Trump tariff war could trigger flood of red ink in Canada no matter who wins the federal election
Election front-runners Mark Carney and Pierre Poilievre are making promises that sound like those made in most other elections as they crisscross the country: new spending and tax cuts on things people want to hear about, such as housing and energy, and vague promises to pay for it by trimming the fat.
But this election is different, given that Canada may soon be facing a host of substantial new costs as it reconsiders its relationship with the United States in the wake of U.S. President Donald Trump’s trade war .
Those costs include direct financial support as a result of a slew of tariffs that have been imposed or threatened, as well as costs associated with reorienting the Canadian economy toward other markets, building supply chain resilience and expanding military spending to meet North Atlantic Treaty Organization (NATO) commitments. The potential for a wider economic slowdown and possibly even a revenue-sapping recession will only add to the bill.
“The bottom line is it’s going to be expensive,” said Rebekah Young, a vice-president and economist at the Bank of Nova Scotia who published a report last month that considered the early impact of U.S. policies on Canadian “ballot box” budget issues.
“Irrespective of what leaders set out as their platforms over the coming weeks, if we find ourselves in a much darker place, they’re going to have to rewrite some of those fiscal plans, or it’s going to be rewritten for them.”
She said nothing has tamped down her view since penning her report, with the risk of the darker scenarios she envisioned, including costly stimulus programs in Canada, only increasing after Trump unleashed varying levels of double-digit tariffs on more than 50 trading partners on April 2, even though he then delayed the stiffest tariffs until July.
“If we face much more serious economic shocks, particularly coming from south-of-the-border policies, whoever is leading the country is going to be ratcheting up stimulus programs,” Young said, pointing to programs rolled out to stabilize the economy following the shocks from the great financial crisis in 2008 and the COVID-19 pandemic in 2020.
That doesn’t appear to be slowing the pace of promises on the campaign trail, which has led many to predict increasing deficits are unavoidable, regardless of who wins, especially given the spectre of a North American and perhaps worldwide economic slowdown.
The Liberals plan to put the federal government back into the business of building the country’s supply of homes by using $25 billion in financing. There are also planned tax cuts for the middle class and capital spending to boost productivity.
Carney has said his government, if re-elected, would create a $5-billion fund for infrastructure projects at Canadian transportation hubs to help refocus trade beyond the U.S. Border security will also be beefed up through new investments, new equipment and hiring 1,000 border services officers. He said the cost of the Liberals’ platform will be available to voters before the advance polls close on Monday.
Poilievre, meanwhile, has focused on tax cuts, pledging to drop the rate on the lowest income tax bracket to 12.75 per cent from 15 per cent and defer capital gains on investments provided they are reinvested in Canada. He has also pledged to cut “wasteful” foreign aid.
But there are spending plans, too, albeit with a pledge to cap government spending by finding equal savings for every new expenditure. Conservative promises include building a $1-billion road connecting critical mineral mining sites to Ontario highways, a $250-million-a-year addiction recovery program and a program to reimburse cities for 50 per cent of each dollar they cut in housing development costs.
Both party leaders have also announced plans to create energy corridors to reduce Canada’s reliance on the U.S. and to streamline approval processes.
A price to be paid
No matter who wins, Doug Porter, Bank of Montreal’s chief economist, said he expects to see a reversal of the downward trend that reduced the federal government’s deficit to around $50 billion this past fiscal year, which ended March 31.
“When you add it all up, we’re looking at almost certainly a widening of the deficit. I wouldn’t be shocked if the deficit goes back above $60 billion in the current year, especially given the fact that the economy is going to be struggling with a trade war,” he said.
“Fiscal policy now, at least temporarily, has to go the other way for a spell, where we’re probably going to have to tolerate somewhat wider deficits, at least for this year and maybe next year.”
Porter said he’s “horrified” by the thought of pandemic-level government spending, though he acknowledged some tariff relief measures may be necessary.
The politicians seem to agree.
Poilievre has already promised to create a “Keep Canadians Working Fund” that will provide up to $3 billion in short-term credit lines and low-interest loans to companies affected by tariffs. Carney, meanwhile, has relaxed employment insurance requirements so that laid-off workers can get benefits right away and has allowed corporate tax payments and GST remittances to be deferred. All that could be just the start.
“I still think there is room, especially in a tough situation, for Ottawa to borrow a little bit more,” Porter said, adding that Canada has retained its borrowing capacity despite years of deficits and there is an appetite for debt in countries with a triple-A rating.
However, one corner of the financial markets has signalled an increase in concern amid the tariff turmoil of the past couple of weeks. While still low risk, the five-year credit default swap on Canadian bonds — which reflects the cost of insuring against a default — rose to 30 basis points on April 10 after sitting flat at 25 basis points through most of March, according to Jan Edvard Ericsson, an associate professor of finance at McGill University who specializes in risk in corporate bond and credit derivative markets.
