Key Points

• Deficit rises to $78.3 billion in 2025/26 from $36.3 billion last year, easing to $56.6 billion by 2029/30 for a cumulative deficit over the next five years of $321.7 billion
• Focus on capital spending intended to reinvigorate Canada’s ‘productive capacity’, and some trimming of the ‘operating' budget
• Defence spending will almost double in 2025/26 to $63 billion
• Very little new information on major projects
• New Climate Competitiveness Strategy focused on industrial carbon pricing and investment tax credits. Oil and gas emissions cap not officially removed, though the budget indicates it may not be necessary 
• Select measures to improve tax competitiveness
• New immigration targets

Context matters

Before diving into the federal budget Prime Minister Mark Carney and Finance Minister Francois-Philippe Champagne delivered yesterday, let’s set the economic stage: 

• Pre-Trump 2.0 - Canada faced some structural economic challenges even before the trade war: chronically weak productivity and private investment (see the chart below taken from the budget). 
• Post Trump 2.0 - The trade war exacerbated and shone a light on these challenges, and increased the urgency to act now, especially in expanding into overseas markets.

The mantra that’s been echoing nation-wide for dealing with these problems is: 1) build things faster; 2) expand into overseas markets; and 3) knock down internal trade barriers.

It is through this contextual lens we review yesterday’s budget.

Our quick take: The shift towards capital spending - the federal government hopes the budget will “catalyse $500 billion in new private sector investments over the next five years” - makes sense given the long-standing investment and productivity problem in Canada. However, the budget carries significant risk - namely, execution risk that government investments don’t materialize into the desired private spending and fiscal risk as borrowing costs increase and the debt to GDP ratio remains permanently higher.  

Dollars and sense - A quick look at the headline numbers

The deficit clocks in at $78.3 billion, the highest on record outside the pandemic. The debt-to-GDP ratio, a key metric of fiscal sustainability, rises to 43.3% in 2027/28, up from 41.2% in 2024/25, and stays above 43% over the forecast period.

The larger deficit is a combination of shrinking revenue (down 0.7%) and higher spending (up 6.9%) in 2025/26.

*Includes debt servicing costs but excludes actuarial losses.  

Major themes

Using fiscal fire power - The International Monetary Fund (IMF) has previously said that Canada has fiscal wiggle room to spend, given its relatively strong position among G7 countries. But spending should be ‘productive’ on things like reducing barriers to labour force participation, investing in infrastructure and increasing AI adoption. In this budget, the government justifies its higher spending as being ‘productive’.

During an economic emergency or slowdown, deficits can be expected. The key is to develop a plan to return to balance and bring down the debt-to-GDP ratio. The government has two “fiscal anchors”: 1) bring the “operating budget” into balance by 2028/29; and 2) reduce the deficit-to-GDP ratio over time. However, the government abandoned its previous anchor to reduce the debt burden, as typically measured by debt-to-GDP, over time.

Build, baby, build - The budget plans to focus on productivity-enhancing investments to reverse the trend we highlight above. The federal government’s spending on capital investment will nearly double from $32.2 billion in 2024/25 to $59.6 billion in 2029/30.

The budget says the first five projects referred to the Major Projects Office for "acceleration" collectively represent $60 billion in total public and private sector capital investment, with an additional list of “nation-building projects” worth $90 billion to be announced later this month. Specifics about these projects, including target sectors, remain undisclosed. The Alberta-based Pathways Plus carbon capture and storage initiative was described as an early-stage project requiring further development.

The question now is all about execution risk. Will it be enough to revitalize private sector investment? Note that the government financing vehicles (e.g. grants, tax credits and loan guarantees) are intended to bolster private investment. But there is no guarantee. If it’s public money that doesn’t leverage new private capital, we’ll keep on the same weak track of government-driven and consumer-driven economic growth. Further, enhancing productivity through capital spending takes time, whereas operating spending (e.g. hiring staff) tends to be more immediately felt. An open question is whether Canadians will have the patience to see these investments materialize.

Tightening the operating belt - As expected, the budget proposes to return the day-to-day operating deficit to zero by 2028/29. This will require direct program expenses (excluding capital investment) to fall by 1% annually over the next four years while capital expenses grow by 8.4% per year, major transfers to persons by 4.4%, and transfers to provinces and territories by 3.4%.* A Comprehensive Expenditure Review is expected to save $13 billion annually by 2028/29. After a major ramp up over the last decade, the budget promises to reduce the size of the federal public services from 368,000 to 330,000 by the end of 2028/29, to bring it more in line with population growth.

*Compound annual growth rate between 2025/26 and 2029/30

Climate policy to focus on competitiveness - Budget 2025 signals a fundamental shift in Canada’s approach: away from overall emissions targets and towards emissions intensity relative to Canada’s global peers. The budget even highlights the emissions intensity advantage Canada has over other countries in the power and oil and gas sectors (see chart below, drawn from the budget).  

A cornerstone of the plan is industrial carbon pricing. Recall that the Carney government, effective April 1, eliminated the consumer carbon tax. It now wants to achieve large-scale emissions reductions through strengthening the industrial pricing signal. Details are sparse, but the general plan is to develop a post-2030 carbon price trajectory (with the provinces and territories) that targets net-zero by 2050, work to harmonize industrial pricing systems across the country, maintain a minimum benchmark price, and continue to issue federal contracts to try to improve carbon price certainty.

