Charting Canada's Fiscal Trajectory: 1990-91 to 2024-25
Canada’s fiscal debate often begins with claims about whether public debt is “too high” or whether deficits can be justified as “investments”. But before judging where fiscal policy should go, it’s useful to understand how we arrived here, for to quote Winston Churchill—“The farther back you can look, the farther forward you are likely to see.” As the Carney government charts Canada’s fiscal future, Churchill’s wisdom should be a guiding light.
The annotated charts that follow trace the evolution of key federal fiscal measures over the past 35 years—from the fiscal crisis of the early 1990s, through the consolidation initiated by Paul Martin’s budget in 1995, followed the shocks of the recession and pandemic that have put the debt ratio once again on an upward trajectory. (The source of data is the Fiscal Reference Tables 2025, published by Finance Canada.)
Anchoring Metric: The Debt Ratio
While interest-bearing debt relative to GDP (the debt ratio) is not the only metric by which to judge fiscal health, this ratio, and particularly its trend across cycles of economic growth, is arguably the best single measure of fiscal sustainability.1
The chart shows that the federal government’s debt ratio has gone through four distinct phases over the past 35 years.
From 1990 through 1995 the ratio was increasing unsustainably and eventually triggered a fiscal crisis that was resolved by the epic Paul Martin budget of 1995.
The measures implemented in that budget (and buoyed by a period of relatively strong growth) caused the debt ratio to decline steadily from a high of about 75% in 1995 to a low of 37% in 2008 on the eve of the Great Recession.
The ratio then stabilized at about 50% of GDP until the outbreak of COVID.
The emergency fiscal measures implemented in response to the pandemic caused the ratio to spike at 65% in 2021. While it has subsequently declined to about 60%, this level is 10 percentage points higher than prevailed throughout the decade 2010-20, which in turn was about 10 points higher than just before the 2008 recession.
Each successive shock has pushed the debt ratio to a higher temporary equilibrium. In dollar terms, the debt has more than tripled from $584B in 1995 to $1,869B thirty years later.
There is no consensus as to an “optimal” or sustainable debt ratio. The ratio at any point in time is the result of political choices interacting with economic conditions while its sustainability depends on risk-reward judgments made by the holders of the debt. For example, by 1995 the investors in federal debt were signalling they had had enough since the debt ratio had been rising relentlessly for years. On the other hand, the sharp increases in response both to the great recession and the pandemic were largely viewed as reasonable.
Mark Carney has stated an intention to make very large public investments in infrastructure and defence and other areas where there is a need to improve social and economic resilience. This will likely cause the federal debt ratio to increase, but may be justified by a mid-to-longer-term payoff in the form of increased economic growth and societal benefit. Only time will tell. In strictly fiscal terms, what matters is the future trajectory of the debt ratio—i.e., how the trend is judged by investors in federal debt, and the extent to which future interest charges might squeeze out spending on government programs and/or lead to higher tax rates and thus to political pushback.
Dynamics of the Debt Ratio
If we are to use the ratio of public debt to GDP as a primary metric of fiscal sustainability it’s important to be clear as to the factors that cause the debt ratio, “d”, to change over time. Based on definitions of the key variables, plus a little algebra, the change (in percentage points) in the debt ratio from one year to the next is, to a close approximation:
Annual change in d = d*(r – g) -pb
Where “r” is the average rate of interest on the stock of interest-bearing debt; “g” is the annual percentage rate of growth of nominal GDP; and “pb” is the primary budget balance (revenue minus program spending)2 as a percent of GDP. Note that the annual change in the debt ratio is proportional to the debt ratio itself with the factor of proportionality being (r – g). If the interest rate is greater than (or less than) the growth rate, the debt ratio tends to grow (or diminish) exponentially. But the effect is offset by the primary budget balance. A surplus (i.e., “pb” is positive) tends to reduce the debt ratio, while a primary budget deficit clearly has the opposite effect. Whether the ratio is increasing or decreasing depends on the size and direction of the factors in the equation above. Let’s look at the trajectory of each factor over 35 years from FY 1990-91.
Growth Rate and Interest Rate
From 1991 until about 2000 the economic growth rate was less than the average interest rate on federal debt: (r – g) was positive, and this tended to cause the federal debt ratio to grow—which it did until the measures in the 1995 budget generated such large primary surpluses that the ratio declined steadily until the 2008 recession hit. Since then, the key parameter (r - g) has generally been negative apart from positive spikes when growth cratered during the Great Recession and COVID, and to a lesser extent in 2016. The mostly negative values of (r – g) since the early 2000s—i.e. the effective interest being less than the rate of GDP growth—provided a fiscal tailwind for the Martin, Harper, and Trudeau governments. But this was offset by the shocks of the recession and the pandemic, reminding us that the unanticipated is more likely to be negative than positive. That’s why it’s so important to accumulate fiscal “dry powder”—a declining debt ratio—whenever economic conditions are favourable.
It’s notable that the generally favourable longer-term trend of (r - g) has been due far more to declining “r” than to robust GDP growth, “g”. The recent uptick in the average rate of interest on federal debt, combined with a declining trend in the rate of growth of nominal GDP since about 2000, is an early warning sign. Unless there is a significant increase in Canada’s chronically weak productivity growth, the effect on the labour force of an aging population will tend to dampen long-term GDP growth while pressure on public spending to support an older population increases—all making for a challenging fiscal environment.
