Fiscal Pulse Nathan Joshua (416)

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1 Mary Webb (416) Nathan Joshua (416) FY11-12 Highlights Budget Highlights British Columbia With the governing Liberal Party selecting a new leader on February 26 th, this is a status quo Budget, sticking to last year s plan to balance the books by fiscal (FY14) at the latest and providing no new policy direction. Its conservative assumptions outlining average annual gains of 3.4% in revenues and 2.0% in expenditures for FY12 through FY14 offer flexibility for the incoming Premier. Alex Koustas (416) The estimated $1.3 billion alex_koustas@scotiacapital.com FY11 deficit, $450 million narrower than Budget, plus the final FY10 improvement of $1.0 billion, puts B.C. $1.4 billion ahead of its bottom-line forecast a year ago. The projected budget shortfall for FY12 is $0.9 billion, just 0.4% of provincial GDP. In FY13, the budget gap is expected to narrow to $440 million, en route to a $175 million surplus in FY14. For taxpayers, the debt burden, estimated at 16.5% of GDP in March 11, is expected to peak at just over 17½% in FY13, well below the 21.3% FY03 high, before edging lower. The FY12 debt service is expected to absorb just 4½ of each revenue dollar. Dampening the rise in taxpayer-supported debt is the unwinding of the recent accelerated infrastructure stimulus, with taxpayer-supported capital investment dropping from an estimated $4.9 billion in FY11 to about $3.1 billion in FY13 and FY14. Gross borrowing in FY11, with some of the remaining requirement possibly met from internal sources, will likely be below $8.0 billion, more than $1 billion less than Budget. For FY12, gross borrowing of $9.2 billion is forecast, dropping to $5.5 billion and $6.1 billion in FY13 and FY14, respectively. Index Highlights 1 Overview 2-3 Budget Arithmetic 2 Outlook 3 Major Budget Measures * B.C. Budget Balances FY b * and Debt* Debt*/GDP, RHS % 24 Debt*, LHS FY b * FY00: -$ mn, FY09: $75 mn. Source: B.C. Finance. * Taxpayer-supported basis. Source: B.C. Finance, GDP forecast: Scotia Economics. Scotia Economics Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) Fax: (416) scotia_economics@scotiacapital.com This Report is prepared by Scotia Economics as a resource for the clients of Scotiabank and Scotia Capital. While the information is from sources believed reliable, neither the information nor the forecast shall be taken as a representation for which The Bank of Nova Scotia or Scotia Capital Inc. or any of their employees incur any responsibility. is available on: Bloomberg at SCOE and Reuters at SM1C

2 Overview The projected $0.9 billion FY12 deficit is virtually unchanged from the last year s Budget forecast, though the budget balances expected this year for FY13 and FY14 are slightly weaker. The government continues its practice of conservative Budget estimates. It assumes a forecast allowance of $150 million for FY11, followed by $350 million for each of the three subsequent years. In its operating expenditure forecast, contingencies of $600 million are included for FY12, with $450 million in each of FY13 and FY14. For FY11, after notional allocations during the first three quarters, $310 million remains of the original $450 million of contingencies for unexpected events or priorities. The taxpayer-supported capital spending estimates are reinforced with capital contingencies of $129 million in FY11 and $0 million in each of the following three years. As well, the economic growth assumptions underlying the Budget estimates are prudent when compared to either the private-sector forecast averages or Scotia Economics current outlook. For 10, the government s 3.1% real GDP growth assumption is in line with Scotia Economics estimate, but its 2.0% forecast for 11 contrasts with our 2.7% forecast, and its expectation of gains of about 2.6% for 12 and 13 could prove slightly low. B.C. s total revenues, after declining 5.7% over FY09 and FY10, are expected to regain their FY08 peak in FY11. The rebound, however, reflects the $2.0 billion gain in federal receipts British Columbia s Budget Arithmetic $ millions except where noted FY11 FY12 Budget Rev. Budget Tax Revenue 17,422 18,166 19,014 Resource Revenue 3,8 2,754 3,100 Commercial Crown Corp. Net Inc. 3,012 2,923 2,941 Other Own-Source Revenue 7,826 8,147 8,702 Federal Transfers 7,685 7,903 7,580 Total Revenue 39,153 39,893 41,337 Program Spending 38,793 39,390 40,113 Debt Service* 1,775 1,618 1,799 Total Spending 40,568 41,008 41,912 Forecast Allowance Surplus (Deficit) -1,715-1, Taxpayer-Supported Debt 33,748 33,388 36,816 Gross Borrowing Requirement 9,030 8,090 9,2 Refinancing 2,6 2,685 2,6 Annual Change, % Taxation Revenue Resource Revenue Total Own-Source Revenue Federal Transfers Total Revenue Program Spending Memo Items, % Own-Source Revenue / GDP Program Spending / GDP Budget Balance/ GDP Taxpayer-Supported Debt/ GDP Debt Service* / Revenue* Resource Price Assumptions Natural Gas, Plant Inlet, C$/GJ Western Lumber** 2x4s, US$/mfbm Cdn Dollar,calendar yr avg,us /C$ * Taxpayer-supported basis. ** Spruce-pine-fir, calendar year. Source: B.C. Finance; Nominal GDP forecasts: Scotia Economics. during FY10 and FY11, with B.C. s own-source revenues this fiscal year remaining 5.5% below their FY08 high. The rise in federal transfers reflects Ottawa s stimulus package as well as $1.6 billion of federal HST transitional assistance, with $250 million delivered in FY10 and $769 million in FY11. In FY12, a 4.1% decline in federal transfers, with the two-year federal stimulus package largely completed, slices B.C. s total revenue growth to 3.6% from an estimated 6.3% in FY11. B.C. s own-source revenues help fill the gap, climbing 5.5% with tax receipts up $0.8 billion and non-renewable resource revenues edging higher. Personal income taxes are expected to jump 8.3% in FY12, in part mirroring solid job growth, but corporate income taxes are forecast to slide 4.1% because of a lower prior-year adjustment payment forecast from Ottawa more than offsetting the higher quarterly installment payments anticipated. Contributing to the projected rise in FY12 resource receipts are a gain of more than 25% in natural gas production volumes and, from very low levels, a jump of about % in lumber exports to the United States. Program spending growth is assumed to slow from 4.2% in FY11 to 1.8% in FY12. In FY13, an additional drop in federal receipts of almost 5% will trim the Province s total revenue gain to 2.7%, allowing only a 1.3% rise in program outlays to keep the deficit narrowing significantly. In FY14, a 2.1% rise in program spending is planned, with an additional $605 million in this Budget for health care. For FY12 to FY14, the government s commitment to maintain core services in its three priority program areas is mirrored in the 2

