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Economic Action Plan: Employment and Output Impacts

Introduction

This annex provides an assessment of the impact on output (real GDP) and employment of the Government’s Economic Action Plan. The estimates presented in this annex suggest that the measures in this budget will boost real GDP by 1.4 per cent by the end of 2010, which translates into about 140,000 jobs created or maintained. Including funds leveraged from other orders of government, the impact on real GDP is estimated to be 1.9 per cent by the end of 2010, translating into almost 190,000 jobs created or maintained.

The measures introduced in this budget represent the second of a two-step process that began with the October 2007 Economic Statement. Measures announced at that time continue to provide incremental stimulus to the economy as consumers and businesses adjust consumption and investment to lower tax rates. These measures are expected to boost the level of real GDP by an additional 0.6 per cent by the end of 2010 from the beginning of 2008, with about 80,000 additional jobs created or maintained.

Consequently, the Economic Action Plan in this budget and the ongoing benefits of tax reductions announced in the 2007 Economic Statement will have provided a boost to real GDP of 2.5 per cent by the end of 2010, with 265,000 additional jobs maintained or created.

The permanent tax reductions announced in this budget, as well as those announced in the 2007 Economic Statement, will continue to have positive economic impacts beyond 2010. These measures will ultimately lead to permanently higher labour market participation and productive capacity.

There is considerable uncertainty surrounding any assessment of fiscal stimulus. The main source of uncertainty is the so-called "multiplier effect"—the relationship between amounts injected in the economy on the one hand and the change in real GDP and employment, on the other hand. To gauge the sensitivity of the estimates in this annex, the Department of Finance asked the Conference Board of Canada and the University of Toronto’s Policy and Economic Analysis Program to calculate multipliers comparable to those used in this analysis. Generally speaking, the multipliers of these two private-sector organizations were similar to, or higher than, those presented in this annex.

Further, the estimates presented here do not account for all policy actions taken by the Government. In particular, the measures to improve access to credit and strengthen the financial system announced in the 2008 Economic and Fiscal Statement and this budget will have significant positive effects on the Canadian economy. However, these effects are difficult to estimate and as such are not taken into account. In addition, these estimates also exclude the impacts of fiscal stimulus implemented internationally, particularly the proposed U.S. stimulus plan, which would support the demand for Canada’s exports.

As a result, the impact estimates in this annex are based on prudent assumptions; the actual economic impact of the Economic Action Plan is likely to exceed the estimates shown here.

This annex describes the channels through which fiscal stimulus translates into higher output and employment, explains how these channels have been modelled, and sets out estimates of the impacts on real GDP and employment.

How Does Fiscal Stimulus
Boost Economic Activity?

There are two primary channels through which fiscal stimulus can affect output and employment. First, governments can invest in infrastructure or purchase goods and services, which translates into an immediate, dollar-for-dollar increase in final domestic expenditure. Second, governments can induce spending increases by households and businesses through tax measures or transfers. However, the extent to which these measures boost higher domestic expenditure and production will be determined by changes in saving and imports.

For example, while a reduction in personal income taxes results in a dollar-for-dollar increase in household disposable income, it does not necessarily translate immediately into higher spending. Households may choose to save some of this additional income, particularly in the short run.1 Higher saving does not lead to higher expenditures in the short run, but in the long run it leads to higher investment and capital accumulation and therefore to a higher sustainable level of output.

For any given increase in expenditure, the impact on domestic production will depend on the proportion of goods and services that will be imported, as some proportion of spending and investment by households, businesses or governments "leaks" out of the Canadian economy to foreign producers. For example, approximately one-half of all consumer durable goods are imported, compared to about one-quarter for nondurable consumer goods (such as food and energy).

For these reasons, the impact on domestic output and employment tends to be smaller in the short run. Over time, however, new spending stimulates employment growth, which in turns yields a further boost to real GDP.

Estimating the Economic Impacts

To estimate the economic impacts of the plan, the measures were allocated into the following seven categories, which correspond with those used in the Department of Finance’s Canadian Economic and Fiscal Model (CEFM): infrastructure investment, housing investment, other spending measures, measures for low-income households, employment insurance premiums, personal income tax measures and corporate income tax measures.

Each of these categories has a different multiplier. Multipliers are summary measures that take into account the channels from fiscal stimulus to short-term economic activity, including first-round, indirect or induced impacts, and leakages to saving and imports. For example, a multiplier of 1 means that one dollar in budgetary expenditure generates one dollar in real output in the short-term. A multiplier of 0.1 means that one dollar in expenditure generates only 10 cents in real output in the short-term.

