What to expect from budget 2023 as ‘storm clouds’ gather over Canada’s economy

Canada’s Liberal government is in a tight spot heading into the 2023 federal budget.

A year of surging prices and rising interest rates has put fresh stress on Canadian households struggling to make ends meet.

Landmark investments in the green transition from the United States have turned up the heat on the Canadian government as it looks to stay competitive with the economic juggernaut south of the border.

And after years of higher spending and a surging recovery from the COVID-19 pandemic, storm clouds are gathering in the economy, putting new scrutiny on government coffers.

Chrystia Freeland, the government’s finance minister and deputy prime minister, has pledged that the 2023 budget will include “targeted” support to help vulnerable Canadians but will not “pour fuel on the fire of inflation.”

Can Ottawa thread the needle through the competing pressures and economic uncertainty while still meeting Canadians’ ends?

Here’s what economists think.

The federal budget comes at a “challenging time” for Freeland and Prime Minister Justin Trudeau, says Sahir Khan, vice-president at the University of Ottawa’s Institute of Fiscal Studies and Democracy.

Now in their third term of governing, Khan tells Global News that the Liberals’ second budget of their current mandate is set to arrive amid a “change in context.”

He says the Liberals have had the “good fortune” of inheriting large revenue surprises in previous budgets, which has helped the government spend more while staying fiscally sustainable.

But government revenues are set to dry up with the economy slowing, Khan warns, even as spending priorities mount.

Among the pressures facing the government are commitments already made on a new health-care accord with the provinces, defence spending both at home and in Ukraine and the green energy transition.

“Storm clouds” are gathering for a possible recession on the horizon, Khan notes, and the federal government will feel pressure to “keep some of their powder dry” for emergency spending to resuscitate the economy if the worst-case scenarios come to pass.

Randall Bartlett, senior director of Canadian economics at Desjardins, says that even with the first quarter of the year off to a stronger start than most economists anticipated, the government still finds itself in a bind with uncertainty about how much the economy slows this year.

“It’s a challenging environment to do budget planning overall,” he tells Global News.

A surging economy through the COVID-19 recovery helped push government revenues higher and Ottawa spent much of this money on support for Canadians hit hard by the pandemic.

While those programs have largely wound up, a recent analysis from the Bank of Montreal showed that government spending per capita is still 11.3 per cent higher than in the pre-pandemic era.

Bartlett says that while government revenues generally see a boost amid high inflationary periods, the federal government is about to experience the “insidious” nature of rising price pressures on the downturn.

Government spending supports that are indexed to inflation, such as Old Age Security (OAS), are now costing more, just as subsiding inflation and a cooling economy are set to slow government revenue growth, he says.

“We’re going to continue to see those knock-on effects of high inflation on the spending side, even as those tailwinds to revenues start to fade,” Bartlett says.

But Bartlett adds that the government is facing “a lot of political pressure” to continue to spend to support vulnerable households.

Some economists worry that too much direct financial support from the federal government will end up fuelling inflation, as Canadians use their contributions to buy more goods and services and end up stimulating the economy all over again.

Top officials at the Bank of Canada, which has raised its benchmark interest rate aggressively over the past year to cool the economy and tame inflation, have said that letting up on pandemic-era stimulus sooner could have limited inflation.

In order to avoid driving inflation higher with government support, Ottawa will need to be “well-targeted” in its spending plans, says Lindsay Tedds, associate professor of economics at the University of Calgary.

Rather than sweeping tax cuts, which would lessen the burden on households but could inadvertently spur more spending, Tedds tells Global News that the Liberals could again double the GST credit or top up guaranteed income supplements.

Doing it this way would ensure government spending goes more towards Canadians who need it to make ends meet on the basic necessities, she says.

“We’re talking about just trying to get them through being able to pay rent and buy groceries and things like that. So it doesn’t have an inflationary impact,” she says.

Khan says the government could also “stagger” its promises, with spending ramping up in years three, four and five of its budget horizon. Doing so could allow the Liberals to keep money back to respond to emergencies while also showing Canadians they’re listening to affordability concerns, he says.

Economists who spoke to Global News say the federal government is feeling pressure to respond to the U.S.’s Inflation Reduction Act, which rolled out a number of incentives for companies to make investments in the green economy south of the border.

Despite restrictions on the government coffers, the Liberals will need to put a “down payment” on some of the clean energy priorities it has talked about for years, Khan says.

If Ottawa does not roll out its own incentives to compete with the U.S., Canada risks losing jobs and investment from large-scale companies in the green economy, he argues.

“They will suck that capital and those jobs out if we don’t look like we’re doing the same for our industry,” Khan says of the U.S.

“There’s going to have to be something actually quite tangible in this budget. It can’t just all be narrative.”

Tedds agrees and notes that announcements on measures like carbon capture and storage will be attractive in Alberta.

Ottawa can’t necessarily go toe-to-toe with American capital, however, and Bartlett says the government should focus spending on industries where Canada has a “comparative advantage.”

He highlights critical minerals as one such area where Canada could position itself in the green economy.

Tedds says Canadians should “moderate their expectations” for the upcoming budget.

While it’s possible Canada avoids the worst of the economic downturn, the outlook is “too unpredictable” for the Liberal government to offer significant relief or big-ticket items in this budget, she says.

Tedds notes she’d like to see an overhaul of the employment insurance program to ensure that when and if Canada’s jobless rate starts to rise, the government is ready to support Canadians through the downturn.

“We really should be recession-ready. There are some sectors that are really hurting, tech being one of them. We’ve seen massive layoffs, especially here in Calgary. And so there are people hurting,” she says.

Despite all the pressures facing the Liberals in their third term in office, Khan says the Trudeau government will need to demonstrate that it’s still “got some fire in its belly” and can deliver results for Canadians.

“I think this time it’s going to be less about aspiration and more about perspiration,” he says.

As opposed to a newly elected government delivering a budget of change in its first spending plans, the Liberals will have to prove they still have ideas and can make progress on projects that matter to Canadians, Khan says.

He expects the Liberals will devote a fair bit of the budget text to the already announced health-care spending announced in February as a “victory lap” of sorts.

If the government wants to hit every spending priority while maintaining the federal debt-to-GDP ratio — a key fiscal guardrail watched not only by the government but by credit rating agencies and international observers — it may have to find new sources of funding.

Bartlett says that with the revenue sources drying up and the Liberals under pressure to maintain their fiscal guardrails, tax hikes could be on the table, likely aimed at corporations or higher-income earners.

Otherwise, he says the Liberals might have “champagne tastes,” but they’re working with a “beer bottle budget.”

“They’re not going to get everything on their wish list,” he says. “And so they need to they need to be mindful of that and exercise some genuine prudence.”

— with files from Global News’ Touria Izri

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