3 planned annual increases averaging 3.8% for health care, 1.1% for the Education envelope in FY12 and FY13 and stable Social Services outlays as the economic recovery proceeds. The three-year spending restraint that reduces total real expenditures per capita by 4.2%, in part reflects the efficiencies resulting from expenditure management initiatives started over the past two years. The expense estimates assume the successful completion of the government s compensation mandate, which stipulated two-year contract renewals with no net increase in total compensation costs for unionized publicsector workers with agreements expiring between December 09 and December 11. Flexibility, however, was allowed in compensation trade-offs with salary increases possible if covered by savings from other adjustments in the collective agreements. The projected decline in full-time equivalents across taxpayersupported programs and agencies during FY13-FY14 is -3.2% or close to 1,000 positions, accomplished through attrition and the government s policy of limited external hiring. As required, the government reports that its planned health expenditures will exceed dedicated revenues from the Harmonized Sales Tax (HST), Medical Services Plan premiums (including a 6% hike in 12), the Tobacco tax, the Health Special Account, the Canada Health Transfer and the Wait Times Reduction Transfer by $5.1 billion (40.6%) in FY12, with the gap only slightly narrowing to $4.6 billion (33.4%) by FY14. Taxpayer-supported capital outlays in FY12 of $4.1 billion are expected to require direct borrowing of $2.5 billion, with anticipated funding from P3 liabilities declining from an estimated $332 million in FY11 to the $100 million range for FY12 through FY14. Self-supported capital spending, after falling an estimated % in FY11 as BC Hydro s investment declined to $1.6 billion, is expected to return to over $3.0 billion in FY12 with BC Hydro s outlays rebounding to more than $2.0 billion. Outlook A significant risk to the Budget estimates is the possible replacement of the HST, adopted on July 1, 10, with the former Provincial Sales Tax (PST) and the federal Goods & Services Tax (GST) if the referendum scheduled for September 24, 11, is approved by a simple majority of the voters that turn out (see p.4 for further referendum details). The immediate fiscal impact for B.C. would be the loss of $1.6 billion of federal HST transitional assistance. The Province in late January set up an independent panel to report by the first week of April on the differential impact of the HST and PST/GST alternatives for B.C. s consumers, its businesses, its economic competitiveness and its fiscal position, as well as other jurisdictions experience. Fortuitously, the outlook for British Columbia s economy should support the government s deficit reduction plans, despite current economic and financial market uncertainties. Scotia Economics forecasts solid real GDP growth averaging 2.9% annually from 10 to 12 and the government expects annual gains of 2.8% from 13 to 15. The expansion of the Province s role as a major North American Gateway to the Pacific is in part linked with the recovery of B.C. s broad resource sector. Mineral exploration outlays in B.C. in 10 doubled from their 09 low as developing nations strong demand for metals and coal persisted, and lumber prices returned to profitable territory, with increased sales to China offering a welcome boost. For natural gas, the forecast is mixed for the Province, with prices over the next three years possibly more subdued than the Budget assumes and some of the higher gas output from wells qualifying for royalty programs and credits British Columbia s Housing Market units 000s $ 000s While B.C. s revenue outlook may prove somewhat stronger than this Budget projects, upward pressures will also exist for program spending. A number of fiscal challenges remain, such as ensuring housing affordability and, as the baby boom generation retires, managing health care which will absorb 42% of the Province s program spending in FY12. However, cushioning B.C. s prospects are the provincial tax and regulatory reforms already undertaken and its relatively strong current fiscal position. Even with rising interest rates, its debt service by mid-decade is unlikely to soar much above 5 of each revenue dollar MLS Prices, RHS Source: CMHC, CREA. Housing Starts, LHS

