Cablegate: Canada's 2005 Budget: Something for Everyone

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS E F T O SECTION 01 OF 05 OTTAWA 000640

SIPDIS

SENSITIVE

DEPARTMENT FOR EB/IFD, EB/OMA, WHA/EPSC, AND WHA/CAN
STATE PASS FEDERAL RESERVE BANK FOR CHUGH
STATE PASS SEC FOR JACOBS
TREASURY FOR WILBUR MONROE AND DAVID NAGOSKI
PARIS ALSO FOR USOECD

E.O. 12958: N/A
TAGS: EFIN ECON PGOV CA
SUBJECT: CANADA'S 2005 BUDGET: SOMETHING FOR EVERYONE

REF: A. OTTAWA 594 (BUDGET POLITICS)
B. OTTAWA 375 (BUDGET PREVIEW)
C. 04 OTTAWA 2779 (SURPLUS)
D. 04 OTTAWA 2837 (EQUALIZATION)
E. 04 OTTAWA 2560 (HEALTH CARE SUMMIT)
F. 04 OTTAWA 832 (2004 BUDGET)

1. Sensitive but unclassified. Not for Internet or
distribution outside the USG.

2. (U) Introduction and Summary: Canada's Opposition
parties were hard-pressed to complain about the minority
Liberal Party's February 23 budget. Prime Minister Paul
Martin and Finance Minister Ralph Goodale listened to
Canadians, and tabled a smorgasbord that funds Liberal
campaign promises, appeases Conservatives with tax cuts and
increases in defense spending, and provides a nod to the Left
with funding for the environment and social programs (refs A
and B). This budget takes a five-year, rather than the
previous years' two-year, outlook and continues the GOC's
commitment to "balanced budgets or better." The hefty budget
drew criticism from some for its lack of focus, its skimpy
funding for many programs, and for back-loading most spending
and tax cuts until after 2007. It is expected to be approved
by Parliament the week of March 7.

3. (U) With fiscal impact next year (2005-06) of C$7.4
billion (US$6 billion), new initiatives in Canada's eighth
consecutive balanced budget total C$75.7 billion (US$60
billion) through 2010, with relatively little spending in the
first two "skinny" years and most spending in the out years
(2008-10). The Liberal party campaigned on promises to boost
spending on health care (ref E), to revise equalization
payments for the provinces (ref D), and to support cities, a
national childcare program, and senior citizens. This budget
funds those priorities while adopting attractive initiatives
from the Opposition parties. The budget previews the
long-awaited (and long delayed) International Policy
Statement by providing additional money for foreign affairs,
steep increases in defense spending (someday), and continuing
the commitment to increase aid budgets by 8% a year.

4. (U) Although markets were largely unmoved (pre-budget
leaks were, on the whole, accurate), analysts attribute the
Canadian dollar's brief post-budget fainting spell to the
announcement that the 30% foreign content ceiling on
tax-advantaged retirement investments would be abolished.
Details of spending follow in paragraph 8. End introduction
and summary.

Notes:
-- Canada's fiscal year runs from April 1-March 31.
-- Canadian dollar amounts are converted at the exchange rate
of about C$0.80/US$1.
-- The budget documents are available at the Department of
Finance website: www.fin.gc.ca/finsearch/wn e.asp.

Assumptions
-----------

5. (U) Using a consensus of private-sector forecasts, the
budget assumes that Canada's economy will grow 2.9% in 2005
(slightly lower than previous forecasts), at 3.2% in 2006,
and at an average of 2.9% for 2007-2009. Growth slowed
towards the end of 2004, and expectations for economic growth
in 2005 have been revised downward as the impact of Canadian
dollar appreciation is re-assessed. The budget is based on
the assumption that in the near term the GOC will not enjoy
revenue flows that created larger-than-anticipated surpluses
in recent years.

-- Commodity prices will remain strong, providing continuing
support to the Canadian dollar.

