E-Sight April 20: Federal Budget 2021: Big in every way

Yesterday, the Trudeau government released its 2021 budget, the first in two years, and it lived up to expectations that it would be a big one. Based on the economic update last fall, the government had signaled $70 to $100 billion in additional spending to support the economic recovery over the next three years. In fact, the budget slightly exceeded that range at $101.4 billion over the next three years. In a whopping 726 pages, the budget laid plans to defeat COVID-19, help the economy recover as quickly as possible, and to build a more equitable future. There was money for everyone – women, seniors, students, low-wage workers, indigenous and racialized communities. In other words, the budget is the basis of a platform the Liberals would be happy to run an election campaign on. This e-sight cannot possibly cover all aspects of Canada’s largest budget and instead focuses on the main economic impacts associated with the most notable measures.

To summarize the budget, we bucketed spending broadly across three categories and will focus on the five-year commitments.

First, there were measures to fight the pandemic and provide support to households dealing with job losses and the impacts of current public health measures. These measures totaled more than $42 billion over the next five years and it includes investment in Canada’s life sciences sector as well as the Canada Workers Benefit program among others.

Second, the government announced new measures in support of a pro-growth agenda. These totaled approximately $80 billion with investments in early learning and childcare, funding for students and digital broadband being the most significant items.

Finally, the government announced measures related to new social programs in support of equality. The largest items are an increase to Old Age Security and investments for Indigenous communities. These totaled more than $28 billion and represent a permanent increase in spending.

Altogether, these measures total approximately $150 billion in new spending over five years and will result in substantial deficits for the foreseeable future. The deficit is estimated at $354.2 billion in fiscal 2020-21 and $154.7 billion this fiscal year. After that, the deficit will slowly decline. What this means is that even after the short-term stimulus spending is over, the government is looking at a structural deficit of around $30 billion five years from now.

The federal government can technically afford the increase in spending and many of the initiatives outlined in the budget have a significant economic and social return. Nevertheless, there are three main concerns from an economic lens with the level of spending.

The first is that interest rates are already on the rise and that, combined with a rapid increase in debt levels, means that the government will have to devote more of its future revenue to interest payments, leaving less for other programs.

Second, the deficits projected throughout the forecast leaves the government with much less fiscal room to maneuver should we find ourselves in another economic downturn in the next five years. Pre-COVID, Canada looked to be late in the business cycle and the pandemic has not unwound many of the imbalances that have developed in the Canadian economy, so future economic shocks cannot be ruled out.

Third, the significant accumulation of federal debt outlined in this budget adds to the near record levels of debt borne by provincial governments and Canadian households. These high debt levels across the economy could make us more vulnerable in the event of another crisis down the road.

Spending on short-term critical needs

The government had to spend to get us out of the pandemic and support households and individuals facing the brunt of public health measures. In support of these goals the government announced funding for vaccines, supporting the healthcare system, controlling the virus and by helping workers and hard-hit businesses recover from the recession. Key measures include:

·       Investing $2.2 billion over seven years in Canada’s bio-manufacturing and life-sciences sector. This will in part support the development and the production of vaccine candidates in the country.

·       Extending the wage subsidy, rent subsidy and lockdown support for businesses and other employees until September 2021. This adds an estimated total of $12.1 billion in support.

·       The Canada Workers Benefit will also be expanded at a cost of $8.9 billion over six years to provide additional income to low-wage workers.

Spending on pro-growth investments

One of the key challenges facing Canada is a slowing of our potential economic growth as our population ages and years of weak investment weigh on our prospects. After the economy bounces back, most economists expect Canadian economic growth to slow to well below 2 per cent per year. By making strategic investments, Deloitte believes Canada could achieve significantly better growth. The government included some measures aimed at impacting our long-term prospects. The most significant ones are detailed below:

·       The government is planning to spend up to $30 billion over five years, and then $8.3 billion a year thereafter to build a high-quality, affordable and accessible early learning and childcare system across Canada. Our analysis suggests this spending will boost participation rates for woman and increase Canada’s long-term growth. This is the largest investment in this budget. It is important to note that this program will require negotiations with provincial governments, since they are the ones responsible for childcare. The proposed funding includes a 50/50 cost sharing between the federal government and the provinces outside of Québec.

