Marc’s Federal Budget 2009 Notes (revised)

The leakiest budget in Canadian history is now in the public domain, and will not lead to the fall of the Harper government. The budget was preceded by numerous press conferences held by Ministers (with the PM uncharacteristically out of sight), leaving some details to be filled in on budget day, largely tax measures, but in the end it featured no big surprises. The budget’s cover is almost cliche, featuring a picture of men working on some big capital project (a good indication of what is to come, i.e. essentially nothing for women amid a flurry of male-dominated infrastructure spending).

I was expecting some large across-the-board tax cuts in the mix but the budget is largely a spending one that is far from what we would have seen under a majority Conservative government. In fact, program expenditures jump from 12.9% in 2008/09 to 14.7% in 2009/10 before easing back down to 13.1% by 2013/14. Chalk up another small victory for minority governments in Canada and the coalition that prompted this about face on the part of the Tories.

My perceptions of the budget are based on relatively low expectations. Having been through some ugly cutting exercises in BC in the 2002-2004 period, any time a budget is tabled that is not a bloodbath of spending cuts, I usually breathe a sigh of relief. Before the budget, the government’s ideological soul mates at the Fraser Institute were calling for both a balanced budget and huge tax cuts, measures that would have required about a 25% reduction in federal spending. So interestingly the budget is closer to the CCPA’s Alternative Federal Budget than the Fraser Institute.

That said, this budget is not equal to the challenges facing the country, nor does it live up to the rhetoric of the Throne Speech delivered only 26 hours before, which claimed that:

Our Government is acting to protect the vulnerable: the unemployed, lower-income Canadians, seniors, Aboriginal Canadians and others hit hardest by the global economic recession.

This budget does little to protect the vulnerable, and while there are some good things in there, it still reeks of a government that is out of touch with those same vulnerable Canadians. It is more of a communications strategy, aimed at the political survival of the government, than a serious budget for tough times. The budget does not do enough in the short term to insulate families from the rough edges of the recession, nor does in make key strategic investments that Canada needs for the long term.

Most of my remarks below are on the macro environment of the budget and the key tax measures. There is a lot of expenditure in the budget with money sprinkled around different regions and parts of the economy, and I do not go into much detail on any of that. I’m hoping my colleagues will shed more light on a range of sectoral and infrastructure measures. And I reiterate my annual complaint that the federal budget sheds no light on federal government operations – there are no line items for federal departments or Crown corporates, the height of absurdity for anyone interested in things the federal government does beyond cutting cheques to individuals or other levels of government.

Macro Framework

The economic projections underlying the budget are arguably too optimistic, reflecting the views of the Bank of Canada and most private sector forecasters. The average private sector forecast in the budget is for real GDP to decline by 0.8% in 2009 with a reversion to growth of 2.4% in 2010. Unemployment rates are projected to rise from 6.1% in 2008 to 7.5% this year and 7.7% in 2010. The feds state that they are taking a more pessimistic estimate for nominal GDP growth of -2.7% in 2009 compared to -1.2% on average than the forecasters. This is sensible given that private forecasting has been so inaccurate and a year ago did not see a recession coming at all. But the feds are right back on track with the private forecasters for 2010.

As argued previously on this blog, there is good reason to be more pessimistic about the period from 2010 due to the collapsing of bubbles in housing, equities and commodities (and housing likely has a way to go). With consumer debt at record high levels they are already in retrenchment mode, and businesses are not going to be making new investments in an environment of weak demand. So what is going to drive those optimistic projections?

The cyclical (or status quo) component to the deficit, estimated by the feds at $15.7 billion in 2009/10, and $14.3 billion in 2010/11, is not stimulus. If the economy faces worse than projected, those deficit figures will grow accordingly. Budget measures considered stimulus are the additional $18 billion in 2009/10 and $15.5 billion in 2010/11. This is just over 1% of GDP in 2009 and less than that in 2010.