Fiscal Projections
------------------

6. (U) Measures proposed since the last budget (ref F) have
a fiscal impact of C$10.9 billion (US$8.7 billion) in 2004-05
and C$7.4 billion (US$6.9 billion) in 2005-06. In addition
to the measures announced on February 23, these figures
include federal commitments made later in 2004 to fund
healthcare (ref E), revise the equalization framework (ref
D), and support those affected by the impact of discovery of
cases of BSE (bovine spongiform encephalopathy) in Canada.
After a surge in spending this fiscal year, the GOC projects
two "skinny" years before spending increases after 2007. Tax
cuts are either phased in gradually (as with elimination of
the tax on jewelry) or take effect starting in 2007 or 2008.
Total net cost of budget initiatives proposed since March
2004:

Fiscal Year C$ billions US$ billion
----------- ----------- -----------
2004-05 10.9 8.7
2005-06 7.4 6.9
2006-07 8.8 7.0
2007-08 11.1 8.9
2008-09 16.3 13.0
2009-10 21.2 17.0
Total net cost 75.7 60.6

7. (U) This budget continues the GOC's decade-long
commitment to debt reduction. The unexpectedly large surplus
in 2004, added to the usual annual C$3 billion set aside for
debt reduction, mean Canada's debt/GDP ratio continues to
decline, reaching 38.6% in 2004-05. The federal debt/GDP
ratio is on target to reach 30.6% by 2009-10 (down from 68.4%
in 1995 and with a goal of reaching 25% in 2015). This budget
maintains the traditional C$3 billion contingency reserve and
an additional cushion for "economic prudence." If not needed
during the year, the contingency reserve is dedicated to
reducing the federal debt. The allocation for economic
prudence increases from C$1 billion (US$800 million) next
year to C$2 billion (US$1.6 billion) in 2006-07 and C$4
billion (US$3.2 billion) in 2009-10, reflecting the increased
uncertainty in longer-term projections.

-- Program expenses: Federal program spending as a share of
GDP is expected to increase 0.6% to 12.2% in 2004-05 due to
one-time commitments to the provinces made last year.
Program expenses in 2005-06 are expected to increase only 2%,
due to the impact of the one-time measures in 2004-05 that
boosted spending by 11.9%. Growth in program expenses in
2006-07 and 2007-08 is expected to be about 5%. In the last
two years of the budget horizon the GOC anticipates growth in
program spending of about 4.5%. Overall, program spending
increases 23% through 2009-10, to C$194.5 billion (US$155.6
billion) from the current C$158.1 billion (126.5 billion).

-- Surplus: This year's surplus is expected to exceed last
year's C$9 billion (US$7 billion) windfall (ref C) but the
GOC projects declining surpluses in the next two years
(2006-07 and 2007-08). Current forecasts show increasing
surpluses after 2008 as economic growth picks up. (Note:
The surplus in 2004 and 2005 has benefited from unexpectedly
strong growth in tax revenue. Corporate tax revenues in 2004
increased 16.6% in 2004 and profits are strong this year.
Revenue from personal taxes grew by 5.8% in 2004. End note.)
The GOC budget addresses that by front-loading some spending
commitments to 2004-05 and postponing others. Over C$11
billion (nearly US$9 billion) committed to the provinces for
healthcare and equalization payments in 2004-05 are pending
Senate passage and royal assent, but are expected to be
booked by the March 31 end of this fiscal year.

-- Expenditure review: Upon taking office in December 2003,
Prime Minister Martin called for expenditure review by all
departments and agencies, with the objective of identifying
C$12 billion in low-priority spending that could be
reallocated (refs C and F). This budget reflects the result,
with C$11 billion (almost US$9 billion) in cost cutting.
Minister Goodale emphasized in his budget speech that
expenditure review will be an ongoing feature of government
operations. Changes include standardizing procurement,
upgrading technology for check processing, reducing the space
and cost of furnishings allocated to federal employees, and
improved property management. About 10% of the savings comes
from actually eliminating programs.