As shown in Table A1.1 below, the short-term multipliers for infrastructure spending, residential investment and transfers to low-income households are relatively high, reflecting smaller leakages to savings or imports.2 In contrast, a reduction in personal income taxes has a considerably lower multiplier in the short run (meaning it has a relatively low short-term impact on real GDP), reflecting leakages of income gains to savings and spending on imported goods. However, in the case of permanent tax reductions, tax multipliers increase gradually as households and businesses adjust spending patterns and behaviour to lower taxes and higher permanent income.

Table A1.1
Expenditure and Tax Multipliers
  2009 2010 2010Q4
(dollar impact on the level of real GDP of a permanent one dollar increase in fiscal measures)
Infrastructure investment 1.0 1.5 1.6
Housing investment measures 1.0 1.4 1.5
Other spending measures 0.8 1.3 1.4
Measures for low-income households 0.8 1.5 1.7
Employment Insurance premiums 0.2 0.5 0.6
Personal income tax measures 0.4 0.9 1.0
Corporate income tax measures1 0.1 0.2 0.3
1 Corporate income tax measures have limited impact on aggregate demand over the periods displayed in the table but have among the highest multiplier effects in the long run. This is because they increase the incentive to invest and accumulate capital, which leads to a higher permanent capacity to produce goods and services.

This analysis also assumes that a 1-per-cent increase in real GDP translates into an immediate 0.2-per-cent increase in employment, rising to about 0.6 per cent after eight quarters. This ratio is consistent with the historical relationship between growth in employment and real GDP in Canada. However, as set out below, the estimated impacts on employment used in this analysis are more conservative than those used in analyses of the proposed U.S. stimulus package.

Allocating the Fiscal Stimulus

Table A1.2 divides the fiscal stimulus measures into the above categories for each of the four principle elements of the plan—Action to Help Canadians and Stimulate Spending, Action to Stimulate Housing Construction, Immediate Action to Build Infrastructure, and Action to Support Businesses and Communities.

Table A1.2
Economic Action Plan
  2009 2010 Total
  (millions of dollars—cash basis)
Action to Help Canadians Stimulate Spending      
  Measures for low-income households 2,030 2,110 4,140
  Other spending measures—training 648 686 1,334
  Other spending measures—others 175 228 402
  Employment Insurance premiums 818 1,631 2,449
  Personal income tax measures 2,210 2,290 4,500
 
Total federal stimulus 5,880 6,945 12,825
Action to Stimulate Housing Construction      
  Housing investment measures 4,365 1,395 5,760
  Infrastructure investment—municipal 1,000 1,000 2,000
 
Total federal stimulus 5,365 2,395 7,760
Housing leverage 725 750 1,475
Immediate Action to Build Infrastructure      
  Infrastructure—provinces and municipalities 3,195 3,195 6,390
  Infrastructure—First Nations 260 255 515
  Infrastructure—knowledge and information 1,786 1,351 3,137
  Infrastructure—federal 983 804 1,787
 
Total federal stimulus 6,224 5,605 11,829
Infrastructure leverage 4,532 4,365 8,897
Action to Support Businesses and Communities      
  Infrastructure investment 30 30 60
  Other spending measures—sectoral 4,342 1,431 5,773
  Other spending measures—training 7 13 20
  Other spending measures—research 100 100 200
  Other spending measures—others 262 180 442
  Personal income tax measures 70 -15 55
  Corporate income tax measures 461 516 977
 
Total federal stimulus 5,272 2,255 7,527
Sectoral leverage 1,300 1,300
Total federal stimulus 22,742 17,200 39,942
Total stimulus (with leverage) 29,298 22,316 51,613
As a share of GDP (%)      
Total federal stimulus 1.5 1.1 2.5
Total stimulus (with leverage) 1.9 1.4 3.2

Economic Impacts

Based on the above estimated multipliers, the Economic Action Plan is expected to boost real GDP growth by 1.2 per cent in 2009 and by 0.1 per cent in 2010 (Table A1.3). Including the funds leveraged through the participation of other orders of government, the positive impact on real GDP growth is expected to be 1.6 per cent in 2009 and 0.2 per cent in 2010. By the end of 2010, the level of real GDP is almost two per cent higher than would be the case without the Economic Action Plan. This is expected to translate into an increase in employment growth of 0.5 per cent in 2009 and 0.4 per cent in 2010, which means an additional 189,000 jobs created or maintained by the end of 2010 than would be the case without the Economic Action Plan.

