This Selected Issues paper reviews empirical evidence on the main determinants of the real bilateral exchange rate between the Canadian and the U.S. dollars, with particular emphasis on the role played by cyclical and longer-term economic factors. The paper aims to identify the nature of the shocks that have contributed to the recent downward trend in the Canadian dollar. The analysis shows that fluctuations in the real bilateral exchange rate can be explained reasonably well by its long-term fundamentals. The paper also analyzes inflation and the natural rate of unemployment in Canada.

Abstract

This Selected Issues paper reviews empirical evidence on the main determinants of the real bilateral exchange rate between the Canadian and the U.S. dollars, with particular emphasis on the role played by cyclical and longer-term economic factors. The paper aims to identify the nature of the shocks that have contributed to the recent downward trend in the Canadian dollar. The analysis shows that fluctuations in the real bilateral exchange rate can be explained reasonably well by its long-term fundamentals. The paper also analyzes inflation and the natural rate of unemployment in Canada.

VI. Poverty traps and social assistance reform in canada1

1. Macroeconomic and structural policy changes, exogenous world events (such as commodity price shocks), and the ordinary functioning of dynamic market economies can cause dislocation in labor markets. Policies intended to ease the burden of adjusting to such dislocation help to maintain social and economic stability. Such programs, however, if not well designed, may introduce incentives to withdraw from the labor force and present hurdles to labor-force re-entry, and thus may create “poverty traps.” From the early 1980s through the mid-1990s, participation in social assistance programs across Canada trended upward. Facing rising welfare rolls and substantial fiscal pressures, most Canadian provinces have recently initiated or completed significant reforms of their social assistance systems. This paper reviews recent developments in social assistance (welfare) programs across Canada with a view to evaluating the scope, extent, and province-specific nature of the poverty trap problem.2

A. National and Provincial Developments in Income Support Statistics

2. The share of the Canadian population on social assistance increased from about 5½ percent at the beginning of the 1980s to a peak of 10½ percent in 1994, before declining to just over 9 percent in 1997 (Table 1 and Figure 1). During the recession years of 1981–82 and 1990–92, the share increased without returning to pre-recession levels in the ensuing years of economic expansion. Although many of the provinces exhibited a similar pattern, the growth of welfare populations varied significantly across provinces. The most dramatic increase occurred in Ontario, where beneficiaries as a share of the population tripled from the early 1980s to their peak in 1994. Over roughly the same period, the ratio doubled in British Columbia and Alberta, increased by around 80 percent in Manitoba, Nova Scotia, and Saskatchewan, and rose by about 40 percent from already high levels in Québec and Newfoundland.

Table 1.

Canada: Share of Population on Social Assistance, by Province, 1971-97 1/2/

(In percent of population)

article image
Sources: Human Resources Development Canada; and Fund staff estimates.

Including dependents.

Fiscal year ending in March.

FIGURE 1
FIGURE 1

CANADA: SHARE OF POPULATION ON SOCIAL ASSISTANCE, BY PROVINCE, 1980-97 1/2/

(in percent of population)

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

Sources: Human Resource Development Canada; and Fund staff estimates.1/ Including dependents.2/ Fiscal year ending in March.

3. After rising by about 30 percent during the 1970s, real social assistance outlays per capita across Canada rose by about 45 percent during the 1980s, before skyrocketing another 70 percent from 1990 to 1994 (Table 2 and Figure 2). Beginning in the 1980s, these increases significantly outpaced the growth rate of real per capita personal income, illustrating the sharply growing burden of social assistance spending on the general population (Figure 3). Real benefits per recipient also increased during the 1970s, 1980s, and the first half of the 1990s (Figure 4), rising by about 20 percent during the 1980s and by another 10 percent over the period 1990–94, compared with real per capita personal income growth of about 18 percent and negative 4 percent during these respective periods. Reforms implemented in the past few years at both the federal and provincial levels have brought overall expenditures down by about 20 percent from their 1994 peak. However, the reductions in spending vary considerably across the individual provinces.

Table 2.

Canada: Per Capita Expenditures on Social Assistance, by Province, 1971-97 1/

(In 1997 dollars) 2/

article image
Sources: Human Resources Development Canada; and Fund staff estimates.

Fiscal year ending in March.

Deflated using consumer price index.