-- Provincial governments: The GOC has agreed to C$41.3
billion (US$33 billion) over 10 years in new health care
funding (ref E) and an increase of C$33.4 billion (US$26.7
billion) over 10 years for a new framework for "equalization"
payments from rich to poor provinces (ref D). The
consolidated provincial-territorial budgets are expected to
return to surplus this year after two years of deficit, with
combined federal, provincial and municipal surpluses of C$17
billion (US$13.6 billion). The provincial-territorial
debt/GDP ratio declines to 22.3% in 2004-05, well below the
federal level. The recent deals with the provinces have
focused attention on the ways in which the federal government
distributes revenues, with Ontario (a net donor province)
calling for more federal money.

Specific Programs: a little for everyone
-----------------------------------------

-- Diplomacy and International Relations

8. (SBU) This budget provides an encouraging preview of the
likely direction of the GOC's long-delayed International
Policy Statement. The Department of Foreign Affairs receives
a significant boost:

o C$42 million (US$33.6 million; "what we hoped for"
according to a policy expert at Foreign Affairs) to increase
the number of diplomats abroad. (Canada severely cut back its
overseas presence in the 1990s due to budget constraints.)

o C$59 million (US$47 million) to boost security at foreign
missions.

o C$500 million (US$400 million) over five years for new a
"Peace and Security Fund" controlled by the Department of
Foreign Affairs. (Comment: Although this money is part of
the foreign assistance envelope, it will be used to fund
foreign policy initiatives such as capacity building for
counter-terrorism and African peacekeeping; police training
(Iraq and Haiti); the Global Partnership with Russia to
dismantle nuclear weapons, and other similar projects. End
comment.)

-- Defense

9. (SBU) The C$12.8 billion (US$10.2 billion) headline
figure in additional spending for defense is the largest in
20 years, although most spending will be after 2008 and much
is for previously-announced projects. Spending increases in
2005-06 (C$500 million/US$400 million) and 2006-07 (C$600
million/US$480 million) are actually smaller than in past
years. By 2009, it is anticipated that the defense budget
will include additional spending of C$5.7 billion (US$4.6
billion) a year. (Note: Officials at Finance explained that
once these spending increases are implemented, the reference
level for future defense spending will be over 20% higher.
End note.) Provisions include:

o C$3 billion (US$2.4 billion) over five years to increase
the number of active duty troops by 5,000 and reservists by
3,000 and C$3.2 billion (US$2.6 billion) for sustaining
operations.

o C$2.8 billion (US$2.2 billion) to fund equipment purchases
such as transport helicopters, aircraft, and support for the
special forces teams and C$3.8 billion (US$3 billion) to fund
the "new defense policy." None of those funds will be
allocated until 2007.

-- Foreign Assistance

10. (U) The foreign assistance envelope increases by C$3.4
billion (US$2.7 billion) over five years, continuing the
commitment to increase foreign aid by 8% a year through 2010
and double aid to Africa from 2003 levels. As with defense,
most of the increased aid spending will come after 2006, with
only C$100 million (US$80 million) of the increase in
FY2005-06. This also signals the start of Canada's new
policy of reducing the number of its recipient countries to
target those that can make best use of assistance. The GOC
says that Canada's generous tsunami response boosted Canada's
ratio of aid to GDP to 0.3% (from 0.25%), and the new money
will allow it to maintain the 0.3% level.

-- Security
11. (U) C$1 billion (US$800 million) over five years is
allocated for security, including:
o C$222 million (US$178 million) for marine security (patrol
vessels in the Great Lakes and port patrols).

o C$433 million (US$346 million) for U.S.-Canada border
security. (Comment: This funding is new, and hasn't yet
been allocated. End comment.)

