The 2009 federal budget proposed a $40 billion economic stimulus package spanning two years and projecting a return to balanced budgets within five. The projected quick recovery of federal finances relies primarily on aggressive assumptions about future interest rates, growth of program expenditures and effectiveness of the economic stimulus plan.fiscal policy, Canadian Federal budget

Alexandre Laurin

Benjamin Dachis

Colin Busby

English

Research Papers in Economics

e-brief
Out on a Limb: Assessing the Fiscal Sustainability
and Effectiveness of the 2009 Federal Budget
By Alexandre Laurin, Colin Busby and Benjamin Dachis
The 2009 federal budget proposed a $40 billion economic stimulus package spanning two years and projecting a return to
balanced budgets within five. The projected quick recovery of federal finances relies primarily on aggressive assumptions
about future interest rates, growth of program expenditures and effectiveness of the economic stimulus plan. 
Sustainable budget plans build confidence in the future: with them, Canadians expect that tax burdens will not need 
to increase in the near term and public services will be maintained.  Uncertainty erodes confidence, delaying private
investments and shrinking the immediate impact of government initiatives on the economy. So budget implementation
needs to focus on the complementary goals of prioritizing the infrastructure and tax initiatives with the best short-run 
effect, and ensuring that the projected return to surplus happens on schedule.
Are Deficits Here to Stay?
The recent global slowdown, given current baseline for federal revenue and spending, will likely result in underlying
budgetary deficits totaling $35 billion over the next five years, adding at least $1.6 billion to annual debt charges.
Meanwhile, the measures announced in Budget 2009 would add about $49 billion to the accumulated deficit,
increasing annual debt charges by an additional $2.2 billion. In total, the federal accumulated deficit is projected 
to increase by nearly $85 billion over the next five years.
This projected rebalancing of federal finances is crucial, before fiscal pressures from demographic change intensify
over the next decade. Lower debts free up resources currently spent on debt charges and better enable the country to
deal with the fiscal pressures of population aging. Robson (2009) recently estimated that, by 2057, population aging
will be a significant strain on the finances of governments in Canada. The current discounted value of this implicit
liability is $1.5 trillion.
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January 30, 2009
 The medium-term federal budgetary outlook relies on optimistic assumptions
that interest rates will remain low relative to recent history and that program
spending will grow at a much lower pace than budgetary revenues.  
 There is mixed evidence on the short- and long-term effectiveness of
economic stimulus measures. Short-term impacts hinge on policy design and
implementation. 
 Public infrastructure investments and business tax measures would be the
most likely to have a lasting positive impact on economic growth, while the
federal government will need to aggressively contain spending in the coming
years to reach its medium-term fiscal target. The main risks to the new medium-term fiscal outlook lie with budgetary expenditure assumptions. First, the combination of
mounting market debt levels and low interest-rate assumptions means that debt charges are increasingly exposed to interest-rate risk.
Second, growth of program expenses will have to be restrained for several years to balance the books in five.
Investment initiatives, such as the Insured Mortgage Purchase Program, loans to the auto industry, and other elements of the
proposed Extraordinary Financing Framework, will contribute more than $150 billion of new market debt by the end of next
year.
1In four years, federal market debt will have increased by more than 60 percent, or $240 billion, to finance underlying
deficits, budget initiatives and financial investments. 
Interest rates on government debt – such as treasury bills and bonds – currently sit at historically low levels (Chart 1), and
are projected to remain relatively low reducing the overall cost of servicing the debt and making new debt issues affordable. As
governments worldwide fund their stimulus packages,
2however, the global supply of new issues of government debt will escalate,
putting upward pressure on interest rates. In response to the crisis, moreover, governments and central banks worldwide have
significantly eased monetary conditions, injecting liquidity and keeping short-term interest rates low. Once growth resumes and
inflationary expectations intensify, long-term interest rates – which are more difficult to influence through monetary policy –
could increase more than expected. Table 1 shows the cumulative budgetary impacts from rising interest charges and its
INDEPENDENT REASONED RELEVANT
| 2 e-brief
1 Importantly, these investments – government purchase of financial assets – are expected to yield investment income sufficient to cover their
interest cost, therefore not increasing the accumulated deficit.
2 For example, the American Recovery and Reinvestment Bill of 2009 proposes US$825 billion (CAD$1 trillion) in fiscal stimulus spending, the
European Commission recommended 200 billion Euro, (CAD $320 billion) while China proposed 4 trillion Yuan (CAD $700 billion).
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Figure 1: Actual and Projected Interest Rates on Government Debt, 1982 – 2014