Table A1.3
Impact on Real GDP and Employment of the Economic Action Plan
  Real GDP Employment
 

  Percentage point change in growth rates Per cent change of level Percentage point change in growth rates Per cent change of level Net new jobs(,000)
  2009 2010 2010Q4 2009 2010 2010Q4 2010Q4
Federal stimulus 1.2 0.1 1.4 0.4 0.3 0.8 142
Provincial/municipal leverage 0.4 0.1 0.5 0.1 0.1 0.3 47
Total stimulus plan 1.6 0.2 1.9 0.5 0.4 1.1 189

2007 Economic Statement

This budget is the second of a two-step process that began with the October 2007 Economic Statement. On October 30, 2007 just before the United States entered a recession and one year before the G20 agreement, the Government of Canada put into place historic tax cuts to boost economic growth. As stated in the introduction to the 2007 Statement, "Given this global economic uncertainty, now is the time to act. Our strong fiscal position provides Canada with an opportunity that few other countries have—to make broad-based tax reductions that will strengthen our economy, stimulate investment and create more and better jobs."

With the 2007 Economic Statement, the Government provided significant, ongoing, incremental tax relief to Canadians starting in 2008 (Table A1.4). These measures included the reduction in the GST rate—from 6 to 5 per cent—and the reductions in general corporate income tax rates as well as personal income tax relief (see Table A1.6 for more detail on specific measures).

Table A1.4
Incremental Tax Relief Relative to 2007 from Measures Announced in the 2007 Economic Statement
  2008–091 2009–10 2010–11
  (millions of dollars—cash basis)
Goods and Services Tax rate reduction 5,895 5,820 6,165
Personal income tax reductions 4,795 1,200 1,230
Corporate income tax reductions 1,320 1,355 1,345
Total tax relief 12,010 8,375 8,740
As a share of GDP (%) 0.7 0.5 0.5
1 Includes measures that come into effect in 2008 and personal income tax relief effective for 2007 that was realized by taxpayers as a result of filing their 2007 returns in 2008. Includes incremental tax relief only.

Similar to fiscal actions taken in this budget, these recent permanent tax reductions will continue to benefit the Canadian economy in 2009 and 2010 as consumers and businesses adjust to the lower level of taxation and second-round effects take place. The approach and model described above have been used to assess the impact these tax cuts had on the economy in 2008 and will have in 2009 and 2010. The results suggest that these tax reductions will continue to have a material impact on the economy this year and next. By the end of 2010, real GDP is estimated to be 0.6 per cent higher and employment 0.4 per cent (equivalent to 77,000 jobs) higher than it would otherwise have been (Table A1.5).

Table A1.5
Estimated Economic Impacts of Tax Relief Measures Announced in the 2007 Economic Statement and the Economic Action Plan
Percentage point
change in
growth rates
Per cent
change of level
Net new
jobs (,000)
   
  2008 2009 2010 2010Q4 2010Q4
  (percentage points, except where otherwise indicated)
Economic Action Plan (including leverage)
  Real GDP 1.6 0.2 1.9
  Employment 0.5 0.4 1.1 189
2007 Economic Statement          
  Real GDP 0.3 0.2 0.1 0.6
  Employment 0.1 0.2 0.1 0.4 77
Total stimulus          
  Real GDP 0.3 1.8 0.3 2.5
  Employment 0.1 0.7 0.5 1.5 266

Therefore, the Economic Action Plan in this budget, together with the ongoing benefits of the tax reductions announced in the 2007 Economic Statement, is estimated to boost real GDP by 2.5 per cent and create or maintain about 265,000 jobs by the end of 2010 (Chart A1.1).

Chart A1.1 - Impact of Economic Action Plan and 2007 Economic Statement Tax Reductions on Real GDP and Employment Levels in 2010Q4

Of note, these impacts do not include a number of other important tax reduction measures that took effect in 2008 or will take effect in 2009 and 2010 but which were announced outside of the 2007 Economic Statement. These measures, with detail on the measures announced in the 2007 Economic Statement, are summarized in Table A1.6 below.

The permanent tax reductions in this budget, as well as those previously implemented by the Government, will have positive economic impacts beyond 2010. These measures improve incentives to work, save and invest, and will ultimately lead to permanently higher productive capacity.3

Table A1.6
Major Incremental Tax Relief for Canadians, 2008–10
Individuals and Families
Taking effect in: Budget 2006 and 2006 Tax Fairness Plan, Budget 2007 2007 Economic Statement Budget 2008 and 2008 Economic and Fiscal Statement
2008
  • Introduction of the Working Income Tax Benefit1
  • Reduction of the GST rate from 6 to 5 per cent
  • Introduction of the Child Tax Credit1
  • Reduction of the lowest personal income tax rate from 15.5 to 15 per cent1
 
  • Introduction of pension income splitting1
  • Increase in the basic personal amount to $9,600 for 2007 and 20081
 
