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Budget 2004 - Budget Plan Chapter 3
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2003–04 | 2004–05 | 2005–06 | |
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(billions of dollars) | |||
November 2003 private sector average planning surplus | 0.0 | 0.0 | 0.0 |
Prudence | |||
Contingency Reserve | 2.3 | 3.0 | 3.0 |
Economic prudence | – | – | – |
Total | 2.3 | 3.0 | 3.0 |
November Update budgetary surplus | 2.3 | 3.0 | 3.0 |
Impact of economic changes1 | |||
Budgetary revenues | |||
Personal income tax | 0.1 | 1.0 | 1.4 |
Corporate income tax | 2.5 | 1.6 | 2.0 |
Other income tax | -0.1 | -0.2 | -0.1 |
Goods and services tax | -1.5 | -2.0 | -2.0 |
Other excise taxes and duties | 0.1 | -0.4 | -0.6 |
Employment insurance premiums | -0.4 | -0.2 | 0.6 |
Non-tax revenues | -0.1 | -0.1 | 0.0 |
Total | 0.7 | -0.4 | 1.3 |
Program expenses | |||
Major transfers to persons | |||
Elderly benefits | 0.0 | 0.0 | 0.2 |
Employment insurance benefits | -0.1 | -0.2 | -0.5 |
Major transfers to other levels of government | |||
Federal transfer support for health and other social programs |
0.0 | -0.2 | -0.2 |
Fiscal arrangements | 2.3 | 1.1 | 1.0 |
Alternative Payments for Standing Programs | 0.0 | 0.1 | 0.1 |
Direct program expenses | -0.1 | -0.1 | 0.4 |
Total | 2.2 | 0.8 | 0.9 |
Public debt charges | 0.4 | 0.8 | 1.4 |
Net change | 3.2 | 1.2 | 3.6 |
Revised "status quo" budgetary surplus | 5.5 | 4.2 | 6.6 |
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1 A positive number implies an
improvement in the budgetary balance. A negative number implies a deterioration in the budgetary balance. Note: Numbers may not add due to rounding. |
Table 3.2 summarizes the impact of the measures proposed in Budget 2004 on the fiscal surplus for planning purposes.
The specific measures and their costs are described in Chapter 4. In addition, Table 3.2 includes the proposed costs of the March 2004 agricultural assistance package of $1 billion, the equalization and Territorial Formula Financing renewal and the restoration of funding to the Canadian Television Fund.
The net impact of the measures proposed in the 2004 budget amounts to $3.6 billion in 2003–04, primarily reflecting the $2.0-billion Canada Health and Social Transfer (CHST) cash payments to the provinces and territories for health care, funding of $0.5 billion to address gaps in public health readiness and the March 2004 $1-billion agricultural assistance package.
The net impact of the measures proposed in the 2004 budget amounts to $2.2 billion in 2004–05, rising to $2.5 billion in 2005–06.
The Government intends to sell its remaining shares in Petro-Canada in 2004–05. Based on an average of recent prices and the book value of this investment, it is expected to provide approximately $2 billion in net budgetary revenues.
As a result, the remaining budgetary surplus is $1.9 billion in 2003–04, $4.0 billion in 2004–05 and $4.0 billion 2005–06. For 2003–04 the $1.9 billion is allocated to the Contingency Reserve. A Contingency Reserve of $3 billion per year is set aside for both 2004–05 and 2005–06. If the monies allocated to the Contingency Reserve are not needed, they will reduce the federal debt. In this budget economic prudence has been established at $1 billion for 2004–05 and 2005–06.
Table 3.2
Fiscal Outlook Including March 2004 Budget Measures
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2003–04 | 2004–05 | 2005–06 | |
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(billions of dollars) | |||
Revised "status quo" budgetary surplus | 5.5 | 4.2 | 6.6 |
Budget 2004 measures | |||
March 2004 agricultural assistance package | 1.0 | ||
The importance of health | 2.5 | 0.1 | 0.1 |
The importance of learning | 0.3 | 0.5 | |
The importance of communities | 0.1 | 0.9 | 0.8 |
The importance of knowledge and commercialization | 0.3 | 0.4 | |
The importance of Canada’s relationship to the world | 0.4 | 0.5 | |
Equalization/Territorial Formula Financing | 0.2 | 0.2 | |
Other | 0.0 | 0.1 | |
Net impact | 3.6 | 2.2 | 2.5 |
Asset sale | -2.0 | ||
Remaining budgetary surplus | 1.9 | 4.0 | 4.0 |
Prudence | |||
Contingency Reserve | 1.9 | 3.0 | 3.0 |
Economic prudence | 1.0 | 1.0 | |
Total | 1.9 | 4.0 | 4.0 |
Budgetary balance | 0.0 | 0.0 | 0.0 |
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Note: Numbers may not add due to rounding. |
Table 3.3 provides the summary statement of transactions, including the impact of all the measures proposed in this budget. The following sections describe the current fiscal outlook in more detail.