FIGURE 2
FIGURE 2

CANADA: REAL PER CAPITA EXPENDITURES ON SOCIAL ASSISTANCE, BY PROVINCE, 1980-97 1/

(in 1997 dollars) 2/

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

Sources: Human Resources Development Canada; and Fund staff estimates.1/ Fiscal year ending in March.2/ Deflated using consumer price index.
FIGURE 3
FIGURE 3

CANADA: REAL PER CAPITA SOCIAL ASSISTANCE BENEFITS AND REAL PER CAPITA PERSONAL INCOME, 1971-97

(Index 1971=100)

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

Sources: Statistics Canada.
FIGURE 4
FIGURE 4

CANADA: REAL SOCIAL ASSISTANCE BENEFITS PER RECIPIENT, 1971-97

(In 1997 dollars per year)

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

Sources: Statscan; and Fund staff estimates.

4. The percentage of long-term welfare recipients also increased during the 1990s. In March 1990, 41 percent of all welfare recipients had been receiving benefits for 25 consecutive months or longer (defined as “long-term” recipients). As the welfare population rose in the recession years of 1990–92, the influx of new recipients initially reduced the share of long-term recipients to 32 percent by March 1992 (Table 3), However, the share of long-term recipients rose steadily through March 1997, when it reached 50 percent.

Table 3.

Canada: Social Assistance Cases by Length of Spell, 1990-97

article image
Source: National Council of Welfare (1998).

Total includes social assistance cases from all provinces and territories, except for New Brunswick, Quebec, and municipal social assistance cases in Nova Scotia and Manitoba, and accounts for between 60 and 66 percent of total national social assistance cases.

5. The real value of social assistance benefits by recipient type rose from the mid-1980s to the early 1990s in Québec, Ontario, and British Columbia, but remained roughly constant, or fell slightly, in the other provinces (Table 4). For single parents and couples with two children, many provinces offered benefits in 1993 that were at or above two-thirds of the average manufacturing wage of full-time workers. Since 1993–94, however, real social assistance benefits have tended to fall across Canada, with relatively steep cuts occurring in Prince Edward Island, Québec, Ontario, Manitoba, and Alberta.

Table 4.

Canada: Provincial and Territorial Social Assistance Benefits

(In constant 1996 dollars, unless otherwise noted)

article image
article image
Sources: National Council of Welfare, (1997b); Clark (1998); and Statistics Canada.

Average income calculated as average hourly earnings of employees paid by the hour for each province or territory multiplied by 2,000 hours, which proxies for the average, full-time hours worked per year

B. Federal and Provincial Roles in Poverty Programs

6. Since adoption of the 1966 Canada Assistance Plan (CAP), the federal government’s role in social assistance has been largely confined to establishing basic national standards and providing transfers to the provinces.3 The specific design, and the associated incentive structure of assistance programs, has been largely the responsibility of the provinces, resulting in a wide variety of rules and regulations. In recent years, the federal government has exerted indirect influence over the structure of these programs through restrictions on federal financing. The systemic decline in real benefits across Canada that has taken place over the past several years was influenced by the restraint in the growth of federal transfers for social assistance exercised in the early 1990s and strengthened under the Canada Health and Social Transfer (CHST).4 More recently, the federal government has been working with the provincial governments to develop a set of shared principles and objectives to underlie social programs in Canada.

7. The National Child Benefit (NCB) is another significant piece of the social safety net in Canada. Launched in July 1998, the NCB is a cooperative initiative by the federal and provincial governments that seeks to mitigate the poverty trap problem by providing payments to all low- and moderate-income families with children regardless of their sources of income. This federal transfer replaces separate systems of child benefits and working income supplements in the various provinces (with the exception of Québec) with an integrated system that does not discriminate against those entering the labor force. Corresponding to this new federal benefit, the provinces have agreed to reduce social assistance payments to families with children by the amount of the NCB and to allocate the freed-up funds to complementary programs that will improve work incentives and benefits for all low-income families with children, rather than just those on social assistance.5

