TaxMatters@EY – May 2016
Where the money comes from and where it goes, our federal finances
Bob Neale, Toronto, and Fred O’Riordan, Ottawa
This is one of a series of articles reviewing selective financial information published by the Canadian federal government. In this article, we make a number of observations regarding the sources of the federal government’s revenues and the programs it funds. Other articles in this series include: “Your share of personal income taxes paid,” TaxMatters@EY September 2015, and “Beneficiary of low interest rates — the federal government,” TaxMatters@EY February 2016.
The federal Department of Finance’s responsibilities include the development of the Canadian economic and fiscal outlook and the preparation of the government’s budget. The most recent fiscal forecast was released in the 22 March 2016 federal budget, which included projections covering the forecast period 2016-17 to 2020-21. These projections were based on the average of private sector forecasts for the economy and factored in a downward adjustment of $40b a year for the period 2016-20 for forecasted nominal GDP.
Also included in the 22 March document was the projected deficit for fiscal 2015-16 ending on 31 March 2016. The final accounts for fiscal 2015-16 will be reported in the fall 2016 economic update.
In addition to the fiscal forecast, the Department of Finance annually publishes Fiscal Reference Tables providing annual data on the financial position of the federal, provincial, territorial and local governments. The most recent tables published in September 2015 provided federal surplus and deficit information from fiscal 1966-67 to fiscal 2014-15 (the last year for which “the books are closed”).
Reviewing the reference tables it’s interesting to note that in 1966-67 federal revenues were slightly less than $10b and the deficit was $485m. It was not until fiscal 1988-89 that revenues exceeded $100b ($106.3b) and the deficit had climbed to $27.9b. Federal revenues first crossed the $200b mark ($200.8b) in fiscal 2003-04 and the deficit was $9.1b that year.
The accompanying table of budgetary surpluses and deficits was compiled from the September 2015 Fiscal Reference Tables for fiscal 2010-11 to 2014-15 and from the 22 March federal budget plan Growing the middle class for fiscal 2015-16 to 2020-21.
Surplus/deficit and federal debt
In general terms, the annual budgetary surplus/deficit is the amount by which the government’s revenue from all sources exceeds or is less than the aggregate of program expenses (including transfers to the provinces) and the public debt servicing charge. During the 11 fiscal years in the accompanying table, the federal government posted a modest budgetary surplus of $1.9b in only one year (2014-15); and in the remaining 10 years had, or projects having, budgetary deficits ranging from $5.1b to $33.4b.
The accumulated deficit, or federal debt, is the difference between the federal government’s total liabilities and its total assets — both financial and non-financial. Non-financial assets include tangible capital assets, such as land and buildings, inventories and prepaid expenses. The annual change in the accumulated deficit is equal to the budgetary balance plus other comprehensive income or loss. As set out in the accompanying table, the accumulated deficit or federal debt is projected to increase from $550.3b in 2010-11 to $732.5b in 2020-21, an increase of $182.2b over 10 years.
In relation to the size of the economy, the federal net debt-to-GDP (gross domestic product) ratio has fallen by more than half in recent years, from a high of 67.1% in fiscal 1995-96 to a low of 31.0% in 2014-15. As shown in the accompanying table, the ratio is projected to increase modestly, reaching 32.5% in fiscal 2016-17, before returning to 30.9% in fiscal 2020-21.
It is worth noting that Canada has the lowest total government (including federal, provincial/territorial and local governments, as well as CPP and QPP) net debt-to-GDP ratio of all G7 countries.
Revenue from personal income tax
Personal income tax revenue is by far the largest component of federal budgetary revenues, accounting for approximately 50% of the total on average over the 10-year period in the accompanying table. Over this period, personal income tax revenues are projected to increase faster than growth in nominal GDP, reflecting expected personal income growth combined with the progressive nature of the personal income tax system (marginal rates increasing as income increases).
Accordingly, personal income tax revenue is projected to increase from 47.6% of total revenue in fiscal 2010-11 to 51.4% in fiscal 2020-21.
Revenue from corporate income tax
The second most important source of income for the federal government is corporate income tax from incorporated businesses carrying on business in Canada. Since 2012, the general corporate income tax rate has been 15% (falling from 18% in 2010 and 16.5% in 2011); there have been no further announced rate changes at the federal level. The small-business income tax rate was 11% for many years and has been reduced to 10.5% for 2016 and subsequent years.
While corporate income tax revenue is projected to grow in absolute terms over the 10-year period in the accompanying table, as a percentage it fluctuates in a narrow range around 13% of total revenue.
Revenue from the goods and services tax
The third-largest source of federal revenue comes from the goods and services tax (GST), accounting for 11.5% of total budgetary revenues over the review period. It is forecast to grow by 5.6% in 2015-16, based on growth in taxable consumption, and by 3.8% per year over the remainder of the forecast period.