-- Environment

12. (U) Environmental programs are considered "winners," with
C$5 billion (US$4 billion) in funding, of which C$3 billion
is new, scattered through a range of programs. Canada is a
Kyoto Accord signatory, and is feeling public pressure to
start addressing emissions targets. About half the spending
provides incentives to reduce greenhouse gases, including:

o C$1 billion (US$800 million) for a "Clean Fund" to
stimulate reduction in greenhouse gases.

o C$225 million (US$180 million) over five years to subsidize
energy-efficient retrofitting of homes.

o C$200 million (US$176 million) over five years (and C$920
million over 15 years) to encourage installation of wind
power turbines;

o C$295 million (US$236 million) over five years to
accelerate the write-off of business spending on energy
efficient technology.

o C$85 million (US$68 million) over five years to combat
invasive species in the Great Lakes and

o C$209 million (US$167 million) over five years to improve
the infrastructure in national parks.

-- Taxes and Finance

13. (SBU) Businesses received a cumulative C$4.9 billion
(US$4 billion) in tax breaks, but they are either phased in
very gradually (such as elimination of the tax on jewelry) or
take effect after 2007. One of the most notable is the
reduction in the corporate income tax rate to 19% from 21% by
2010. Capital cost allowance rates will also be better
aligned with the life of the assets. (Note: We are told
that tax cuts will not be a high priority going forward. The
magnitude of corporate tax cuts probably won't change, but
implementation may be advanced. It would be hard to take
further action on corporate taxes without matching efforts on
personal taxes. End note.) Tax provisions include:

o Increasing the basic personal tax exemption to C$10,000
(US$8,000) over five years (from C$6,500 now).

o Increasing the contribution limits for tax-advantaged
retirement accounts to C$22,000 in 2010, from C$18,000 in
2006.

o Increasing tax benefits for those caring for disabled
dependents or adopting a child.

-- Financial sector

14. (U) There was reiteration of federal support
(non-financial) for "an enhanced system of securities
regulation," and the GOC plans to convene a meeting with the
provinces to work on the issue.

-- There was no mention in the budget of a long-awaited
decision on bank mergers.

-- The budget launched a review of financial institutions
legislation, seeking to "refine the current framework to
increase legislative and regulatory efficiency." The review
should result in legislation in 2006.

-- A provision removing the 30% limit on foreign content in
tax-advantaged retirement plans received widespread
attention. Analysts attribute the Canadian dollar's brief
post-budget fainting spell to this measure);

Everybody's paid, but not everybody's happy
-------------------------------------------

15. (SBU) A GOC fiscal expert describes the budget as a
"qualified success." The Liberals handily avoided a
no-confidence vote, but have been criticized for lack of
focus, skimpy funding for many programs, and for back-loading
the spending and the tax cuts. Several analysts commented on
the switch to a five-year horizon, despite Paul Martin's
repeated opposition to long-term budgeting while he was
finance minister. The explanation is straight-forward:
revenues in the coming two "skinny years" are inadequate to
fund campaign promises and an increasing number of
initiatives have a five-year (or longer) implementation
strategy. Finance officials say "we would have been killed"
had the budget only addressed funding for the next two years.
The five-year time frame was praised by private-sector
forecasters (and was recommended by the IMF and others) but,
given that most spending was deferred to the out-years, drew
some cynical response that this government is making promises
it may not be around to fulfill. There has also been
criticism that for a government preaching "fiscal prudence,"
this much spending is only possible due to surpluses
resulting from over-taxing Canadians.

16. (SBU) Some of the strongest opposition came from
officials of the Ontario Liberal Party (not to be confused
with the federal Liberals). Premier Dalton McGuinty is
outspoken about the fact that Ontario provides 40% of federal
government revenues but receives C$23 billion a year less
than it provides due to the "equalization payments" to fund
health care and other provincial services. As the central
government revises the equalization framework to provide more
goodies to Quebec, the Atlantic provinces, the west and
various interest groups (ref D), Ontario, one of the three
"donor" provinces, is starting to demand more attention.

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