The budget (Table 1.2) adds on some other measures as stimulus to get closer to the 2% of GDP target expressed by the IMF and OECD. This includes $2.7 billion in loans to the auto sector, and $1 billion in each of 2009/10 and 2010/11 in loans to municipalities in support of infrastructure. Then about $6.5 billion in 2009/10 and $5.1 billion in 2010/11 in anticipated provincial contributions is counted to bring the total to $29.3 billion (1.9% of GDP) and $22.3 billion (1.4% of GDP).

Annex 1 provides a discussion of economic impacts and Table A1.1 has multipliers for various measures to confirm the numbers we have seen recently from Informetrica and Moody’s. Corporate income tax cuts have the least impact, at 10 cents per dollar of tax cut; Ei premiums are lower than estimated by Moody’s, at 20 cents; and personal income tax cuts are 40 cents. Based on these multipliers, the feds estimate their economic action plan to boost real GDP by 1.2 percentage points in 2009 and 0.1 percentage points in 2010. With the provincial contributions added in, these numbers are 1.6 and 0.2 respectively.

Tax Cuts

It is hard to imagine a Conservative budget that did not include tax cuts, but the tax cut crowd is sure to be disappointed with these ones. There is broad-based tax reduction, not in terms of tax rates, but arising through an increase in the basic personal exemption (the threshold for starting to pay income tax) and the next two bracket thresholds by 7.5% above 2008 levels. Those brackets are indexed to the rate of inflation in any event, so the calculations below are overstating the impact somewhat (depending on which rate of inflation chosen).

All in all a strange choice of tax cut that will be hard to sell to Canadians, most of whom do not get the technicalities of the tax system. But still rather costly, at almost $2 billion per year, with a stimulative impact this will be very small given retrenchment by households. By definition, it gives money to those who have income rather than those who do not (and has value of zero for any tax filer with income under $10,600).

For a single individual (Table A5.2) the basic personal amount is an even $33 for incomes of about $10,540 and over. About 20% of taxfilers earn less than this amount and so would get nothing. The bracket increases have a bigger benefit for those with higher incomes, so nothing up to just under $40,000 of income (or two-thirds of taxfilers). Over $100,000 you get the maximum possible savings of $284 ($317 if you add back the $33 gain from the basic exemption). Be careful what you read in the press – I have seen at least a couple media reports that have grossly overstated the tax cut benefits for various families.

As a percentage of income, these amounts are regressive (though a bit staggered due to the bracket impacts). At $20,000 this is 0.165% of income (but it will likely all be spent), whereas at $100,000 this is almost double relative to income, at 0.317% (and most of which will be saved).

Based on the amounts in the budget and tax revenue data, my back-of-the-envelope estimate is that almost one-third (32.3%) of these tax cuts above will go to the 8.4% of taxfilers with income above $80,000, and more than half (54.2%) to the 16.6% of taxfilers with incomes above $60,000. This higher-income group is the most likely not to be liquidity constrained and will save their tax cut.

For seniors, there is an increase in the age credit, worth $325 million in 2009/10.

Another temporary but big-ticket item is the home renovation tax credit, a $3 billion tax expenditure ($2.5 billion in 2009/10). There is certainly a nice incentive here for those who have long contemplated home renos but one has to have sufficient income to take advantage of this (and to be in a position to launch a reno project) and much of the cost of this measure will go to people who were planning on doing those renos anyway (a free rider effect).

The maximum savings from the credit is $1,350 per family (not individual), and that would be if you spent more than $10,000 on your renovation (i.e. a 13.5% savings if the work is done in 2009). It does not apply for the first $1,000, so small renovations are not eligible nor are appliance upgrades. And it is non-refundable, so you have to pay income taxes in order to benefit from the deduction. One interesting aspect of the announcement is that it may bring some of the underground economy above ground (hat tip to my lock-up buddy, Sherri Cooper). Basically, think of it as marble counter-tops for the middle class.

On the small business side there is similar increase in the threshold for tax paid at the federal small business rate, from $400,000 to $500,000. The cost of this item is relatively small, at $45 million in 2009/10, rising to $80 million in 2010/11. Worth more is the accelerated Capital Cost Allowance for new computers, $340 million in 2009/10.