C. Incentive Effects of Income Support Programs

8. Although the trend toward increased welfare participation in Canada likely has multiple causes (including reduced employment opportunities for poorly educated individuals, and a rise in the number of single-parent families), the role of financial disincentives to work, and thus to terminate reliance on social assistance—poverty traps—should not be understated. The poverty traps problem can be decomposed into two elements. The first is the extent to which the system of income support tends to draw people out of the labor force and onto government assistance rolls. The second is the extent to which the system of income support tends to discourage existing recipients from re-entering the labor force. The level of benefits relative to average wages for unskilled workers, the restrictiveness of eligibility rules and their enforcement, and the extent, if any, of social stigma attached to welfare, are among the features of a social assistance program that determine the tendency to attract participants. Once in the system, effective marginal income tax rates, determined in large part by the withdrawal of benefits upon entry into the labor force (but also by payroll taxes and federal and provincial income tax rates), can strongly discourage labor market participation. For example, a social assistance beneficiary moving into the workforce to earn $600 a month in labor income could face an effective marginal income tax rate in excess of 80 percent (tabulation below). Also, time limits on the duration of benefits and education and training opportunities all help to determine the extent to which existing welfare recipients might be discouraged from working. However, if social assistance recipients are allowed to retain some benefits after re-entering the labor force, effective marginal tax rates can be reduced, but low-wage workers that have migrated through social assistance to work may be financially better off than those who have never accepted social assistance benefits (tabulation below). This condition may create a “revolving door” through social assistance. The specific design of social assistance programs can exacerbate or mitigate all of these conditions to varying degrees.

Marginal Income Tax Rates for Social Assistance Recipients, Earning $600 per Month from Employment 1/

article image

The average social assistance benefit for a single parent with one child was $11,000 in 1997.

3.2 percent for income above $3,500 per year.

2.7 percent for all insurable income in 1998. Reduced to 2.55 percent in 1999.

17 percent for income over $6,956.

Varies across provinces from 75 to 100 percent and is applied to net income.

Assumes a single parent with one child receiving benefits of $11,000 per year.

Total excludes provincial tax rates which range from 45 to 69 percent of the personal income tax bill. Surtaxes also apply in a number of provinces.

D. Recent Developments in Provincial Social Assistance Programs

9. Although the approach that has been taken across provinces varies widely, a number of generalizations can be drawn to describe recent provincial social assistance reforms. One feature that has been common across most reforming provinces is to divide social assistance recipients into two distinct groups: employable and unemployable (the disabled and mothers with young children). The rules and regulations governing social assistance benefits differ significantly depending on this classification, and only those rules and regulations governing employable recipients are discussed here. The typical provincial reform package applicable to employable individuals has reduced the generosity of benefits, tightened eligibility requirements, and strengthened training and employment search requirements (Table 5).6 There was also some effort to reduce the high effective marginal income tax rates faced by welfare recipients. Notably absent from the list of reforms is the introduction of time limits on the duration of benefits.

Table 5.

Canada: Recent Welfare Reforms, by Province 1/

article image
article image
article image
article image
Sources: National Council of Welfare (1997a); Boessenkool (1997); and various provincial ministries responsible for social assistance.

Information on reforms in Manitoba was unavailable.

10. Of those provinces that adjusted the level of benefits, all but one (Nova Scotia) reduced benefits. Frequently, cutbacks were greater for single employable individuals than for employable individuals with dependent children. Ontario, Prince Edward Island, and Alberta enacted the largest relative cuts in benefits.

11. In several cases, steps were taken to significantly raise the bar for obtaining social assistance benefits. In Alberta, for example, program administrators adopted more intensive reviews of new and existing cases; required new applicants to attend information sessions before processing applications; required recipients to follow through on their case plans (including plans for finding employment) as a condition of continued eligibility; established waiting periods for non-emergency cases; and, in some districts, routinely denied first applications, except in certain hardship cases, to encourage applicants to pursue other means of support including employment.7 British Columbia ended eligibility altogether for people under 19 years of age, and Ontario extended the waiting period for recently unemployed individuals and placed new restrictions on the eligibility of cohabiting couples. In contrast, Québec eased eligibility somewhat by raising the ceiling on personal liquid assets above which an individual is excluded from receiving social assistance benefits.

12. Provinces generally strengthened training and job-search requirements as a condition of continued receipt of benefits. In many cases, refusal to participate in training and/or education programs intended to improve employment prospects can be grounds for ineligibility. Although in some cases such conditions were formally in place prior to the reform drive, enforcement was generally lax. The Ontario Works Program is a clear example of the trend toward social assistance programs with strict training and work requirements. In British Columbia, the strictest job search and training requirements were established for recipients ages 19–24.

