This paper examines economic developments and policies in Canada during 1990–95. Spurred by the robust growth in the United States and the easing of monetary conditions between 1991 and 1993, economic growth in Canada continued to strengthen during 1994. Real GDP grew by 4.5 percent in 1994 after growing by 2.2 percent in 1993 and 0.6 percent in 1992. Economic growth in 1994 was led by exports and investment in machinery and equipment. However, growth was more broadly based in 1994; private consumption strengthened, and there was a rebound in residential and nonresidential construction.

Abstract

This paper examines economic developments and policies in Canada during 1990–95. Spurred by the robust growth in the United States and the easing of monetary conditions between 1991 and 1993, economic growth in Canada continued to strengthen during 1994. Real GDP grew by 4.5 percent in 1994 after growing by 2.2 percent in 1993 and 0.6 percent in 1992. Economic growth in 1994 was led by exports and investment in machinery and equipment. However, growth was more broadly based in 1994; private consumption strengthened, and there was a rebound in residential and nonresidential construction.

VII. Fiscal Policy Developments 1/

1. Federal fiscal developments during the 1983/84-1993/94 period 2/

The federal fiscal situation deteriorated sharply in the early 1980s, causing the federal deficit to rise to 8 1/2 percent of GDP and net debt to rise to 45 1/2 percent of GDP in 1984/85 (the fiscal year begins on April 1). 3/ In response, a multi-year program of deficit reduction was adopted in November 1984. The program included measures to reduce government administrative costs and cut civil service staffing, as well as actions to reduce transfers and subsidies to businesses, persons, and the provinces. Commitments also were made to privatize a large number of government-owned enterprises. Revenue initiatives included partial de-indexation of the personal tax system, the elimination of various personal and corporate income tax deductions, the imposition of income surtaxes, and increases in excise taxes.

As a result of these efforts and several years of robust growth, the deficit fell to just over 6 percent of GDP in 1986/87. No significant deficit-reduction measures were taken during the subsequent two years; instead, the focus of federal fiscal policy was on a number of important tax reform initiatives. These included the 1988 reform of the personal and corporate-income tax systems, which eliminated many exemptions and deductions, reduced the number of tax brackets, and lowered marginal-tax rates. In addition, the introduction of a value-added-tax--the Goods and Services Tax (GST)--was announced in 1989.

The deficit fell to 4 1/2 percent of GDP in 1989/90, and the debt/GDP ratio reached 55 percent by year-end. However, this outcome represented a substantial shortfall from the level projected in previous years’ budgets, in part owing to the transitional effects of the tax reform on revenues. In addition, the fiscal situation began to deteriorate again in 1990/91 owing to the effect on debt-service costs of the tightening of monetary conditions that began in 1987, the economic downturn that began in 1990, and less-than-expected receipts from the GST.

Efforts to strengthen the fiscal situation included measures in the 1989/90 budget to tax old-age security benefits and family allowances for high-income recipients, reduce the Government’s contributions to the unemployment-insurance system, and increase excise taxes. The Expenditure Control Plan--which imposed a multi-year constraint on spending growth–was introduced with the 1990/91 budget, and the spending limits were tightened in subsequent budgets. Additional spending cuts were introduced as part of the 1991/92 budget; the Spending Control Act of 1991 defined ceilings for program spending (noninterest outlays) extending to 1995/96; and the 1993/94 budget reduced access to unemployment-insurance benefits. Despite these efforts, the deficit rose to an average of 6 percent of GDP in 1992/93 and 1993/94.

2. Federal fiscal developments in 1994/95

The current, Liberal government took office in October 1993, and presented its 1994/95 budget in February 1994. The budget adopted an interim fiscal objective of reducing the deficit to 3 percent by 1996/97 and also contained a commitment ultimately to balance the budget. In order to achieve the Government’s interim deficit target, the budget contained measures whose yield was estimated at about 1 1/4 percent of GDP by 1996/97.

Expenditure-reduction measures yielding about 1 percent of GDP in 1996/97 included reductions in operating costs, an extension of the civil service salary freeze for an additional two years, reductions in defense spending, cuts in UI benefits, and further constraints on transfers to the provinces. Revenue-raising measures yielding just under 1/4 percent of GDP included a reduction in the tax preference for capital gains, income testing of the old age credit, and lowering the business entertainment deduction. The effects of increased outlays for research and development, training programs, and child care were offset by the inclusion of various deficit-reducing measures announced by the previous Government. The budget also included a $3 billion contingency reserve to cover the effects of possible changes in the macroeconomic environment or spending requirements.

