Andrew Pyle
April 08, 2022
Let's call it a survival budget
They say that there is nothing like time on the job to hone one’s skills. Upon reading today’s federal budget, this must surely be the case for the Trudeau government. Running a minority government for now 7 years and performing the misstep of calling a covid election last September, the only thing that matters for the next three years is political survival. This is why the Liberal government entered into an agreement with the NDP the other week, to stave off non-confidence votes. It is also the reason why today’s budget was not the far-reaching progressive budget that many market and tax professionals feared.
Many of you have already been inundated with the media headlines of the budget, so I will dispense with the summary page, other than to say that this budget was actually more fiscally responsible than anticipated. It certainly was forest-friendly, weighing in at less than half the number of pages than were contained in the last budget. Economists had expected an additional $100 billion in new spending measures, but we only got about $30 billion. The NDP succeeded in winning dental care and a new tax on banks and insurance companies but will have to wait another year to see the light of day on Pharma-care initiatives.
Money has been ear-marked towards the housing market and improving affordability, although there are conflicting forces the government is contending with. On the one hand, measures to increase housing supply makes sense and I have been arguing for a while this is the only real way to cap runaway home price inflation. Yet, spending just over $10 billion over five years and banning some foreign home purchases is not going to make much of a dent in the problem.
The new Tax-Free First Home Savings Account (TFFHSA) is an interesting initiative. Like an RRSP, contributions into the TFFHSA (maximum of $8000 per person per year to a grand total of $40,000) are tax deductible. Unlike an RRSP (or its retirement incarnation, the RRIF) the funds taken out for a home purchase are not taxable – just like our good old TFSA. Given that the average home price in Canada is north of the $800,000, the $40,000 maximum contribution may seem small; however, a couple can combine their plans (total contribution of $80,000) to make a more significant dent in the downpayment.
The one problem with this initiative is that to achieve real tax efficient growth of capital, we would normally expect funds to be invested for at least ten years or more. If someone is investing over five years and that is close to their window for making a purchase, then any savvy advisor is going to counsel against taking on too much risk to maximize growth. No point in putting in $40,000 to end up with $20,000 when it’s time to come up with the downpayment. Still, the measure is useful and for young Canadians who have often wondered whether they should contribute to an RRSP (then use it to fund a downpayment but have to pay it back to the RRSP over time) or to a TFSA, this gives them a better alternative. It is not that progressive, however, as one can argue that the deductibility of contributions will have a benefit that is skewed to higher incomes.
The Russian invasion of Ukraine clearly threw a wrench into the works for the Liberals, exacerbating supply constraints and commodity price inflation. Thankfully, Canada is a net winner (at least initially) when it comes to higher energy and material prices, and this is padding the revenue ledger. It is also another source of inflation at a time when the economy doesn’t need it. There was speculation going into the budget that the federal government and the Bank of Canada might be juxtaposed in the inflation battle should Trudeau and crew opt for massive spending. The fact that the net add on spending was about a third of that feared by the street suggests there was a meeting of the minds behind closed doors.
The invasion also provided a window for the government to pivot from a healthcare crisis to a geopolitical one. Who would have thought, even before the pandemic, that a minority Liberal government would raise defense spending to 1.5% of GDP? This is still below the NATO threshold of 2%, but it does show that the government has its ears to the ground. Most of us would argue that improvement and modernization of Canada’s military is long overdue, and it is unfortunate that it took the brutal invasion of an almost NATO member to move the item up the to-do list. Better late than never.
Speaking of ground, one of the hidden positives in this budget was the $1.5 billion initiative aimed at bolstering “critical minerals” in Canada. These include rare earth elements, as well as more basic items like copper and zinc. There will also be a new tax credit for mineral exploration and the government actually uses the terminology “economic security” in its outline of these initiatives. Considering that the majority of these key minerals are being sourced from China, and we are living through the consequences of being dependent on an authoritarian regime for energy, the inclusion in the budget (albeit small) is understandable. Canada has one of the largest reserves of rare earth minerals on the planet at about 14 million tonnes. This is the equivalent of 100 years' worth of Chinese production. In my opinion, I would have liked to see initiatives in this area multiplied by a factor of ten or more.