13. The introduction of the National Child Benefit in July 1998 helped to lower the marginal effective tax rate faced by certain very low-income workers, but did not change the effective rate for social assistance recipients. Because the National Child Benefit is separate from social assistance benefits, payments for children are no longer clawed back at low-to-moderate levels of earned income. However, while this lowers the marginal effective tax rates of certain low-income workers whose welfare benefits have been fully substituted by earned income, welfare recipients still face high rates of clawback of non-child benefits (see Appendix). As long as there are significant welfare benefits remaining that are subject to clawbacks, a social assistance recipient continues to face a high marginal effective income tax rate, and thus strong disincentives to work. Such disincentives could be dealt with by reducing the clawback rate, offering an earned income supplement, or by substituting a negative income tax8 for the traditional type of social assistance program. While some provinces have reduced the clawback rates of social assistance benefits and/or increased the earnings exemption, clawback rates remain high (Tables 5 and 6). Alberta enacted the most significant reduction in the clawback rate, reducing it from 90 percent to 75 percent. Saskatchewan introduced an earnings supplement that is designed to ensure that families would be better off working. Ontario and Newfoundland raised the earnings exemption to help offset a reduction in benefit levels.

Table 6.

Canada: Monthly Earnings Exemptions and Clawback Rates for Employable Individuals on Welfare

article image
Sources: National Council of Welfare (1997b); and various provincial ministries responsible for social assistance.

E. Considerations in Structuring Further Reforms

14. Because it is difficult to measure the costs and benefits associated with the different approaches to welfare reform and because the precise goals for social assistance programs likely differ across provinces, no single optimal approach can be identified. The elements of any reform package can be separated into those factors that affect eligibility directly (the “sticks”) and those that affect financial incentives (the “carrots”). The former address the specific criteria that must be met before administrators may certify eligibility. The latter address the relative appeal of social assistance benefits relative to work, which, in turn, influences an individual’s choice between social assistance and work.

15. Restrictions that directly affect eligibility include: asset restrictions; duration restrictions; minimum age restrictions, training/education and/or work-search requirements; and various administrative measures such as waiting periods, fraud detection efforts, and routinely discouraging first-time applicants. A proper assessment of any of these measures requires consideration of the costs and benefits, which are difficult to quantify. In the case of asset restrictions, for example, although it is consistent with the goals of a social safety net to exclude from eligibility individuals with significant tangible and financial assets, such restrictions could also discourage saving by low-income workers and could penalize those with the longest work history. Restricting the duration of social assistance helps ensure that social support does not become an extended lifestyle choice, but it also implies that some of the truly needy could become unprotected. The same is true of age limits that, for example, might prohibit the participation of young people. Education/training and work-search requirements help to advance the goal of returning social assistance recipients to work, but both may also entail steep budgetary costs.

16. Policies affecting financial incentives include the generosity of benefits; benefit clawback rates; the earnings threshold below which benefits are not subject to clawbacks; earned income supplements for former welfare recipients; and the negative income tax approach to social assistance. Although cutting the generosity of social assistance benefits can reduce the financial incentive to seek or to retain benefits, at some point this will also undermine the adequacy and “fairness” of the social safety net. An overly generous system, on the other hand, may draw individuals from the labor force, implying a deadweight economic loss for the economy as a whole, and will be relatively costly in terms of budgetary outlays. Although lowering clawback rates will reduce the disincentive to work by reducing the marginal effective income tax rate, it also implies that social assistance recipients who enter the labor force will be better off than identical workers who have remained off of social assistance. Very low rates of clawback may thus create a “revolving door,” whereby some low-skill workers will enter social assistance in order to achieve the higher-income levels available to them upon returning to work. Low clawbacks may also be deemed “unfair” by low-wage workers who have remained off social assistance. Earned income supplements for welfare recipients who choose to return to work will also reduce the marginal effective tax rate facing social assistance recipients and so improve work incentives. But income supplements are also subject to the “revolving door” and “unfairness” critiques. A negative income tax approach to social assistance ensures that the marginal effective tax rate facing low-wage workers and non-workers is equalized, and thus does not discourage re-entry into the labor force. At the same time, however, this approach may draw workers from the labor force (imposing a deadweight loss on the economy) if the guaranteed income level is relatively high. Because such an income transfer is not targeted to the needy but is available across the board, it generally would be quite costly to adopt. If, on the other hand, the guaranteed level of income support were set very low, which would alleviate the problems mentioned above, it may not fulfill the objectives of a social safety net.

17. One possible reform that would appear not to have any drawbacks in terms of the objectives of a social safety net is to establish rules that reduce benefits and/or set time limits on the duration of benefits for employable social assistance recipients who reject repeated offers of employment. Repeated offers of employment can be taken as a strong indication that if social assistance benefits were to be reduced and eventually eliminated, such individuals would not fall through the social safety net but would return to the workforce. In order for this type of reform to work, however, it would have to be implemented in combination with a strict employment search obligation and adequate monitoring arrangements.

List of References

  • Boessenkool, Kenneth, 1997, “Back to Work: Learning from the Alberta Welfare Experiment,” C.D. Howe Institute Commentary (Toronto), April.

    • Search Google Scholar
    • Export Citation
  • Clark, Christopher, 1998, Canada’s Income Security Programs, Canadian Council on Social Development (Ottawa).

  • National Council of Welfare, 1998, Profiles of Welfare: Myths and Realities (Ottawa).

  • National Council of Welfare, 1997a, Another Look at Welfare Reform (Ottawa).

  • National Council of Welfare, 1997b, Welfare Incomes 1996 (Ottawa).

  • National Council of Welfare, 1996, Welfare Incomes, (Ottawa).

Appendix: The National Child Benefit and Marginal Effective Income Tax Rates

Representative Social Assistance Parameters:

Suppose the monthly benefit for a single employable mother with one child is $400 before the National Child Benefit (NCB).

Let the monthly benefit for a single employable mother with one child be $300 after the NCB.

Assume the monthly NCB = $100

Assume that the clawback rate is 80 percent and is applied to gross income.1

Monthly earnings exemption = $100

Notation:

PT = payroll tax rate

PIT = personal income tax rate

MET = marginal effective income tax rate

uA01app01fig01

Before NCB

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

uA01app01fig02

After NCB

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A006

1

Prepared by Paula De Masi and Michael Leidy.

2

The focus of the paper is on poverty traps generated by social assistance, and therefore employment insurance, disability insurance, old-age income support programs, and social assistance for the disabled are excluded from the discussion.

3

Under the CAP, the federal government finances half of the total value of provincial outlays for social assistance, provided provincial programs meet certain national standards.

4

Beginning in fiscal year 1996/97, the federal government’s contribution to provincial health and social programs (including post-secondary education) was consolidated in a single block transfer, the CHST.

5

See, for example, the summary of provincial benefits for families with children in Clark (1998). Under the NCB, provinces are expected to implement new programs for all low-income families with children including one or more of the following: (i) income support programs; (ii) earned income supplements; (iii) child support supplements; (iv) extension of in-kind benefits now available to social assistance recipients to all low-income families; (v) tax measures; and (vi) other social services, such as child care.

6

Brief summaries of provincial reforms are available in a longer draft of this paper.

7

For a detailed discussion of welfare reform in Alberta, see Boessenkool (1997), and National Council on Welfare (1997a).

8

A negative income tax establishes a guaranteed minimum level of income support available to all working-age individuals. In its purest form, an unconditional income transfer would replace all other types of social assistance support (in-kind or cash). Earned income is then taxed according to statutory tax rates without any withdrawal of the income transfer.

1

Although clawbacks are typically applied to net earned income, this assumption simplifies the exposition and does not affect the conclusion. Applying the clawback rate to net income only increases the thresholds beyond which the marginal tax rate falls to PT + PIT.

Canada: Selected Issues
Author: International Monetary Fund
  • View in gallery

    CANADA: SHARE OF POPULATION ON SOCIAL ASSISTANCE, BY PROVINCE, 1980-97 1/2/

    (in percent of population)

  • View in gallery

    CANADA: REAL PER CAPITA EXPENDITURES ON SOCIAL ASSISTANCE, BY PROVINCE, 1980-97 1/

    (in 1997 dollars) 2/

  • View in gallery

    CANADA: REAL PER CAPITA SOCIAL ASSISTANCE BENEFITS AND REAL PER CAPITA PERSONAL INCOME, 1971-97

    (Index 1971=100)

  • View in gallery

    CANADA: REAL SOCIAL ASSISTANCE BENEFITS PER RECIPIENT, 1971-97

    (In 1997 dollars per year)

  • View in gallery

    Before NCB

  • View in gallery

    After NCB