Federal budget 2023: Ottawa loosens fiscal restraints with new spending

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Slower economic growth and higher public spending are straining Ottawa’s bottom line, as the Liberal government’s 2023 budget announced billions in new spending on clean technology and an expanded national dental care program.

Finance Minister Chrystia Freeland said her economic plan will position Canada to take advantage of a moment in which the United States and other democratic allies are seeking to green their economies, while reducing their supply-chain dependence on China and Russia.

The government abandoned its timeline to balance the books within five years. The fiscal year that begins April 1 is projected to show a $40.1-billion deficit, compared with a $30.6-billion forecast in the fall update. The government expects the deficit to shrink to $14-billion by 2027-28. It had previously forecast a small surplus for that year.

After two years of rapid growth as pandemic restrictions loosened, the Canadian economy is expected to stall this year under the weight of higher interest rates. Recent turmoil in the U.S. and European banking sectors has increased the odds of a more severe downturn.

This worsening economic outlook combined with new spending means Ottawa is straying from its “fiscal anchor.” Federal government debt compared with the size of the economy is expected to rise in the coming fiscal year, before returning to a downward trend. Ms. Freeland has frequently said that a downward trend in the debt-to-GDP ratio is the government’s key measure of fiscal responsibility.

The budget projects this ratio will rise to 43.5 per cent in the coming fiscal year, up from 42.4 per cent in the current fiscal year. It is then projected to drop in the following years, reaching 39.9 per cent in the 2027-28 fiscal year. A downside scenario, contained in the budget, shows debt-to-GDP rising over the next two years.

The budget followed through on the main themes Ms. Freeland had promised over the past few weeks. The document details the new health care transfers announced in February, various affordability measures aimed at lower-income Canadians – including an extension of the temporary increase in GST credit payments – and an effort to show fiscal discipline through a 3-per-cent reduction in eligible spending by federal departments.

The budget also reveals that the minority Liberal government’s promised expansion of a national dental care program – a key concession in its supply and confidence arrangement with the NDP – will now cost $13-billion over five years. Only about $6-billion had previously been budgeted.

NDP Leader Jagmeet Singh praised the fact that the budget includes spending on NDP priorities such as the GST credit and dental care. Conservative Leader Pierre Poilievre said the budget shows Canada is being run by “an NDP government” and predicted the higher spending will ultimately hurt those it aims to help.

“Low-income working class people will suffer the most as a result of this costly inflationary Liberal deficit,” Mr. Poilievre said.

Ms. Freeland’s budget contains nearly $21-billion in spending on various tax credits and programs for green projects.

The billions for renewable energy form part of a $67.3-billion package of total new spending over five years, which is partly offset by $21.5-billion in internal savings and tax hikes aimed at higher-income Canadians and banks.

The clean energy incentives are aimed at responding to the U.S. Inflation Reduction Act, which was approved last year and is estimated to be worth hundreds of billions of dollars over the next 10 years.

To that end, the budget announces a new investment tax credit for clean energy manufacturing that is worth $4.5-billion over five years and follows through on plans for a similar credit for clean hydrogen production, worth $5.6-billion.

Calling it “the most significant economic transformation since the Industrial Revolution,” Ms. Freeland said in her budget speech that Canada must react to the fact that the United States and other allies are investing heavily to build clean economies and the net-zero industries of tomorrow. She also pointed to the fact that Canada’s allies are moving quickly to “friendshore” their critical supply chains through democracies.

“Together, these two great shifts represent the most significant opportunity for Canadian workers in the lifetime of anyone here today,” she said.

The government is also planning to save $7.1-billion over five years through reduced spending on outsourcing and travel.

Of the $21.5-billion in internal savings or tax hikes over five years, more than half comes from tax increases. This includes a plan to raise nearly $3-billion through changes to the Alternative Minimum Tax, which is a second way of calculating tax obligations to ensure a high-wealth individual can’t make excessive use of tax deductions.

Weakening growth poses a challenge for the government as it tries to manage the country’s debt burden after spending heavily on COVID-19 programs – a task made more urgent by the rise in interest rates which has increased the government’s cost of servicing its debts.

Federal debt exploded during the pandemic, rising from $721-billion in the 2019-20 fiscal year to $1.13-trillion last year. At its peak in fiscal 2020-21, the debt-to-GDP ratio hit 47.5 per cent, up from 31.2 per cent before the pandemic.

Although the cost of servicing that debt remains low by historical standards, the rapid rise in interest rates over the past year puts additional pressure on federal finances.

The government expects to spend $43.9-billion servicing its debt in fiscal 2023-24, which is $11-billion higher than it forecast in last year’s budget. Annual debt-servicing costs are expected to rise to $50-billion by fiscal 2027-28.

The percentage of government revenues going to debt-interest payments is expected to rise to around 9 per cent in the coming years. That’s up from a low of 5.7 per cent in fiscal 2021-2022, but well below the crisis levels reached in the 1990s. At a peak in 1995, the government was spending 35 cents for every dollar it collected servicing debts.

Some economists questioned the government’s new bottom-line projections, warning that annual deficits could come in higher if the economy underperforms or the internal savings and increased revenue from tax hikes fail to materialize as expected.

“My overall assessment is that the deficit is going to be higher than what they are showing,” said Mostafa Askari, chief economist with the University of Ottawa’s Institute of Fiscal Studies and Democracy.

Scotiabank economist Rebekah Young also questioned whether the savings and new tax revenue will materialize.

“It’s the first budget in a long time that is really making a concerted effort on the growth front, but at the same time, it’s reverting back to its past practices of spending a lot more in other areas,” she said. “It’s hard to argue that this is a budget of fiscal restraint in any sense.”

Robert Asselin, senior vice-president of the Business Council of Canada and a former economic adviser to the Trudeau government, said the savings referenced in the budget are not as thorough as the expenditure reviews of previous Conservative and Liberal governments.

“It’s obvious that after COVID, there’s less travel in government in general. It’s obvious that because they were at historically high spending on consultants, spending will come down a bit,” he said. “So those for me are not like spending reviews. They’re more like natural lapses in the fiscal framework.”

Canadian Labour Congress president Bea Bruske questioned how the government will find internal savings in federal departments at a time when public sector unions are at the negotiating table seeking pay raises to reflect higher costs of living.

Ms. Bruske also said she was pleased to see the dental care expansion and the extension of the boost to the GST credit, but was disappointed that the budget did not announce new funding for pharmacare and did not move ahead with promised improvements to employment insurance.