Table 3.3
Summary Statement of Transactions (Including March 2004 Budget
Measures)
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Actual 2002–03 |
2003–04 | 2004–05 | 2005–06 | |
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(billions of dollars) | ||||
Budgetary transactions | ||||
Budgetary revenues | 177.6 | 181.1 | 187.2 | 195.8 |
Total expenses | ||||
Program expenses | -133.3 | -143.4 | -147.9 | -156.1 |
Public debt charges | -37.3 | -35.8 | -35.4 | -35.7 |
Total expenses | -170.6 | -179.2 | -183.3 | -191.8 |
Underlying budgetary surplus | 7.0 | 1.9 | 4.0 | 4.0 |
Prudence | ||||
Contingency Reserve | 1.9 | 3.0 | 3.0 | |
Economic prudence | 1.0 | 1.0 | ||
Total | 1.9 | 4.0 | 4.0 | |
Budgetary balance | 7.0 | 0.0 | 0.0 | 0.0 |
Federal debt (accumulated deficit) |
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Balanced budget (no debt reduction) | 510.6 | 510.6 | 510.6 | 510.6 |
Apply Contingency Reserve to debt | 510.6 | 508.7 | 505.7 | 502.7 |
Non-budgetary transactions | 0.7 | 2.0 | -4.5 | -4.0 |
Financial source/requirement | 7.6 | 2.0 | -4.5 | -4.0 |
Per cent of GDP | ||||
Budgetary revenues | 15.4 | 14.9 | 14.8 | 14.7 |
Program expenses | 11.5 | 11.8 | 11.7 | 11.7 |
Public debt charges | 3.2 | 2.9 | 2.8 | 2.7 |
Budgetary balance | 0.6 | 0.2 | 0.3 | 0.3 |
Federal debt (accumulated deficit) |
||||
Balanced budget (no debt reduction) |
44.2 | 42.0 | 40.4 | 38.4 |
Apply Contingency Reserve to debt |
44.2 | 41.9 | 40.0 | 37.8 |
Other | ||||
Public debt charges as a share of revenues | 21.0 | 19.8 | 18.9 | 18.2 |
Annual per cent change | ||||
Budgetary revenues | 3.4 | 2.0 | 3.4 | 4.6 |
Program expenses | 6.6 | 7.6 | 3.1 | 5.6 |
Total expenses | 3.6 | 5.0 | 2.3 | 4.7 |
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Note: Numbers may not add due to rounding. |
From the early 1980s to the mid-1990s, the federal deficit was stuck at about $30 billion or more per year. However, with structural reforms introduced principally in the 1995 and 1996 budgets, the deficit was eliminated and a surplus was recorded in 1997–98—the first surplus after 27 consecutive years of deficits.
The Government of Canada has recorded six consecutive annual surpluses since then, and on the basis of this budget a balanced budget or better is expected again for 2003–04. This will mark the seventh consecutive balanced budget, the first time this has occurred since Confederation.
Balanced budgets or better are also projected for 2004–05 and 2005–06.
The federal debt-to-GDP ratio is the most appropriate measure of the debt burden, as it measures the federal debt (accumulated deficit) relative to the ability of the nation’s taxpayers to finance it.
With the reduction of federal debt of $52.3 billion in the last six years and strong economic growth, the federal debt-to-GDP ratio fell to 44.2 per cent in 2002–03, a decline of nearly 25 percentage points from its peak of 68.4 per cent in 1995–96.
The debt-to-GDP ratio is expected to decline further to 42 per cent in 2003–04. With balanced budgets or better and forecast economic growth, it is projected to decline to about 38 per cent by 2005–06.
The Government is committed to keeping the federal debt-to-GDP ratio on a downward track. In this budget it has announced its objective to lower the ratio to 25 per cent within 10 years.
