Annex 1 – Details of Economic and Fiscal Projections

Economic Projections

The average of private sector forecasts has been used as the basis for fiscal planning since 1994 and introduces an element of independence into the Government's fiscal forecast. This practice has been supported by international organizations such as the International Monetary Fund.

The Department of Finance Canada regularly surveys private sector economists on their views on the outlook for the Canadian economy. The economic forecast presented in this section is based on a survey conducted in December 2016.

The December 2016 survey included the views of 14 private sector economists:

• BMO Capital Markets,
• Caisse de dépôt et placement du Québec,
• Canadian Federation of Independent Business,
• CIBC World Markets,
• The Conference Board of Canada,
• Desjardins,
• IHS Global Insight,
• Industrial Alliance Insurance and Financial Services Inc.,
• Laurentian Bank Securities,
• National Bank Financial Markets,
• Royal Bank of Canada,
• Scotiabank,
• TD Bank Financial Group, and
• the University of Toronto (Policy and Economic Analysis Program).

In the December 2016 survey, private sector economists expected real gross domestic product (GDP) growth of 1.9 per cent in 2017 and 2.0 per cent in 2018. They projected real GDP growth to slow to about 1.7 per cent on average per year over the remainder of the forecast horizon (Table A1.1).

Private sector economists expected GDP inflation (the broadest measure of economy-wide price increases) to pick up to 2.1 per cent in 2017 and to average 2.0 per cent per year over the following four years.

Private sector economists assumed West Texas Intermediate (WTI) crude oil prices of US$54 per barrel on average in 2017. Crude oil prices were projected to reach US$64 per barrel by 2021.

Nominal GDP growth in the December 2016 survey was expected to be 4.1 per cent in 2017, 4.0 per cent in 2018, and about 3.7 per cent on average over the following three years. Overall, the projected level of nominal GDP (the broadest single measure of the tax base) in the December 2016 survey is lower than projected in the 2016 Fall Economic Statement by $5 billion in 2017, with the difference rising to $16 billion lower by 2021.

Private sector economists projected the unemployment rate to stand at 6.9 per cent in 2017 and to gradually decline to 6.4 per cent by 2021.

In the December 2016 survey, the outlook for the 10-year government bond rate is higher by 20 basis points per year, on average, compared to the Fall Economic Statement. This reflects the rise in U.S. and Canadian government bond yields in the last quarter of 2016. On the other hand, the outlook for short-term rates is lower from 2018 onwards, by an average of about 10 basis points per year.

The fourth-quarter Canadian Economic Accounts results were somewhat more positive than expected in the December 2016 survey, and suggest firmer economic momentum heading into 2017. However, uncertainty and risk continue to weigh on the domestic and global economy. Overall, the risks to the December 2016 economic outlook remain broadly balanced, and the outlook is an appropriate basis for fiscal planning.

Fiscal Projections

The remainder of this annex outlines changes to the fiscal projections since the 2016 Fall Economic Statement (Table A1.2).

Impact of Economic and Fiscal Developments Since the 2016 Fall Economic Statement (Before Policy Actions and Investments)

Relative to FES 2016, projected budgetary revenues are higher in the first four years of the forecast primarily due to higher projected corporate and non-resident income tax revenues based on recent financial results. However, this growth is more than offset in the outer years by lower projected personal income tax revenues, reflecting weaker economic growth expectations in those years, as reflected in the December survey of private sector economists.

Excise taxes/duties are higher largely as a result of higher projected customs import duties. Previously, customs import duties were slated to decline based on the anticipated introduction date of January 1, 2017 for the Canada-European Union Comprehensive Economic and Trade Agreement (CETA) and the Trans-Pacific Partnership (TPP) agreement. Based on recent developments, CETA is now expected to enter into force in mid-2017, resulting in no forgone revenues in 2016–17, and somewhat smaller forgone revenues in 2017–18. In addition, given the uncertainty surrounding the TPP agreement, it is now assumed that tariffs will continue to be charged at existing rates, and the impact of lower tariffs has been removed from projected revenues. Together, these changes have resulted in an increase in projected customs import duties over the forecast horizon.

Employment Insurance premium revenues are virtually unchanged in all years of the forecast.

Other revenues, such as those resulting from loans and investments, interest and penalties, enterprise Crown corporations' profits and assets held in the Exchange Fund Account, are lower in all years of the forecast horizon largely as a result of lower year-to-date program revenues in 2016–17 and downward revisions to projected short-term interest rates for the remaining years (lowering the rate of return on interest-bearing assets).