Source: Natural Resources Canada
As I said in the title, this was a budget of survival for the Liberal government, and it was probably the best foot forward they could come up with. It won approval from their legislative partner, such that we won’t be talking about non-confidence votes this weekend. It didn’t make a ton of friends on Bay Street, but measures were well telegraphed on that front. What didn’t happen was a frontal attack on high-net-worth individuals and families. The capital gains inclusion rate wasn’t altered and there was no tinkering with dividend treatment. As my old friend Amanda Lang said tonight on air, we are all going to have to pay more taxes eventually, just not right now. Think of the electorate and think of the developments in this country over the past several weeks and you can understand why there wasn’t the attack on personal taxes that many accountants feared. That’s why I term it a survival budget. It
The question is whether this budget gets the government through the next three years. The agreement with the NDP is not without its ejection seat buttons and there is a groundswell in this country on the other side of the political spectrum that will generate its own influences. For us as economists and portfolio managers, the more important question is what this does for the economic outlook and, hence, our investments?
On the economic front, the federal government is sitting in the backseat of a car travelling on a winding mountain road. No steering wheel, gas pedal or brake. Just a lot of hope. In terms of the budget influencing international investor opinion, I really don’t think it does. Considering everything else that is going on in the world, not to mention the recent gyrations in monetary policy expectations, the document is a bit of a snore. The Canadian dollar was basically flat after the budget was released. We had traded below 80 US cents before the session started and are holding around 79.50 cents now. There was a modest blip higher in Canadian government bond yields but, after the trouncing seen in March, this week has been relatively quiet. In fact, I believe we are entering a period where piecing back into government bonds is starting to make sense.
Bottom line, this budget was a carefully orchestrated walk down a very narrow pathway. The Liberals provided just enough to the NDP to keep the honeymoon going, but the party didn’t alienate moderates either. Are there deficiencies? Absolutely. There are basically no initiatives aimed at improving economic growth and productivity. Small businesses were largely left off the editing block, however, we did not see the full assault on taxes either. There will be adjustments to the alternate minimum tax, which the budget says we will hear about by the fall, but our clients are not in the camp of those who pay minimal taxes. If anything, they pay too much already and still are penalized in terms of the treatment of registered accounts (like RRSPs and RRIFs) at death. Thankfully, there was no mention of a wealth tax.
As for the housing market. home prices aren’t going to come sliding down because of this budget, but they will likely correct in the face of higher interest rates. The fact that the 5yr Government of Canada bond yield is through 2.6% for the first time in 11 years is a wake-up call in itself. If investors do not believe that the government can get close to a balanced budget in five years, the upside pressure on yields could intensify and that means mortgage rates will be biased higher as well. The fiscal deficit is still way too wide considering the revenue windfall and the debt can has been kicked down the road, though not as far down the road as we expected. And there is a risk that much weaker growth and higher interest rates come back and bite the federal government.
All that said, the budget doesn’t cause us to change our portfolio strategy. What happens across the Atlantic and in the halls of the Federal Reserve might. Note, the Pyle Group will be hosting its monthly conference call on Monday April 11th to discuss market conditions and the budget in more detail.
Toll-free dial-in number (Canada/US): 1-800-806-5484
Local dial-in number: 416-340-2217
International dial-in numbers: https://www.confsolutions.ca/ITL?oss=7P9R8008065484
Participant passcode: 6531450#
On behalf of the Pyle Group, have a wonderful weekend.
Andrew
CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc. “CIBC Private Wealth” is a registered trademark of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2022.CIBC Wood Gundy, a division of CIBC World Markets Inc
These are the personal opinions of Andrew Pyle and may not necessarily reflect those of CIBC World Markets Inc.