Budgetary revenues are expected to increase by 2.0 per cent in 2003–04, following an increase of 3.4 per cent in 2002–03 (Table 3.4). The slowdown in the rate of growth in 2003–04 reflects the impact of the various shocks that hit the Canadian economy in 2003 and the impact of the 2000 Five-Year Tax Reduction Plan. In both 2004–05 and 2005–06 budgetary revenues are again expected to increase more slowly than the growth in the economy, primarily reflecting the impact of tax reduction measures introduced in this and previous budgets, as well as the downward revisions to economic growth as described in Chapter 2.
Personal income tax revenues are the largest component of budgetary revenues, amounting to just over 45 per cent of total revenues. Based on the financial results to the end of January 2004 and estimates for the balance of the year based on previous years’ experience, personal income tax revenues are expected to increase by 2.2 per cent in 2003–04, down from the increase of 2.8 per cent in 2002–03. The lower growth in 2003–04 reflects the impact of the shocks that hit the economy in 2003. The increase in personal income tax revenues in 2003–04 is consistent with the underlying increase in the tax base, after adjusting for the impact of the tax reductions announced in previous budgets. In 2004–05 personal income tax revenues are expected to increase slightly slower than nominal GDP, reflecting the fiscal impact of the final year of the tax reduction measures introduced as part of the $100-billion Five-Year Tax Reduction Plan. In 2005–06 personal income tax revenues are projected to increase broadly in line with the growth in nominal GDP.
Corporate profits increased by 10.1 per cent in 2003. This is the main factor contributing to the strong rebound in corporate income tax revenues in 2003–04. Corporate income tax revenues are expected to increase by 16.7 per cent in 2003–04, after declining in each of the previous two fiscal years. At $25.9 billion, corporate income tax revenues are still below their peak of $28.3 billion in 2000–01. The increase in 2003–04 primarily reflects robust profitability in the financial sector and lower refunds relating to previous years’ reassessments. Corporate income taxes are projected to increase only marginally in 2004–05 and broadly in line with the growth in the economy in 2005–06.
Excise taxes and duties are expected to decline by 1.5 per cent in 2003–04, following an increase of 11.4 per cent in 2002–03. The decline in GST revenues primarily reflects weak consumer expenditures in 2003. Customs import duties are expected to decline by 9.0 per cent in 2003–04, primarily reflecting the impact of the appreciation of the Canadian dollar. Other excise taxes and duties are expected to be virtually unchanged, as the impact of lower tobacco consumption offsets increases in the other components. Thereafter the growth in excise taxes and duties is expected to be broadly in line with the growth in the economy.
Employment insurance (EI) premium revenues are expected to decline by 4.2 per cent in 2003–04 and 0.8 per cent in 2004–05. This reflects the impact of the premium rate reductions for both 2003 and 2004, which more than offsets the increase in the number of Canadians employed and therefore paying premiums. The employee premium rate for 2003 was $2.10 per $100 of insurable earnings, down from $2.20 in 2002. For 2004 the employee rate is $1.98. EI premium revenues are projected to rise slightly more than 3 per cent in 2005–06.
Other revenues include Crown corporation revenues, return on investments, foreign exchange revenues and revenues from the sale of goods and services. The increase in 2004–05 reflects the inclusion of the expected net proceeds from the sale of the Government’s remaining shares in Petro-Canada.