Benefits to seniors
Benefits for seniors (elderly benefits) comprise the Old Age Security and Guaranteed Income Supplement and Allowance payments. Payments to seniors are projected to rise quite dramatically over the 10-year review period, from $35.6b in fiscal 2010-11 to an estimated $60.1b in fiscal 2020-21.
In addition to growing in nominal terms, payments to seniors are projected to increase relative to other program expenses, from 14.6% in fiscal 2010-11 to 18.6% in fiscal 2020-21. This is not surprising, given Canada’s aging population, the fact that elderly benefits are fully indexed and the Guaranteed Income Supplement for low-income single seniors was increased in the 2016 federal budget.
Prior to 2016, children’s benefits consisted primarily of the Canada Child Tax Benefit and the Universal Child Care Benefit programs. Effective 1 July 2016, these programs will be replaced by the Canada Child Benefit (CCB) program. The CCB provides significantly greater benefits for modest- and middle-income Canadian families and, as a result, the required annual funding increased by approximately $4b compared to the previous programs.
Again, the fiscal forecast is influenced by the change in Canadian demographics, this time the trend to families with fewer children, as the projected annual expenditure for children’s benefits rises slightly and then actually falls by $1.0b from fiscal 2017-18 to fiscal 2020-21. Children’s benefits also fall, from 7.5% to 6.7%, when expressed as a percentage of projected program expenses over the same four-year period.
Major transfers to other levels of government
Major transfers to other levels of government include the Canada Health Transfer, the Canada Social Transfer, fiscal arrangements (equalization, transfers to the territories, a number of smaller transfer programs and the Quebec abatement), Gas Tax Fund transfers, and other transfers.
These transfers accounted for 24.9% of total federal program expenses in 2014-15 (the latest year for which “the books are closed”). Over the remaining years in the forecast period, set out in the accompanying table, these transfers are projected to remain fairly stable, annually representing about 24% of total program expenses.
Operating expenses reflect the cost of doing business for more than 100 federal departments and agencies, as well as Crown corporations.
The previous government’s return to a modest surplus in fiscal 2014-15 was in part accomplished by reducing operating expenses through planned reductions in departmental spending in a series of strategic and departmental program reviews and an operating budget freeze that was in place in 2014-15 and 2015-16.
The 2016 federal budget signalled that the new government plans to continue putting downward pressure on operating expenses, which are projected to fall as a percentage of total program expenses over the forecast period, from 31.2% in 2014-15 to 29.5% in 2020-21. This will be accomplished in part by reallocating $3.7b that had been budgeted for National Defence large-scale capital projects from the 2015-16 to 2020-21 period to future years.
Other transfer payments administered by government departments include transfers to provincial, municipal and Aboriginal governments and post-secondary institutions for investment in infrastructure, as well as funding for education. These transfer payments as a percentage of total program expenses have dropped steadily, from 17.8% in 2010-11 to 12.6% in 2015-16. Over the next five years, they are expected to average approximately 14% of total program expenses.
Public debt charges
As discussed in the February 2016 issue of TaxMatters@EY, the federal government has benefited significantly from the long-term trend to lower interest rates. Between fiscal 2010-11 and fiscal 2015-16, the annual debt service charge fell from $30.9b to a projected $25.7b, despite the fact that the principal amount of the federal debt increased from $550.3b to a projected $619.3b. Expressed as a percentage of total federal expenses (program expenses plus debt servicing charges), the annual debt service charge falls from 11.3% in fiscal 2010-11 to a projected 8.7% in fiscal 2015-16.
Looking forward over the next five years in the fiscal forecast, the federal debt is projected to increase by $113.2b from $619.3b in fiscal 2015-16 to $732.5b in fiscal 2020-12. Over the same time period, the Department of Finance is projecting an increase in the average interest rate of the public debt charge from 4.15% in fiscal 2015-16 to 4.85% in fiscal 2020-21. This is projected to push the annual debt service charge back up to 9.9% of total federal expenses by 2020-21.
The way forward
Economic forecasting is an inexact science subject to considerable uncertainty in domestic and global markets and errors in estimating the time paths of many independent variables. It is for this reason that the government normally incorporates a contingency reserve in its projections to account for risk and uncertainly.
It’s very likely that once the “books are closed” on fiscal 2020-21 five years from now, the total federal revenue for that fiscal period will be an amount other than $344.4b and the federal debt will not be exactly $732.5b. The performance of the Canadian economy and the tax and spending choices made by the federal government will dictate the actual amounts.
That said, understanding the sources of revenue and how those monies are spent by the federal government is important to all Canadians.