Economic analysis

The three big things to watch on budget day

If you want a deeper understanding of what is actually going on, it is worth digging into these three aspects of the budget

Chris Young/CP

Chris Young/CP

All fiscally responsible eyes are fixed on the federal budget, to be delivered on Tuesday afternoon in Ottawa. Over the last week, we’ve seen the now-traditional advance hints of budget content. I’ve learned to disregard these leaks. LUniversité Laval’s Stephen Gordon pointed out in Maclean’s that leaks prior to the 2013 budget foretold cuts in tariffs, while the actual 2013 budget did the exact opposite and raised tariffs. So, without trust in the quality of information in the pre-budget leaks, what should budget-watchers look for in Tuesday’s budget? I’ve come up with three items that may not be attention-grabbers on Tuesday, but on which budget-savvy analysts should focus their attention.

GDP Deflator

First: What will be the projection for the GDP deflator? A few weeks ago, I was interested in the impact of the oil shock on the federal budget situation. I worked it through for Maclean’s here. I took the projections for 2015 and 2016 economic numbers from TD Economics and combined them with estimates of how sensitive the budget balance is to changes in the economy, provided by the Department of Finance. This exercise showed that the oil shock will not have a big impact on budgets through lower GDP growth, mostly because the GDP impact of the oil shock will not actually be that big. Instead, the impact of the GDP deflator on the budget is three times as large as the oil-induced change to real GDP.

The GDP deflator is the broadest measure of prices in the economy. Lower oil prices mean there will be a large shock to prices throughout the economy. In the short run, most of this effect is downward. TD Economics projects the GDP deflator to come in at -0.6 per cent for 2015, which is more than two full percentage points lower than was projected by the government in the fall fiscal update in November. That has an effect on the budget balance in the range of $5 billion for the current fiscal year, compared to only about $1.5 billion for the loss in real GDP growth. In the longer run, the lower exchange rate induced by the oil-price shock will start to feed through to increased prices for consumer goods to counteract the oil-price-induced drops in prices.

Why does the GDP deflator matter so much for tax revenue? Taxes are levied on the actual nominal dollar value of transactions, so the level of prices in the economy matters a lot. The brackets and thresholds throughout the tax system have already been set for 2015. If inflation comes in lower than expected, that means fewer dollars will rise over those fixed thresholds, leading to lower-than-expected tax revenue.

So, budget-savvy analysts should keep their eyes on the projection for the GDP deflator in Tuesday’s budget documents.

Tax Free Savings Accounts

The Conservatives promised a doubling of the annual contribution limit to Tax Free Savings Accounts (TFSAs) in their 2011 election platform. Pre-budget communications from the finance minister suggest the government will make good on that platform promise in the budget. This expansion of TFSA room has attracted many critics. My own principal concern with TFSA limit expansion is not really the change in the annual contribution room; there are many people who could use more than $5,500 of room per year. Instead, I have my eye on the long-term impact of TFSA room accumulating from age 18. At $11,000 per year per person, a 30-year-old couple would have $264,000 of TFSA room available. By age 50, it would be $704,000. When you think about the combination of TFSA and RRSP contribution room, very few Canadians will ever run out of contribution room under this system. This development is light years away from the original motivation for TFSAs to bolster savings opportunities for lower-income Canadians.

The way to address the concerns about large lifetime contribution room is with some kind of lifetime contribution limit. A lifetime limit would refocus the TFSA toward its original intention and lessen the concern that it benefits only high-income contributors. Some people may doubt that the Harper government would incorporate criticism when formulating policy. However, the final version of the income-splitting family tax cut did substantially respond to criticism, both by limiting the total monetary value to $2,000 and by jury-rigging the credit so as to leave the income tax revenue of the provinces unaffected by the federal tax change. So, given these precedents, I will be looking to see if the expansion of TFSA limits accommodates any of the criticisms.

Spending projections

The most surprising fiscal development over the past five years has been consistent under-spending of projected budgetary expenses. (See the recent expenditure monitor from the Parliamentary Budget Office here.) Across Canada, most economists have become accustomed to watching solemnly promised expenditure-restraint programs falter in the implementation; cutting budgets is always easier to talk about than to do. However, over the past five years, the spending restraint by the Harper government has missed in the other direction—more restraint than promised. To keep an eye on this, it will be useful to compare the actual spending numbers for the 2014-15 fiscal year just completed to those projected in the budget presented in March 2014. How much was underspent, and where?

When the finance minister rises to give the budget speech, I expect he will draw attention to the already announced family tax measures and other election-ready budget items. But, if you want a deeper understanding of what is actually going on, it is worth digging into these three aspects of the budget.


(My disclosure statement is here.)



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