·       $5.7 billion over five years for Canada’s youth to make college and university more affordable. The government plans to double the Canada Student Grant for two years and extend the waiver of interest on federal student loans through March 2023.

·       In support of digital investment, the government announced $4 billion to help SMEs buy new technologies to facilitate their growth. Another $1 billion over 6 years is set for the Universal Broadband Fund, to support access to high-speed internet in rural and remote communities.

·       Our emissions reduction goals will benefit from a $5 billion issuance target for Canada’s inaugural federal green bond and $5 billion over 7 years to the Net Zero Accelerator.

·       The budget also includes $14.9 billion over eight years to build new public transit, electrify existing transit systems and develop transit solutions to connect rural, remote and Indigenous communities.

Other social spending

The last category is spending largely related to redistribution or equality. The largest items include:

·       $18 billion in new spending to further narrow gaps between Indigenous and non-Indigenous people. Spending includes a COVID-19 response, health care, water, social services, education, income assistance, infrastructure, job creation, languages and culture, policing and governance and meaningful reconciliation with First Nations, Inuit and the Métis Nation.

·       $3 billion over 5 years to help provinces and territories improve the standard of care in their long-term care facilities.

·       An increase in Old Age Security (OAS) for Canadians 75 and over at a cost of $12 billion over five years. This includes a one-time payment of $500 in August 2021 to OAS pensioners who will be 75 or over as of June 2022.

The Economic Impact

While the economic recovery is clearly underway across the country, what has also become evident over the past few weeks is that we are not yet done dealing with the pandemic. As noted above, the government is prepared to continue to support businesses and households as they contend with what is hopefully the last significant wave of COVID-19 infections in the country. From an economic perspective, Budget 2021 all but ensures that this year will indeed be a spectacular one for economic growth as the federal government plans to inject an estimated $49.3 billion in new spending this fiscal year. Spending will remain elevated for the next two years as the host of initiatives described above are rolled out.

Our economic outlook, released last month, anticipated some but not all the increased spending outlined in the budget. Given that economic growth had proven remarkably resilient up to that point, and therefore didn’t need substantive stimulus, our forecast expected the government to spend on the lower end of the $70-$100 billion range provided in the Fall Economic Statement.

There is often a difference between when spending is recorded on the government books and when it actually hits the economy. A prime example of that is the significant income supports the government provided during the pandemic. The government has spent that money but a large portion of it is sitting in savings accounts waiting to be unleased into the economy. Given that disconnect, we expect some of the spending tagged for this fiscal year to benefit the economy next year. Despite that delay, the $77.6 billion over this and next fiscal year will undoubtedly impact the economy. Our rough calculations suggest that real GDP growth could see a boost of 0.6 percentage points this year and next should the full amount of the spending roll out in a timely manner. This could raise our growth forecast for 2021 above 6.5 percent and 2022 above 4.5 percent if the money flows quickly. Growth in 2023 would be weaker than our forecast expects as the spending falls off.

One concern with all this spending is inflation. As we discussed in our spring economic forecast, households saved over $200 billion last year and that is money that is waiting to be spent when the worst of this pandemic is behind us. If that money hits the economy faster than our forecast predicts and is then amplified by the federal spending, a period of above target inflation is possible. However, high inflation is by no means guaranteed as there remains significant slack in the Canadian economy and how fast that is absorbed will ultimately determine the outlook for price growth in the near-term. As we look longer out, some of the budget initiatives, such as the investment in early learning and childcare, boost our economic potential and, therefore, will not materially impact the inflation outlook.

The Fiscal Outlook

The economy is improving at a faster pace than projected during last year’s November Fall Economic Statement. This has resulted in a significant improvement in the outlook for the federal government’s finances. Back in November, before the budget measures were introduced, the government was forecasting the deficit for the fiscal year just ended at an estimated $346 billion. The deficit was expected to decline to $105 billion this year before falling to $14.6 billion by fiscal year 2025-26.

