By Robert Kavcic

April 16, 2024

The 2024 federal budget lands at a time when the economy is struggling to grow, the Bank of Canada is still leaning on inflation pressures, the loonie is under stress, and the impact of torrid population growth pervades across much of the country. Against that backdrop, the fiscal path is little changed from that laid out in the 2023 Fall Economic Statement, but only after another significant increase in spending fully offsets revenue gains from a resilient economy and further tax increases.

The FY24/25 budget deficit is estimated at $39.8 billion (1.3% of GDP), with the numbers massaged just enough to meet the various ‘fiscal guideposts’. Any path to a balanced budget remains absent. Below the surface, the near-term economic outlook has actually improved relative to the fall baseline, netting $3.9 billion in positive economic and fiscal developments for this fiscal year, mostly from higher income tax receipts. At the same time, Ottawa is layering on an additional $6.9 billion in tax hikes on higher-income earners and corporations, partly offset by a few targeted reductions. But, the combined additional revenue room is vapourized by $11.6 billion in new spending initiatives, leaving the bottom line slightly worse than projected in the fall. All in, net new stimulus announced for FY24/25 totals $5.3 billion, or $36 billion over the five-year forecast horizon.

While the impact of net new stimulus is relatively small (roughly 0.2% of GDP for FY24/25), it’s another step in a long line of tax-and-spend policies that, for the market and credit watchers, is probably getting old.

Consider that program spending for this fiscal year is now running a massive $66 billion above the FY24/25 level set out in Budget 2021. This has not only prevented fiscal consolidation, but the steady flow of net stimulus has only made the Bank of Canada’s inflation battle tougher, and has also been countered by perennial tax increases. This is not a great look when the country is desperate for productivity-enhancing investment.

This budget targets priority areas such as housing, health and infrastructure, Indigenous priorities and defence. The headline tax measure is a long-speculated increase in the capital gains inclusion rate, from 50% to 66.7%, although limited to corporations, trusts, and individuals with gains exceeding $250,000. Some of the other rumoured items are absent, but allocators of capital are probably already asking: what’s next?

Steady Fiscal Outlook

The budget deficit is estimated at $39.8 billion in FY24/25 (1.3% of GDP), little changed from $40 billion in FY23/24. The latter is unchanged from the Fall Economic Statement (FES), as increased spending matches a further in-year economic improvement. While the deficit is now well down from the record $328 billion in FY20/21, shortfalls persist through the forecast horizon as tax increases and stronger-than-expected revenues are fully offset by new spending. Cumulatively, the total deficit between FY23/24 and FY28/29 is now running $10 billion larger than in the FES.

Revenues are projected to rise a solid 6.7% to $457 billion in FY24/25, led by broad gains in tax receipts. Meantime, program spending is projected to jump 6.7% this fiscal year. In the five years pre-COVID, program spending averaged a steady 14.5% of GDP. This year, spending will run at 16.0% of GDP, before fading to 15.5% late in the forecast. That’s a noteworthy increase in government spending as a share of the economy, especially at a time when nominal output has surged on the back of rising prices, and the Bank of Canada has been leaning on inflation pressure. The debt-to-GDP ratio will dip to 41.9% in the coming fiscal year, from 42.1% in FY23/24, before declining gradually to just under 40% by FY28/29.

Reasonable Economic Assumptions

The budget projections are based on the private-sector consensus. This round was put in place just as activity was firming early in the year, and most were revising up their near-term forecasts. That leaves the consensus slightly on the conservative side for 2024 growth, although rate cut expectations have also been scaled back for both the Federal Reserve and Bank of Canada.

The budget is based on real GDP growth of 0.7% this year (we are now at 1.2%), and 1.9% next year (2.0%). While real growth gets the focus, nominal growth has been the big story and the driver of revenues in recent years. Ottawa expects nominal growth to pick up to 3.8% this year after 2.7% growth in 2023 (we’re at 4.2%). So as it stands now, there might be some modest upside to the fiscal outlook from the underlying economy this year if recent momentum holds. The medium-term outlook, however, builds in productivity and population growth assumptions that could prove to be firm given recent trends and changes.

Meantime, interest rates now sit incrementally higher than Ottawa expected along the curve in the FES. The 10-year yield is pegged at 3.3% this year, while the Bank of Canada is presumed to start cutting rates in the coming months. Both of those assumptions are generally consistent with our current view, although we continue to see the magnitude of expected rate cuts get dialled back—that’s consistent with a higher neutral rate and more stubborn U.S. inflation trends. Note that Ottawa assumes 3-month T-bills at 2.7% over the medium term, suggesting that they are still not fully accounting for the likelihood that neutral interest rates are now higher.

Debt Management Strategy

Ottawa’s borrowing requirements will take a step up in FY24/25. Gross bond issuance is expected to rise to $228 billion, up $14 bln from the prior year. After accounting for maturities, that pegs net issuance at $81 billion.

Prior moves in the Debt Management Strategy have extended the term of debt and, after dipping last fiscal year, issuance in the 10- and 30-year sectors will be ramped up again. The 10-year will rise to $60 billion in FY24/25, from $47 billion last fiscal year (ditto for the 5-year), while the 30-year will increase to $16 billion from $14 billion. The 2-year will hold relatively steady (up $2 billion to $88 billion), while the 3-year will be phased out as previously announced. Benchmark sizes will increase for 5s and 10s, while holding steady for 2s and 30s.

