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By Tegan Hill and Grady Munro
Following the recent release of the Carney government’s first budget, Fitch Ratings (one of the big three global credit rating agencies) issued a warning that the “persistent fiscal expansion” outlined in the budget—characterized by high levels of spending, borrowing and debt accumulation—will erode the health of Canada’s finances and could lead to a downgrade in Canada’s credit rating.
Here’s why this matters. Canada’s credit rating impacts the federal government’s cost of borrowing money. If the government’s rating gets downgraded—meaning Canadian federal debt is viewed as an increasingly risky investment due to fiscal mismanagement—it will likely become more expensive for the government to borrow money, which ultimately costs taxpayers.
The cost of borrowing (i.e. the interest paid on government debt) is a significant part of the overall budget. This year, the federal government will spend a projected $55.6 billion on debt interest, which is more than one in every 10 dollars of federal revenue, and more than the government will spend on health-care transfers to the provinces. By 2029/30, interest costs will rise to a projected $76.1 billion or more than one in every eight dollars of revenue. That’s taxpayer money unavailable for programs and services.
Again, if Canada’s credit rating gets downgraded, these costs will grow even larger.
To maintain a good credit rating, the government must prevent the deterioration of its finances. To do this, governments establish and follow “fiscal anchors,” which are fiscal guardrails meant to guide decisions regarding spending, taxes and borrowing.
Effective fiscal anchors ensure governments manage their finances so the debt burden remains sustainable for future generations. Anchors should be easily understood and broadly applied so that government cannot get creative with its accounting to only technically abide by the rule, but still give the government the flexibility to respond to changing circumstances. For example, a commonly-used rule by many countries (including Canada in the past) is a ceiling/target for debt as a share of the economy.
The Carney government’s budget establishes two new fiscal anchors: balancing the federal operating budget (which includes spending on day-to-day operations such as government employee compensation) by 2028/29, and maintaining a declining deficit-to-GDP ratio over the years to come, which means gradually reducing the size of the deficit relative to the economy. Unfortunately, these anchors will fail to keep federal finances from deteriorating.
For instance, the government’s plan to balance the “operating budget” is an example of creative accounting that won’t stop the government from borrowing money each year. Simply put, the government plans to split spending into two categories: “operating spending” and “capital investment” —which includes any spending or tax expenditures (e.g. credits and deductions) that relates to the production of an asset (e.g. machinery and equipment)—and will only balance operating spending against revenues. As a result, when the government balances its operating budget in 2028/29, it will still incur a projected deficit of $57.9 billion when spending on capital is included.
Similarly, the government’s plan to reduce the size of the annual deficit relative to the economy each year does little to prevent debt accumulation. This year’s deficit is expected to equal 2.5 per cent of the overall economy—which, since 2000, is the largest deficit (as a share of the economy) outside of those run during the 2008/09 financial crisis and the pandemic. By measuring its progress off of this inflated baseline, the government will technically abide by its anchor even as it runs relatively large deficits each and every year.
Moreover, according to the budget, total federal debt will grow faster than the economy, rising from a projected 73.9 per cent of GDP in 2025/26 to 79.0 per cent by 2029/30, reaching a staggering $2.9 trillion that year. Simply put, even the government’s own fiscal plan shows that its fiscal anchors are unable to prevent an unsustainable rise in government debt. And that’s assuming the government can even stick to these anchors—which, according to a new report by the Parliamentary Budget Officer, is highly unlikely.
Unfortunately, a federal government that can’t stick to its own fiscal anchors is nothing new. The Trudeau government made a habit of abandoning its fiscal anchors whenever the going got tough. Indeed, Fitch Ratings highlighted this poor track record as yet another reason to expect federal finances to continue deteriorating, and why a credit downgrade may be on the horizon. Again, should that happen, Canadian taxpayers will pay the price.
Much is riding on the Carney government’s ability to restore Canada’s credibility as a responsible fiscal manager. To do this, it must implement stronger fiscal rules than those presented in the budget, and remain accountable to those rules even when it’s challenging.
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