Federal budget stimulus to provide a lift to the economy

by Craig Alexander, Vice-President & Deputy Chief Economist, TD Bank Financial Group

An engineer and consultant holding a laptop stand outside discussing a quote.

New spending initiatives in the stimulus package include infrastructure and enhanced training and employment insurance benefits.

The January 27, 2009, federal budget unveiled a stimulus package totalling about $40 billion over the next two fiscal years. About three-quarters of the total is earmarked for new spending, with infrastructure and enhanced training and employment insurance benefits stealing a good part of the show. There were also some personal tax relief measures in the budget (see “The budget and your taxes,” below).

From deficit to balanced budget

The budget projects deficits of $30 billion to $34 billion over the next two fiscal years, which the government states should fall to zero by fiscal year 2013-14.

The big push into red ink reflects more than the cost of the stimulus measures. Even before factoring in the new spending, the government had projected deficits of $16 billion and $14 billion over the next two fiscal years, along with smaller deficits in the following years as a result of an increase in economic growth, the end of some one-time government spending measures, and a slower pace of government spending in general in the future.

The government estimates that its stimulus plan — combined with the effect of matching infrastructure investment from other levels of government — will boost real GDP by 1.6% in 2009 and a total of 1.9% by 2010.

At TD Economics, we believe that the government’s assessment of the economic impact of the stimulus is on the high side. We would place the real GDP lift closer to about 1% over the next two years and more weighted to 2010, when much of the infrastructure spending will flow.

Overall, the federal government’s fiscal position will remain relatively healthy. Planned deficits in the order of $30 billion to $34 billion over the next two years represent 2% of GDP, which pales in comparison to the deficits of 4% to 8% of GDP racked up during the recessions of the 1980s and 1990s, and is far less than the estimated 8% of GDP deficit for the United States in 2009.

The market’s reaction

For investors, the budget did not trigger a major reaction from financial markets, even though the stimulus package helps to improve the outlook for economic growth and profits.

On the tax side, personal income taxes were reduced, as was widely anticipated, and corporate tax cuts were unchanged from the government’s prior commitments. There were no changes to the capital gains taxes or dividend taxes.

More of a concern in bond markets could be the government’s financing requirement. The government will need to tap money and bond markets to the tune of $101 billion in this upcoming fiscal year 2009-10.

What this means for bond yields

At TD Economics, we believe that substantial issuance of government debt can be absorbed without a major increase in bond yields over the next year. For one, low-risk government bonds are expected to remain an attractive investment alternative in the year ahead. Second, the increase in government borrowing is likely to continue to be offset by lower private-sector borrowing in the bond market. And last, investors will take some comfort in the fact that the government’s net financing requirement is forecast to fall after next year.

These factors, combined with another reduction in the Bank of Canada rate this spring, should leave government bond yields at historically low levels in the coming months.

For a more comprehensive analysis of the budget, please see “The 2009 Federal Budget,” available at www.td.com/economics under Canada, then under Public Policy & Government Finances, dated January 27, 2009.

The budget and your taxes

Here are a few of the key personal financial measures contained in the January 2009 federal budget:

Personal taxes reduced. The amount you can earn tax-free increases to $10,320 from $10,100 for the 2009 taxation year, after which the amount will be tied to inflation. The upper threshold for federal tax brackets is also increased.
RSP/RIF losses after death. The budget includes a relieving measure to allow the amount of post-death decreases in the market value of registered plans to be carried back to the deceased’s tax return in the year of death and deducted against RSP/RIF income.
RIF withdrawals confirmed. A one-time 25% reduction in RIF minimum withdrawals for the 2008 taxation year was confirmed.
Home renovation tax credit. Owners of home and vacation properties in Canada can benefit from a 15% tax credit on renovations, to a maximum of $1,350. Eligible renovations must be completed before February 1, 2010.