Budget 2025 lays out an expansionary fiscal plan to help address numerous headwinds buffeting Canada’s economy. Spending is being refocused on industrial support, infrastructure, defense, and housing, financed in part by an ambitious plan to rein in direct program spending and shrink the public service. Measures to boost private investment are a step in the right direction.
The ultimate success of this budget will depend on execution – getting major infrastructure built, crowding in private investment, and delivering on fiscal consolidation. But first, the minority Liberals will need the support (or abstention) of a handful of opposition Members of Parliament (MPs) to pass it.
Overview
It has been more than 18 months since Budget 2024 – and nearly a year since the previous government’s ill-fated Fall Economic Statement – and much has changed in the interim.
There is a new government in Ottawa with campaign promises to deliver on. There is a new administration in Washington whose protectionist and isolationist policies threaten Canada’s economy and raise concerns about national security. And there are perennial challenges related to sluggish productivity growth, housing supply and affordability, and climate change.
At the same time, global bond investors are expressing growing concern about fiscal imbalances and punishing spendthrift governments with higher borrowing costs.
The Liberals campaigned on balancing these priorities by splitting the government’s finances into capital and operating budgets, with a plan to balance the latter via spending restraint while allowing persistent deficits in the former – long-term investments financed by long-term borrowing.
If delivered, the planned spending restraint allows the overall deficit to shrink from a sizeable 2.5% of GDP in the current fiscal year (FY) to 1.5% by the end of the projection horizon.
Budget 2025 follows through on that, planning to dramatically slow growth in direct program spending and shrink the public service by about 10% so that government revenues cover all non-capital spending (including debt servicing costs) by fiscal year 28/29. We think there are risks that they fall somewhat short of this sizeable fiscal consolidation.
But if delivered, the planned spending restraint allows the overall deficit to shrink from a sizeable 2.5% of GDP in the current fiscal year (FY) to 1.5% by the end of the projection horizon. That’s still a notable shortfall – particularly when combined with provincial deficits – and doesn’t do anything to shrink the federal debt load as a share of GDP.
The capital spending portion of the budget includes measures to help industries impacted by tariffs, funding for trade and local infrastructure, and new investments in defense and housing. That should be economically stimulative, but not all measures will necessarily boost productivity (and thus help pay for themselves) over time.
On net, the increase in capital spending is only about $10B annually over the projection horizon relative to the previous fiscal plan, although there is some ramp up in the current and upcoming fiscal years relative to FY 24/25.
At the very least, a greater focus on competitiveness, and re-orientation of spending toward more productive uses sends a positive signal that the government is taking Canada’s economic challenges seriously.
New and replenished incentives for private capital investment and efforts to advance major nation-building projects could provide more of a lift than their relatively low price tags suggest. But they will require the business sector to step up in the face of substantial uncertainty. It’s worth noting that Canada already had a relatively low marginal effective tax rate on new investment, yet business capex has stagnated.
Much of the impact of this budget will come down to execution and follow through by both the government and the private sector. But at the very least, a greater focus on competitiveness, and re-orientation of spending toward more productive uses sends a positive signal that the government is taking Canada’s economic challenges seriously.
Overall, the budget is perhaps not quite as bold from an investment and deficit perspective as some expected. We have been budgeting for a fiscal lift of about half a percent of GDP next year which still seems reasonable, although we could refine that estimate as we continue to sort through the details of Budget 2025.
It’s important to note that as a minority government, the Liberals will need the support (or possibly abstention) of a handful of opposition MPs to pass this budget. We think that’s likely given the Liberals’ relatively strong mandate – they are just three seats shy of a majority. Governments with such a strong plurality of seats have historically lasted longer than two years. And current polling suggests another election wouldn’t significantly change seat counts.
Fiscal outlook
The deficit for the current fiscal year (FY 25/26) is projected at $78B or 2.5% of GDP, roughly in the range of many pre-budget estimates but not quite as high as some projections. Still, that is more than twice the size of the previous year’s $36B deficit and well above the $42B shortfall previously projected.
Deficits remain sizeable in upcoming fiscal years, shrinking only gradually from 2.0% of GDP next fiscal year (FY 26/27) to 1.5% of GDP at the end of the projection horizon (FY 29/30). A shrinking deficit-to-GDP ratio is one of the government’s two new fiscal anchors.
The government plans to balance its operating budget (ensuring revenue covers all non-capital spending, including debt servicing costs) by FY 28/29 – the second of its two fiscal anchors. Deficits thereafter reflect capital spending of nearly $60B annually, about $10B more than the previous budget’s baseline and nearly double the $32B invested in FY 24/25.