With respect to expenses, major transfers to persons are largely unchanged, as a decrease in elderly benefits of approximately $0.1 billion per year, due to lower forecasted inflation, is generally offset by a projected increase in the Canada Child Benefit ranging between $0.1 billion and $0.2 billion per year. The increase in children's benefits is driven by lower projected household income resulting from the weaker economic outlook.

Major transfers to other levels of government are higher in the near term compared to FES 2016 projections. The increase in the early years is driven by revised tax-point transfers under the Quebec Abatement.

Compared to FES 2016, direct program expenses are projected to be lower, particularly in the near term. The decrease is driven by: year-to-date results, which carry forward to a limited extent over the forecast horizon; lower expenses for flow-through items (items which give rise to an equal and offsetting change in revenues); and lower capital amortization expenses based on current capital expenditure profiles.

Compared to FES 2016, public debt charges are lower in 2016–17, reflecting year‑to-date results, notably in respect of bond buybacks. From 2017–18 onwards, public debt charges are higher, reflecting the impact of higher forecasted long‑term interest rates on interest-bearing debt—market debt, public sector pension accounts, and employee future benefits. 

Impact of Policy Actions Announced Since the 2016 Fall Economic Statement

The Government's spending plans are generally laid out in the annual budget. However, due to operational reasons, some funding decisions may be required outside of the budget cycle. Consistent with the Government's commitment to open and transparent spending, all such "off-cycle" funding decisions taken since FES 2016 are detailed in Table A1.3. Altogether, these actions are expected to reduce the budgetary balance by approximately $0.9 billion over six years starting in 2016–17.

Impact of Investments Announced in Budget 2017

Table A1.4 summarizes the net fiscal costs of investments announced in Budget 2017. The cost of policy actions undertaken since FES 2016 and investments proposed in this budget is approximately $5.7 billion over six years, starting in 2016–17. Reflecting risks to the economic and fiscal forecast, Budget 2017 includes an adjustment for risk of $3.0 billion in 2017–18 and future years.  

Summary Statement of Transactions

Table A1.5 summarizes the Government's projected financial position over the forecast horizon. These projections are based on the December private sector survey, and include all new policy decisions.

After accounting for Budget 2017 proposals, the budgetary balance is expected to show deficits of $23.0 billion in 2016–17 and $28.5 billion in 2017–18. Over the remainder of the forecast horizon, deficits are expected to decline gradually from $27.4 billion in 2018–19 to $18.8 billion in 2021–22. The federal debt-to-GDP ratio is projected to decline gradually after 2018–19 to the end of the fiscal horizon, reaching 30.9 per cent in 2021–22.

Outlook for Budgetary Revenues

Table A1.6 sets out the Government's projection for budgetary revenues. Overall, a slight pick-up in economic growth drives a 4.3 per cent increase in projected revenues in 2017–18, up from a 1.1 per cent decline in 2016–17. Budgetary revenues are then projected to grow at an average of 4.0 per cent per year from 2018–19 to 2021–22, in line with the outlook for nominal GDP.

Personal income tax revenues, the largest component of budgetary revenues, are projected to decrease by $1.7 billion, or 1.1 per cent, to $143.2 billion in 2016–17. This reduction reflects the impact of tax planning by high-income individuals to recognize income in the 2015 tax year before the new 33 per cent tax rate came into effect in 2016. This behaviour raised revenues in 2015–16 but will lower them in 2016–17. Over the remainder of the projection period, personal income tax revenues are forecast to increase somewhat faster than growth in nominal GDP, averaging 4.5 per cent annual growth, reflecting personal income growth combined with the progressive nature of the personal income tax system.

Corporate income tax revenues are projected to increase by $1.1 billion, or 2.6 per cent, to $42.5 billion in 2016–17, reflecting strength in recent financial results. Over the remainder of the projection period, corporate income tax revenues are projected to grow at an average annual rate of 3.4 per cent, less than the rate of growth in nominal GDP, reflecting the projected outlook for profit growth and the anticipated use of loss carry-forwards.

Non-resident income tax revenues are income taxes paid by non-residents on Canadian-sourced income, notably dividends and interest payments. For 2016–17, non-resident income tax revenues are projected to increase by $0.1 billion, or 2.2 per cent. Over the remainder of the projection period, non-resident income tax revenues are projected to increase at an average annual rate of 3.8 per cent, in line with projected growth in dividends, interest payments and profits.

Goods and Services Tax (GST) revenues are forecast to grow by 2.2 per cent in 2016–17. Over the remainder of the projection period, GST revenues are forecast to grow by 4.0 per cent per year on average, based on projected growth in taxable consumption.

