, $1.5 billion for diagnostic/medical equipment fund, $0.6 billion for health information technology, and $0.5 billion to research hospitals;

• $2.5 billion is for increased elderly and employment insurance benefits;

• $0.8 billion is for increased defence and security-related spending; and

• The remainder—$3.8 billion—is for other direct program spending. This component includes the operating costs of government, payments to Crown corporations and other transfers and subsidies, such as farm income assistance, transfers to Aboriginal communities and international assistance.

• Over the next two fiscal years, the growth in total program spending is projected to be less than the growth in the economy. This reflects, in part, the impact of the $1-billion savings from reallocating spending from lower to higher priorities and the one-time initiatives in 2002–03, primarily for health.

• Major transfers to persons are projected to increase, reflecting both higher elderly and employment insurance benefits.

Table 8.7
The Program Spending Outlook

• Major transfers to other levels of government are projected to decline in 2003–04. This decline reflects liabilities with respect to the proposed Canada Health and Social Transfer supplement and the Diagnostic/Medical Equipment Fund, which are recorded in 2002–03. Thereafter increased funding for the Health Reform Fund as well as the Canada Health Transfer and Canada Social Transfer result in higher spending.

As part of the February 2003 health accord, first ministers reaffirmed the importance of the equalization program in ensuring that all provinces have the ability to provide comparable levels of public services at comparable levels of taxation. The federal government has agreed to permanently remove the equalization ceiling on a going-forward basis. The budget will implement this commitment through amendments to the equalization legislation to eliminate the ceiling, effective fiscal year 2002–03.

• Direct program spending is projected to increase by $4.5 billion in 2003–04 and $2.9 billion in 2004–05—an average annual increase of 6 per cent.

Spending-to-GDP ratio down significantly from mid-1990s

• The program spending-to-GDP ratio has declined significantly, from about 16 per cent in 1993–94 to about 11 per cent in 2000–01. This decline was largely attributable to the expenditure reduction initiatives announced in the 1995 budget aimed at eliminating the deficit.

• In 2001–02 the spending ratio increased to 11.4 per cent, from 11.1 per cent in 2000–01, reflecting the impact of higher cash transfers to the provinces of $3.8 billion as specified under the September 2000 health agreement, and increased employment insurance benefits, 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.

• Reinvestment in the key priorities of Canadians, including increased cash transfers to the provinces and territories under the Canada Health and Social Transfer, results in a projected increase in the ratio in 2002–03.

• Over the next two years the ratio is projected to decline, as economic growth exceeds growth in program spending. As a percentage of GDP, program spending is expected to average about 12 per cent over the 2002–03 to 2004–05 period.

Market Debt Declining

• The federal government’s market debt consists of debt issued on credit markets in the form of Government of Canada bonds, Canada Savings Bonds and Treasury bills. The decline of $34.6 billion in market debt since 1996–97, coupled with sustained economic growth, resulted in a decline in the market debt-to-GDP ratio from 57 per cent to 40.5 per cent in 2001–02, a decline of 16.5 percentage points.

• This decline mirrors the rapid fall in the federal debt-to-GDP ratio over the last five years.

Debt Management

• Effective management of the federal debt is important to all Canadians as the annual debt-servicing cost is the largest single spending program of the federal government. One of the Government’s key objectives in managing the debt is to strike an appropriate balance between low financing costs and cost stability. In general, borrowing long-term debt is less risky but more costly than borrowing short-term debt.

• The Government maintains a prudent debt structure to protect its fiscal position from unexpected increases in interest rates and to limit annual refinancing needs. One of the measures of prudence is the fixed-rate share of the debt, that is, the share of the debt that does not need to be refinanced within a year.

• During the 1990s the Government raised the fixed-rate portion of the federal debt from one-half to two-thirds to provide more cost stability in an environment of annual deficits, volatile interest rates and high debt levels.

• Over the past five years the economic and fiscal position in Canada has strengthened considerably. Canada now has low and stable inflation and interest rates, strong employment growth, lower foreign indebtedness and a current account surplus. The federal debt has fallen by $47.6 billion and is at its lowest level, relative to the size of the economy, in nearly two decades. These developments have provided the Government of Canada with greater financial stability, reduced vulnerability to events happening beyond its borders, and contributed to the restoration of Canada’s triple-A credit rating.

• As a result of these positive economic and fiscal developments, the Government is now in a position to reduce the fixed-rate portion of the market debt in order to lower debt-servicing costs. The Government now intends to reduce the target for the fixed-rate portion of the debt from two-thirds to 60 per cent. The reduction will begin in the upcoming fiscal year and will be implemented in an orderly and transparent manner over the next five years to allow the market time to adjust. The debt structure remains prudent, with a majority of the debt being at a fixed rate.

