On January 27, Federal Finance Minister Jim Flaherty tabled the 2009 federal budget. This bulletin provides a brief overview of the economics underpinning the fiscal plan, describes the key measures and discusses the “politics” going forward in the minority Parliament.

The Economics

The Federal fiscal plan presented by Minister Flaherty assumes annual budgetary deficits of $34 and $30 billion during the next two fiscal years, followed by a rapid decline in the deficit in 2011-12 to $14 billion, $7 billion in the following year and eventually a balanced budget in 2013-14. Approximately ½ of the deficit is attributable to the “automatic stabilizers” triggered in a downturn, with ½ attributable to discretionary stimulative actions (in the form of increased spending and tax relief).

The Finance Department has assumed a relatively short, though sharp, recession during 2009, with a recovery commencing at the end of the calendar year. Of some comfort is the intentional “discounting” of the economic assumptions in 2009 relative to recent private sector forecasts that adds an additional 15% or $5 billion to the deficit in the upcoming fiscal year. (This effectively brings the Government’s forecast in line with the latest IMF projection). Central to this five-year scenario is an assumption that the real rate of economic growth will outpace the real rate of interest by a considerable margin – the same fundamental mathematics that allowed the deficit to decline so rapidly in the mid-1990’s following the last major recession (and the opposite of the interest/growth rate relationship that existed during the 1980’s, when central banks were seeking to contain price inflation, rather than deflation).

The total federal stimulus package approaches 2% of GDP (Canada’s recent G-20 commitment) and constitutes the major component of an all-government stimulus package that could approach nearly 3% of GDP. This package pales in comparison with the astonishing $825 billion fiscal package (or 5% of GDP) that is being promoted by US President Obama. It should be noted that the US federal budget deficit is projected to reach $1.2 trillion (8% of GDP) in the absence of a stimulus package , meaning that the total 2009 US deficit could more than double the previous American record deficit as a % of GDP. To put the US fiscal situation in perspective, the record Canadian budget deficit was the “8% of GDP” shortfall that was inherited by the Mulroney administration in 1984-85.

The total federal stimulus package approaches 2% of GDP (Canada’s recent G-20 commitment) and constitutes the major component of an all-government stimulus package that could approach nearly 3% of GDP. This package pales in comparison with the astonishing $825 billion fiscal package (or 5% of GDP) that is being promoted by US President Obama. It should be noted that the US federal budget deficit is projected to reach $1.2 trillion (8% of GDP) in the absence of a stimulus package , meaning that the total 2009 US deficit could more than double the previous American record deficit as a % of GDP. To put the US fiscal situation in perspective, the record Canadian budget deficit was the “8% of GDP” shortfall that was inherited by the Mulroney administration in 1984-85.

“Canada Inc” essentially generates national income through the sale of automotive and energy products to US customers and employment through the domestic service economy. It follows that, while increased domestic investment in infrastructure etc may fill a short-term void, sustained economic recovery in Canada depends crucially on the restoration of American demand for Canadian exports. It remains to be seen whether the Obama package will stimulate an American economy suffering from excessive public and private sector debt loads and a substantial international deficit.

The Measures

The 2009 Budget contains a rather impressive “Shock and Awe” barrage of spending and tax relief – over 100 specific initiatives - with a deliberate front-end loading of the measures in 2009 and 2010. It is beyond the scope of this bulletin to list all of the measures, let alone analyze them. They include:

  1. A continuing focus on maintaining financial stability and increasing access to credit at all levels in the financial system (eg expanding EDC and BDC lending capacity via capital infusions as proposed in the November fiscal update; expanding the existing credit facilities and creating new facilities to fill the void in auto/equipment leasing and backstop financial institutions seeking liquidity via the wholesale market – all to be overseen by a new Advisory Committee). Note as well the cryptic note to consult on allowing the entry of the banks into auto leasing; and the launch of a process to reform the registered pension plan regime in 2009.
  1. An effective “doubling” of planned infrastructure spending in the near term ($13 billion in 2009), including not just traditional roads, bridges and sewers etc but investment in “knowledge infrastructure” (renovating university facilities etc), “green” infrastructure and the Recreational Infrastructure Canada – “RinC” – which will be financing repairs to community centres and arenas across (Western?) Canada. These programs include multi-partner projects and federal-only initiatives that should be easier to commence in short order.
  1. Financial support for hard-pressed sectors, including automotive and forestry; as well as such politically-sensitive sectors as “culture” (with the bulk of the funds flowing to the television and newspaper industries, including community papers).
  1. Extending eligibility for Employment insurance benefits (including job-sharing terms), as well as additional funds for retraining, support for older worker adjustment and distressed communities;
  1. Tariff relief on imported machinery and equipment, combined with an extension of the accelerated depreciation of machinery and equipment and a new (temporary) incentive to encourage the acquisition of computer hardware and software.
  1. Significant additional support for the Canadian Foundation for Innovation (CFI), the National Research Council’s IRAP program for small and medium-sized businesses seeking R&D support.
  1. A new 5 year/$1 billion Regional Development Fund for Southern Ontario, with formal recognition of Ontario as a new have-not province under the Equalization formula.
  1. A series of initiatives to support housing, including substantial funds for social and first nations’ housing, a one year tax credit for home renovations (effectively equal to sales tax relief on approximately $9,000 worth of activities), and measures to support first-time home purchasers;
  1. A series of income tax reduction measures targeted primarily at low and middle income households with children, as well as seniors; and
  1. A $1 billion Clean Energy Fund that the Government hopes to lever on an 1:4 basis in carbon capture and storage projects, (as well as an accelerated CCA rate on carbon capture and storage equipment); and a $351 Million operating contribution to AECL, with a promise to consider “private sector” participation.  