Note: f = Budget forecast.
Source: Bank of Canada.3 For a survey of the recent literature, see Spilimbergo et al. (2008).  
importance to the credibility of the medium-term outlook. 
Some $5 billion of the stimulus package – mostly income tax measures – will be permanent. In addition, interest charges on
the accumulated deficit will yield another $4 billion expense, resulting in about $9 billion of total annual incremental expenses. To
balance the books and fund this incremental spending, budgetary projections show program spending growing at about 3.8
percent on average – without accounting for the cost of stimulus initiatives – starting in 2010 once the recession is over. This
growth is about 2.7 percentage points lower than average projected budgetary revenue growth over the same period and about 1.7
percentage points lower than average program spending growth in the last 11 years of budgetary surpluses. The challenge for the
years ahead will be to keep program spending growth well below that of revenues and recent experiences.
Rating the Effectiveness of Stimulus Measures
Budget stimulus measures can be readily assessed based on two overarching criteria: their immediate ability to provide an
immediate boost to the domestic economy; and their consistency with long-term economic growth and fiscal sustainability. Table 2
presents a quick assessment of how well these criteria are met, as well as potential implementation problems.
Our evaluation of effectiveness relies on theory, empirical evidence and measure-specific judgements – the effects of such
measures elsewhere are uncertain,
3 and estimates vary by country and evaluation methods (Perotti 2004). 
Empirical evidence is mixed on the immediate impact of government investment spending in the first year, but shows it
stimulates more growth 1.5 years later (Perotti 2004). Government transfers to lower levels of government for infrastructure have
larger multipliers than other transfers (Elmendorf 2009). Targeted subsidies to firms have lower multipliers than other stimulus
measures (Spilimbergo et al., 2008), and countercyclical tax cuts have had no measurable impact on GDP growth in the United
States within the first six months, but after two years a one percent of GDP tax reduction leads to a 1 to 3 percent increase in GDP
(Romer and Romer 2008).
We find that many of the initiatives have at least some potential to immediately contribute to the domestic economy if done
right. In the longer term, few initiatives – particularly public infrastructure investments and business tax measures, which account
for more than one-third of the total package – seem likeliest to have a lasting positive impact.
In theory, public works spending is likely to have the most reliable immediate impact on the economy through increased
aggregate demand and wages. With $17 billion in new construction and infrastructure expenditures over two years, the short-term
impact depends critically on the amount of current capacity utilization in these sectors. 
The immediate effect of measures intended to boost consumer spending are more ambiguous since individuals base their
decisions to spend not only on conditions today but also on expectations of future tax burdens. Low-income Canadians, however,
INDEPENDENT REASONED RELEVANT
e-brief /3
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14
Budgetary Balance (Budget 2009) -1.1 -33.7 -29.8 -13 -7.3 0.7
Budgetary Balance 
(with rising interest rates)   -1.1 -33.7 -31.0 -16.2 -11.9 -4.9
Table 1: Projected federal budgetary balance from a 200 basis points interest rates increase in 2010,
followed by a sustained 100 basis points decline in 2012. (billions of dollars)
Sources: Authors’ calculations from The Budget Plan 2009, sensitivity analysis.| 4 e-brief
INDEPENDENT REASONED RELEVANT
Table 1: Assessing Budget Iniatives
Source: The Budget Plan 2009.
Budget Measure Cost
($B)
Immediate Impact Lasting Impact
Government Investment 
Public Works
Projects
12.7 Positive, contingent on idle resources in suppliers, and
on speed of applications and approvals. Repair and
maintenance is most timely. Empirical evidence on
immediate economic benefits of public infrastructure
investment varies by country (Perotti 2004).
Positive. Builds public infrastructure capacity
supporting long-term growth if spent on
productive assets. Perotti (2004) finds that GDP
growth for government investments in Canada is
highly positive 1.5 years after spending.
Social Housing 2.0 Positive, contingent on idle resources in
construction industry. Fewer approvals needed
than for many public infrastructure projects, but
coordination among governments is a problem.
Negative. Hard for federal government to
extricate itself from this area, because of
intergovernmental pressure.
Stimulus for Consumers
Income Tax
Changes
5.0 Somewhat positive, since low-income Canadians
are likely to spend a larger proportion of their
after-tax income.
Mixed. Lower marginal tax rates for many people
improve labour supply. But permanent fiscal cost
raises concerns about sustainability, potentially
damping boost to growth.
Construction and
Homebuilding
3.5 Positive. Private, small scale investment does not
require lengthy approval process. Tax credit
implementation may be difficult on large scale.
Negative. Permanent tax reduction measures for first-time
homebuyers further skew the tax system towards favouring
home ownership, and create continuing fiscal costs.
Job Retraining 2.3 Little effect. Developing criteria for coverage of
non-EI beneficiaries will slow implementation.
Evidence from provincial retraining programs