Federal debt-to-GDP rises to 43.1% next year and doesn’t decline over the projection horizon. A falling debt-to-GDP ratio (over the medium term) was one of the previous government’s fiscal anchors. The pre-pandemic debt-to-GDP ratio was around 31%.
Major initiatives
Tariff response and trade diversification
The government is pledging $12B (half of which is classified as capital spending) to support strategic industries and workers impacted by U.S. tariffs. That includes $5B over six years for a new Strategic Response Fund ($1B of which is earmarked for the steel industry) and $3.7B over three years for enhanced Employment Insurance.
Aiming to double non-U.S. exports over the next decade, the Trade Diversification Corridors Fund will receive $5B over seven years to invest in port and rail infrastructure. Another $1B over four years goes to arctic infrastructure.
The budget provides operational funding for the previously announced Major Projects Office which aims to fast-track nation-building projects. The first projects being referred to the office include energy and mining projects and port infrastructure.
Private and public investment
Reinstating the Accelerated Investment Incentive (which was being gradually phased down) for most capital assets and allowing immediate expensing of other business capex (manufacturing, cleantech, digital, and intangible investment) is expected to cost $1.5B over five years.
The government claims these initiatives – collectively referred to as the Productivity Super-Deduction – will lower Canada’s marginal effective tax rate on new investment to 13.2% from 15.6%, the lowest in the G7 and 4.4 ppts below the U.S. rate (including OBBBA incentives).
A new Build Communities Strong Fund gets $51B over 10 years – some of which is repurposed from other, pre-existing funds – to support local infrastructure including transit projects, community centres, theatres and athletic facilities.
Defense
The budget proposes $82B in defense spending (on a cash basis) over five years, of which $9B was previously announced. Planned measures include increasing military pay, defense and training infrastructure, digital infrastructure and cyber-security, investments in vehicles and weaponry, and a new Defense Industrial Strategy to develop Canada’s defense industrial base.
As previously announced, the government will meet NATO’s 2% of GDP defense spending target this year with plans to reach 5% of GDP (including 3.5% direct military spending and 1.5% in infrastructure, cyber-security and related spending) by 2035.
Spending restraint
A comprehensive expenditure review is projected to save $44B over four years. With additional efforts to enhance government productivity and a handful of other measures, total savings are projected at nearly $60B over four years.
As part of the review, the government plans to right-size the federal public service which has grown by 40% over the past decade. The plan to cut 10% of public service jobs by FY 28/29 (about 40k positions) is expected to be achieved largely through attrition and early retirement incentives.
Direct program spending (which excludes transfers to individuals and other levels of government) is expected to grow by less than 1% annually, compared with an 8% average increase over the past decade. A nearly 5% reduction in projected direct program spending by FY 28/29 is about one-third the fiscal consolidation achieved in the mid-1990s.
Immigration
The government plans to admit 380k permanent residents annually in 2026-28, down slightly from 2025’s intake, although that does represent a slightly higher target for 2027. Temporary resident admission will be cut faster than previously planned, to 385k in 2026 and 370k in 2027-28. Overall, planned immigration inflows over the next two years are cumulatively 290k lower than the previous targets, restraining Canada’s population growth even further.
The government will spend $1.7B over 13 years to recruit international talent and will launch an accelerated pathway for U.S. H-1B visa holders in the coming months.
Housing (all previously announced)
The budget pledges $13B over 5 years for Build Canada Homes, a new federal agency aiming to expedite construction of affordable, non-market housing.
Eliminating GST for first-time homebuyers (on homes up to $1M, with reduced GST on homes between $1-1.5M) costs $3.9B over five years.
Personal tax measures (all previously announced)
Reducing the first marginal personal income tax rate from 15% to 14.5% this year and 14% in 2026 (and thereafter) costs $27B over six years.
Canceling the capital gains tax increase costs $23.6B over six years.
Repealing the digital services tax (in an effort to advance trade negotiations with the U.S.) costs $6.8B over six years.
Canceling the consumer carbon tax costs $4.2B in the current fiscal year.
Other initiatives
The government will scrap plans for an oil and gas sector emissions cap, suggesting a strengthened industrial carbon pricing scheme and regulations to reduce methane leaks make a cap unnecessary.
After the U.S. passed the GENIUS Act over the summer, the federal government plans to introduce legislation to regulate stablecoin issuance in Canada. As it stands, almost all stablecoins are pegged to the U.S. dollar.