• Based on the budget outlook, the planned change to the debt structure is expected to reduce the Government’s debt-servicing costs by up to $750 million cumulatively during the five-year phase-in period and by up to $500 million, on average, each year thereafter. These savings can be used to meet the priorities of Canadians.

• Further details on the outlook for 2003–04 borrowing programs and the federal government’s debt structure will be provided in the 2003–04 Debt Management Strategy, which will be released in March.

Public Debt Charges Falling

• Public debt charges are projected to decline by $2.1 billion in 2002–03 due to the impact of lower interest rates and a decline in interest-bearing debt, as shown in Table 8.5. Over the next two fiscal years they are projected to increase slightly, reflecting the forecast increase in interest rates.

• Public debt charges as a percentage of budgetery revenues declined from its peak of 37 per cent in 1995–96 to 22.9 per cent in 2001–02. This ratio means that in 2001–02, the Government spent just under 23 cents of each revenue dollar on interest on the federal debt.

• This ratio is expected to continue to decline, falling to under 20 per cent in 2004–05.

Financial Requirements/Source

Table 8.8
The Budgetary Balance and Financial Requirements/Source

• The budgetary balance is presented on a full accrual basis of accounting, recording government liabilities and assets when they are incurred or acquired, regardless of when the cash payment or receipt is made. In addition, the budgetary balance includes only those activities over which the Government has legislative control.

• In contrast, financial requirements/source measures the difference between cash coming in to the Government and cash going out. This measure is affected not only by the budgetary balance but by the cash requirements/source resulting from the Government’s investing activities through loans, investments and advances; its acquisitions of capital assets; and its operating activities, primarily through the federal employees’ pension accounts. These activities are included in non-budgetary transactions.

• With a projected balanced budget in 2002–03, there is a projected financial source of $3.4 billion in 2002–03, down from $4.7 billion in 2001–02. Financial requirements are forecast in each of the next two fiscal years.

• The cash requirement in "loans, investments and advances" is primarily due to government borrowing on behalf of the Canada Student Loans Program. The requirement in both 2003–04 and 2004–05 in "pensions and other accounts" reflects the transfer of the Government’s holdings in the Canada Pension Plan to the Canada Pension Plan Investment Board. A source of $4.3 billion is estimated in "other" transactions in 2002–03, with a financial requirement of $3.7 billion in 2003-04. This is largely attributable to liabilities in 2002–03 for which cash disbursements will not be made until passage of applicable legislation in early 2003–04.

• In 2003–04 and 2004–05 the Government will need to fund cash requirements arising from previous budgetary initiatives, as well as the transfers of Canada Pension Plan operating balances from non-market debt to market debt. Financial requirements are currently planned to be met without raising new market debt.

Sensitivity of the Fiscal Outlook to Economic Shocks

Table 8.9
Estimated Change in Fiscal Position

• The fiscal projections are extremely sensitive to changes in economic assumptions—particularly to changes in real economic (GDP) growth, inflation and interest rates. To ensure that such developments do not adversely affect the government’s balanced budget target, it follows a prudent approach to budget planning.

• A decrease in the growth of real GDP (through equal reductions in employment and productivity) would lead to lower federal government revenues through a contraction in various tax bases and an increase in spending, primarily due to higher employment insurance benefits. Using standard sensitivity analysis, a 1-per-cent decrease in real GDP growth for one year would lower the budgetary balance by $2.5 billion in the first year and by $2.6 billion in the second year.

• A 1-per-cent reduction in the growth in nominal GDP resulting solely from a one-year decline in the rate of GDP inflation would lower the budgetary balance by $1.4 billion in the first year and $1.3 billion in year two. Most of the impact would be on budgetary revenues, as wages and profits would be lower, as well as the price of goods and services subject to sales and excise taxes. The impact on expenditures would be largely reflected in those programs that are indexed to inflation, such as elderly benefit payments.

• A sustained 100-basis-point decline in all interest rates would improve the budgetary balance by $0.8 billion in the first year, rising to $1.3 billion in year two. This improvement comes solely from the reduction in public debt charges, which reduces overall budgetary expenditures. Expenditures would fall by $1.2 billion in the first year and $1.8 billion in year two, as longer-term debt matures and is refinanced at the lower rates. Moderating this impact are somewhat lower interest earnings on the Government’s interest-bearing assets, which are recorded as part of non-tax revenues.

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