However, instead of slowly decreasing the deficit, the government has embarked on an ambitious new spending plan totaling $150 billion in new spending over the next five fiscal years, although $7.2 billion of this is to be offset by small new tax increases. While some of this spending is necessary to support Canada’s fight against the pandemic or will boost long-term growth, other spending represents an increase in current spending with little economic rationale. 

The spending is spread across 10 categories. While much of this spending is set to occur over the next three years to fight the pandemic and support the economic recovery, about $16 billion will be permanent spending. The largest of this will be in support of the governments early learning and childcare plan but there is also funding for the environment, employment insurance reform, affordable housing, a 10% increase in Old Age Security and much more.   

After taking account of the new measures, the government deficit is projected to fall from $354.2 billion last fiscal to $154.7 billion in 2021-22. However, it will then average just below $50 billion a year over the next three fiscal years before dropping to $30.7 billion in 2025-26. The federal debt as a share of GDP is projected to peak at 51.2% this year before easing slightly over the next four years. For comparison, it was hovering just above 30 per cent prior to the pandemic. Public debt charges as a share of revenues will rise from a low of 6.2% in 2021-22 to 9% in 2025-26.

The big question is whether this string of deficits and substantial increase in debt is affordable. Low interest rates will help maintain affordability for now, keeping debt payments below 10% of the budget. However, when you add the sizable increase in provincial debt over the last year, aggregate government debt in Canada is reaching worrisome levels. For example, Ontario is projecting their net-debt to GDP to reach 50.2% in 2023-24. Combining that with the federal government puts the net debt to GDP at about 105% in 2023-24, a level that is troubling.

The provinces are already struggling to pay for rising health care due to an aging population. Today’s outlook for the debt leaves them little room to maneuver. In addition, when you add in near-record levels of household debt, it certainly makes Canada more vulnerable in the event of rising interest rates or another crisis down the road.

Final Thoughts

The first federal budget in over two years made up for lost time with a vast number of initiatives introduced that cannot be fully captured in this short commentary. There is no doubt that the supports provided during the COVID-19 pandemic were critically needed to prevent an even worse social, health and economic crisis than what we experienced. And, we are still in the pandemic, so continued government support was essential. But the economy is proving resilient to the third wave and the recovery is proceeding. This raises a legitimate question of whether a highly stimulative budget was needed? Personally, I think the answer is no. So, how can the government justify large deficits in years to come? My conclusion would be that the measures would have to be part of a pro-growth agenda that would help the future rebalancing of government finances and improve the standard of living of Canadians. 

The good news is that some of the new measures will boost our long-term capacity for economic growth. The large-scale investment in early learning and childcare is particularly welcome. While this comes with a big fiscal price tag, we know from the Quebec experience that the impact on female labour participation should bring in significant tax revenues down the road and there could be savings in provincial education through reduced need for special education classes reflecting children being more school ready. Other important investments include measures for Indigenous reconciliation, incentives for digital investment by small businesses, and incentives for green investments that provide economic and environmental gains. 

However, there were spending commitments that add to the deficit without boosting potential economic growth, such as the $12 billion allocated to Old Age Security. And, there were areas where investment fell short. For example, the money for OAS would have been better allocated to senior care and measures to help seniors age at home. On the business front, there were many initiatives aimed at helping support small businesses – and they have been more impacted by the recent recession than large business. But, there is little in the way of incentives to boost investment and improve competitiveness of large businesses in Canada, which make up the bulk of Canadian economic output. At some point, I wish governments in Canada would drop their obsession with the cult of small business. 

Finally, with permanent increases in spending, the government has driven its structural deficit higher and will add hundreds of billions to our national debt. Again, much of the additional government spending will pay significant economic dividends, but Canada will eventually need a plan to close the gap between what the government earns and spends. Given the commitment to spending outlined in the budget, the realignment is likely to come in the form of higher taxes down the road.