Primary Budget Balance
The primary budget balance is the surplus or deficit before interest payment, and is the difference between government revenue and spending on programs and operations. The fiscal consolidation measures introduced in Paul Martin’s 1995 budget helped boost the primary surplus to $64 billion by 2000-01, more than 5% of GDP. With a fiscal crisis averted, the primary balance then declined steadily relative to GDP, turning to deficit during the Great Recession and hovering just above zero since then with the exception of the deep deficit (14% of GDP) to cope with COVID.
The chart opposite traces the two components of the primary balance—i.e., total revenue and spending on government activity and programs. Revenue (the solid line) has remained relatively steady in a band between about 14% and 17% of GDP, tending to mirror the state of the economy since that affects the yield of various forms of taxation. Program spending (the dotted line) is more variable, reflecting political choices that usually seek to counter economic cycles. Spending was 17% of GDP in 1993 and dipped to a low of 11.8% in 2000 and 2001. Since then, the trend has been steadily upward, particularly during the Trudeau years—from 12.3% in 2014 to 15.9% in 2025, dramatically punctuated by the COVID spike of 28% in FY2020-21.
Thanks largely to declining average interest payments until very recently, low or even negative primary budget balances were still compatible with manageable overall deficits. Apart from the COVID spike the federal budget deficit has been generally in the range of one to two per cent of GDP since the great recession. Nevertheless, this does not justify complacency since chronic deficits lead to a steadily increasing debt ratio, a situation reminiscent of the 1980s to the mid-90s.
Looking Forward
The Carney government’s investment objectives—while largely holding the line on taxes—will likely reduce the primary balance, and perhaps push it into deficit. The hope is that the productive impact of the new investment will ultimately translate into a higher GDP growth rate (“g”) and that the effective interest rate on federal debt (“r”) will remain below the growth rate. In that case the government’s fiscal position can be sustainable even without a primary budget surplus. But if GDP growth continues to be weak, and as the higher interest rate environment pushes up “r”, the key dynamic parameter (r - g) risks becoming chronically positive. The debt ratio would then grow inexorably unless offset by sustained measures to boost the primary budget—i.e., some combination of higher taxes and restrained spending amid political resistance to both.
International Perspective
Debt ratios—based on gross debt of all levels of government to permit international comparison—have continued to increase across all G-7 countries with the exception of Germany. As of 2024, six of the group had debt ratios above 100%. The increases in the US and UK were particularly dramatic—less so in Canada. The generally relentless increase in the debt ratios across affluent countries reflects a combination of factors: population aging and expanded social programs; repeated economic shocks; and political resistance to tax rate increases, all in the context of a long-term reduction in the rate of economic growth. Canada, as usual, is somewhere in the middle of the pack.
It’s instructive to compare Canada’s fiscal trajectory with that of the US and Germany—the latter being generally representative of the large affluent western European countries. Spending relative to GDP (by all levels of government combined) follows a similar time pattern across the G7, peaking in recessions but otherwise varying within relatively narrow bands. Canada’s spending, averaging about 40% of GDP, rests midway between the US and the more “progressive” states of continental Europe. United States’ expenditure has drifted up from about 33% in 2001 to 38% of GDP in 2024, while both Canada and Germany have seen spending on an upward trajectory relative to GDP since about 2015; in Canada’s case from 40% of GDP in 2015 to 44.7% in 2024.
Revenue exhibits less variance over time than spending since it tends to track GDP more closely than expenditure which reflects counter-cyclical fiscal decisions. Revenue in both Canada and Germany has been tracking up, relative to GDP, since the end of the Great Recession, reaching 42.7% and 46.8% respectively in 2024. The revenue trajectory in the US has been essentially flat at 30% of GDP since the turn of the century. Although Americans often think of themselves as over-taxed, the fact is that US government revenue relative to GDP is consistently about the lowest among all highly developed countries. Nevertheless, the US political system has steadfastly resisted taxation to match the demand for government goods and services.
Consequently the US has run chronic deep deficits throughout the period 2001-24, during which time the debt ratio increased from 53% of GDP to 122%. The pattern in Canada and Germany has been directionally similar but with much lower deficits than have prevailed in the United States, and consequently much more moderate increases in debt ratios—in Canada’s case from 81% of GDP in 2021 up to 111% in 2024.
The US is better able than most countries to borrow to finance its public sector by virtue of the depth of its capital markets and the status of the US dollar as the de facto global currency. The downside, however, is the political incentive this creates to borrow rather than tax, which then has the effect of (i) increasing the US trade deficit (that is the flip side of drawing in foreign savings to help finance the deficits), (ii) accumulating a fiscal burden on future generations, and (iii) eventually undermining faith in the US dollar, thus diminishing American power and influence. The longer fiscal profligacy goes unchecked, the more wrenching the inevitable adjustment will be—a truth that applies not only to our American neighbours but to Canadians as well.
In this paper, GDP is stated in current dollar or “nominal” terms. This includes the effect of inflation while real GDP has inflation removed. Revenues, expenditures, and public debt are all measured in current dollars, thus budgetary analysis uses the same nominal measures. The key variables are expressed relative to the size of the economy to keep the focus on fiscal sustainability. This paper uses interest-bearing debt as the benchmark since this is the amount relevant for the public debt charges that enter into the budget balance. The concept of Net Debt also includes various accounts payable and is reduced by the government’s financial assets. The ratio of federal net debt to GDP declined from 74% in 1995 to 45% in 2025.
For example: assume the debt ratio is 40% at the beginning of the year; the effective interest rate is 6%; the growth rate is 3.5%; and the primary budget surplus is 0.2% of GDP. Then at the end of the year the debt ratio would have increased by 0.8% to 40.8%. If on the other hand, growth was 5% and the effective interest rate was 2.5%, the debt ratio would decrease 1.16% to 38.8%.
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