Yesterday’s federal budget confirms the Trudeau government’s ongoing fiscal trajectory of higher program spending, more deficits and debt, and ultimately bigger government. A key difference from recent years however is that it also sets out significant new tax increases—including a higher capital gains tax rate—that begin to raise revenues to match the government’s higher levels of spending. This should be understood as a possible step towards a permanently larger government. 

Let’s start with a short history. When the Trudeau government was first elected in 2015, federal program spending was roughly $250 billion (or about 12.5 percent of GDP) per year. Although the incoming government intended to increase spending on the margins based on “modest,” short-term deficits, its overarching fiscal policy message was mostly one of continuity with its predecessor. In fact, if anything, the 2015 Liberal Party platform lamented “the Harper legacy of chronic deficits” and promised to restore “fiscal prudence.” 

Instead, the government’s first budget increased program spending by 6 percent and it never looked back. Program spending was up by 36 percent over just five years even before the pandemic hit. The government as a share of GDP gradually began to grow. 

This trend of higher spending and bigger government has continued in the post-pandemic years and is reaffirmed in the new budget. This year’s projected program spending is now nearly double the level that it was ten years ago in the Harper government’s final year in office. It’s projected to hit more than $544 billion by 2028-29. Program spending as a share of GDP is now roughly three percentage points higher than it was when the Trudeau government was first elected and the highest it’s been in 30 years. 

Recap: the Trudeau government came to office understating its plans to grow program spending and the size of government itself. It has subsequently gone about systematically increasing both mostly using deficit financing. Revenue as a share of GDP (particularly if one backs out the federal carbon tax which is supposed to be revenue neutral) has experienced minimal change.  

Two recent developments however have seemingly shifted the Trudeau government’s deficit-financed plan to grow the size of the federal government. The first is the increase in its borrowing costs. In a higher-interest rate world, it’s simply more expensive to increase the size of government without taxpayers paying for it. It’s notable for instance that annual public debt charges have more than doubled since the government took office and are now the equivalent of total GST revenues. 

The second is that the government and its proponents have become more straightforward about the case for bigger government. Perhaps liberated by their poor election prospects, they’ve abandoned old euphemistic arguments in favour of the decidedly progressive case that government “got too small” following the global financial crisis and the Trudeau government’s legacy is to right-size it.  

The budget’s tax increases—including nearly $20 billion over five years from the capital gains tax hike alone—are a manifestation of this new political economy reality. They should be understood as a first (but hardly last) step to backfill Ottawa’s large-scale spending growth over the past near-decade.  

It reflects the inverse of the common notion that tax-cutting conservatives—particularly in the U.S.—have pursued a fiscal policy strategy to “starve the beast” by cutting taxes to such a level that there eventually becomes no choice but to cut the size of government to bring it in line with tax revenues. 

The Trudeau government has effectively sought the opposite strategy—what one might call “gorge the beast.” It has driven up government spending so high using deficit financing that it’s now saying we need to raise taxes in order to pay for its higher public expenditures. 

One consequence is that it potentially sets up a starker set of political choices than we’ve had in the recent past. Cheap borrowing costs had enabled the Trudeau government to both promise more spending and low taxes. Canadians were effectively able to get big government for a discount. 

Rising borrowing costs and the government’s own progressivism have begun to bring an end to that fiscal bargain. Taxes will eventually have to increase more broadly to sustain the Trudeau government’s inexorable spending ambitions. Canadians will ultimately have to decide if it’s worth it.  

It ought to create a clear choice in the next election: did the government indeed get “too small,” and, if so, are Canadians prepared to pay for it to get bigger? 

Thank heavens it’s almost over! Canada has a cottage industry of folks employed in the business of developing, forecasting, assessing, and evaluating government budgets. It’s quite unlike many other parts of the world particularly given how seasonal the trade is with activity usually lighting up when the first major province releases a budget—often British Columbia in February—and culminates in budgets from the federal government and the biggest provinces. The season is almost at an end, for now.

Canada’s federal government releases its annual budget on Tuesday. Much of what it will contain has already been spilled. Long gone is the era when budgets would be all new on budget day, followed by business leaders attending evening and morning-after presentations and meetings by economists as well as accounting and consulting firms. For years now, governments have used budgets as rolling P/R stunts. Imagine a company that releases its financials in bits and pieces over weeks in advance as routine habit.

It’s no secret that it will be a big spending budget that will probably hit relatively upper-income earners and corporations with higher taxes while never targeting a balanced budget. Key in terms of whether the latter matters or not is whether the assumption of a beautiful economy for years to come through the decade’s end comes to fruition given the rise of structural deficits that could be substantially magnified by a wider primary deficit in a weaker scenario. Ottawa is sending it out faster than it comes in on the assumption that the skies stay sunny forever; this assumption through the 1970s and 1980s ultimately led to a crisis.

Canadian governments are not lightweights when it comes to debt. Many cite net debt-to-GDP ratios that are healthier, but do so on the implied assumption that the financial assets in sinking funds, sovereign wealth funds, pensions, etc. are accessible. 

But for now, the manageable deficits are one thing. The impact on the economy from heavy spending is another. The federal government’s program spending has skyrocketed by about one-third compared to the fiscal year just before the pandemic and is slated to be 60 percent bigger than pre-pandemic levels by FY 2028–29. If not for such spending by the Feds and provinces, the Bank of Canada would not have had to hike its policy rate by as much as it has and might have already been in a position to begin easing.

Expect a strong focus on housing. The government created a problem with severe housing shortages through the serial application of demand-side stimulus and wildly excessive immigration and is now trying to fix that with sundry incentives to build more housing. Its target of 3.9 million additional homes to be built by 2031 is laughable. Canada would have to sustainably ramp up annual housing starts to much more than double what has ever been achieved in any prior year and despite labour shortages.

The housing plan they have announced has some constructive elements, such as training for the skilled trades, but its targets are a pure and simple photo-op. The targets also assume there will be demand for the type of housing they are trying to encourage—cheap units on public lands, factory-built homes, and homes like the ones built in mass fashion for returning soldiers after the Second World War that have since driven a booming business in tear downs and rebuilds.

Alongside such fanciful supply-side ambitions are curious efforts to further stimulate demand despite already widespread housing shortages. I wrote about the plans to ease mortgage financing here.

As for taxes? That depends upon how you define the middle class and how you adjust this definition for different types of families, different regions, and varying individual circumstances. We’re told the middle class will be left unscathed but are unclear about how the Feds will define this. At risk is hiking taxes on the folks who drive much of the growth, and further vilification of successful industries and, by the government’s definition, anyone outside of the middle class doesn’t work hard…

We will be assessing the implications of the Budget for the Bank of Canada in light of its recent communications (recap here) and the fact it has yet to incorporate anything on the budget in its forecasts. How ratings agencies respond may be a risk.

Finally, it would be extraordinarily naïve to assume that whatever is announced on Tuesday will be the end of the government’s plans. Canada faces an election by no later than October 2025. Governments that are doing as badly in the polls as the Trudeau-Singh-Freeland administration is performing don’t typically turn fiscally prudent. Bear that in mind in terms of the prospect for further fiscal easing that complicates the outlook for the BoC and that entails drawing implications for debt management and issuance plans beyond what is laid out this week.

This excerpt was originally published at Scotiabank.com.