THE 2008 QUEBEC BUDGET

Released on March 13, 2008

HIGHLIGHTS

• $1.8 billion reserve by fiscal year-end …
• … used to shore up projected shortfalls of $1.4 billion and $0.4 billion in the next two years
• Immediate elimination of capital taxes for manufacturers
• Private childcare tax credits enhanced, public daycare spaces expanded by 10% over 5 years
• Harmonization of CCA, TFSA, and retirement income tax credit with federal system

Québec Minister of Finance Monique Jérôme-Forget unveiled her second Budget today without fanfare. Understandably, and much like her federal counterpart, she was busy tempering expectations in the last few weeks as Quebec’s economy tries to avoid a recession in 2008. The Liberal minority government’s first budget of May 2007 emphasized personal and corporate income tax relief, and the familiar triumvirate of health / education / infrastructure priorities on the spending side of the ledger. But the current prudent tone in the midst of an economic slowdown left little room for anticipating major new spending initiatives or further tax relief. However, when compared to last May’s Budget, significantly better-than-expected revenues (+$1.8 billion) for the current fiscal year (FY) ending in March did provide the government with sufficient wiggle room to lighten some tax burdens, particularly those of families and manufacturers. The targeting of these two taxpayer segments comes as no surprise, having been identified by opposition parties as key to Budget approval. As much as four lengthy pre-budget meetings with these same opposition parties presumably made this Budget a compromise unlikely to trigger an election.

Bigger surplus to help soak up shortfalls over next two years

Half of the unanticipated revenue for the current, soon to end, fiscal year is due to a decent performance by the provincial economy in 2007, which translated into higher personal and corporate income tax receipts. The other half of this revenue upswing came in roughly equal amounts from stronger Hydro-Québec profits and an upward revision of federal transfers for health and post-secondary education. The upside surprise to revenues was partially offset by higher expenditures (+$481 million) and a welcome accounting adjustment which negatively impacts the net result of consolidated entities (-$645 million, mainly from consolidation of schools & hospitals). The ‘status quo’ surplus improvement before reserve comes in at +$717 million. After an additional $200 million deposit to the Generations Fund (GF), bringing total deposits to this debt repayment account to $603 million, the remainder was allocated to boost the contingency reserve by $517 million. Together with the previous year’s $1.3 billion reserve, this brings the reserve to a total $1.8 billion.

This larger-than-expected reserve comes at a much-needed time, as the economic slowdown will crimp government revenues in 2008. Finance Québec forecasts real economic growth of 1.5% this year, in line with the latest TD Economics forecast of an anemic 1.2%. Nominal GDP, a proxy for the tax base, is projected to grow by a mere 3.2%. The government’s own-source revenue forecast is lower at -0.8%, partly as it builds in the cost of revenue measures and plays it safe. With a Canadian dollar expected to remain near parity against the U.S. dollar and the distinct possibility of a deeper or more prolonged recession stateside –whose market takes up three-quarters of Québec’s international exports – the economic risks lie mostly to the downside. Total revenues are expected to remain essentially flat (+0.1%) as own-source revenues decline while federal transfers increase (+3.2%). The challenge in this environment is to keep a lid on expenditure growth, while simultaneously satisfying the government’s pledge not to raise taxes. With program spending slated to increase by 4.2%, the government will have no choice but to tap into the reserve to absorb a $1.4 billion ‘status quo’ deficit in FY 08-09 and another $0.4 billion deficit in FY 09-10. The planning horizon was also lengthened to five years as multiple measures were back-end loaded.

Produce and procreate; Incentives for manufacturers and families

While capital taxes for manufacturers had effectively been eliminated prior to today, through the implementation of capital tax credit, the government announced a broader and immediate elimination of capital taxes for all manufacturers. Before Budget 2008, many manufacturers whose investments were too low were unable to take advantage of a 15% capital tax credit and still ended up paying capital taxes. The capital tax credit is eliminated, and the proposed measure is simpler and broader. The resulting number of businesses engaged in manufacturing activities paying no capital taxes will effectively increase from 14,500 to 20,700. A partial reduction of capital taxes is also offered to an estimated 8,000 businesses for which 20% to 50% of activity consists of manufacturing. These combined measures are estimated to cost $95 million in foregone revenue over the next three years. On par with Ontario, other (non-manufacturing) businesses will have to wait until 2011 to see their capital taxes eliminated, a highly positive measure announced in the previous Budget which will no doubt enhance investment and job creation in the province.

Effective immediately, the government also announced a 5% tax credit for purchases of manufacturing & processing equipment for any business, except aluminum & oil producers. This measure, estimated to cost $50 million per annum, is temporary and will expire at year-end 2015. The tax credit will be refundable for SMEs (paid-up capital up to $250 million), non-refundable for larger corporations (paid-up capital equal or greater to $500 million), and partially-refundable, on a sliding scale, for medium-sized corporations (paid-up capital higher than $250 million but less than $500 million).

