Canadian Economic Outlook:5 Storm Clouds on the Horizon

Niels VeldhuisPresident, Fraser Institute

twitter: @nielsveldhuis

Canada has outperformed on economic growth, 2005-2014

Canada USA G-7 Euro area Japan0.0

0.5

1.0

1.5

2.0

Pe

rce

nt

Source: OECD, Economic Outlook (May 2014); Average Private Forecasters (BMO, RBC, CIBC, and TD Economics); Bank of Canada, Monetary Policy Report (October 2014); calculations by authors.

Looking Forward:Economic Growth, 2015-2017

USA Canada G-7 Euro area Japan0.0

0.5

1.0

1.5

2.0

2.5

3.0

Pe

rce

nt

Source: OECD, Economic Outlook (November 2014); Average Private Forecasters (BMO, RBC, CIBC, and TD Economics); Bank of Canada, Monetary Policy Report (April 2015); calculations by authors.

We are unduly burdening the next generation

1

“The biggest challenge facing mature democracies is how to restore the social contract between the generations.” ~ Harvard Professor Naill Ferguson

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

billions

Source: Statistics Canada, CANSIM Table 385-0032.

2004-05$822B

2013-14$1,291B

Federal, Provincial and Local Government Net Debt

Federal-Provincial Government Net Debt, 2014/15

NL PEI NS NB QC ON MB SK AB BC

-20%

0%

20%

40%

60%

80%

100%

Sources: Federal and provincial budgets and updated; Statistics Canada; RBC Economics and TD Economics forecasts; calculations by authors.

Cost of Debt:Federal Interest costs compared to

GST revenue

Debt Servicing Costs Revenue From GST0

5

10

15

20

25

30

35

$29.3 $29.9

Bil

lio

ns

$

Source: Speer et al. (2014).

Cost of Debt:Consolidated government interest costs

compared to other expenditures

Debt Servicing Costs Public K-12 Education Spending

0

10

20

30

40

50

60

70$61.7 $61.0

Bil

lio

ns

$

Source: Speer et al. (2014).

Interest Rate Risks

2000-I

2000-IV

2001-III

2002-II

2003-I

2003-IV

2004-III

2005-II

2006-I

2006-IV

2007-III

2008-II

2009-I

2009-IV

2010-III

2011-II

2012-I

2012-IV

2013-III

2014-II0.0

1.0

2.0

3.0

4.0

5.0

6.0Quarterly Average Rate – 3-Month T-Bill

No

min

al I

nte

rest

Rat

e

Source: Bank of Canada.

Surplus/Deficit as % of GDP,2015/16

NL AB NB ON MB PEI NS QC Federal BC SK-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

-3.3%

-2.5%

-1.4%-1.1%

-0.7% -0.6%

-0.2%

0.0% 0.1% 0.1% 0.1%

Sources: Federal and provincial budgets and updated; Statistics Canada; RBC Economics and TD Economics forecasts; calculations by authors.

How do we tackle the problem?

We’ve been here before….Canada (1965-95), a fiscal time-

bomb in the making

Federal Revenues & Program Spending (1961 – 1993)

19611963

19651967

19691971

19731975

19771979

19811983

19851987

19891991

199310.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

26.0%

Spending Revenues

Per

cen

t o

f G

DP

15.0%

23.5%

Federal Deficit / Surplus(1966 – 1993)

1966

-67

1968

-69

1970

-71

1972

-73

1974

-75

1976

-77

1978

-79

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

-9.0

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

Per

cen

t o

f G

DP

Federal Accumulated Debt(1966 – 1995)

19661968

19701972

19741976

19781980

19821984

19861988

19901992

19940.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Per

cen

t o

f G

DP

18.4%

67.1%

Federal Interest Costs(1961 – 1994)

19611963

19651967

19691971

19731975

19771979

19811983

19851987

19891991

19930.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

Per

cen

t o

f R

even

ues

10.2%

34.6%

Canada in 1995…

“Turn around and check out Canada, which has now become an honorary member of the Third World in the unmanageability of its debt problem…

If dramatic action isn’t taken in next month’s federal budget, it’s not inconceivable that Canada could hit the debt wall....”

~ Wall Street Journal, January 12th, 1995

Federal Budget 1995: A New Direction for Canada

"We are acting on a new vision of the role of government…smaller government ... smarter

government.” ~ Paul Martin Canada’s Finance Minister

“The debt and deficit are not inventions of ideology. They are facts of arithmetic. The last thing Canada needs is another lecture on the

dangers of the deficit. The only thing Canadians want is clear action.”

Federal Revenues & Spending(1990 – 2008)

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

Spending Revenue

Per

cen

t o

f G

DP

23.5%

15.2%

Federal Deficit / Surplus(1983-2008)

1983

-84

1984

-85

1985

-86

1986

-87

1987

-88

1988

-89

1989

-90

1990

-91

1991

-92

1992

-93

1993

-94

1994

-95

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

Per

cen

t o

f G

DP

Federal Accumulated Debt(1990 – 2009)

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Per

cen

t o

f G

DP

67.1%

28.2%

Federal Interest Costs(1990 – 2010)

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

20100.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Per

cen

t o

f R

even

ues

35.2%

12.8%

And the world didn’t end…in fact quite the opposite

Significant Tax Relief : • Personal Income taxes• Corporate Income taxes• Capital Gains Taxes• Sales Taxes• Expansion of RRSP &

TFSA

Positive Economic Results

Canada is ageing and our working age pop. is shrinking

2

“Coming age war will displace the class warfare of the past.”