Customs import duties are projected to remain unchanged in 2016–17 and to decrease by $0.5 billion, or 8.5 per cent, in 2017–18. This decrease reflects the elimination of most of the tariffs/duties on imports from the European Union under CETA. Over the remainder of the projection horizon, annual growth in customs import duties is projected to average 3.7 per cent based on projected growth in imports.

Other excise taxes and duties are projected to increase by 0.9 per cent in 2016–17, consistent with year-to-date results. Over the remainder of the forecast horizon, other excise taxes and duties are expected to grow at an average annual rate of 0.7 per cent based on historical consumption trends.

Employment Insurance (EI) premium revenues are projected to decline by 3.3 per cent in 2016–17 and by 4.8 per cent in 2017–18 due to the introduction of the seven-year break-even rate mechanism in 2017. This new rate-setting mechanism ensures that EI premiums are no higher than needed to pay for the EI program over time. The break-even rate is estimated to increase in 2018, due to a weaker economic outlook than that which formed the basis for the 2017 EI premium rate and the impact of the EI measures announced in Budget 2017. EI premium revenues are expected to resume their upward trend in 2018–19 based on projected growth in wages and salaries and the projected EI premium rate over the remaining forecast horizon.

Other revenues are made up of three broad components: Crown corporation revenues from consolidated Crown corporations and net income from enterprise Crown corporations; other program revenues from returns on investments, proceeds from the sales of goods and services, and other miscellaneous revenues; and foreign exchange revenues.

Crown corporation revenues are projected to decrease by 18.7 per cent in 2016–17. This decrease largely reflects that 2015–16 revenues were supported by a one-time fiscal gain of $2.1 billion realized on the sale of the Government's remaining holdings of General Motors common shares. From 2017–18 to 2021–22, these revenues are projected to grow at an average annual rate of 6.0 per cent, reflecting Crown corporations' corporate plan projections.

Other program revenues are affected by interest rate movements, exchange rate movements (which affect the Canadian-dollar value of foreign-denominated assets) and flow-through items that give rise to an equal and offsetting expense and therefore do not impact the budgetary balance. These revenues are projected to decrease by $0.3 billion, or 1.4 per cent, in 2016–17. Over the remainder of the projection period, other program revenues are projected to increase at an average annual rate of 5.2 per cent, largely as a result of the projected increase in interest rates.

Net foreign exchange revenues, which consist mainly of returns on investments held in the Exchange Fund Account, are volatile and sensitive to fluctuations in foreign exchange rates and foreign interest rates. These revenues are expected to decline in 2016–17, due in large part to significant one-time gains on the sale of investments in the Exchange Fund Account in 2015–16, which are not expected to reoccur. Over the remainder of the projection period, net foreign exchange revenues are projected to grow at an average annual rate of 10.1 per cent, reflecting projected increases in interest rates.

Outlook for Program Expenses

Table A1.7 provides an overview of the projections for program expenses by major component. Program expenses consist of major transfers to persons, major transfers to other levels of government and direct program expenses.

Major transfers to persons are projected to increase from $91.2 billion in 2016–17 to $110.6 billion in 2021–22. Major transfers to persons consist of elderly, EI and children's benefits.

Elderly benefits, which are comprised of Old Age Security, Guaranteed Income Supplement and Allowance payments to qualifying seniors, are projected to grow from $48.3 billion in 2016–17 to $63.7 billion in 2021–22, or approximately 5.7 per cent per year—faster than nominal GDP. The expected increase in elderly benefits is due to both projected consumer price inflation, to which benefits are fully indexed, and an expected increase in the population of eligible recipients.

EI benefits are projected to increase by 8.4 per cent to $21.0 billion in 2016–17. This growth is in line with year-to-date results and the roll-out of EI benefit measures announced in Budget 2016. Over the remainder of the projection period, EI benefits are projected to grow moderately, averaging 2.4 per cent annually. This is due to growth in average weekly benefits and the impact of EI measures announced in Budget 2017, which are partially offset by a decline in the number of regular beneficiaries, reflecting the expected improvement in the labour market.

Children's benefits are projected to rise from $21.9 billion in 2016–17 to $23.2 billion in 2021–22, reflecting the new Canada Child Benefit, which replaced the Canada Child Tax Benefit and the Universal Child Care Benefit as of July 2016, and will be indexed to consumer price inflation beginning in 2020.

Major transfers to other levels of government, which include the Canada Health Transfer (CHT), the Canada Social Transfer (CST), Equalization, Territorial Formula Financing and the Gas Tax Fund, among others, are expected to increase over the forecast horizon, from $68.7 billion in 2016–17 to $80.1 billion in 2021–22.