2009  
  • Increase in the basic personal amount to $10,100
  • Introduction of the Tax-Free Savings Account
     
  • Temporary reduction in RRIF minimum withdrawals
Businesses
Taking effect in: Budget 2006 and 2006 Tax Fairness Plan, Budget 2007 2007 Economic Statement Budget 2008 and 2008 Economic and Fiscal Statement
2008
  • Reduction of the general corporate income tax rate from 21 per cent to 20.5 per cent
  • Accelerate the reduction of the general corporate income tax rate to 19.5 per cent
  • Reduction of the small business tax rate from 12 per cent to 11.5 per cent
  • Accelerate the reduction of the small business tax rate to 11 per cent
 
  • Elimination of the corporate surtax
   
 
  • Temporary accelerated CCA incentive for machinery and equipment investment by manufacturing or processing firms
   
2009
  • Reduction of the general corporate income tax rate to 20 per cent
  • Accelerate the reduction of the general corporate income tax rate to 19 per cent
  • Extension of the temporary accelerated CCA incentive for machinery and equipment investment
 
  • Reduction of the small business tax rate to11 per cent
   
2010
  • Reduction of the general corporate income tax rate to 19 cent
  • Reduction of the general corporate income tax rate to 18 per cent
  • Extension of the temporary accelerated CCA incentive for machinery and equipment investment
1 While these measures were effective for the 2007 tax year, they were not reflected in changes in withholding   tables or instalment payments during 2007. Thus, individuals did not benefit from tax reductions accruing in   2007 until they filed returns in early 2008.

Comparison with Proposed
U.S. Fiscal Stimulus Plan

The U.S. Council of Economic Advisors has estimated that the proposed U.S. fiscal stimulus plan (assumed to be US$775 billion) would increase the level of real GDP by 3.7 per cent and employment by 2.6 per cent, or 3.7 million jobs, by the end of 2010. These estimated impacts are similar to those published by Macroeconomic Advisors, a leading U.S. forecast firm, which estimates the boost to U.S. real GDP at 3.2 per cent and employment at 2.3 per cent, or 3.3 million jobs, by the end of 2010.

The estimates presented in this annex suggest that the combined impact of Canada’s Economic Action Plan, including leverage from other levels of government, and the impact of the permanent tax reductions announced in the 2007 Economic Statement, will boost employment by 1.5 per cent by the end of 2010. However, this estimate assumes that a 1-per-cent increase in real GDP increases employment by 0.6 per cent after two years, compared to 0.75 per cent in the two U.S. studies. Using the output-employment multiplier used in these U.S. studies would raise the employment effect to 1.9 per cent by the end of 2010, compared to 2.6 per cent in the U.S. Council of Economic Advisors’ study.

This comparison accounts for permanent tax reductions implemented in Canada in 2008 as a result of the 2007 Economic Statement but does not account for the sunsetting of temporary tax cuts in the United States. In effect, the estimate for the U.S. stimulus plan includes tax reductions that offset the expiration of their 2008 temporary tax cuts. These tax reductions account for about one-third of the currently proposed U.S. plan, and are largely temporary. While these new tax cuts will compensate for the contractionary effect of last year’s temporary reductions running their course, they will not provide significant additional economic stimulus. Moreover, temporary personal income tax reductions create significantly less economic activity than permanent reductions, as a significant share of temporary tax reductions are saved.

This is illustrated in Chart A1.2, which compares the multiplier for a permanent personal income tax reduction to that of a two-year temporary reduction, where about 70 per cent of these reductions are saved. This estimate of the proportion of the tax reduction saved is in line with private sector estimates of last year’s U.S. temporary tax reduction.4 Taking this into account, the current Canada’s Economic Action Plan and proposed U.S. fiscal stimulus plan will provide approximately the same proportional impact on employment.

Chart A1.2 - Impact on Real GDP Growth of Permanent and Two-Year Temporary Personal Income Tax Reductions Equivalent to 1 per cent of Real GDP


1 One notable exception is the case of lower-income households, who tend to spend most of their income.

2 The multipliers presented above are based on the assumption that interest rates and exchange rates are unchanged as a result of the current stimulus. Given the current synchronised global slowdown and low interest rates, we consider this the most appropriate assumption.

3 A detailed description and analysis of the channels through which various tax reductions affect economic activity in the long run are provided in the Department of Finance working paper 2004–10 "Taxation and Economic Efficiency: Results from a Canadian CGE model," Max Baylor and Louis Beauséjour.

4 See, for example, Macroeconomic Advisers "Forecast Details," February 8, 2008, and Goldman Sachs "A Trader’s Recession," February 1, 2008, which both place the proportion of the 2008 temporary U.S. tax reduction saved at 70 per cent.

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