Further along this tax credits theme, Québec matched the three-year federal extension of the accelerated capital cost allowance (CCA). A refundable 30% tax credit for the development of e-business was also introduced, slated to cost $50 million over the next two years.

For middle-income families not using public $7/day daycare, the child care expenses tax credit was enhanced in an effort to help equalize the net cost to households of the different (public, private, home) daycare alternatives. This enhanced refundable tax credit for child care expenses will benefit an estimated 150,000 families at a cost to the treasury of $5 million in FY 08-09 and $20 million per year thereafter. Families have been the darlings of this and other governments in recent Budget rounds. Québec’s family-oriented measures total $5 billion since 2003.

The province will also harmonize its treatment of tax-free savings accounts (TFSAs, issuable starting in 2009 – see our Federal Budget commentary for details) along Federal guidelines. This is one less thing to worry about for Quebec residents. Investment income from TFSAs will be sheltered from tax by both governments. The Budget also progressively lowers the gross-up rate applicable to eligible dividends from the current 45% to 38% by 2012. Importantly, full harmonization of TFSA treatment with the federal tax system implies that withdrawals will not be treated as taxable income and will therefore not impact eligibility for income-tested benefits. This is a definite plus for lower-income individuals and households.

The tax credit to informal caregivers for seniors is being enhanced from 25% to 30%, a $35 million per year measure. Another measure aimed at helping seniors is a matching of the Federal government’s increase of the retirement income tax credit from $1,500 to $2,000 by 2009.

Spending & other initiatives

On the spending side of the ledger, no new major initiatives were announced. The priority areas like health and education will still see the largest program spending increases (5.5% and 4.6% respectively) in the upcoming fiscal year, largely in line with what was slated in May. Funding for post-secondary education at universities and vocational / technical schools was increased modestly, as was funding for programs to help integrate immigrants and improve labour mobility.

A few noteworthy measures were nonetheless present. First, consistent with the family theme, an additional 18,000 new public, reduced-contribution ($7/day) child daycare spaces will be created by 4,500 increments over the next four years, at a cumulative cost of $606 million to bring total spaces to 220,000 by 2012. Combined with the enhanced child care expenses tax credit discussed above, this family-oriented measure will lead ADQ Finance critic Gilles Taillon to recommend to his caucus that it not defeat the government on this Budget. They also support a measure increasing Hydro-Québec’s dividend payment to government coffers from 50% of net profits to 75%. This might sound like a pure cash grab but note that Hydro-Québec’s revenues are already fully consolidated within government accounts. Profits not paid out as dividends (investments) create a financing requirement for the government and have been responsible for about one-third of total debt increases since 2002. What this change essentially means is less government-side borrowing and more direct borrowing from the public utility. Solid capitalization in Hydro-Québec in recent years allows the government to reduce its investments in this public corporation. The cumulative effect should mean a diminished net borrowing requirement of $11 billion by 2025, roughly $600 million per year, when compared to a status-quo projection.

Bottom Line

Fulfilling their pledge not to raise taxes means the government must tap into the contingency reserve to achieve its zero-deficit target for FY 08-09 and FY 09-10. The government has elected to lengthen the planning horizon and argued that a zero deficit (before reserve) should only be achieved over the economic cycle rather than on a strictly annual basis. If faced with a choice between using the built up $1.8 billion reserve or increasing taxes, we could agree with the government’s choice of using the reserve. However, this creates a risk of not addressing the issue of increasingly unsustainable spending pressures, in public health care provision in particular. This begs the question of how it would deal with further downside risks to both economic growth and own-source revenues, which have the potential to bring the shortfall beyond the reserve amount.

On the plus side, the government’s matching of some Federal measures is welcome, in particular its tax-sheltering of investment income within TFSAs. The Federal government’s reduction of the sales tax (GST) also eats into provincial revenues at the margin, and it would have been tempting – maybe justified from our perspective – to fill up the leftover room by increasing its own sales tax (TVQ). We also note that its ‘no tax increases’ pledge also precluded the province from following in the footsteps of British Columbia by broadening and increasing its existing (and largely symbolic) carbon tax. Surprisingly, no opposition party has publicly asked for either tax to be leveraged. The announced measures were certainly not groundbreaking, but will have to do in the current economic context. At the same time, in a felling of déjà-vu, the government provided opposition parties with very little to hang their hat on in protest, akin to the Federal scenario that unfolded just two weeks ago. The announced measures will, in fact, prove to be enough to garner support from one of the opposition parties, namely the ADQ, by partly satisfying its demands for measures targeting families. This minority government will survive to see another day, with the help of a lackluster but prudent Budget which, albeit slowly, moves in the right direction on multiple fronts. Bolder public services financing reform and tax relief measures will have to wait another day, when the economy picks up some steam and sufficient political consensus can be mustered.

Pascal Gauthier, Economist
416-944-5730