Snow and ice build up on the roof of the Confederation building on Parliament Hill on Feb. 18.Sean Kilpatrick/The Canadian Press
Canada’s next prime minister will face a tough decision as the country faces steep U.S. tariffs and other fiscal headwinds: Add more to the national debt or cut spending elsewhere to finance new priorities.
Prime Minister Justin Trudeau’s government has been heavily scrutinized for increasing spending year after year, with no plan to balance the federal budget. The fall economic statement projected the federal deficit will come in at $48.3-billion in the 2024-25 fiscal year. While critics may hope his successor will prioritize fiscal restraint, the task of reducing the deficit and the country’s debt load will likely get significantly harder.
“I do think higher deficits are almost inevitable right now for Canada,” said Desjardins deputy chief economist Randall Bartlett in an interview.
For one, U.S. President Donald Trump continues to threaten broad-based tariffs after announcing 25-per-cent levies on aluminum and steel starting March 12. If Canada enters a full-blown trade war, the federal and provincial governments will likely need to dole out support for affected industries and workers.
Ottawa is also facing pressure to increase defence spending to reach NATO’s target. Conservative Leader Pierre Poilievre and Liberal leadership front-runners Mark Carney and Chrystia Freeland have promised to work toward reaching the benchmark of 2 per cent of gross domestic product.
On the revenue side, U.S. tariffs would slow down the Canadian economy, which would weigh on personal and corporate tax revenues. The federal government has also delayed its proposed increase to the capital-gains inclusion rate, which was supposed to raise more than $19-billion over five years. The Conservative Leader, as well as Mr. Carney and Ms. Freeland, have all pledged to scrap the increase and cut other taxes. A federal campaign is likely to come with other costly promises.
Although federal finances today aren’t where fiscal hawks would like them to be, a new Desjardins report suggests the federal government has the fiscal room to increase spending. The report, which focuses on whether Ottawa has the money to respond to tariffs, estimates it could increase spending by a one-time $100-billion in the 2025-26 fiscal year and still keep the federal debt-to-GDP ratio below the pandemic peak of 47.2 per cent.
“Regardless of what one’s views are on current program spending … Canadian federal finances are among the best in the developed world, among certainly major advanced economies,” Mr. Bartlett said.
“That’s allowed the federal government, I think, to have some room if it does need to provide stimulus for individuals and companies that are going to be impacted by potential tariffs from the U.S.”
The fiscal picture becomes less rosy when provincial, territorial and local finances are taken into account. As a percentage of GDP, consolidated government debt in 2023 was 103.5 per cent, according to Statistics Canada.
Decisions on how to pay for tariff-related supports or increased defence spending will be up to whoever is prime minister after the next federal election, which is expected to be called sometime after the Liberal leadership race concludes on March 9.
McGill University economics associate professor Christopher Ragan said it would be “fiscally lazy” to respond to the challenges Canada faces with more debt-financed spending. Instead, he suggested the next government should consider a more thoughtful version of Elon Musk’s “department of government efficiency” in the United States.
“I’m not suggesting hacking and slashing. I’m suggesting something much more like what [then-finance minister] Paul Martin did in the mid-1990s with program review,” Prof. Ragan said.
“If you really want to free up money, what you need to look at is programs that are costing a lot of government money. And then ask yourself, do we really need those programs?”
The Desjardins report suggests a future government could look for savings in direct program expenses, which reflect the cost of running government departments and programs as well as other transfer payments. While major transfers to persons and other levels of government have returned to prepandemic levels, the report notes direct program expenses are still elevated.
Both the Conservatives and Liberals have acknowledged spending cuts will be needed to finance their parties’ plans and appear to be eyeing cuts to the federal public service. Mr. Poilievre has promised to cut international aid and find one dollar of savings in government for every dollar of additional spending. The Conservative Leader has also said he wants to reduce the number of bureaucrats in Ottawa, while Mr. Carney and Ms. Freeland have said they would find savings in the cost of running government.
Mr. Carney has also proposed a new approach to federal finances, promising to balance the government’s operating budget, which reflects its day-to-day expenses on things like workers’ wages and transfers to provinces, within three years. Government could then borrow to finance capital expenditures, which includes spending on assets such as infrastructure and military equipment.
Prof. Ragan said that approach would make sense: It would encourage the government to cover its operating expenses from its revenues and borrow to pay for investments that would theoretically reap benefits over a longer period of time.
“As an economist who thinks about fiscal policy, I mean, this is one of the things that we love,” Prof. Ragan said about Mr. Carney’s proposal.
Mr. Bartlett said the challenge, however, is that governments are rarely constrained by self-imposed limits to spending. Instead, he said it takes a real fiscal crisis – like the one Canada experienced in the 1990s – for governments to wean themselves off debt-financed spending.
“I think when restraint becomes binding is when there’s no other option,” he said.
Editor’s note: (Feb. 19, 2025): This article has been updated to correct the title of Desjardins deputy chief economist Randall Bartlett.