Treasury bill issuance is planned to increase by $5 billion to $272 billion, with the temporary introduction of a 1-month bill (starting in May) to support the money market during the transition from BAs. Ottawa will also keep the Green Bond program at $4 billion annually. Overall, issuance isn’t quite as high as expected (due in part to a $16 billion drawdown in cash holdings), with 2s and 30s actually taking a step down from the prior quarter’s pace, while the increase in bill issuance is muted.

Summary and Market Impact

This budget is another swing of the tax-and-spend policy hammer, with billions of dollars’ worth of economic upside and tax increases fully churned over into more program spending. However, the bottom-line fiscal metrics have held their ground, debt services costs remain contained at just under 11% of revenues, and Canada might still look downright responsible compared to the U.S. But, this is another case where an opportunity for fiscal consolidation has been passed over, while another round of tax increases will only leave more questions about future policy moves—and the only thing worse than higher taxes might be uncertainty over taxes.

While issuance was modestly higher, it was below expectations, and the big levers of income tax on the personal and corporate side were left untouched. Accordingly, this budget should be viewed as neutral on balance for bonds and the Canadian dollar, all else equal, and near-term inflation trends and Bank of Canada messaging will likely dominate. Given the exact distribution of the tax hike at the sector level is unclear, it makes it difficult to assess any impact on the TSX. There might even be temporary relief in some sectors (e.g., grocers, oil & gas and telecom) given more targeted tax hikes were absent in this budget. For real estate, the housing measures have already been documented in recent days, and the market impact should be minimal. But the higher capital gains inclusion rate will impact those planning to sell valuable properties with much lower cost bases.

Highlights of Major Measures

Net additional stimulus amounts to $5.3 billion for FY24/25, and measures $36 billion over the five-year forecast horizon. Here are some of the most significant measures or proposals:

Major taxation measures

Increase in the capital gains inclusion rate on annual gains above $250,000 for individuals, and on all gains for corporations and trusts. The inclusion rate will rise from 50% to two-thirds, and apply to gains realized after June 25, 2024. The total impact for FY24/25 will be a hefty $6.9 billion, split between $4.9 billion on corporations and $2 billion on individuals.

While the capital gains threshold for individuals sounds high on the surface, consider that high real estate values will mean that many sellers of investment or cottage properties, with a much lower cost base, will get dinged by the higher inclusion rate. This will similarly be a concern for Baby Boomers passing down property to younger generations. Principal residences will remain exempt.

Lifetime capital gains exemption on the sale of small business will rise modestly and become indexed to inflation. Ottawa will also introduce a lower one-third inclusion rate for entrepreneurs selling all or part of a business, subject to some conditions.

Innovation and productivity incentive will allow full expensing of patents, network equipment, computers and other related assets until January 1, 2027. This will cost $760 million in FY24/25.

Various adjustments to the AMT framework including charitable donations and Employee Ownership Trusts.

Increase in the tax on tobacco and vaping products.

Housing Plan

The updated housing plan builds on past efforts focusing on building more homes. We’ve long argued that tripling the rate of construction is simply not a realistic solution to the affordability problem given the industry is already running at capacity, and builders will continue to respond to market conditions first and foremost. That said, any measures to make supply more responsive are certainly welcome, and this budget does take a few steps on that front. At the same time, caps on nonpermanent residents should carve population growth down to 1% or lower in the years ahead, which will likely have the biggest impact at the end of the day. After all, housing has been hit by massive demand shocks, not a lack of building. Some of the measures:

Allowing 30-year mortgage amortizations for first-time home buyers purchasing new builds. This measure zeroes in on a small subset of the market, so won’t have a big impact on overall conditions. In general though, this is a measure that stokes demand at a time of excess demand, and ultimately does little to improve affordability once prices adjust.

Increase the Home Buyers’ Plan (RRSP) limit from $35,000 to $60,000, and extend the payback period by three years.

Renters’ bills of rights and tenant protection fund. Some details here are curious, such as a national standard lease agreement (which is provincial jurisdiction). At any rate, the deck is stacked against landlords from bringing more quality rental supply to market—think taxes, landlord-tenant board backlogs, non-payment risk and market conditions.

Accelerated CCA on the construction of new purpose-built rentals; and removal of the HST on construction of student rentals.

Increase the annual Canada Mortgage bond limit to $60 billion from $40 billion.

New low-interest loans up to $40,000 to add a secondary suite to existing homes (details in the coming months).

Topping up the Housing Accelerator Fund to incentivize the removal of zoning barriers; and tying transit funding to densification along transit corridors.

Measures such as a standardized low-rise design catalogue to speed up the permitting and approval process.

Making a tool available through the Canada Revenue Agency to verify borrower income for mortgages. This would be a worthwhile attempt to combat mortgage fraud.

Restrict the purchase of existing single-family homes by large, corporate investors. Further details in the 2024 Fall fiscal update.

Other notable measures

In the financial sector, a pending review of the CDIC framework; efforts to reduce banking and NSF fees; amendments to the PCMLTFA and criminal code to combat money laundering and terrorist financing.

The Crypto-Asset Reporting Framework will be adopted in Canada for the exchange of tax information on crypto-related assets.

Funding for the AI sector totalling $2.4 billion over five years.

Begin discussion on driving more domestic investment within Canadian pension funds.

A new Canada Disability Benefit of up to $2,400 per year for lower-income individuals with a disability.

Child Care Expansion Loan Program, with $1 billion of loans to public and non-profit providers to increase capacity.

Extension of full-time student loan grants and interest-free student loans for another year.

Preventing telecom providers from charging switching fees, and making it easier for customers to change plans. That’s along with efforts to create more transparency in pricing for airline tickets and concert fees, and reduce banking fees.

Robert Kavcic is Director and Senior Economist with BMO Capital Markets.