The 1994/95 deficit is estimated at $37.9 billion (5 percent of GDP), somewhat lower than the $39.7 billion originally expected in the 1994/95 budget (Table VII-1). Excluding special one-time restructuring charges relating to the costs of civil service layoffs ($1 billion) and the elimination of transport subsidies ($1.6 billion), the deficit was $35.3 billion (4 3/4 percent of GDP). The principal factors contributing to the better-than-expected outcome included $1.9 billion lower noninterest spending, mainly owing to lower-than-expected unemployment insurance outlays that more than offset larger transfers to the provinces, and the fact that $2.4 billion of the $3 billion contingency reserve that had been included in the 1994/95 budget was not required. The effect of higher-than-expected interest rates on public debt charges was offset by increased nontax revenues.

Table VII-1.

Canada: Federel Fiscal Accounts

(Public accounts basis)

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Source: Department of Finance, Canada.

Includes restructuring costs and contingency reserve.

3. The 1995/96 budget

The 1995/96 budget was presented to Parliament on February 27, 1995 and introduced measures to achieve the interim deficit target that was announced in the previous year’s budget. In particular, the measures were expected to achieve a reduction in the deficit to $32.7 billion (4.2 percent of GDP) in 1995/96, and to $24.3 billion (3 percent of GDP) in 1996/97.

1995/96 Budget Measures 1/

(In billions of dollars)

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The budget initiatives were concentrated in the area of spending cuts, largely related to the Program Review that was initiated as part of the previous year’s budget. 2/ The expenditure reductions focussed in large part on business and agricultural subsidies. For example, grain-transportation subsidies (which totaled roughly $0.6 billion in 1994/95) were eliminated, dairy subsidies (which totalled roughly $0.2 billion in 1994/95) were cut by 30 percent over two years, and regional transportation subsidies (which totalled roughly $0.1 billion in 1994/95) were eliminated. 3/ Subsidies for industry, farm-income stabilization and regional development, as well as cultural subsidies also were sharply reduced.

In addition, defense spending was lowered relative to its baseline level by an amount that would rise to $1 billion by 1997/98. The budget called for substantial reductions in government operating costs; in particular, federal civil service employment was to decline by an estimated 45,000 (roughly 15 percent of 1994/95 levels) and roughly 20,000 of this reduction would take place by the summer of 1996. The process of downsizing the civil service would be concurrent with the privatization of various government operations, particularly in the transportation sector. 1/

In addition to these cuts, the budget announced an important change to the system of federal-provincial transfers. In particular, transfers under the Canada Assistance Plan (CAP), which had been used to fund provincial social welfare programs on a shared-cost basis, were to be merged with the transfers provided under the Established Programs Financing (EPF) system, which provided block grants to fund provincial post-secondary education and health programs. The merger would be effective in 1996/97 and the combined transfer–termed the Canada Social Transfer (CST)–would be made as a block grant. As part of the merger, funding would fall compared to baseline projections by $2.5 billion in 1996/97 and $4.5 billion in 1997/98. The budget indicated that CST was to be allocated between provinces according to existing arrangements for the CAP and EPF grants in 1996/97; consultations with the provinces would be undertaken to determine allocations thereafter.

The budget’s tax measures mostly affected corporate income taxes. They included an increase in the tax rate on large corporations (on capital) from 0.215 percent to 0.225 percent, an increase in the federal corporate surtax from 3 percent of basic federal corporate-income tax to 4 percent, a temporary tax on deposit-taking institutions, a tax on investment income of private corporations, and the elimination of deferral advantages for business and professional income. Personal tax rates were not affected, but contribution limits were reduced for tax-assisted retirement saving plans, and the excise duties on gasoline and tobacco were increased. Finally, in order to help offset the costs of integrating new immigrants, a $975 fee was introduced for adult applicants for immigration.

In addition to these initiatives, the budget noted that measures would be undertaken in the near future that also would bolster the fiscal situation. These included further reforms to the unemployment insurance system (to take effect by July 1996) and the federal-provincial transfer system. Moreover, the budget committed the Government to release by end-1995 proposals to reform the system of assistance to the elderly, with measures to take effect in 1997.

The budget projected that federal net debt would rise to nearly 74 percent of GDP by the end of 1995/96. On April 12, 1995, Moody’s Investor Service downgraded federal government debt from an AAA rating to an AA1 rating (Table VII-2).

Table VII-2.

Canada: Government Bond Ratings 1/

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Source: Department of Finance, Canada.

Very high quality debt is rated AAA or AA by Standard and Poors, and Aaa or Aa by Moody’s. High quality debt is rated A or BBB by Standard and Poors, and A or Baa by Moody’s. A plus (minus) sign by Standard and Poors indicates the strongest (weaker) rating. Moody’s uses a 1, 2, 3 designation, with 1 indicating the strongest.

As at January 1995, unless otherwise noted.

Reduced to AAl on April 12, 1995.

