News that the federal government will be releasing the 2007 Economic & Fiscal Update on Tuesday has analysts anticipating tax cuts.

TD Bank notes that it was recently reported there’s a $13.8 billion federal surplus for 2006-07, compared to a budget estimate of $9.2 billion, and an $8.7 billion surplus for the first five months of 2007-08, $1.5 billion ahead of the surplus for the corresponding period the previous year. “The large surpluses, together with intentions announced in the Speech from the Throne, have lead to speculation there may be broad-based tax relief in the Update,” it says.

TD Economics has taken its economic forecast and updated the fiscal outlook to provide an assessment of the fiscal capacity to cut taxes. The projections in the Update will differ because Finance uses the average of private sector economic forecasts (TD Economics is a bit more pessimistic on economic prospects than the average) and does its own fiscal projection. Nevertheless, the numbers provided here should be indicative of what will appear in the Update.

The TD Economics fiscal projection says the 2007-08 surplus is estimated at $14.5 billion. The surplus grows every year thereafter. For 2008-09 it is projected to be $16 billion. The government has committed to paying down $3.0 billion a year against the debt. That leaves $13.0 billion that could be allocated to new initiatives. For 2009-10 the surplus is projected to be $16.5 billion, leaving $13.5 billion after the debt payment.

Beyond 2009-10 the surpluses grow quickly as revenues rise faster than program spending and interest payments on the public debt are flat, it says. By 2012-13, for example, the surplus is projected to be $27.5 billion, leaving $24.5 billion for fiscal action after the debt payment. By 2012-13, the federal debt-to-GDP ratio could be down to 17.9% if no additional fiscal action is taken. If only the $3.0 billion annual payments are made the ratio would be 23%. In either case the Government’s target of a 25% debt-to-GDP ratio would be met.

The TD Economics fiscal projection suggests the federal government has ample room to deliver broad-based tax relief. The second point cut in the GST rate could be made effective immediately as it lops around $5.5 billion off revenues annually, it says.

However, TD says that hopefully a GST cut will not be a priority as it does nothing to address the competitiveness needs of the economy. “Instead, the priority should be personal and corporate income tax cuts,” it says. “The government has spoken in favour of extending income-splitting beyond pensions to include all forms of income but has balked at the cost. But at around $5 billion per annum, it could clearly be financed under these projections.” Alternatively, the marginal personal income tax rates for low-to-middle income class taxpayers could be reduced by cutting the tax back rates on various social payments such as the Canada Child Tax Benefit, the low-income GST credit or Guaranteed Income Supplement payments.

A one point cut to the general corporate income tax rate costs around $1 billion per year, TD says. “The opportunity is there for a bold move to deliver substantial personal and corporate income tax relief that, if structured appropriately, would raise the economy’s productive capacity limit,” it says.

Global insight calls for the government to reduce the lowest marginal rate from the current 15.5% down to 15.0%, which it says would come at a fiscal cost of just under $2 billion per year. It says it should accelerate the planned reductions in the corporate income tax by taking it from the current 21% down to 20% effective January 1, 2008, at fiscal cost of just under $2 billion. Also, the firm recommends some reduction to marginal rates of personal income tax at the midrange, such as eliminating the 26% bracket (tax on income between $73,000 and $119,000 would then be 22% instead of 26%) — again, at a fiscal cost just over $2 billion.

The government should specifically not use the fiscal room currently available to accelerate the timing of second GST reduction, currently budgeted for 2010/11, it says. “This GST cut has some potential to indirectly provide incentive for increased business investment if it can be delivered as part of a package of harmonization of the GST with the provinces,” the firm adds.

@page_break@“The proposed tax reductions are the classic broad-based tax cuts, with the expected positive impacts on the strength of the Canadian economy. Specifically, the proposed cuts will strengthen the incentives for people to seek more and better employment opportunities. On the corporate side, the income tax reduction will increase the incentive for companies to invest and to be innovative. While much of the tax relief is focused on the lowest-income taxpayers, all individuals and families would share in the benefits of this proposed tax relief, as would all corporate taxpayers,” it says.