Table 3.4
The Revenue Outlook
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Actual 2002–03 |
2003–04 | 2004–05 | 2005–06 | |
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(millions of dollars) | ||||
Tax revenues | ||||
Income tax | ||||
Personal income tax | 81,707 | 83,500 | 86,940 | 92,455 |
Corporate income tax | 22,222 | 25,940 | 26,245 | 27,840 |
Other income tax | 3,291 | 3,250 | 3,285 | 3,450 |
Total income tax | 107,220 | 112,690 | 116,470 | 123,745 |
Excise taxes/duties | ||||
Goods and services tax | 28,248 | 27,685 | 28,540 | 30,310 |
Customs import duties | 3,221 | 2,930 | 3,000 | 3,085 |
Energy taxes | 4,992 | 5,275 | 5,290 | 5,455 |
Other excise taxes/duties | 4,475 | 4,475 | 4,490 | 4,680 |
Air Travellers Security Charge | 421 | 390 | 355 | 370 |
Total | 41,357 | 40,755 | 41,675 | 43,900 |
Total tax revenues | 148,577 | 153,445 | 158,145 | 167,645 |
Employment insurance revenues | 17,870 | 17,125 | 16,980 | 17,515 |
Other revenues | 11,115 | 10,510 | 12,110 | 10,660 |
Total budgetary revenues | 177,562 | 181,080 | 187,235 | 195,820 |
Per cent of GDP | ||||
Personal income tax | 7.1 | 6.9 | 6.8 | 6.9 |
Corporate income tax | 1.9 | 2.1 | 2.1 | 2.1 |
Other income tax | 0.3 | 0.3 | 0.3 | 0.3 |
Goods and services tax | 2.4 | 2.3 | 2.2 | 2.3 |
Excise taxes/duties (excluding GST) |
1.1 | 1.1 | 1.0 | 1.0 |
Total tax revenues | 12.9 | 12.6 | 12.4 | 12.5 |
Employment insurance revenues | 1.5 | 1.4 | 1.3 | 1.3 |
Other revenues | 1.0 | 0.9 | 1.0 | 0.8 |
Total budgetary revenues | 15.4 | 14.9 | 14.8 | 14.7 |
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Note: Numbers may not add due to rounding. |
Employment
Insurance
The Employment Insurance Act required that the Canada Employment Insurance Commission set premium rates at levels that cover program costs while keeping rates relatively stable over the business cycle. However, the December 1999 Report of the Standing Committee on Finance noted that the current rate-setting process "involves not only a ‘look forward’ process in assessing the level of revenues sufficient to cover program costs over a business cycle, but also a ‘look back’ process by taking into consideration the level of any past excesses or shortfalls of revenues relative to program costs." As EI premium revenues and program costs are consolidated in the Government’s budgetary balance, the "look back" provision, the report concluded, would cause serious disruptions to the overall management of the Government’s budget. The report recommended, therefore, that EI rates be set on the basis of the level of revenues needed to cover program costs over the business cycle looking forward and not take into account the level of the cumulative surplus or deficit. Recognizing these difficulties, the Government announced that it would undertake a review of the premium rate-setting process. In the interim Bill C-2 gave power to the Governor in Council to set the rates for 2002 and 2003. In the 2003 budget the Government set the employee premium rate at $1.98 for 2004. Based on the private sector economic forecasts used in that budget, this was the rate estimated that would generate premium revenues equal to the projected program costs for 2004. In the 2003 budget the Government also launched consultations on a new permanent rate-setting mechanism based on the following principles:
The results of the consultations are now being reviewed. A summary of the consultations is available at www.fin.gc.ca. It is the Government’s intention to introduce legislation to implement a new mechanism that would be consistent with these principles, taking into account the views expressed during the consultations. However, to ensure against the risk that such legislation may not be passed in time to set the rate for 2005, the Government proposes to give the Governor in Council the authority to set, in the fall of 2004, the rate for 2005. In doing so, it would set the rate in a manner consistent with the new rate-setting mechanism. For planning purposes, the Government is assuming an employee premium rate of $1.98 (per $100 of insurable earnings) for 2005, which is the rate expected to generate revenues sufficient to cover expected program costs, based on the economic assumptions used in this budget. |
A useful perspective on movements in budgetary revenues can be obtained by examining the "revenue ratio"—federal revenues in relation to total income in the economy (or GDP). This represents an approximate measure of the overall federal "tax burden" in that it compares the total of all federal revenues accrued to the size of the economy.
There is a cyclical element to the revenue ratio. It tends to decline during economic downturns and to increase during recoveries, reflecting the progressive nature of the tax system and the cyclical nature of corporate profits and capital gains. 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 to the economic slowdown in 2001, the decline in the stock market as well as 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 to 2005–06 due to the ongoing impact of the tax reductions announced in previous budgets as well as further tax measures proposed in this budget.
Table 3.5 presents the program expenses outlook to 2005–06. Total program expenses are expected to increase by 7.6 per cent in 2003–04. This increase reflects the $2.5 billion of health-related spending included in this budget, $1.4 billion in assistance to the agricultural sector and funding to the province of Ontario to assist in the fight against SARS. Program expenses are projected to increase 3.1 per cent in 2004–05 and 5.6 per cent in 2005–06. Average annual growth in program expenses over the years 2003–04 to 2005–06 period is projected to be 51?2 per cent, slightly above average annual nominal GDP growth. For the next two fiscal years—2004–05 and 2005–06—it averages about 41?2 per cent, slightly less than the growth in nominal GDP over this period. Program expenses reflect the $1 billion of savings from reallocation from current spending referred to in the section "Reallocation and Efficiency Improvements—Securing the $1 billion" on page 56.
