Let's get real about budgets and deficits

What the right refuses to acknowledge is that capital investment in long-term economic growth results in increased revenue and smaller deficits down the road.

Finance Minister François-Philippe Champagne and Prime Minister Mark Carney.

In the lead up to the November 4 budget, a lot of irresponsible and misleading arguments about budgets and deficits have been put forward by the Conservative Party, Canadian business leaders, the interim Parliamentary Budget Officer, and think tanks like the C.D. Howe Institute.

The gist of the misleading commentary is that federal government spending is out of control and that this is resulting in Canada’s fiscal situation being, in the words of Jason Jacques, the interim Parliamentary Budget Officer (PBO), “stupefying,” “shocking,” and “unsustainable”. Yes, he actually used those words during a recent appearance before the House of Commons government operations and estimates committee.

An October 7 missive from the C.D. Howe Institute builds on the PBO report and borders on the hysterical by concluding with “The last thing Canadians need from the coming budget is a fiscal track even more alarming and unsustainable than the one we are now on.” C.D. Howe projects a 2026-27 deficit in the $85-90 billion range, up from the $68.5 billion projected by the PBO in 2025-26.

Now, while the C.D. Howe deficit projection seems a little high, it is possible that with all the new defense, infrastructure and housing spending (i.e. capital investments under the new budget accounting framework), the deficit could actually be in the $85 - $90 billion range. But would a deficit of that size necessarily be bad?

Not at all. Let me explain.

First of all, there is no absolute number that makes a deficit good or bad. It all depends on the overall size of the economy and that makes the debt-to-GDP ratio the most important marker for fiscal health.

So how is Canada doing on that score?

Not bad at all, it turns out. Canada’s debt-to-GDP is the lowest in the G7 by a good margin with traditionally fiscally conservative Germany (in 6th spot) considerably more profligate.

Yes, deficit hawks will argue, but this metric excludes provincial debt which is substantial. True, Canada is a federated country in which the provinces are responsible for health and education spending so provincial spending and debt are not insignificant. But even by the combined measure, Canada only moves up a bit in the G7 pack.

When combining national and sub-national debt, Japan is the outlier at 230%, driven by an ageing population. Italy and United States follow at 140% and 122.6%, respectively. By this measure, Canada loses its top spot in the G7 but still sits at a very respectable 74.8%, well below the U.S. Germany maintains the lowest ratio at 70%, reflecting its historically conservative fiscal stance.

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But the real argument for an increase in capital spending in a budget (and therefore a modest, short term increase in the debt-to-GDP ratio) is that this sort of spending is a strategic investment in long-term economic growth and productivity which results in increased revenue and smaller deficits down the road.

For example, capital spending builds infrastructure—roads, transit, energy systems—that directly supports economic activity. Moreover, investment in capital projects tends to have a higher fiscal multiplier than operational spending, stimulating job creation and private investment.

Public capital investment can also attract private sector co-investment. That is not to say that all (or even most) of Canada’s P3 models are necessarily well thought out (Ontario’s P3 model, especially for building large-scale transit projects, is borderline dysfunctional because the advertised risk transfer to the private sector never really takes place. As unanticipated problems present themselves, the private consortia partners keep coming back to government for more). But catalyzing private investment through well-targeted public investment can be made to work. You just have to get the details right.

At a slightly more technical level, capital spending can be amortized over decades, smoothing the fiscal impact and aligning costs with benefits. The new capital accounting framework for the federal budget unveiled a few weeks ago, makes this clear.

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So the 2026-27 budget to be presented on November 4 is going to show an increase in the deficit from roughly $70 million in 2025-26 to maybe $85 billion. All of this increase will be driven by capital spending. The question is, if this sort of spending enables large-scale, future-oriented projects—housing, infrastructure, clean energy, digital networks—that underpin long-term prosperity and increased revenues down the road, what are the Conservatives, the C.D. Howe Institute, etc. complaining about?

The co-authors of the C.D. Howe brief, Don Drummond, William Robson and Alexandre Laurin, have been around a very long time. They’re pretty smart guys and they certainly understand the arguments for an increase in capital spending. What are they up to?

Well, they let the cat out of the bag with this line in their October 7 document:

Given the confidence-sapping trade frictions Canada already faces, and a federal fiscal stance so oriented toward spending and so little toward growth-enhancing tax changes, the PBO’s assumptions look optimistic.

In other words, the C.D. Howe folks want tax cuts, especially corporate income tax (CIT) cuts, and are more explicit about this in an April 2 document entitled Sustainable Growth-Friendly Tax Reform: The 2025 Shadow Budget. In that document, they recommend reducing the federal CIT rate from 15% to 13% by 2027.

And because they believe a deficit driven by capital spending has more legitimacy than a deficit driven by undifferentiated spending, not once in the October 7 document do the C.D. Howe folks mention capital spending. Spending, as in too much spending, they mention a lot - but not capital spending. This, despite the fact that Carney and his Finance Minister, François-Philippe Champagne, have widely advertised the budget as one of “next generation projects”.

In fact, Champagne has, rather extravagantly stated that “This is like 1945… the moment where Canada needs to reinvent itself.” In other words, he’s positioning the budget as a down payment on future prosperity, akin to post-war reconstruction.

So that is pretty much what the right side of the political spectrum is up to with their broad criticism of budget deficits and their silence on the capital spending priorities of the upcoming Carney budget. They want corporate tax cuts and deregulation now and don’t want their tax cuts crowded out by capital spending. That is why they have no patience for the argument that such investments increase revenue and reduce deficits down the road.

Of course, there is room for criticism of the Carney approach to fiscal matters. Carney has asked his ministers to look for cuts in operational spending of 15% by 2028 with provincial transfers (Canada Health Transfer, Equalization, etc.) as well as statutory benefits (e.g. CPP, EI, OAS) protected. Given Canada’s relatively healthy fiscal situation relative to other G7 nations described above, I am not convinced this is necessary.

But that sort of criticism must come from the left, not the right, and at the present moment the left is in a sorry state, indeed.