“I don’t know how active this market is, but the (bottom line) would be that the cost of insuring against default in Canadian treasury markets has increased quite a bit in the last two weeks,” he said.
Trump delayed the harshest of his reciprocal tariff threats on April 9, following a week of tumbling stock markets and soaring U.S. bond yields. But persistent concerns about the widening of trade disruptions across the globe and the increased risk of recession , which add a layer to the price tag that Canada’s government will be faced with to assuage an aggressive U.S. administration, come at a difficult time for the country.
The federal government hasn’t fully reined in the deficits run up during COVID-19, which ground the economy to a halt, followed by a slow recovery period marked by inflation. A path to reducing the deficit no longer seems as sustainable as it did just six months ago.
During the first full year of the pandemic, fiscal 2020-21, the deficit soared to $328.7 billion as a result of increased health and social spending and reduced revenues, according to Statistics Canada. It still topped $90 billion the following year and, despite a dip in fiscal 2022-23, it swelled back up to $62 billion the year after that, well above the $39.4-billion deficit in 2019.
In the previous couple of years, the deficits were below $20 billion and represented less than one per cent of gross domestic product (GDP), though Porter said that was partly due to low interest rates.
A $48-billion deficit was forecast for 2025 before Trump began sabre-rattling on trade, a figure Scotiabank’s Young said could quickly balloon in the event a full-blown trade war is not averted.
Based on past crises, she said she wouldn’t be surprised to see potential stimulus spending of around two per cent of GDP, or $60 billion, on top of material shortfalls stemming from revenue losses owing to much weaker economic activity. Combined, that could add another $100 billion to spending over the next two years.
“Election risk adds further to fiscal pressures. Middle-income tax relief along with ramped-up military investments alone could tally up to $10 billion a year before any offsets through cost cutting,” she said.
While both of the front-running candidates and their parties are talking about making cuts and fiscal restraint, the easy targets they’re espousing may not be enough.
“Even aggressive attrition of the public-service footprint would likely only make a small dent in spending pressures, given compensation reflects only 12 per cent of total federal outlays,” Young said.
On the spending side of the ledger, boosting the military will require significant outlays.
As Canadian political leaders laid out their latest promises this month, U.S. Secretary of State Marco Rubio upped the ante on NATO-spending commitments, demanding that member countries spend an eye-watering five per cent of GDP to fund the defence alliance.
The Liberal government has pledged to crank up the country’s NATO commitment to the current expectation of two per cent of GDP by 2030, with spending on track to reach $60 billion a year by the end of the decade. Poilievre has also supported more defence spending.
Young pegs the budgetary increase — beyond what was already planned for less aggressive NATO spending — at an incremental $10 billion to $15 billion a year on the accelerated timeline through 2030.
However, if a higher threshold must be met, as Rubio has suggested, whoever is elected could be forced to come up with an additional $100 billion annually by 2030, she said.
Borrow to invest
Whichever party forms the next government would be wise to pay for competing priorities by looking first at borrowing and spending that will improve Canada’s position regardless of what this or any U.S. administration is pushing, according to David Detomasi, a professor of international business at Queen’s University who specializes in political economy and military studies.
“There is borrowing that you do for investment that should lead the country to be in a better place down the road,” he said. “Those are things like pipelines, like ports; things like that build the infrastructure, particularly east-west, that should generate a return.”
Such projects could be financed through public-private ventures and risk-allocation mechanisms that would take some of the load off government, he said.
Detomasi said the government could be forced to rethink spending on some social programs, such as Old Age Security , where people with considerable means are nevertheless eligible for top-ups, though such cuts are unlikely to be popular politically.
“There’s a growing bulge in government deficits that is due to the promises that have been made to people who are about to retire,” he said. “We have to decide what kind of debt is good and what debt isn’t.”
Ottawa has room to cut costs beyond the public service, where both employment and the use of consultants have soared over the past decade. A Macdonald-Laurier Institute report released on April 3 said spending cuts of nearly 15 per cent would only bring Ottawa back in line with the proportion of GDP spent before a steady ramp-up began 10 years ago.
There is a school of thought that the next government can find ways to pay for this current crisis without dragging the country into years of rising deficits and debt repayments by tapping into a playbook from the mid-1990s.
Christopher Ragan, an associate professor of macroeconomics and public policy at McGill University, said the next government should commit to a program of closely scrutinizing all programs and services, ranking them and then cutting spending from the bottom rather than simply resigning itself to borrowing.
“This is the really hard part of government: to set priorities,” he said. “If defence is now a No. 1 priority, or No. 2 priority after health care … what can we kick off the list?”
