Galloping inflation is a major headache for Canadian households, but not for Ottawa’s finances.
The biggest price surge in two decades is set to deliver a revenue bounce worth billions of dollars as the government prepares to deliver a fall fiscal update.
The April budget presented a picture of an economy rebounding briskly, with a burst of moderately higher inflation. In the intervening months, however, that assessment has turned out to be overly optimistic.
Private-sector economists are now paring back their forecasts for the growth in real (or inflation-adjusted) gross domestic product in 2021 even as they boost their estimates for the level of nominal GDP for this year.
A rising standard of living in Canada depends upon gains in real GDP, but it is nominal GDP that drives tax revenues. So, this year’s burst of inflation will push up the amounts that Ottawa collects in personal income taxes, corporate income taxes and sales taxes.
“The bottom line is, [Prime Minister Justin] Trudeau is much richer than he thought,” said Benjamin Tal, CIBC World Markets deputy chief economist.
CIBC forecasts nominal GDP to rise by 12.9 per cent in 2021, much higher than the 9.3-per-cent increase – the average private-sector forecast for nominal GDP – used in the April budget. By contrast, CIBC estimates real GDP will grow 4.8 per cent in 2021, a full percentage point lower than the budget’s prediction of 5.8 per cent.
It’s a similar story at Bank of Nova Scotia, whose latest estimates peg 2021 nominal GDP growth at 12.4 per cent, and real GDP at 4.9 per cent.
Mr. Tal said each percentage-point increase in nominal GDP over the course of a full fiscal year adds about $4-billion to Ottawa’s revenue, meaning that the federal government’s inflation-driven windfall is likely to hit at least $12-billion.
Fiscal updates from the provinces have given some early hints at just how big a windfall awaits Ottawa. Earlier this month, Ontario predicted a big jump in tax revenue for fiscal 2021-22: personal income taxes were projected to be $41.3-billion, up from the March budget forecast of $36.4-billion; corporate tax revenues were projected to be $17-billion, up from $14.4-billion; and sales tax revenues were forecast to be $31-billion, up from $27.6-billion. Over all, Ontario boosted its tax revenue estimates by $14.6-billion. And last week, New Brunswick also boosted its forecasts for personal income, corporate and sales taxes.
Rebekah Young, director of fiscal and provincial economics at Scotiabank, said those same forces are at work in federal finances. “That trend would be there,” she said.
Just ahead of the summer election campaign, the Parliamentary Budget Officer released updated fiscal and economic projections as a baseline for costing parties’ campaign promises. Those projections, like current private-sector forecasts, assumed much higher inflation rates, and nominal GDP, than the federal government’s April budget. As a result, the PBO forecast a $12.1-billion increase in revenue for fiscal 2021-22 from the budget’s projections. (However, unlike some private-sector forecasters, the PBO’s estimates for real GDP were higher than those of the budget.)
The extra fiscal headroom was good news for the federal Liberals, who were able to make expensive campaign promises without having to talk about bigger deficits, said Kevin Page, president and chief executive officer of the Institute of Fiscal Studies and Democracy at the University of Ottawa, and a former parliamentary budget officer.
Although the Liberals provided detailed platform costing during the campaign, they have yet to commit to the timing of implementing that program.
A fall fiscal and economic update in the wake of the Speech from the Throne could serve that purpose. But the Finance Department has yet to say what kind of update might be delivered this fall, or when it would take place.
Mr. Tal said the big question to watch for in a fiscal update is how much the Liberals increase the level of permanent spending.
In any case, the benefits of an inflationary economy will be fleeting, Mr. Tal said, with the fiscal bonanza short lived, as inflation eases next year.
There could be some added cost to providing government services, noted Alexandre Laurin, director of research at the C.D. Howe Institute, as well as pressure to increase public-sector wages.
Ottawa does adjust personal income tax brackets, as well as income thresholds for benefits, for inflation. That policy is designed to keep Canadians from moving into higher tax brackets simply because their wages are rising along with inflation.
But those adjustments are slow-moving, and backward looking. The increase for 2021, calculated last year, is just 1 per cent – far below this year’s actual inflation rate. For 2022, the rate is 2.4 per cent, still lower than the current increases in the Consumer Price Index.
Statistics Canada said earlier last week that the CPI rose by 4.7 per cent in October from the same month a year ago. That was an increase from 4.4 per cent in September, and the biggest jump since February, 2003.
Those increases will eventually show up in indexation. But in the meantime, Mr. Laurin says, Ottawa’s inflation-driven gain is another source of pain for Canadian taxpayers. “It’s a hidden, implicit tax,” he said.
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