suggests low initial take-up.
Negative. Ongoing cost raises concerns about
sustainability. Government-sponsored training
programs have poor record of building human
capital (Poschmann and Robson, 2001). 
EI Benefit
Extension
1.4 Somewhat positive, since affected individuals may
feel more able to spend.
Mildly negative. Will be difficult to reverse, 
but ongoing costs are internal to EI program,
promising little lasting impact on Ottawa’s
bottom line.
Working Income 
Tax Benefit
1.2 Marginally positive. Stimulates consumption by
targeting low-income individuals with the highest
propensity to consume.
Mixed. Encourages greater labour market
participation. Ongoing fiscal cost raises concerns
about sustainability.
Stimulus for Firms
Industry Supports 4.9 Negative. Targeted subsidies to firms have lower
multipliers than than other stimulus measures
(Spilimbergo et al 2008); help to one firm hurts
domestic competitors.
Negative. Sustaining industries in decline diverts
resources from more promising uses. Subsidies
create constituencies for more subsidies, raising
concerns about long-term impact on Ottawa’s
bottom line.
EI Premium Rate
Freeze
4.5 Positive. Stimulates consumption and lowers cost
of labour.
Marginally negative. Future premiums will have
to rise to cover upcoming costs, but requirement
to balance EI account reduces concerns about
long-term sustainability.
Regional Supports 1.6 Negative. Targeted business subsidies have lower
multipliers than other stimulus measures
(Spilimbergo et al 2008), and noneconomic criteria
affect grants (Mintz and Smart 2003).
Negative. Subsidies are hard to withdraw, diverting
resources from more promising uses and threatening
continued impact on Ottawa’s bottom line.
Corporate Income
Tax Changes and
Tariffs Reductions
1.0 Likely positive. Profitable industries will be in a
better position to utilize the accelerated
depreciation, reducing scope of total effect.
Positive. Broad corporate tax reductions, such as
tariff elimination on business inputs, will boost
investment, more than offsetting concerns about
lasting impact on federal revenue.INDEPENDENT REASONED RELEVANT
have pressing needs and are likely to spend a larger proportion of income; hence, the rationale for targeted measures such as EI
benefit extensions and lower taxes for low-income households.  
Recommendations
Business measures, unlike consumer-based measures, should be broad-based and not targeted at specific industries and regions.
Governments have a bad record of picking winners and losers, and subsidies are hard to withdraw. Resources employed at sustaining
industries in decline tend to be diverted from more effective and promising use. The 2009 budget proposed over $6 billion in targeted
industry and regional supports. On the other hand, broad corporate tax reductions, such as elimination of tariffs on business inputs,
have a lasting impact on economic growth through their effect on investment.
Ultimately,  the ability of the federal government to rapidly eliminate the deficit rests in limiting program spending growth to
historically low levels. Given the risks posed by population aging, the need to control spending in the coming years and reduce overall
exposure to interest rate movements appears essential to achieving medium-term fiscal sustainability. Once balanced budgets are
achieved, surpluses should be put towards quickly eliminating the deficit accumulated over five years – rather than passing it on to
coming generations. The greater Canadians’ confidence on this score, the greater the likelihood that the economic stimulus in the
2009 federal budget will foster an early recovery. 
e-brief /5References:
Elmendorf, Douglas. 2009. “The State of the Economy and Issues in Developing an Effective Policy Response.” Congressional Budget
Office before the Committee on the Budget, U.S. House of Representatives, January 27.
Mintz, Jack and Michael Smart. 2003. Brooking no Favorites: A New Approach to Regional Development in Atlantic Canada. C.D. Howe Institute
Commentary. C.D. Howe Institute: Toronto.
Perotti, Roberto. 2004. “Public Investment: Another (Different) Look.” IGIER – Università Bocconi, Working Paper n. 277
Poschmann, Finn and William B.P. Robson. 2001. “Reprogramming the EI Cash Machine: Matching Employment Insurance Premiums
and Payouts.” C.D. Howe Institute Backgrounder. C.D. Howe Institute: Toronto.
Robson, William B.P., Alexandre Laurin and Finn Poschmann. 2009. “Lasting Bang for the Stimulus Buck: Priorities for the 2009 Federal
Budget.” C.D. Howe Institute e-brief. January.
Robson, William B.P. 2009. “Boomer Bulge: Dealing With the Stress of Demographic Change on Government Budgets in Canada.” C.D.
Howe Institute e-brief. January.
Romer, Christina and David Romer. 2008. “The Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal
Shocks” University of California, Berkeley Working Paper.
Spilimbergo, Antonio, Steve Symansky, Olivier Blanchard and Carlo Cottarelli. 2008. “Fiscal Policy for the Crisis” International Monetary
Fund Staff Position Note SPN/08/01.
This e-brief is a publication of the C.D. Howe Institute.
Alexandre Laurin is a Senior Policy Analyst, Colin Busby and Benjamin Dachis are Policy Analysts at the C.D. Howe Institute.
For more information call 1-416-865-1904.
This e-brief is available at www.cdhowe.org.
Permission is granted to reprint this text if the content is not altered and proper attribution is provided.
INDEPENDENT REASONED RELEVANT
e-brief /6

Out on a Limb: Assessing the Fiscal Sustainability and Effectiveness of the 2009 Federal Budget

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