Major transfers to persons are projected to increase, reflecting both higher elderly and EI benefits. The 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. The growth in EI benefits reflects the projected increase in the number of people eligible for benefits and increases in average benefits.
Major transfers to other levels of government include cash transfers to support health and other social programs, fiscal arrangements, and Alternative Payments for Standing Programs. In the 2003 budget incremental funding was provided to the provinces and territories for health care and other social programs as part of the February 2003 First Ministers’ Accord on Health Care Renewal (see "The Importance of Health" in Chapter 4). As a result, liabilities with respect to the $2.5-billion health supplement and the $1.5-billion Diagnostic/Medical Equipment Fund were recorded in 2002–03. In January 2004 the Prime Minister committed an additional $2 billion to the provinces and territories for health. This liability is recorded in 2003–04. In addition, this budget provides an additional $400 million to the provinces and territories to support a national immunization strategy and to assist in enhancing their public health capacities. Thereafter the funding levels reflect the measures in the 2003 Health Accord.
The major programs under fiscal arrangements are equalization and transfers to the territories. The federal government provides equalization payments to less prosperous provinces so they can provide their residents with public services that are reasonably comparable to those in other provinces, at reasonably comparable levels of taxation.
Table 3.5
The Program Expenses Outlook
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Actual 2002–03 |
2003–04 | 2004–05 | 2005–06 | |
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(millions of dollars) | ||||
Major transfers to persons | ||||
Elderly benefits | 25,692 | 27,020 | 27,925 | 28,815 |
Employment insurance benefits | 14,496 | 15,505 | 15,715 | 16,085 |
Total | 40,188 | 42,525 | 43,640 | 44,900 |
Major transfers to other levels of government |
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Federal transfer support for health and other social programs | 22,600 | 22,725 | 22,050 | 24,725 |
Fiscal arrangements | 10,366 | 8,720 | 11,170 | 11,985 |
Alternative Payments for Standing Programs | -2,321 | -2,430 | -2,620 | -2,775 |
Total | 30,645 | 29,015 | 30,600 | 33,935 |
Direct program expenses | 62,490 | 71,885 | 73,610 | 77,235 |
Total program expenses | 133,323 | 143,425 | 147,850 | 156,070 |
Per cent of GDP | ||||
Major transfers to persons | ||||
Elderly benefits | 2.2 | 2.3 | 2.4 | 2.5 |
Employment insurance benefits | 1.3 | 1.3 | 1.2 | 1.2 |
Total | 3.5 | 3.5 | 3.4 | 3.4 |
Major transfers to other levels of government |
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Federal transfer support for health and other social programs | 2.0 | 1.9 | 1.7 | 1.8 |
Fiscal arrangements | 0.9 | 0.7 | 0.9 | 0.9 |
Alternative Payments for Standing Programs | -0.2 | -0.2 | -0.2 | -0.2 |
Total | 2.7 | 2.4 | 2.4 | 2.5 |
Direct program expenses | 5.4 | 5.9 | 5.8 | 5.8 |
Total program expenses | 11.5 | 11.8 | 11.7 | 11.7 |
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Note: Numbers may not add due to rounding. |
As discussed in the section "Fiscal Outlook Before the Measures Proposed in the 2004 Budget," final personal income tax data for 2002, received from the Canada Revenue Agency in January 2004, resulted in a lowering of equalization entitlements for 2002–03. This has been carried forward to 2003–04 and the outer years. For 2003–04 a receivable has been established for the overpayments in both 2002–03 and 2003–04, even though these amounts will be recovered over a number of years. This accounts for the decline observed for 2003–04.
The equalization program is renewed every five years. Over the past five years, the federal and provincial governments have worked together to develop an approach that will make equalization payments more stable and predictable and improve the measurement of provinces’ abilities to raise revenues. This budget sets out the changes that the Government will propose to Parliament for the period 2004–05 to 2008–09, including a smoothing mechanism by which payments will be made more stable and predictable. These changes are expected to add an extra $1.5 billion to equalization transfers to provinces over the next five years (2004–05 to 2008–09). For further details, see Annex 6, "Renewing Equalization and Territorial Formula Financing."
