Focus
April 19, 2024 | 13:04
Federal Budget: Capital Punishment
Federal Budget: Capital Punishment |
Tax and Spend, Again and AgainThe 2024 federal budget lands at a time when the economy is struggling to grow, the Bank of Canada is still leaning on inflation, the loonie is under stress, and the impact of torrid population growth pervades across much of the country. Against that backdrop, the fiscal path is little changed from that laid out in the 2023 Fall Economic Statement, but only after another significant increase in spending fully offsets revenue gains from a resilient economy and further tax increases, including a contentious increase in the capital gains inclusion rate. |
The FY24/25 budget deficit is estimated at $39.8 billion (1.3% of GDP), with the numbers massaged just enough to meet the various ‘fiscal guideposts’ (Table 1). Any path to a balanced budget remains absent. Below the surface, the near-term economic outlook has actually improved relative to the fall baseline, netting $3.9 billion in positive economic and fiscal developments for this fiscal year, mostly from higher income tax receipts. At the same time, Ottawa is layering on an additional $6.9 billion in tax hikes on higher-income earners and corporations, partly offset by a few targeted reductions. But, the combined additional revenue room is vapourized by $11.6 billion in new spending initiatives, leaving the bottom line slightly worse than projected in the fall. All in, net new stimulus for FY24/25 totals $5.3 billion, or $36 billion over the five-year forecast horizon. While the impact of net new stimulus is relatively small (roughly 0.2% of GDP for FY24/25), it’s another step in a long line of tax-and-spend policies that, for the market and credit watchers, is probably getting old. Consider that program spending for this fiscal year is now running a massive $66 billion above the FY24/25 level set out in Budget 2021 (Chart 1). This has not only prevented fiscal consolidation, but the steady flow of net stimulus has only made the Bank of Canada’s inflation battle tougher, and has also been countered by perennial tax increases. This is not a great look when the country is desperate for productivity-enhancing investment. |
This budget targets areas such as housing, health and infrastructure, Indigenous priorities and defence. The headline tax measure is an increase in the capital gains inclusion rate, from 50% to 66.7%, although limited to corporations, trusts, and individuals with gains exceeding $250,000. Some of the other rumoured items are absent, but allocators of capital are probably already asking: what’s next? Steady Fiscal Outlook |
The budget deficit is estimated at $39.8 billion in FY24/25 (1.3% of GDP), little changed from $40 billion in FY23/24 (Chart 2). The latter is unchanged from the Fall Economic Statement (FES), as increased spending matches a further in-year economic improvement. While the deficit is now well down from the record $328 billion in FY20/21, shortfalls persist through the forecast horizon as tax increases and stronger-than-expected revenues are fully offset by new spending. Cumulatively, the total deficit between FY23/24 and FY28/29 is now running $10 billion larger than in the FES. Revenues are projected to rise a solid 6.7% to $457 billion in FY24/25, led by broad gains in tax receipts. Meantime, program spending is projected to jump 6.7% this fiscal year. In the five years pre-COVID, program spending averaged a steady 14.5% of GDP. This year, spending will run at 16.0% of GDP, before fading to 15.5% late in the forecast. That’s a noteworthy increase in government spending as a share of the economy, especially at a time when nominal output has surged on the back of rising prices, and the Bank of Canada has been leaning on inflation pressure. The debt-to-GDP ratio will dip to 41.9% in the coming fiscal year, from 42.1% in FY23/24, before declining gradually to just under 40% by FY28/29 (Chart 3). Reasonable Economic AssumptionsThe budget projections are based on the private-sector consensus. This round was put in place just as activity was firming early in the year, and most were revising up their near-term forecasts. That leaves the consensus slightly on the conservative side for 2024 growth, although rate cut expectations have also been scaled back for both the Federal Reserve and Bank of Canada. |
The budget is based on real GDP growth of 0.7% this year (we are now at 1.2%), and 1.9% next year (2.0%). While real growth gets the focus, nominal growth has been the big story and the driver of revenues in recent years. Ottawa expects nominal growth to pick up to 3.8% this year after 2.7% growth in 2023 (we’re at 4.2%). So as it stands now, there might be some modest upside to the fiscal outlook from the underlying economy this year if recent momentum holds. The medium-term outlook, however, builds in productivity and population growth assumptions that could prove to be firm given recent trends and changes. Meantime, interest rates now sit incrementally higher than Ottawa expected along the curve in the FES. The 10-year yield is pegged at 3.3% this year, while the Bank of Canada is presumed to start cutting rates in the coming months. Both of those assumptions are generally consistent with our current view, although we continue to see the magnitude of expected rate cuts get dialled back—that’s consistent with a higher neutral rate and more stubborn U.S. inflation trends. Note that Ottawa assumes 3-month T-bills at 2.7% over the medium term, suggesting that they are still not fully accounting for the likelihood that neutral interest rates are now higher. Summary and Market ImpactThis budget is another swing of the tax-and-spend policy hammer, with billions of dollars worth of economic upside and tax increases fully churned over into more program spending. However, the bottom-line fiscal metrics have held their ground, debt services costs remain contained at just under 11% of revenues, and Canada might still look downright responsible compared to the U.S. But, this is another case where an opportunity for fiscal consolidation has been passed over, while another round of tax increases will only leave more questions about future policy moves—and the only thing worse than higher taxes might be uncertainty over taxes. While issuance was modestly higher, it was below expectations, and the big levers of income tax on the personal and corporate side were left untouched. Accordingly, this budget should be viewed as neutral on balance for bonds and the Canadian dollar, all else equal, and near-term inflation trends and Bank of Canada messaging will likely dominate. Given the exact distribution of the tax hike at the sector level is unclear, it makes it difficult to assess any impact on the TSX. There might even be temporary relief in some sectors (e.g., grocers, oil & gas and telecom) given more targeted tax hikes were absent in this budget. For real estate, the housing measures have already been documented, and the market impact should be minimal. But the higher capital gains inclusion rate will impact those planning to sell valuable properties with much lower cost bases. While the capital gains threshold for individuals sounds high on the surface at $250,000, consider that high real estate values will mean that many sellers of investment or cottage properties, with a much lower cost base, will get dinged by the higher inclusion rate. This will similarly be a concern for Baby Boomers passing down property to younger generations. Some professions, that typically save within a corporation, will also feel a significant impact. For a complete analysis and notable new measures, see our 2024 budget report here. |