17 Apr

Canadian Federal Budget 2024: Higher Deficits, Higher Government Spending, And Higher Taxes for the Wealthy

Economics Insights

Posted by: Yen (Frank) Feng

Federal Budget Targets Rich Canadians For New Spending

The budget focuses on helping Millennial and Gen Z voters experiencing rising housing costs and other inflationary pressures. The government has set fiscal anchors, such as keeping the deficit below 1% of GDP starting in 2027.

The Canadian federal government released its 2023 budget over a year ago, promising to conduct a strategic spending review to find $15.4 billion in savings. The savings were supposed to achieve fiscal credibility by offsetting the $43 billion in new government spending. However, nearly a year after its announcement, the spending review found only $9 billion in savings, while the government piles on new spending measures in this year’s budget.

The fiscal path is mostly the same as in the 2023 Fall Economic Statement, but only after revenue gains from a resilient economy and further tax increases triggered even bigger spending initiatives.

Government spending is expected to be $480 billion in the next fiscal year, including $54 billion in payments on the country’s debt. 

Finance Minister Freeland also announced a soak-the-rich tax scheme, levelling higher taxes on capital gains for people who make more than $250,000 selling stock or property other than a person’s primary residence.

Currently, 50% of capital gains profits are taxed, compared to 100% of a person’s employment income. That will remain the case for the first $250,000 of capital gains income, but it will rise to 66.6% on income above that level. So, the proposal is to reduce the tax-exempt amount to one-third for capital gains exceeding $250,000.

The lower exemption would also apply to businesses for all capital gains, not just those over $250,000. The additional capital gains taxes are expected to rake $19.4 billion into the government’s coffers over the next five years, which is no small measure. This will reduce business capital spending, already at rock-bottom lows, rendering the Canadian productivity problem even more egregious. Higher capital gains taxes also disincentivize investment in residential rental real estate. 

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 continues to be absent. 

Bank of Canada Governor Tiff Macklem has said provincial government spending is already making it harder to lower inflation. Running federal deficits — on top of large provincial deficits in Quebec, Ontario and British Columbia — is irresponsible. The government had previously set fiscal anchors, like keeping the deficit below 1% of GDP starting in 2027.

Philip Cross of the National Post writes, ”deficit spending when inflation is above target violates the 1991 accord between the Government of Canada and the Bank of Canada, which “jointly set forth targets for reducing inflation” and requires both parties to collaborate to achieve that goal.”

Cumulatively, the total deficit between FY23/24 and FY28/29 is now running $10 billion larger than in the Fall Economic Statement.

The Housing Plan

The housing measures were pre-announced, and the market impact should be minimal. However, the higher capital gains inclusion rate will impact those planning to sell valuable properties with much lower cost bases. It will change the economics of real estate investment in rental properties, an area that needs to be more generously funded. 

Some Other Housing 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. In general, though, it stokes excess demand and ultimately does little to improve affordability once prices adjust. Also, limits on the size of insured mortgages mitigate its impact in our most expensive cities. Pre-construction sales usually require a 20% downpayment, which limits the use of insured mortgages, which account for only 15% of mortgage originations.

Increase the RRSP Home Buyers’ Plan limit from $35,000 to $60,000 and extend the three-year payback period.

Create a 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.

Accelerated capital cost allowances on the construction of new purpose-built rentals and removal of the HST on the construction of student rentals.

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

Top up the Housing Accelerator Fund to incentivize the removal of zoning barriers and tie transit funding to densification along transit corridors.

Bottom Line

This is a pre-election ‘tax and spend’ budget, which will do little to address the problems it claims to solve. It exacerbates other concerns, including insufficient business capital spending, low productivity growth, and insufficient investment in rental real estate. 

Slowing the growth in nonpermanent immigration will, in time, do more to address the housing shortage than any of these measures. 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

15 Apr

Housing Data In March Provides Hints Of Coming Strength In Spring

Housing Update

Posted by: Yen (Frank) Feng

Recent Signs Show Housing Activity Will Strengthen Meaningfully In April

The Canadian Real Estate Association (CREA) announced today that national home sales for March were roughly flat, while new listings fell and prices stagnated. CREA analysts are confident that recent activity will harken stronger housing markets for the rest of this year. 

There is significant pent-up demand for housing owing to rapid population growth and first-time homebuyers’ fears that prices will rise sharply once the Bank of Canada cuts interest rates. Moreover, Ottawa has been handing out goodies for first-time buyers–leaking what’s to come in the April 16 federal budget. The Finance Minister has already announced the resumption of 30-year amortization on insured mortgages for first-time buyers of new construction. While this is less than meets the eye, in that pre-sales typically require a 20% deposit, the homebuilders’ association is pretty excited.

In addition, Ottawa has eased restrictions on the RRSP Home Buyers’ Plan, allowing F-T buyers to withdraw $60,000–up from $ 35,000 (never mind that the $35K ceiling is hardly ever broached)–with 5 years until repayments must begin, up from two years.