Expenditures

Given today’s news of a big increase in EI claims (up 12% in November 2008 over Nov 2007), it is alarming that there is not much more in income support through the EI program. The duration for receiving benefits has been increased from 45 to 50 weeks, for a period of two years. The rate has been frozen at 1.73 cents per hundred dollars of earnings.

Thus, little has been done to restore the federal government’s key automatic stabilizer for what looks to be a doozy of a downturn. The outlook for EI premium revenues and benefits paid shows a deficit on the EI account of $2.1 billion in 2009/10 and $1.6 billion in 2010/11, and these numbers will be ever larger if there is a large increase in unemployment. The budget makes some claims that the rate freeze is like a tax cut because the rate should really be going up to make the program balance, but this supposed benefit of $4.5 billion is pretty tortured and few journalists bought it as bona fide stimulus.

Most of the action on unemployment is around retraining rather than income support. This includes $1 billion through the EI program, another $500 million for those who do not qualify for EI training, and another $200 million for smattering of other programs.

In the same vein of not supporting incomes per se but linking support to the labour market, the budget also includes an almost doubling of the Working Income Tax Benefit. This is close to what was called for by the CCPA’s Alternative Federal Budget. It is a bit complicated to go into all of the details here but the new formula leads to a maximum benefit of $925 for individuals that would apply for incomes in the $6,000 to $10,500 range ($1,680 for single parents and couples). The value of the increase is estimated at $415 for a single individual earning $10,000, rising to $636 if a single parent at the same income level. Cost of $580 million per year.

Somewhat better, though still small, is the increase in the phase-out amounts for the Canada Child Tax Benefit and its low-income supplement, the National Child Benefit. Total cost of $230 million in 2009/10, rising to $310 million in 2010/11.

In terms of transfers to the provinces, there is essentially no change in CHT/CST outlook. The line on Equalization is larger than it was in the 2008 budget, but I am told that the baseline should have been much higher due to the economy and the new formula announced in the 2007 budget. Equalization has instead been capped based on a moving average of nominal GDP, which according to the Canadian Labour Congress amounts to a loss of $7 billion over two years relative to what was expected. Newfoundland and Quebec are particularly incensed by this change, which was originally tabled in the November Economic and Fiscal Statement.

In addition to Transport Minister John Baird’s pre-budget announcement of municipal/provincial infrastructure support, there are investments for “knowledge infrastructure” and other federal projects. There has been concern that all infrastructure projects would have to follow a P3 model. It does not look like this will be the case, although the P3 fund (one part of the Build Canada Fund) will be issuing a call for proposal, and undoubtedly P3 proposals in other areas will be looked upon favourably. But the difficulty in getting financing and other delays as part of negotiating complex contracts will mean that P3s are much less likely to be “shovel ready”.

Social housing also got some attention from the feds for the first time in a decade and a half. The $2 billion allocated over two years is earmarked for renovating existing housing stock and for projects for First Nations and seniors. Thus, in spite of this investment there will be no funds for increasing the stock of low income social housing, precisely the type that is so desperately needed to fight homelessness, a point made by new Vancouver Mayor Gregor Robertson.

There is a wide range of sectoral measures included in the budget. It is a long list and there is not much detail on how they would all work. The long list looks like a recipe for excessive administration and micromanagement to me (some federal bureaucrats I chatted with during my stay commented on how the federal government is already tying itself up in red tape making it hard to get things done). There are some awfully small numbers for certain buckets of cash that would then have to be regionally distributed and approved based on applications from the provinces and municipalities and so on.

My quick read of these infrastructure and sectoral measures is that they do not add up to a coherent strategy. It is like the Tories put out a call to the bureaucracy for project ideas, and each got some money. This lack of strategic focus is a missed opportunity to position Canada for the next generation by greening our economy — infrastructure decisions today will lock in patterns of development for decades — and to make Canada a more just society.