If spending isn’t prioritized in this way, given the demands imposed by the current U.S. administration, it can only mean higher taxes, further borrowing or both, Ragan said, adding this would push Canada towards the dangerous path the country was on 30 years ago. That resulted in a debt downgrade and a warning that the International Monetary Fund might have to step into the country’s fiscal affairs.
“My fear is that we wake up one morning and … ‘Oh my god, the bond buyers no longer want to buy our bonds.’ And that’s exactly what happened in 1995 for Canada,” he said.
Things don’t even have to get that extreme for bond markets to react negatively in response to a country’s fiscal plans. After Trump announced his broadest and deepest tariff threats in early April, there was a selloff of U.S. government bonds, which was unusual since equity markets were also tumbling.
“The backup in yields was mostly driven by rising real yields and not higher inflation premiums … indicating a more fundamental drop in demand,” BMO’s Porter said.
Another example is the United Kingdom’s bond market that was shaken in 2022 in response to concerns that prime minister Liz Truss was going to fund large tax cuts paid for by borrowed money.
“The (U.S.) bond market will be critical to watch in the months to come because Trump’s fiscal policy will (also) be expansionary,” Craig Alexander, president of Alexander Economic Views Inc. and a former chief economist at Toronto-Dominion Bank, said. “Tariff revenues will be inadequate to cover tax costs. So, a Truss-style bond crisis could be in store for America if they are not careful.”
As for Canada, he said the country may have no choice but to run large deficits to pay the full cost of a multifaceted pivot away from the U.S. for trade and foreign investment.
“Could it cost us our triple-A credit rating? The answer is, yeah, it could,” he said. “But it might be what you have to do in order to respond to this existential crisis facing Canada.”
Ragan said Canada’s debt and deficits would have to climb much higher for a replay of the bond drama in this country in the 1990s. Government debt represented more than 70 per cent of GDP — compared to around 40 per cent today — and the Liberals of the day instituted drastic cuts, including to the public service and transfer payments to provinces.
But it concerns him that there seems to be little fear among Canadian politicians about heading towards a repeat scenario even in the face of the current trade imbroglios and threats from the U.S. administration.
“We’re in a situation that is politically a little bit tougher (to effect such change), which is that it’s very easy for governments now, provincial and federal, to be complacent,” Ragan said.
Provincial governments also aren’t ignoring the concerns businesses are feeling. For example, Doug Ford ’s Conservative government in Ontario announced $9 billion of relief for businesses on April 7, including six-month tax deferrals to help them keep workers employed.
Temporary relief and stimulus packages are a valid response to a crisis, but Robert Shepherd, a professor at Carleton University’s School of Public Policy and Administration, said governments across Canada should be approaching the increased fiscal demands and unsteady economic outlook far more broadly.
He said elected officials would be well advised to use these turbulent times to move away from their usual budgeting practices and institute comprehensive reviews of strategic priorities and spending to reduce program inefficiencies and cost overruns as well as accommodate new policy and program priorities.
“This is not simply about moving money around from one pot to another to address different priorities,” he said. “There is so much more that has to be done first.”
Shepherd said some senior government officials have endorsed the idea laid out last year in a C.D. Howe Institute study that suggested governments would insulate themselves from the fiscal upheaval of crisis after crisis if they built in frequent and comprehensive reviews of their spending and strategic priorities.
“The essential point is that all spending has to be reviewed, as well as setting up the conditions for a strategic review of our policy and governance arrangements to support smarter spending,” he said. “It could be decided from such a strategic review that defence spending has to increase. The question then becomes, what does one have to give up to support that spending while maintaining other priorities?”
The C.D. Howe study said strategic reviews in countries such as the Netherlands, Denmark, Ireland and Spain have led to fiscal sustainability — from controlling deficit size and the amount of public debt to properly managing the debt-to-GDP and interest-cost-to-revenue ratios. They can also improve long-term public policy outcomes by reducing overlaps and identifying areas to direct spending and investment to create strategic advantages for the future.
“Rooted in the understanding that policies and programs reflect the context and assumptions of governments and societies when they were designed, this perspective asks what happens when domestic and international contexts evolve precipitously,” the authors said. “They identify the mounting pressures, reallocation possibilities, and emerging challenges which all political parties … should consider and address.”
With little insight so far on the campaign trail about whether the next Canadian government will embrace such an approach, Detomasi said the first six weeks for whoever wins will set the tone.
“You’ve got a double whammy hitting our financial wherewithal,” he said. “So, (they’ve) got to figure out a way to not only pay for what Mr. Trump wants, but to also somehow pay for the promises that are currently being made.”
• Email: bshecter@nationalpost.com
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