The budget of the newly elected federal government is striking a balance between strengthening the middle class finances and keeping the federal public debt under control.
To begin with, the biggest winners from the 2016 federal budget are low and middle-income households. The new Canada Child Benefit, more generous and better targeted than the current child benefit system, is the biggest single measure of this budget. Starting in July, Canada Child Benefit will replace the Child Tax Benefit and the Universal Child Care Benefit and add another $5B annually in the pockets of middle class households.
The budget also includes, as widely expected, an enhancement to the Employment Insurance (EI) program. Most notably, the duration of EI regular benefits will be extended by 5 weeks in the 12 regions where the decline in commodity prices led to a sharp increase in unemployment; regions mostly located in Alberta and Saskatchewan (none in Quebec). For long-tenured workers, EI benefits will be extended by 20 weeks, up to a maximum of 70 weeks. These extended benefits will be available for one year starting in July 2016 and applied retroactively to all eligible EI claims made as of January 4, 2015. In our view, this additional income will contribute to ease the level of financial stress on Canadians who recently lost their jobs in the commodity sector. In addition, the budget confirms the cancellation of the previously announced increase in the age of eligibility to OAS payments from 65 to 67 years old and introduces a series of measures to improve the quality of life for seniors.
Altogether, the household-oriented measures taken by Finance Minister Bill Morneau will contribute to mitigate the risks associated to household indebtedness; by far the largest concern for financial stability in Canada. In comparison to households, the budget provides a softer tailwind to businesses. On the negative side, the federal government decided to defer further reductions in the small business income tax rate. It is now projected to remain at 10.5%, instead of declining by 0.5 percentage point a year to 9.0% by 2019 as previously planned. On the positive side, the budget creates various funding programs for companies to innovate and grow in tomorrow’s low-carbon economy. Furthermore, companies will indirectly benefit from the multiplier effect related to infrastructure spending, another key theme of this budget. The first phase of the 10-year $120B infrastructure plan includes money for public transit, green infrastructure and social infrastructure.
The Department of Finance estimates that the tax relief and spending measures announced in the 2016 budget will add 0.5% to real GDP in FY 2016-17 and 1.0% in FY 2017-18. This fiscal stimulus, combined with the projected rebound in WTI oil prices to about US$60 in the medium-term, will allow real and nominal GDP growth to accelerate overtime. Moreover, if everything goes according to plan, deficits will remain manageable and the debt will increase at a softer pace than NGDP growth. For example, the $29.4B deficit penciled for FY 2016-17 - the largest in today’s new 5-year fiscal outlook - represents a modest 1.5% of NGDP. Granted, Bill Morneau’s first budget does not include a plan to return to a balanced budget. However, the debt-to-NGDP ratio is projected to peak at only 32.5% in FY 2016-17 before gradually falling back below 31% in FY 2020-21; roughly the same level as in FY 2015-16. Put simply, investors will be pleased to see that the fiscal outlook is far from resembling the deterioration in federal public finances seen in the 1980s and early 1990s, when the debt-to-NGDP ratio was increasing by 2.5% per year on average.
Regarding the debt management strategy, the gross issuance of government bonds is projected to rise significantly from $92B in FY 2015-16 to $133B in FY 2016-17. The plan is to increase issuance of all maturities along the curve with a focus on the issuance of short and medium-term bonds with maturities of 2, 3 and 5 years. When the Federal Department of Finance decided, about a year ago, to stop issuing 3-year bonds, the level of debt was projected to stay about the same in the near future. Today, given the negative impact of lower commodity prices on the economy and the country’s public finances, it now makes sense to bring back 3-year bonds on the market; the timing and the size for the issuance of the 3-year bond will be confirmed following market consultations. Overall, the Department of Finance judges that issuing 2 to 5-year bonds strikes a balance between minimizing financing costs to take advantage of low short and medium-term rates and debt rollover risks. Finally, the stock of Treasury bills is poised to edge down from $136B to $134B by the end of FY 2016-17.
Omitted from the budget today are a revised Canada Health Transfer formula, federal funding for Bombardier and an enhancement of the CPP. Further developments could occur later this year on these fronts. Furthermore, despite rumors, the budget did not include any changes to capital gains tax rates.
Finally, the budget restores the labour-sponsored venture capital corporations tax credit (FTQ) and includes funding for Statistics Canada to gather data on the purchases of housing by foreign homebuyers.
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