4. The provincial fiscal situation 1/

Provincial fiscal deficits rose sharply from near zero in 1989 and 1990 to nearly 3 percent of GDP in 1992, owing to an increase in the expenditure/GDP ratio from 25 percent to 29 percent during the 1989-92 period (Tables VII-3 and VII-4). 2/ The increase in the expenditure ratio was primarily the result of an expansion in government consumption, but also reflected the effects of the economic downturn and higher interest rates on transfer payments and debt-service outlays. Revenues as a share of GDP rose by 1 1/4 percentage points during this period, mainly owing to increases in personal and indirect tax rates, which more than offset the adverse effect of the recession on tax receipts.

Table VII-3.

Canada: Transactions of the Consolidated Public Sector

(National accounts basis, in millions of dollars)

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Source: Statistics Canada (supplied by DRI).

Estimate.

Includes hospitals.

Table VII-4.

Canada: Transactions of the Consolidated Public Sector

(National accounts basis, in percent of GDP)

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Source: Statistics Canada (supplied by DRI).

Estimate.

Includes hospitals.

Provincial deficits narrowed somewhat after 1992, falling to about 1 1/2 percent of GDP in 1994. The improved fiscal situation was the result of expenditure restraint, as purchases of goods and services as a share of GDP fell by 1 percentage point. A decline in subsidies and transfer payments as a share of GDP helped offset the continued growth in debt-service payments. The fall in the expenditure ratio was offset partially by the effect of constraints on federal transfers to the provinces, which fell by nearly 1/2 percent of GDP.

The provinces’ 1994/95 budgets generally contained commitments to eliminate their current account or budgetary deficits by 1998/99 or earlier (see tabulation below). 3/ Particularly ambitious fiscal adjustment programs included those by Newfoundland, Alberta, Manitoba, Saskatchewan and British Columbia, which committed to balanced budgets by 1996/97. Ontario and Quebec, whose deficits are relatively large, adopted considerably less stringent fiscal programs and have committed only to achieving a balanced current account by 1998/99.

Provincial/Territorial Fiscal Objectives 1/

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The 1994/95 provincial budgets emphasized expenditure restraint as the principal vehicle for achieving fiscal consolidation. An important focus was on reducing wage costs; for example, Nova Scotia, Prince Edward Island, Alberta, and the Yukon implemented nominal wage cuts, while Ontario and Manitoba required civil servants to take unpaid leave. In addition, Nova Scotia, New Brunswick, and Alberta cut capital spending, while transfers to municipalities were reduced in New Brunswick and Alberta. Spending initiatives in other areas included cuts in social services outlays by New Brunswick, Alberta, and the Northwest Territories, and reductions in spending on education in Newfoundland, Prince Edward Island, Nova Scotia, New Brunswick, Ontario, Manitoba, Alberta, and the Yukon.

The provinces did not attempt major revenue raising initiatives in their 1994/95 budgets, besides increases in excise duties on fuels in some provinces. Indeed, a number of provincial revenue measures were in the direction of reducing tax rates. For example, Nova Scotia and Quebec reduced personal-income tax rates, and British Columbia lowered a variety of tax rates. Corporate tax rates were lowered in Newfoundland, Manitoba, Saskatchewan, and British Columbia, and investment incentives were enhanced in Nova Scotia, New Brunswick, Ontario, and Manitoba.

1/

Prepared by Christopher Towe.

2/

See SM/94/97 (4/20/94), Chapter V for details of fiscal developments during this period.

3/

The discussion of federal fiscal developments is in the context of the public accounts measure of the deficit and net debt, which treats the civil service pension plan and the Canada Pension Plan (CPP) as extrabudgetary entities.

1/

Source is Department of Finance, Canada, Budget Plan. (Ottawa: Supply and Services, 1995)

2/

The Program Review involved a review of all federal-spending programs and the preparation by departments of action plans outlining strategic priorities and proposals.

3/

In order to offset the effects of the cut in grain subsidies, the budget made provisions for one-time grants to grain farmers totaling $1.6 billion (which were booked as an expenditure in 1994/95), $0.3 billion to improve prairie-transportation systems, and $1 billion in additional loan guarantees. Payments totalling $0.3 billion over five years would be made to offset the effects of cuts in freight subsidies.

1/

Candidates for privatization included Petro-Canada, Canadian National Railways, as well as various transportation-related functions of government.

1/

The discussion in this section is with regard to the national accounts measure of the deficit. The national accounts measure differs from the public accounts measure principally because the national accounts treat expenditure and revenues on an accrual basis, define capital transactions relating to existing assets as a financing item, and exclude transactions by government entities that are run on a commercial basis. In addition, the national accounts consolidate the civil service pension plans with the accounts of the federal and provincial governments.

2/

The provincial fiscal figures quoted in this section include the transactions of local governments.

3/

The discussion relies heavily on Canada’s Department of Finance, Annual Report on the National and Provincial Economies and on Government Sector Fiscal Developments in Canada: The Brown-Green Book--1994 Edition (January 1995).

1/

Source: Department of Finance, Canada.

2/

Commitment to balance current account.