Ottawa is also providing assistance to at-risk homeowners, telling lenders to work with these households to lower payments “to a number they can afford, for as long as they need to” by allowing longer remaining amortizations. The Department of Finance is encouraging lenders to begin working with these at-risk households two years before scheduled renewals. The unintended consequences of this could be significant. For example, what happens to the mortgage-backed securities market and other investors in mortgages? Also, this reduces competition by discouraging refinancing and could raise the cost of borrowing for all participants. 

Ottawa has never been very good at considering the second-order effects of their actions. A case in point is the decision to markedly increase immigration (for lots of good reasons) without considering where all of these new people would live. This has led to a massive housing shortage and the least affordable housing in Canadian history. Now that Trudeau’s approval ratings have suffered, they are scrambling to remediate, but increasing demand for housing is obviously not the answer. 

There will be more news on Tuesday when I dissect the federal budget’s housing initiatives. The more government money spent, the more money borrowed, which will only raise interest rates from what they will otherwise be. 

Back to the March data, national home sales edged up a mere 0.5% month-over-month, although activity rose 1.7%. That was a much smaller gain than those recorded in the previous two months, although a part of that does reflect a mostly inactive market during the Easter long weekend.

New Listings 

The number of newly listed homes declined by 1.6% month-over-month in March. “While the official March monthly numbers were quite flat, anecdotal evidence from late last month and early April suggests activity is ramping up,” said Larry Cerqua, Chair of CREA.

With sales edging up and new listings falling in March, the national sales-to-new listings ratio tightened to 57.4%. The long-term average is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

At the end of March, there were 3.8 months of inventory nationwide, unchanged from the end of February. The long-term average is about five months of inventory. 

New listings rose sharply in late March and early April–good news on all fronts.

The actual national average home price in March was up 2% year-over-year from a markedly depressed level. The MLS Home Price Index was roughly unchanged, down markedly from its early 2022 peak when the central bank’s overnight policy rate was a mere 25 basis points before they started hiking rates in March, two years ago.

Bottom Line

With pent-up demand for housing rising with every rent increase, the spring housing season is likely to be robust, even before the central bank cuts interest rates. We believe the BoC will begin reducing the policy rate in June or July, depending on the next two CPI reports. March inflation data will be released on Tuesday (a big day for economic news), and April data will come out on May 21st. The next Bank of Canada decision date is June 5th. 

 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

8 Apr

Canadian Job Market Whimpers in March While US Roars

Labour Force Report

Posted by: Yen (Frank) Feng

March’s Weak Jobs Report Sets The Stage For A June Rate Cut

Today’s StatsCanada Labour Force Survey for March is much weaker than expected. Employment fell by 2,200, and the employment rate declined for the sixth consecutive month to 61.4%. 

Total hours worked in March were virtually unchanged but up 0.7% compared with 12 months earlier.

The details were similar to the headline: as full-time jobs dipped, total hours worked fell 0.3%, and only two provinces managed job growth. Among the type of worker, a 29k drop in self-employment was the primary source of weakness, while private sector jobs managed a decent 15k gain. The issue for the Bank of Canada is that wage gains are not softening even with a rising jobless rate. Average hourly wages actually nudged up to a 5.1% y/y pace, now more than two percentage points above headline inflation. With productivity barely moving, these 5% gains will feed into costs and threaten to keep inflation sticky.

The unemployment rate in Canada jumped to 6.1% in March of 2024 from 5.8% in the earlier month, the highest since October of 2021, and sharply above market expectations of 5.9%. The result aligned with the Bank of Canada’s rhetoric that higher interest rates have a more significant impact on the Canadian labour market, strengthening the argument for doves in the BoC’s Governing Council that a rate cut may be due by the second quarter. The unemployed population jumped by 60,000 to 1.260 million, with 65% searching for jobs for over one month. Unemployment rose to an over-seven-year high for the youth (12.6% vs 11.6% in February) and grew at a softer pace for the core-aged population (5.2% vs 5%).In March, fewer people were employed in accommodation and food services (-27,000; -2.4%), wholesale and retail trade (-23,000; -0.8%), and professional, scientific, and technical services (-20,000; -1.0%). Employment increased in four industries, led by health care and social assistance (+40,000; +1.5%).

Average hourly wages among employees rose 5.1% (+$1.69 to $34.81) year over year in March, following growth of 5.0% in February (not seasonally adjusted). This is still too high for the Bank of Canada’s comfort.

Bottom Line

The central bank meets again next Wednesday, and a rate cut is unlikely. Rate cuts are expected to begin at the following meeting in June. The Canadian economy, though resilient, will suffer from rising mortgage costs as many mortgages come under renewal over the next two years. Delinquency rates have already risen. Moreover, the planned reduction in temporary residents will also slow economic activity.

With the US jobs market still booming, it is likely the BoC will begin cutting rates before the Fed.

 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres