Federal Budget Spending: A Ripple Rather than a Wave

Canada’s latest federal budget may have had more than $31 billion in new spending measures, but the government’s commitments were more restrained than many had expected, said Douglas Porter, BMO’s Chief Economist at a post-budget BMO client event on Friday. “I was bracing for quite an onslaught of new spending, but instead it was really more of a ripple rather than a wave.”

The digital event, “First Look at the Canadian Federal Budget,” featured Porter and John Waters, Vice-President and Director of Tax Consulting Services with BMO Private Wealth, on a panel moderated by Caroline Dabu, Head of Wealth Distribution and Advisory Services with BMO Private Wealth.

Based on the net-new level of spending, which Porter says will cost about $7 billion in the next fiscal year, or 0.3% of the overall share of the economy, it’s clear that Finance Minister Chrystia Freeland recognized that the country is tapped out after two years of pandemic-related relief.

“The finance minister heard the message loud and clear that we were dealing with an economy that’s operating right up to capacity,” said Porter. “We’re also dealing with the highest inflation rate that we've seen in 30 years and we did not really need a big wave of stimulus spending.”

Second-Largest Deficit on Record

What may have been most notable was the government’s deficit projections, which dropped to around $114 billion for the fiscal year that ended in March, from December’s $144 billion projection. It was still the second-largest deficit on record, but that number is expected to continue dropping – to $53 billion in the 2022-2023 fiscal year. The decline is due largely to windfall commodity revenues that offset spending, said Porter.

As welcome as that news may be, Porter said he would have liked to see the government reduce the deficit even further, particularly given how well the economy is doing. On Friday, Statistics Canada announced that the unemployment rate hit 5.3% – its lowest level on record – which means more tax revenues will surely come in over the next fiscal year.

“If I was finance minister,” said Porter, “I would have taken this opportunity to rein in the deficit a little more rapidly. When the sun is shining, government policy should prepare for tougher times and so I would have liked to have seen a little bit more of an intensive attack on the deficit.”

Spending Priorities

When it came to spending priorities, increasing housing affordability topped the government’s list and for good reason. Since 2015, the average home price in the country increased by nearly 50% to $816,720 in March 2022. “If it had not been for the invasion of Ukraine and the deal with the NDP, this budget really would have been all about housing,” noted Porter.

The budget introduced several new measures, most notably a First Home Savings Account, a tax-free account aimed at helping first-time home buyers that allows Canadians to make $8,000 in tax-deductible contributions per year, up to a lifetime maximum of $40,000. Amounts withdrawn to make a qualifying first home purchase from the account are tax-free.

Other incentives included an increase in the Federal first-time home buyer’s tax credit to $1,500 and the introduction of a newrefundable multi-generational home renovation tax credit. The latter would allow families to recover up to $7,500 for those who modify their homes to allow for elderly parents (or disabled adults) to move in and live independently.

Other measures focused on making housing more affordable for Canadians included increased funding for new housing, a two-year ban on foreign or non-resident buyers, as well as a new flipping tax, which would force someone who sold a house within 12 months of buying it to declare any gains as business income (with exceptions for certain life events). “They’re sort of walking a tightrope,” explained Waters. “Trying to perform this balancing act to increase accessibility for one demographic, but also reduce demand from others, such as foreign investors.”

The challenge, both Porter and Waters noted, is that some of these measures are contradictory – and may not do enough to halt rising prices.

“Putting a lot of money into supporting and trying to accelerate new building and supply is very worthy,” Porter explained. “But at the same time, they're also juicing demand with buying incentives. Effectively, measures like that will just support demand and tend to offset anything the government is likely to do on the supply side.”

“Those who are looking for this budget to provide some serious relief in terms of dampening home prices,” he added, “are probably going to be somewhat disappointed.”

Beyond housing, the government also introduced $8 billion in new defence spending, which wasn’t initially in the plans but was an expected response to Russia’s invasion of Ukraine, and a commitment to dental care, which is projected to cost the government $5.3 billion over the next five years.

As is often the case, what’s not in the budget is almost as important as what is, like the fact that average Canadians will not have to pay any more tax on their income or on their capital gains. “The headline would be that there are no changes to the tax brackets or any broad-based rate changes to personal or corporate taxes,” Waters said. “In addition, there was no change to the capital gains inclusion rate, which is a perennial rumour every time we have a budget.”

Rising Interest Rates and Roaring Inflation

Although inflation wasn’t specifically addressed in the budget, Porter did say the rate could increase, in part because he expects wages to go “straight up” thanks to Canada’s tight labour market. While wages are only growing by 3.4% annually today, which is two percentage points below the inflation rate, salaries are about to play catch up, he noted.

The prospect of higher wages, the record low unemployment and still-rising inflation should prompt the Bank of Canada to increase rates more than expected in 2022, Porter said, noting that before the pandemic, the overnight rate was at 1.75%, which will be the minimum they hit this year. “We think they’ll do a little more and then that won’t be the end of the story,” he said.

However, we’re not looking at a return to the 1970s or 1980s, when rates were in the double digits. They won’t hit pre-2008 recession numbers of about 5%, either. “They’ll go a bit above where we were before the pandemic, but then they’ll peak,” he said. “Between calmer fiscal policy, a better supply chain, the speed with which they are raising rates and so-called quantitative tightening – all those things combined will help to calm inflation.”