Price inflation affects both sides of the budgetary balance: higher revenues and expenses.
Revenues: Higher prices for Canadian-produced goods and services lead to higher incomes and in turn higher tax revenue. That said, the personal income tax system is indexed, which means that income tax brackets and credits rise with CPI inflation to ensure that Canadians only pay additional taxes on real income gains.
Expenses: Various government benefits and transfers are indexed to inflation/CPI, resulting in higher expenses, impacting multiple years as benefits are calculated based on previous years data.
Net impact of inflation on budgetary balance: While the specific amount of revenue and expenses attributable to a given inflationary episode cannot be quantified with certainty, sensitivity analysis in Budget 2024 table A1.14 is informative:
A 1 percentage point increase in nominal GDP growth proportional across income and expenditure, resulting solely from higher GDP inflation (assuming that the CPI moves in line with GDP inflation), would tend to improve the forecast budgetary balance by $2.3 billion in the 1st year, $2.6 billion in the 2nd, and $1.9 billion in the 5th.
