The 2023 federal budget will be remembered as much for what it didn’t include as for what it did. While the government emphasized themes like the green energy transition, partially to keep pace with the United States, and new healthcare spending, Ottawa offered few measures to help Canadians cope with skyrocketing inflation.
From a personal tax perspective, the budget offered a “grocery rebate”, minor tweaks to some registered plans and reform of the Alternative Minimum Tax (AMT), which will impact higher-earning Canadians, as well as new provisions to help private businesses.
These were some of the main takeaways from a panel of experts featuring Doug Porter, Chief Economist and Managing Director, and John Waters, Vice President and Director of Tax Consulting Services at BMO Private Wealth. The virtual panel, First look at the 2023 Canadian Federal Budget, was moderated by Caroline Dabu, Head of Wealth Distribution and Advisory Services at BMO Private Wealth, addressed everything from the impact of the rising deficit to how changes to the AMT will impact high-net-worth Canadians.
Short on Inflation
“From an economic perspective, I would have to characterize this budget as a little bit light on that front,” Porter said in his opening remarks, noting an emphasis new spending on green energy and health care and limited steps to address affordability for Canadians as they wrestle with the highest inflation in decades. “Inflation is still public enemy number one,” he said, adding that the only real step to address affordability was a so-called grocery rebate, which is effectively an enhancement of the GST tax credit.
On balance, said Porter, the 2023 federal budget introduces net new spending and stimulative measures rather than taming inflation. “It’s sort of acting at cross purposes of what monetary policy has tried to do over the past year.”
Most of those new spending measures come in the form of tax credits to incentivize investment in the clean economy to respond to the U.S. Inflation Reduction Act, which included a US$369-billion investment in domestic energy production and manufacturing, amongst other steps, to reduce carbon emissions by roughly 40 percent by 2030.
While the new incentives outlined in the budget will be modest initially, they will rise to more than $5 billion per year by the 2026/27 fiscal year. Some of those measures include credits for investments in renewable energy production and clean manufacturing, and offsets for the cost of mining and production equipment for mining and processing critical minerals. All of the credits are contingent on manufacturers maintaining wage and benefit programs and training apprentices.
The new provisions, while meaningful, don’t go as far as the spending plan in the U.S., although as Porter noted, Ottawa doesn’t have the fiscal heft to match that level of spending on clean tech. Instead, Canada’s overall strategy has been to tax carbon and let the market resolve it.
Growing Budget Deficit
Heading into the budget lockup, the budget deficit was expected to come in under $40 billion for the current fiscal year and then moderate to $30 billion for the fiscal year that begins in April. Now, Ottawa is looking for a deficit of $43 billion for the current year and $40 billion for the coming year, said Porter. “Not a huge deal, but on balance, it’s a bit of a deterioration and a step in the wrong direction.”
Still, he doesn’t expect the new spending will pose a risk to the Canadian economy. Overall, he forecasts that Canadian GDP will grow slightly by between 0.5 percent and 1 percent this year, factoring in an expected mild contraction in the North American economy over the next few quarters. With the Canadian economy operating at near full employment and the economy operating flat out despite persistent headwinds, Porter said the new budget represents a bit of a misstep. “I’d have to characterize it as a little bit of an economic disappointment in the fact that we did see this net new spending at a time when monetary policymakers are trying to restrain the economy and rein in inflation,” said Porter.
The prospect of a contraction in the Canadian economy and a slightly lower-than-expected print on the consumer price index will likely keep the Bank of Canada (BoC) from raising the overnight rate again this year, said Porter. “Our official call is that we think the Bank of Canada is done raising rates,” he said. “We don’t think the budget changes that, and we expect the BoC, in fact, to stay on hold through the rest of this year and then begin trimming interest rates in 2024.” That’s in contrast to the BoC’s global counterparts – notably the U.S. Federal Reserve (the Fed) – which are expected to continue to hike rates to fight inflation.
The divergent paths between the BoC and the Fed has pressured the Canadian dollar early this year, but banking sector stress in the U.S. has recently given the loonie a bit of a lift, and it is likely to strengthen rather than weaken over the next 12 to 18 months as the U.S. dollar “loses some altitude.” With another U.S. rate hike on the horizon, Porter expects that trend to start soon thereafter.
Limited Tax Implications
From the personal and private business income tax perspective, BMO’s John Waters said the 2023 budget brought few surprises.
“There’s definitely some significant changes that will impact high-net-worth Canadian individuals as well as Canadian businesses,” said Waters. “But there were no broad-based changes to personal or corporate tax rates to write home about."
While there were some minor tweaks to allow students to withdraw up to $8,000 from their Registered Education Savings Plans (RESP) in the first 13 weeks of enrollment year versus $5,000, and there was the GST rebate, or the so-called grocery rebate, which will support some 11 million lower- and modest-income Canadians, the expected changes to the AMT was one of the more notable changes.
The AMT has been in place since 1986 to ensure tax filers are paying a minimum amount of tax regardless of their deductions or tax credits claimed. The AMT is a separate calculation that is run parallel to ordinary income tax rules, with the taxpayer paying whichever amount is higher. For the purpose of the AMT calculation, the minimum tax base will be broadened (by increasing the capital gains inclusion rate to 100% from 80%, for example) and only 50% of many common expenses and tax credits, like interest charges and charitable donations, will now be deductible for AMT purposes, explained Waters.
Ottawa is also increasing the AMT tax rate to 20.5% from the flat 15%, he added. At the same time, the federal government is raising the basic exemption level to $173,000 from $40,000, to protect lower and middle income individuals from AMT. The changes, which are proposed to come into effect in 2024 could increase tax for higher income individuals, and are expected to generate about $3 billion in tax revenue over the next five years, said Waters. Most of the revenue will come from individuals earning more than $1 million.
“It’s not going to affect everyone,” explained Waters. “There may be some changes in tax behaviour and looking at other options, like using a corporation to earn investment income.”
Good News for Private Corporations
Waters said there were a couple of positive changes for private corporations in the budget. The government is introducing a new trust structure to facilitate employee ownership of private businesses. “The goal here is to increase or encourage employee participation and engagement incentives,” noted Waters, adding that it will provide another exit option for business owners.
Rather than owners having to exit their business by selling to a competitor or risk having that business being shut down or seeing its assets sold off, “the concept here is that the trust would take on the debt to purchase the company, and the loan would be repaid from future company profits so that employees participating would have a minimal upfront cash payment and benefit from growth down the road,” he explained.
The new trusts will also be exempt from the 21-year rule that would otherwise apply to trusts, to recognize the longer time frame of the strategies. More details are expected to be announced, but it’s a positive development that will put Canada more in line with the United Kingdom and the U.S., said Waters. The new trust structure is expected to be in place for 2024.
Overall, both Porter and Waters had mixed reviews of the budget, surprising more for what it lacked than for what it contained. The muted market reaction suggests investors felt the same. “I would probably rank this in the bottom 10 of the past 30 in terms of market moving or importance,” said Porter.
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