The CHT is projected to grow from $36.1 billion in 2016–17 to $42.9 billion in 2021–22. In 2016–17, the CHT is legislated to grow by 6.0 per cent. Starting in 2017–18, the CHT will grow in line with a three-year moving average of nominal GDP growth, with funding guaranteed to increase by at least 3.0 per cent per year. The CST is legislated to grow at 3.0 per cent per year, increasing from $13.3 billion in 2016–17 to $15.5 billion in 2021–22. The Gas Tax Fund is projected to grow from $2.1 billion in 2016–17 to $2.3 billion in 2021–22 as these payments are indexed at 2.0 per cent per year, with increases applied in $100 million increments.

Direct program expenses are projected to rise from $130.9 billion in 2016–17 to $147.8 billion in 2021–22. Direct program expenses include operating expenses, transfer payments administered by departments and capital amortization.

Overall, transfer payments are projected to increase from $42.7 billion in 2016–17 to $51.1 billion in 2021–22. This increase reflects growth in transfers to support investments in infrastructure, to develop new technologies and conduct research, and to support training and educational programs, as well as the impact of the recent agreements for health care funding to provinces and territories with the federal government.

Operating expenses reflect the cost of doing business for more than 100 government departments and agencies. Operating expenses are projected to increase from $83.2 billion in 2016–17 to $88.3 billion in 2017–18, reflecting normal growth in government operations, as well as higher expenses for the Canadian Commercial Corporation (which are fully offset by higher revenues) and measures announced in FES 2016 and this budget. Growth is projected to moderate over the remainder of the projection period, with operating expenses reaching $89.9 billion by 2021–22.

Capital amortization is expected to increase from $5.0 billion in 2016–17 to $6.7 billion in 2021–22 as a result of recent and planned investments and upgrades to existing federal capital.

Financial Source/Requirement

The budgetary balance is presented on a full accrual basis of accounting, recording government revenues and expenses when they are earned or incurred, regardless of when the cash is received or paid.

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 also by the Government's non-budgetary transactions. These include changes in federal employee pension liabilities; changes in non-financial assets; investing activities through loans, investments and advances; and changes in other financial assets and liabilities, including foreign exchange activities.

As shown in Table A1.8, a financial requirement is projected over the entire forecast period. The projected financial requirements for 2016–17 to 2021–22 largely reflect requirements associated with the budgetary balance, increases in retained earnings of enterprise Crown corporations, and growth in other assets, including financing of the Exchange Fund Account.

A financial source is projected for pensions and other accounts for 2016–17 to 2021–22. Pensions and other accounts include the activities of the Government of Canada's employee pension plans and those of federally appointed judges and Members of Parliament, as well as a variety of other employee future benefit plans, such as health care and dental plans, and disability and other benefits for veterans and others. The financial source for pensions and other accounts largely reflects adjustments for pension and benefit expenses not funded in the period.

Financial requirements for non-financial assets mainly reflect the difference between cash outlays for the acquisition of new tangible capital assets and the amortization of capital assets included in the budgetary balance. They also include disposals of tangible capital assets and changes in inventories and prepaid expenses. A net cash requirement of $1.1 billion is estimated for 2017–18.

Loans, investments and advances include the Government's investments in enterprise Crown corporations, such as Canada Mortgage and Housing Corporation (CMHC), Export Development Canada (EDC), the Business Development Bank of Canada (BDC) and Farm Credit Canada (FCC). They also include loans, investments and advances to national and provincial governments and international organizations, and for government programs. The projected requirements for enterprise Crown corporations from 2016–17 to 2021–22 reflect retained earnings of enterprise Crown corporations as well as the Government's decision in Budget 2007 to meet all the borrowing needs of CMHC, BDC and FCC through its own domestic debt issuance. In general, loans, investments and advances are expected to generate additional revenues for the Government in the form of interest or additional net profits of enterprise Crown corporations, which partly offset debt charges associated with these borrowing requirements. These revenues are reflected in projections of the budgetary balance.

Other transactions include the payment of tax refunds and other accounts payable, the collection of taxes and other accounts receivable, the conversion of other accrual adjustments included in the budgetary balance into cash, as well as foreign exchange activities. Projected cash requirements associated with other transactions mainly reflect forecast increases in the Government's official international reserves held in the Exchange Fund Account, as per the prudential liquidity plan, as well as projected growth in accounts receivable, in line with historical trends.

Risks to the Fiscal Projections

Risks associated with the economic outlook are the greatest source of uncertainty for fiscal projections. To help quantify these risks in respect of their impact on the fiscal outlook, tables illustrating the sensitivity of the budgetary balance to a number of economic shocks are provided below.

