- Support programs will be extended to get the economy through the final stages of the pandemic.
- A substantially improved economic outlook makes $70-100B in stimulus spending look excessive.
- Recovery spending is expected to focus on child care, training and digital and green infrastructure.
- Any new spending should keep debt sustainability in mind—investors and rating agencies will be watching closely.
- The government should avoid tax increases that would slow the recovery.
From bridging the gap to supporting the recovery…
The current fiscal year (FY21/22) will be one of transition. It begins with many provinces battling a third wave of COVID-19 and once again tightening containment measures. The government has spent heavily to ‘bridge the gap’ to the other side of these restrictions, and with some support programs set to expire before the economy fully re-opens, Budget 2021 will likely include further extensions to wage and rent subsidies (CEWS and CERS) and income support for the self-employed (CRB).
These programs should be phased out over the current fiscal year but a firm timeline for their withdrawal is unlikely at this stage. The bill for the government’s COVID-19 Economic Response Plan in FY21/22 is likely to increase from $51B in the Fall Economic Statement (FES 2020) but will still pale in comparison to $275B budgeted for FY20/21.
Phasing out expensive but necessary support programs for households and businesses doesn’t mean the government’s spending days are over. Rather, FY21/22 will see it pivot toward efforts to support the recovery, centred on $70-100B in “targeted stimulus” over the next three years—money that was announced but not allocated in FES 2020.
An improving economic outlook has weakened the case for stimulus worth 3-4% of GDP, though the government’s appetite to spend likely hasn’t changed. But where upside surprises on revenue (due to a stronger economy) can’t fund new spending, the government should look to reallocate other program spending to avoid adding significantly to its debt load. Focusing on programs that can boost the economy long-term and generate additional revenue over time would also help. However, a cautious and targeted approach is still needed given risks in how growth-enhancing initiatives actually play out in practice.
To that end, we expect child care and early learning will be a key priority in Budget 2021. Provincial jurisdiction limits the federal government’s ability to implement a national strategy so enhancing existing funding (currently less than $1B per year) for provinces, territories and Indigenous groups is likely the easiest way to improve access to affordable child care. Well-designed child care policies have the potential to boost women’s labour force participation, stimulating growth and tax revenue.
Other initiatives to support the recovery could include temporary funding to address skills, investment and infrastructure gaps that have been highlighted or exacerbated by the pandemic. Funding for training to tackle long-term unemployment and skills mismatches (particularly for those in hard-hit services sectors), improving internet access, and encouraging tech adoption by businesses are worthwhile initiatives that can help increase the economy’s potential output. We could also see additional funding for energy and clean tech infrastructure, building on the Canada Infrastructure Bank’s $10B growth plan announced in October.
These measures would be in addition to $7.2B in funding for provinces, territories and municipalities for spending on health care, vaccine programs and local infrastructure recently announced by Finance Minister Freeland, adding billions more to a budget deficit that was already set to exceed 5% of GDP in FY21/22.
…while keeping an eye on debt sustainability and avoiding tax hikes
The current fiscal year will coincide with dramatic improvement in Canada’s economy. Growth was surprisingly resilient through the second wave of COVID-19, and while a third wave is clouding the near-term outlook, we expect accelerating vaccine rollout will help the economy build momentum over the summer. RBC’s forecast for 2021 nominal GDP growth is 9.5% compared with 6.9% assumed in FES 2020. Even with slightly higher interest rates, ‘positive economic developments’ should improve the government’s bottom line by $12-15B.
Our forecast assumes the economy will be operating close to full capacity by this time next year, significantly sooner than envisioned in FES 2020. A closed output gap is the Bank of Canada’s guide for when it should start withdrawing monetary stimulus and we think the government should take a similar approach in assessing the amount and timing of fiscal stimulus. The government’s proposed “fiscal guard rails” (employment, unemployment and hours worked) are lagging indicators and leave plenty of room for interpretation—at the very least clarifying how they will be applied would add confidence that additional spending is truly needed.
This is all the more important as excessive stimulus spending could generate inflationary pressure, put upward pressure on interest rates and crowd out private investment, and threaten debt sustainability. On the latter, the government’s projections in FES 2020 showed $100B in stimulus spending could push its debt-to-GDP ratio as high as 58.5% in the coming years, about where it was in 1991—not exactly the halcyon days of federal government finances. Again, initiatives like child care that boost long-term economic output and could pay for themselves over time should be a priority.
While a low interest rate environment—even accounting for a cyclical increase in the next few years—makes the current federal debt load manageable, complacency about deficits must be avoided. A new fiscal anchor should be adopted sooner rather than later to ensure Canada retains the confidence of investors and ratings agencies.
Temporary stimulus spending or new, permanent programs should be scaled to avoid tax increases that would threaten the economic recovery and potentially offset the positive effects of increased government spending. Canada is already a higher-tax jurisdiction relative to the OECD average, particularly when it comes to personal income taxes. Increasing the GST has been flagged as a less distortionary way of generating revenue but would be politically unpopular. We don’t think the government should follow the Biden administration’s proposal to raise corporate taxes, which have a high economic cost per dollar raised and would threaten Canada’s international competitiveness.
Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.
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