The federal government is also putting in place new five-year funding arrangements with territorial governments that will commit additional resources to assist territories to invest in key priorities and respond to the unique challenges and higher costs in the North. Territorial Formula Financing (the principal federal transfer to the territories) will be increased, providing an additional $150 million over five years. The health transition funding of $20 million annually will be extended, providing another $60 million over the five-year period. The Parliamentary Secretary to the Minister of Indian Affairs and Northern Development with special emphasis on Northern Economic Development, and the Minister of Indian Affairs and Northern Development, are working to develop a northern strategy that will aim to ensure that economic development opportunities are developed in partnership with northern Canadians. This budget provides $90 million over the next five years to support this strategy. The proposals set out in this budget total $300 million over five years.
The Alternative Payments for Standing Programs represent recoveries of federal tax point abatements under contracting-out arrangements. These arrangements allow provinces to assume the administrative and financial authority for certain federal programs. In turn, the Government of Canada provides provinces with tax points, the value of which are netted against total entitlements and accordingly recovered from cash transfers. These recoveries reflect the growth in the value of the tax points.
Direct program expenses consist of subsidies and other transfers (such as assistance to farmers, students and Aboriginal peoples and for international and regional development), payments to Crown corporations and the operating expenses for departments and agencies, including National Defence. This component is expected to increase by 15.0 per cent in 2003–04, primarily reflecting the impact of new initiatives announced in the 2003 budget and since that budget. In the 2003 budget incremental funding was provided for National Defence, infrastructure, affordable housing and the advancement of sustainable development.
Since the 2003 budget the Government of Canada announced a number of initiatives, primarily to respond to unexpected developments during 2003. These included:
In addition, as outlined in the Annual Financial Report of the Government of Canada for 2002–03, direct program expenses in 2002–03 were affected by the impact of one-time adjustments, which lowered expenses in this component. Beyond 2003–04 this component is projected to grow broadly in line with the growth in nominal GDP.
The program expenses-to-GDP ratio has declined significantly, from about 16 per cent in 1993–94 to 11 per cent in 2000–01. This decline was largely attributable to the expenditure reduction initiatives announced in the 1995 and 1996 budgets aimed at eliminating the deficit and strong economic growth in 1999 and 2000.
Since 2000–01 the ratio has increased to an estimated 11.8 per cent in 2003–04. The increase in the ratio in both 2001–02 and 2002–03 primarily reflects the impact of higher cash transfers to the provinces and territories as specified under the September 2000 and February 2003 health accords. The increase in 2003–04 again reflects, in part, additional funding to the provinces and territories for health care, as well as special assistance to those most affected by the unexpected shocks in 2003.
Over the next two years the ratio is projected to stabilize at 11.7 per cent.
Public debt charges are projected to decline by $1.5 billion in 2003–04 due to a decline in the average effective interest rate on interest-bearing debt. Over the next two fiscal years they are projected to remain relatively unchanged.
Public debt charges as a percentage of government revenues are estimated to have declined from their peak of 37.6 per cent in 1995–96 to just under 20 per cent in 2003–04. This means that in 2003–04 the Government spent just under 20 cents of each revenue dollar on interest on the federal debt.
This ratio is expected to continue to decline, falling to about 18 per cent in 2005–06.
Effective management of the federal debt is important to all Canadians as the annual debt-servicing cost is the largest single federal government expense. 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 share of the debt that pays a fixed rate of interest, compared to a floating rate of interest. Debt that matures within the next year is considered floating, as it will be refinanced at prevailing market rates.
In the early 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. However, the increase in the fixed-rate portion of the debt increased debt-servicing costs because long-term fixed-rate debt (e.g. bonds) tends to be more costly than short-term floating-rate debt (e.g. Treasury bills).
Over the past six years the economic and fiscal position has strengthened. Canada now has low and stable inflation and interest rates, strong employment growth, lower foreign indebtedness and a current account surplus. The federal debt level has fallen by $52.3 billion and is at its lowest level, relative to the size of the economy, in nearly two decades. Over this time period market debt has been reduced by $37.1 billion. This reduction has provided the Government of Canada with greater financial stability, reduced its vulnerability to events happening beyond Canada’s 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 announced in the 2003 budget that it would reduce the fixed-rate portion of the market debt in order to lower debt-servicing costs, while maintaining a prudent level of cost stability. The target for the fixed-rate portion of the debt is being reduced from two-thirds to 60 per cent. The reduction is being implemented in an orderly and transparent manner over the next few years to allow the market time to adjust.