Besides the economic outlook, there are other unique sources of upside or downside risks to the fiscal projections, such as the volatility in the relationships between fiscal variables and the underlying activities to which they relate. For example, the relationship between personal income taxes and personal income, the extent to which corporations use losses to reduce taxable income in previous and future years, or the extent to which departments and agencies do not fully use all of the resources appropriated by Parliament can fluctuate for reasons not directly linked to economic variables. These fluctuations introduce an additional level of uncertainty for fiscal projections.

Sensitivity of the Budgetary Balance to Economic Shocks

Changes in economic assumptions affect the projections for revenues and expenses. The following tables illustrate the sensitivity of the budgetary balance to a number of economic shocks:

• A one-year, 1-percentage-point decrease in real GDP growth driven equally by lower productivity and employment growth.
• A decrease in nominal GDP growth resulting solely from a one-year, 1‑percentage-point decrease in the rate of GDP inflation (assuming that the Consumer Price Index (CPI) moves in line with GDP inflation).
• A sustained 100-basis-point increase in all interest rates.

These sensitivities are generalized rules of thumb that assume any decrease in economic activity is proportional across income and expenditure components, and are meant to provide a broad illustration of the impact of economic shocks on the outlook for the budgetary balance. Actual economic shocks may have different fiscal impacts. For example, they may be concentrated in specific sectors of the economy or cause different responses in key economic variables (e.g. GDP inflation and CPI inflation may have different responses to a given shock).

A 1-percentage-point decrease in real GDP growth proportional across income and expenditure components reduces the budgetary balance by $4.7 billion in the first year, $4.2 billion in the second year and $4.6 billion in the fifth year (Table A1.9).

• Tax revenues from all sources fall by a total of $4.2 billion in the first year and by $4.1 billion in the second year. Personal income tax revenues decrease as employment and the underlying tax base fall. Corporate income tax revenues fall as output and profits decrease. GST revenues decrease as a result of lower consumer spending associated with the fall in employment and personal income.
• EI premium revenues increase as a result of an increase in the EI premium rate, which, under the seven-year break-even mechanism, adjusts to offset the increase in benefits due to the higher number of unemployed, such that the EI Operating Account balances over time.
• Expenses rise, mainly reflecting higher EI benefits (due to an increase in the number of unemployed) and higher public debt charges (reflecting a higher stock of debt due to the lower budgetary balance). This rise is partially offset by lower other program expenses (as certain programs are linked to growth in nominal GDP).

A 1-percentage-point decrease in nominal GDP growth proportional across income and expenditure components resulting solely from lower GDP inflation (assuming that the CPI moves in line with GDP inflation) lowers the budgetary balance by $2.1 billion in the first year, $1.8 billion in the second year and $1.4 billion in the fifth year (Table A1.10).

• Lower prices result in lower nominal income and, as a result, personal income tax revenues decrease, reflecting declines in the underlying nominal tax base. As the parameters of the personal income tax system are indexed to inflation and automatically adjust in response to the shock, the fiscal impact is smaller than under the real shock. For the other sources of tax revenue, the negative impacts are similar under the real and nominal GDP shocks.
• EI premium revenues decrease in response to lower earnings.
• Other revenues decline slightly as lower prices lead to lower revenues from the sales of goods and services.
• Partly offsetting lower revenues are the declines in the cost of statutory programs that are indexed to inflation, such as elderly benefit payments, which put downward pressure on federal program expenses. Payments under these programs are smaller if inflation is lower. In addition, other program expenses are also lower as certain programs are linked directly to growth in wages and nominal GDP.
• Public debt charges decline in the first year due to lower costs associated with Real Return Bonds, then rise due to the higher stock of debt.

An increase in interest rates decreases the budgetary balance by $0.9 billion in the first year, $1.8 billion in the second year and $3.3 billion in the fifth year (Table A1.11). The decline stems entirely from increased expenses associated with public debt charges. The impact on debt charges rises through time as longer-term debt matures and is refinanced at higher rates. Moderating the overall impact is an increase in revenues associated with the increase in the rate of return on the Government's interest-bearing assets, which are recorded as part of other revenues. The impacts of changes in interest rates on public sector pension and benefit expenses are excluded from the sensitivity analysis.

Investing in Canada—Allocation of Budget 2016 and 2016 Fall Economic Statement Infrastructure Investments

The following tables reconcile the current allocation of the infrastructure investments announced in Budget 2016 and the 2016 Fall Economic Statement. Table A1.12 shows the current allocation of Budget 2016 infrastructure investments. Table A1.13 shows the current allocation of the long-term infrastructure investments presented in the 2016 Fall Economic Statement.