The status of the oil and gas emissions cap is unclear. The budget indicates that given current policies, “the oil and gas emissions cap would no longer be required as it would have marginal value in reducing emissions”. Whether this means the cap disappears is an open question, but it's the strongest signal to date that it may not proceed. Finance Minister Champagne underlined the new approach to the cap at a news conference before tabling the budget Tuesday. "There are a number of steps that need to happen. And when conditions are met, we won't need the cap anymore. But the conditions will have to be met.”

In addition to the industrial carbon price, the government will rely on incentives in the form of investment tax credits. Relevant to Alberta, the budget proposes to extend the availability of the full carbon capture, utilization and storage tax credit by five years. Outside the oil and gas emissions cap, other climate regulations remain in place like the Clean Electricity Regulations, and Clean Fuel Regulations. The budget did not propose to repeal the Oil Tanker Moratorium Act (Bill C-48) or mention the building of a west coast pipeline (though a second tranche of major projects is expected to be announced by Grey Cup).

Selective improvements to tax competitiveness - The budget announced a set of “Productivity Super-Deduction” measures aimed at reducing the marginal effective tax rate by allowing businesses to write off the cost of certain investments more quickly. This is something business groups were urging, especially given the full expensing provisions in the U.S. under the One Big Beautiful Budget Bill. Among the measures is the reinstatement of the Accelerated Investment Incentive, which applies to most capital assets. However, the full expensing (100% deduction) is temporary and only applies to select assets: manufacturing machinery and equipment, capital R&D, clean energy, and select “productivity-enhancing investments” like AI, data networks, and computers.

One missing piece in this budget is a so-called “patent box”, proposed in the Liberal platform and the subject of recent federal consultations. A patent box taxes the return from income derived from intellectual property at a lower corporate tax rate, with the goal of encouraging more scaling of start-ups and the commercialization of research & development (R&D) in Canada (a long-standing challenge). While the Scientific Research and Experimental Development (SR&ED) tax credit was expanded to include “public” Canadian companies, and the eligible spending was lifted from $4.5 million to $6 million, the federal government continues to front-load tax support to spending, with less focus on rewarding the returns to R&D.

On the housing front, the budget carries through on promises to eliminate the GST for first-time home buyers on new homes valued at or less than $1 million, with a reduced rate on those valued $1-1.5 million, and proposes to eliminate the Underused Housing Tax.

Arming Canada - The budget proposes to provide $81.8 billion in defence spending over five years starting in 2025/26, to “rebuild, rearm, and reinvest” in the Canadian Armed Forces. Key investments include:

• $20.4 billion on recruitment, pay raises and health care support
• $19.0 billion on defence infrastructure
• $10.9 billion for upgrades to digital infrastructure and cyber defence
• $17.9 billion to expand Canada’s military capabilities such as armoured vehicles, counter-drone and long-range precision strike capabilities, and domestic ammunition production
• $6.6 billion to strengthen Canada’s defence industry through a Defence Industrial Strategy
• $6.2 billion to expand Canada’s international defence partnerships

The budget is less clear regarding how Canada will meet the NATO Defence Investment Pledge of investing 5% of GDP in defence by 2035.

Immigration re-think - Fewer international students and foreign workers - The federal government is aiming to reduce the number of immigrants, and especially temporary residents, it allows into Canada. The new Immigration Levels Plan:

• reduces the target for permanent resident admissions from 395,000 in 2025 to 380,000 per year for the next three years
• increases the target for economic immigrants* from 59% to 64%
• reduces the target for temporary resident admissions (mostly workers and students) from 673,650 in 2025 to 385,000 in 2026, and 370,000 in 2027 and 2028
• includes a one-time measure to accelerate the conversion of up to 33,000 work permit holders to permanent residency.

The budget restates the previously announced proposal to provide $97 million from existing departmental resources over five years to establish the Foreign Credential Recognition Action Fund to work with the provinces and territories to improve foreign credential recognition, with a focus on health and construction sectors.

There are no details, but the budget says the federal government will “launch an accelerated pathway” for H1-B visa holders* as part of its International Talent Attraction Strategy and Action Plan. The U.S. recently added a US$100,000 fee to H1-B applications in an effort to address what it describes as the use of the program to “replace, rather than supplement, American workers with lower-paid, lower-skilled labor.”

As an “early measure” under the International Talent Attraction Strategy and Action Plan, the budget proposes a one-time initiative to recruit over a thousand highly qualified international researchers to Canada that would include up to $1.7 billion for a suite of recruitment measures.

*Immigrants who have been selected for their ability to contribute to Canada's economy through their ability to meet labour market needs, to own and manage or to build a business, to make a substantial investment, to create their own employment or to meet specific provincial or territorial labour market needs.

Answer to the previous trivia question: The average price of a barrel of West Texas Intermedia crude oil in October was US$60.07.

Today’s trivia question: How many different federal Finance Ministers have there been since Confederation?