~ Harvard Professor Naill Ferguson

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

5%

10%

15%

20%

25%

Sources: Statistics Canada, CANSIM Tables 051 -0001 and 052-0005.

Share of Total Population, 65 years old and over

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

50%

55%

60%

65%

70%

Sources: Statistics Canada, CANSIM Tables 051 -0001 and 052-0005.

Share of Total Population, 16 to 64 years old

Unfavourable Demographics for Spending

Health42%

Education21%

Social Services

12%

Environ-ment and Economic Develop-

ment10%

Post-Sec-ondary

Education7%

Justice4%

General Gov't and

Other4%

Source: Public Accounts of Ontario (2014).

Total Current and Future Revenues & Spending

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

30

35

40

45

50

55

Revenues Expenditures

Per

cen

t o

f G

DP

Source: Ragan (2011).

Future economic dynamism is at risk w/ start-ups plummeting

3

“It is the creation of new companies that serves as a natural engine for growth. New ideas, new products and new ways of producing them are often the seeds of new companies.”

~ Bank of Canada Governor Stephen Poloz

Number of New Entrants per 100 Incumbents, Small Size

Firms, 2001-2012

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20122.0

2.5

3.0

3.5

4.0

4.5

Sources: Statistics Canada, CANSIM Tables 527-0002 and 527-0008

5 to 20 employees

Number of New Entrants per 100 Incumbents, Medium Size

Firms, 2001-2012

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20120.0

0.5

1.0

1.5

2.0

2.5

3.0

20 to less than 50 employees

50 to less than 100 employees

Sources: Statistics Canada, CANSIM Tables 527-0002 and 527-0008

Super-charging Entrepreneurship

• Reform capital gains taxes, a key tax for entrepreneurs and the financial backers of entrepreneurs

• Reduce the burden of regulations/red tape

• Remove barriers to entry in regulated industries

• Examine bankruptcy laws

We continue to penalize Canadians with uncompetitive personal income tax rates

4

Taxes on Income and Profits as % of Total Taxation

DenmarkAustralia

New ZealandIcelandCanada

United StatesIreland

SwitzerlandFinland

BelgiumItaly

United KingdomSweden

GermanyOECD - Average

NorwayAustria

SpainLuxembourg

GreeceNetherlands

JapanIsrael

FranceEstonia

SloveniaTurkey

HungaryKorea

Czech RepublicSlovak Republic

0% 10% 20% 30% 40% 50% 60%Source: OECD.

On the need to reduce personal income taxes:

"Lower personal taxes would also provide greater rewards and incentives for middle-and high-income Canadians to work, save and invest."

~ Prime Minister Paul Martin, 2005

"Canada's tax burden on highly skilled workers is too high relative to other countries ... Canada needs lower personal income tax rates to encourage more Canadians to realize their full potential.“

~ Prime Minister Stephen Harper, 2007

Ontario’s and Alberta’s investment climates will drag down Canadian growth

5

Ontario’s Investment Climate

Ontario’s investment climate has taken a substantial hit over the past decade:

• rising energy costs• unstable fiscal outlook• higher taxes• increased regulation• bordering U.S. states have made their

economies more attractive

A Slew of Tax Increases

• Increase in personal income taxes

• Introduction of the HST (major tax increase)

• Ontario Health Premium

• Increased taxes on aviation fuel, alcohol, tobacco products

• Ontario Pension Plan premiums coming

• Cap and Trade System coming

Ontario’s Power Prices

• Power prices up 52% since 2004 (inflation-adjusted)

• 50% increase in electricity prices results in a 28.7% decrease in rate of return to capital in manufacturing

• Highest commercial power rates in Canada

• Solar and wind systems provide just under 4% of Ontario’s power but account for about 20% of cost

Economic PerformanceOntario vs. Rest of Canada,

• Ontario’s economic growth has lagged the national average in every year since 2003;

• Unemployment rate has been above the national average;

• Per person incomes in Ontario, which used to be 20% above the national average, are now lower than the Canada average;

• Over the past decade, Ontario has witnessed the largest and most sustained net out-migration to other provinces on record;

Which Direction for Alberta’s Future?

Alberta Surplus/Deficit

2004/05

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11

2011/12

2012/13

2013/14

2014/15

2015/16 (f)

2016/17 (f)

2017/18 (f)

(8,000)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

8,000

10,000

No

min

al

Do

lla

rs (

In M

illi

on

s)

A Lack of Spending?

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

2015-16

0

10

20

30

40

50

60

Pro

gra

m S

pe

nd

ing

, B

illi

on

s

$2

01

5

$10.3 B

Alberta Debt and Assets

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

2013-14

-40,000

-30,000

-20,000

-10,000

0

10,000

20,000

No

min

al D

oll

ars

(mil

lio

ns)

Source: Finance Canada, Fiscal Reference Tables, 2014.

Spot Crude, $/barrel

0.0

20.0

40.0

60.0

80.0

100.0

120.0

$104.00

$58.10$65.70

$74.00

$/b

bl

Source: IMF Commodity Price Forecasts, March 2015.

5 reasons to worry:

Ontario’s and Alberta’s investment climates

4

1

3

2

5

We continue to penalize Canadians w/ uncompetitive personal income tax rates

Canada is ageing and our working age pop. is shrinking

Future economic dynamism is at risk w/ start-ups plummeting

We are unduly burdening the next generation

The End………Phew!

Email: niels.veldhuis@fraserinstitute.org

Twitter: @nielsveldhuis

Global Risks - China

• Economy continues to slow.• Mounting bad debt in the banking system

and ongoing problems with SOEs.• Reaching limits of model? Indicates need

for large-scale reform.• Political corruption and instability.