Further details on the outlook for 2004–05 borrowing programs and the Government’s debt structure will be provided in the 2004–05 Debt Management Strategy, to be released in late March.
Market debt consists of debt issued on credit markets, including Government of Canada bonds, Canada Savings Bonds and Treasury bills. The decline of $37.1 billion in market debt since 1996–97, coupled with sustained economic growth, has resulted in a decline in the market debt-to-GDP ratio from 57.0 per cent in 1995–96 to 38.1 per cent in 2002–03, a decline of 18.9 percentage points. This decline mirrors the rapid fall in the federal debt-to-GDP ratio.
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.
Table 3.6
The Budgetary Balance, Non-Budgetary Transactions and Financial
Source/Requirement
|
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|
Actual |
2003–04 |
2004–05 |
2005–06 |
---|---|---|---|---|
|
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(billions of dollars) | ||||
Budgetary surplus | 7.0 | 0.0 | 0.0 | 0.0 |
Non-budgetary transactions | ||||
Capital investing activities | -0.9 | -1.6 | -1.5 | -1.7 |
Other investing activities | -2.2 | -2.3 | -2.3 | -2.3 |
Pensions and other accounts | 0.4 | 1.7 | -2.2 | -1.7 |
Other transactions | 3.4 | 4.2 | 1.6 | 1.7 |
Total | 0.7 | 2.0 | -4.5 | -4.0 |
Financial source/requirement | 7.6 | 2.0 | -4.5 | -4.0 |
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Note: Numbers may not add due to rounding. |
In contrast, the financial source/requirement 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 source/requirement resulting from the Government’s investing activities through loans, investments and advances; its acquisition and disposal of capital assets; and its operating activities, primarily through the federal employee pension accounts. These activities are included in non-budgetary transactions.
With a balanced budget and a source of $2.0 billion in non-budgetary transactions, a financial source of $2.0 billion is estimated in 2003–04, down from $7.6 billion in 2002–03. Financial requirements are forecast in each of the next two fiscal years, primarily because of the transfer of Canada Pension Plan assets to the Canada Pension Plan Investment Board, as described below.
Given the impact of the expected transfer of the Canada Pension Plan operating balances, the Government may seek special borrowing authority to fund the transfer through the issuance of new market debt. Under the Financial Administration Act, the Government has standing authority to refinance market debt maturing in a fiscal year. The need for additional borrowing authority will be considered later in 2004–05, in light of the Government’s prevailing fiscal position at that time.
The fiscal projections are extremely sensitive to changes in economic assumptions—particularly to changes in real economic (GDP) growth, inflation and interest rates. Table 3.7 illustrates this sensitivity to a number of economic shocks.
Table 3.7
Estimated Change in Fiscal Position
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Year 1 |
Year 2 |
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(billions of dollars) | ||
1-per-cent decrease in real GDP growth | ||
Revenue impact | -1.9 | -1.9 |
Expense impact | 0.6 | 0.7 |
Deterioration in fiscal balance | -2.5 | -2.6 |
1-per-cent decline in GDP inflation | ||
Revenue impact | -1.9 | -1.8 |
Expense impact | -0.5 | -0.5 |
Deterioration in fiscal balance | -1.4 | -1.3 |
100-basis-point decrease in interest rates | ||
Revenue impact | -0.4 | -0.5 |
Expense impact | -1.4 | -2.0 |
Improvement in fiscal balance | 1.1 | 1.5 |
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Note: Numbers may not add due to rounding. |
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 by $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 expenses 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 $1.1 billion in the first year, rising to $1.5 billion in year two. This improvement comes solely from the reduction in public debt charges, which reduces overall budgetary expenses. Expenses would fall by $1.4 billion in the first year and by $2.0 billion in year two, as longer-term debt matures and is refinanced at the lower rates. This impact is slightly larger than that presented in previous years, reflecting the reduction in the fixed-rate portion of the market debt in order to lower debt-servicing costs. 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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Last Updated: 2004-03-23 |
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