Federal Budget: no big change in deficit thanks to higher taxes

Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud. 

Bottom line

Budget 2024 shows a deficit of $40bn for FY2024-25, unchanged from the Fall Economic Statement (FES), and only marginally higher than expected over the projection period. Moreover, the Budget sees the debt-to-GDP ratio continuing its decline, respecting the self-imposed fiscal rule. However, the government is spending all the higher revenues from better-than-economic performance since the FES and needs to raise taxes to ensure the deficit does not widen and that fiscal rule is respected.

Nevertheless, there are some potential upsides in the details. More specifically, we note that the economic forecast assumptions are likely too low. As such, the survey of private forecasters used in the Budget, does not take into account of the recent strength in growth at the end of 2023 and beginning of 2024, with the Budget assuming growth of 0.7% in 2024 and 1.9% in 2025. Comparatively, the Bank of Canada expects growth to be 1.5% and 2.2%, respectively. This means that, with the level of GDP in 2024 and 2025 likely higher than expected in the Budget, the deficits this year and next are likely to be smaller than projected.

Considering that the government has spent every penny coming from higher revenues due to a stronger economy, the question is: What are they going to do with the extra revenues this year?

In terms of the measures announced, the increase in the capital gains tax on gains above $250,000 was the main surprise in the Budget. While the impact is likely to be small, a tax increase could marginally hinder investment in Canada by worsening the business environment.

Many measures to improve housing affordability have been preannounced and should help support some aspects of home construction. However, the amount committed remains relatively small compared to the ambitious objective of building 3.78 million homes by 2031. Moreover, the measures to improve accessibility will support demand at the margin, which could put further pressure on house prices given the housing shortage.

With the overall deficit virtually unchanged, the Budget has no important impact on the Bank of Canada’s fight against inflation. With that in mind, it does not change our view that the BoC will cut its policy rate at the June meeting.

While the Budget address somewhat the productivity issues in Canada, it does not address the issue of how higher investment should be financed and some possible sources for the current weak business investment (see Canada’s housing obsession is cannibalizing productivity)

Canada’s Finance Minister, Chrystia Freeland, released the 2024 Budget, showing an expected deficit of $40.0bn for the current fiscal year and $39.8bn for FY2024-25 and $38.9bn for FY2025-26. Moreover, the fiscal projection shows no plan to balance the fiscal book on the projection horizon, with the deficit reaching $20.0bn.

This is slightly higher than expected in the Fall Economic Statement 2023 (FES), when the deficits were expected at $40.0bn, $38.4bn in FY2024-25 and $38.3bn in FY2025-26. Relative to GDP, the deficits are expected to be 1.4%, 1.3% and 1.2% in  FY2023-24, FY2024-25, and FY2025-26, respectively (See Fig. 1 for details).

The slightly higher deficits are mainly the result of higher spending, as stronger economic growth compared to the FES led to smaller deficits before policy actions over the projection period, while the increase in the capital gains tax raises revenues. As such, the measures announced in the Budget 2024 and since the FES increased the deficit in the current fiscal year by $3.3bn, by 5.3bn in FY2024-25, by $7.5bn in FY2025-26.

The measures announced in the 2024 Budget amount to an increase in the deficit of $11.6bn in FY2024-25, and $10.9bn in FY2025-26. On the flip side, the increase in tax reduces the deficit by $6.5bn in FY2024-25, and $3.0bn in FY2025-26.

The level of federal debt is expected to have reached $1,215.5bn or 42.1% of GDP in FY2023-24. This is slightly lower than in the FES because of stronger economic growth this fiscal year. The debt-to-GDP ratio is expected to decline over the projection period, but it remains marginally lower than in the fall update, with the debt-to-GDP ratio expected at 39.0% in FY2028-29 compared to 39.1% previously.

As a result of the increase in the debt level and continued higher interest rates, the public debt changes are expected to rise to 1.6% of GDP in FY2023-24 and to stabilize at 1.8% of GDP thereafter. Relative to revenues, public debt charges are expected to represent almost 11% of revenues in FY2024-25 and over the projection period. This means that for each dollar of fiscal revenue, 10 cents need to be used to service the public debt. While this is lower than in the 1990s when it reached 37% of revenues, it is the highest since 2011, when debt-to-GDP was closer to 34% of GDP, but interest rates were lower.

The measures in the Budget that retain our attention are:

Housing affordability. Many measures had already been announced in the days leading to the release of Budget 2024. As such, the government has set an objective to have 3.87 million new homes built by 2031. To reach this goal, the Budget includes measures to promote the use of government land (public land, Canada Post properties, National Defence land, underused Federal offices), improve accessibility by allowing 30-years amortization for first-time buyers purchasing new builds, increase the Home Buyers’s plan to $60,000 from $25,000.

Increase in capital gain tax. The inclusion rate—the portion of capital gains on which tax is paid—for capital gains for individuals with more than $250,000 in capital gains in a year will increase from one-half to two-thirds. Individuals will continue to only pay tax on 50 percent of capital gains up to $250,000 per year. The increase is justified by a need to improve fairness in the tax system. The Budget documents suggest that the increase in the capital gain tax will only affect a small proportion of the population, about 0.13%, and will not affect Canada’s competitiveness.

Economic growth and productivity. The Budget includes measures for targeted investment in AI, and enhancement to research support and research grants. The Budget also introduces a carbon tax rebate to small- and medium-sized enterprises with 499 or fewer employees. There are also measures to promote investment in the net-zero economy, through an EV supply chain investment tax credit, implementing the clean electricity tax credit, advancing nuclear energy and delivering by year-end the major Economic Investment Tax Credits (CCUS, clean energy investment, clean hydrogen, clean electricity, etc.)