4 Major Budget Measures and Policy Developments Revenues For the Corporate Income Tax (CIT), the general rate dropped to 10% from 10.5% on January 1, 11, as scheduled, and the small business rate is slated to fall to zero on April 1, 12. Both reductions are financed from the revenue-neutral Carbon Tax program. Schedule III banks (branches of foreign banks operating in Canada) will qualify for the International Business Activity Program offering CIT refunds, with respect to their international financial business operating in B.C., as of April 1, 11, as previously announced. The BC Homeowner Grant, with the phase-out threshold raised for 11 by roughly 10% to homes valued at $1.15 million, will continue to be received in full by 95% of B.C. homeowners. The maximum reduction in residential property taxes is $570, with an additional grant of $275 possible for individuals such as Seniors or the disabled. As planned, as of 11, a Northern and Rural Area Homeowner Benefit of up $0 is available for households eligible for the Homeowner Grant. The Industrial Property Tax Credit was raised to 60% for 11, as scheduled, for light and major industrial properties, and school property taxes will be halved for land classified as farm. The latter three measures will be funded from the revenue neutral Carbon Tax program. For the HST referendum, legislation stipulates that a successful yes vote must receive the support of more than 50% of B.C. s registered voters plus more than 50% of the registered voters in at least two-thirds of the electoral ridings. The government has set a much lower bar, accepting a yes vote on a simple majority of the voter turn-out. Medical Services Plan premiums will increase by about 6% on January 1, 12, as announced in the September 09 Update (revenue impact: FY12: +$30 million; FY13:+$118 million). The Carbon Tax, following the last scheduled increase on July 1, 12, to $30 per tonne of carbon dioxide equivalent, is assumed to remain at this rate through FY14. For biomethane (a carbon neutral renewable fuel produced from biomass), currently exempt from the Carbon Tax in its 100% pure form, a credit for the biomethane portion of a blended natural gas purchase will be provided on natural gas bills as of February 16, 11. From FY09 to FY14, under the revenue neutral Carbon Tax program, cumulative revenue is estimated at $4.9 billion and tax relief at $6.0 billion, with 41% of the relief directed to individuals, including the Low Income Climate Action Tax Credit, and 59% received by business. BC Hydro s Q2 results for FY11 saw net income rise 11.1% from a year earlier. On April 1, 10, a 6.1% general power rate increase was implemented on an interim basis. The government has recently introduced two changes to mitigate further electricity rate increases. B.C. Hydro s deemed equity for rate setting is now more narrowly based on assets-in-service, lowering its allowed return on equity from 14.38% in FY12 to 12.75% for each of the following two years. As well, water rental rates for hydro power producers will be indexed to the CPI, not to BC Hydro s general power rate increase. For British Columbia Lottery Corporation, revenues, net of payments to the federal government, are expected to rise an average 3.3% annually from FY12 to FY14, largely due to PlayNow internet gaming. Over the next three years, the Province plans to distribute % ($669 million) of its gaming income to local governments and charities. Insurance Corporation of British Columbia (ICBC) is undertaking a $400 million Transformation Program to promote a fairer, customerbased risk pricing model. This Program will be funded entirely from Optional insurance capital to avoid affecting Basic insurance rates B.C. s Revenue Neutral Carbon Tax total carbon tax revenues, FY r 12b 13b 14b Source: B.C. Finance. 4

5 Major Budget Measures and Policy Developments continued Expenditures The Ministry of Education will make full-day kindergarten available as of September 11, 300 StrongStart centres are offering free pre-school learning programs and Neighbourhood Learning Centres, schoolbased community hubs, are providing services for learners of all 190 ages. Treaty negotiations continue with First Nations. The government also is committed to negotiating new revenue-sharing and reconciliation agreements to streamline consultations on natural resource decisions, offer increased certainty to investors and support new economic opportunities for communities. The Province s regulatory burden will continue to be trimmed in 11, with the government reporting a decrease in its regulatory requirements of more than 42% since 01. For the 10 Olympic and Paralympic Winter Games, wind-up activities are in the final stages. With the audited results of the Vancouver Organizing Committee (VANOC) indicating a balanced position for the fiscal year ending July 31, 10, there have been few material changes to the Province s report in July 10. The Province s FY11 Contingencies Vote retains a small allocation to cover any remaining financial risks Source: Statistics Canada. British Columbia-origin exports to Asia (excluding the Middle East) totalled $11.7 billion in 10, surpassing the 08 record by $1.1 billion, with $4 billion of shipments directed to both Japan and China. For the latter destination, these shipments last year were up more than 63%. British Columbia s provincial elections are currently set for the second Tuesday in May every four years, placing the next election on March 14, Non-Residential Construction Price Index index 02=100 Edmonton Toronto Vancouver 5