The fall-off in expenditures in the years beyond 2010 is reinforced by the maintenance of some of the policies that caused such acrimony in the Fall Fiscal update, including a cap on public service wages (though with an increase in the size of the public service), the inclusion of pay equity as a matter of collective bargaining, rather than “human rights”, and a cap on the growth of equalization payments that, when combined with the new Southern Ontario development fund, effectively results in the redirection of funds away from Quebec and Newfoundland back to Ontario As noted earlier, the essential key to a rapidly falling deficit is the maintenance of a beneficial relationship between real economic growth and interest rates so that revenues outpace expenditures.

Were there any surprises? Perhaps three – (i) the absence of military procurement as a fiscal stimulus tool; (ii) the continued refusal of Finance to expand the refundability of scientific research and experimental development credits (perhaps a prudent move in light of the recent Nortel bankruptcy; or still a non-starter for those who recall the refundability scandals of the early 1980’s); and (iii) the lack of a structural reform in the Employment Insurance system (though this might not have met the test of immediate and temporary action).

Ironically, a strong argument can be made that the single most important “announcement” this week was actually the “trial balloon” from Ontario Premier McGuinty that his Government was prepared to look again at replacing the Ontario retail sales tax with a value-added tax that could be harmonized with the Federal GST – a reform that would lower the marginal effective tax rate on new business investment in the industrial heartland of Canada by an amount greater than the complete elimination of the existing Ontario provincial corporate income tax.

The Politics

The January 27 Federal budget is one that can easily be supported by the Liberal Party, and as we learned today, has received just such support. From a substantive perspective, the “Policy Accord to address the Current Economic Crisis” that was signed by then-Liberal leader Stephane Dion and NDP leader Jack Layton on December 1, 2008 is in some respects an executive summary of the January 2009 budget. From a strategic or tactical perspective, new Liberal leader Michael Ignatieff is well aware that (i) Canadians outside Quebec remain adamantly opposed to a coalition government requiring the support of the Bloc Quebecois; (ii) a majority of Canadians want the budget to pass; (iii) there are better places to make a stand than opposing income tax reductions for low and middle income Canadian families; and (in his own words) Canadians need and want an election like “a hole in the head”. Furt hermore, while Liberal support has strengthened significantly with the arrival of a new leader, Mr. Ignatieff is not yet well-known to Canadians; and it is no secret that much work needs to be done to rebuild the Liberal Party. On the other hand, the Liberal caucus is loathe to put themselves back in the compliant position that they were seen to occupy previously.

The approach taken by Mr Ignatieff – to demand periodic accounting as a condition of support – is therefore an intelligent tactical response. It creates periodic windows of opportunity for the Liberals to claim ownership of the popular parts of the budget and to highlight the less successful pieces, all the while allowing the Liberal Party time to prepare for a battle at some future date when (i) they will be more election-ready; and (ii) the Harper Government may be “wearing” the Recession of 2009 (just as the Liberals wore the Recession of 1981-82 to the benefit of Mr Mulroney in 1984, and the Conservatives wore the recession of 1991-92 to the benefit of Mr Chrétien in 1993).

Canada was the last (and least) in to the current global morass - the veritable “one-eyed man in the land of the blind”. There is good reason to expect Canada will be first out. What is unknown is the timing of the exit. No amount of domestic stimulus can change the fact that a sustained Canadian recovery requires renewed American demand, meaning that, for better or worse, the electoral fortunes of the Conservative Party are hitched to the new political star in the White House.