Despite Canada’s reputation for fiscal conservatism, over the past few years the country’s government has grown increasingly comfortable with expanding budget deficits and rising debt.

The Canadian federal government plans to spend C$333 billion in the upcoming fiscal year, an increase of 5% from the previous year, while collecting just $305 billion from taxpayers.

This will leave a deficit of about C$28 billion dollars, which is equivalent to 1.3% of the country’s annual gross domestic product (GDP). If provincial governments’ projected deficits are included, then the overall government budget deficit amounts to around 2.5% of GDP.

Although the government’s shortfall has been growing, Canada is still in better fiscal shape than most of its developed-world peers, including the U.S., where the budget deficit amounts to 4.1% of GDP.

General government spending (including the provinces) now amounts to 41% of annual GDP compared to 38.6% 10 years ago. Canada’s spending now exceeds the G7’s average, and it’s also 6% above the level of the U.S.

Each year, the Fraser Institute, a Canadian think tank, does a calculation intended to demonstrate the tax burden imposed on the average worker by determining how many days it would take to earn enough money to pay taxes if all taxes were paid up front.

Last year, the Fraser Institute declared “Tax Freedom Day” on June 7, since that marked the first day of the year (by this clever metric) in which the average worker was finally earning for himself instead of the government. Put another way, the average Canadian paid 42.9% of annual income to the government in tax-year 2016.

Gross general government debt, which includes federal, provincial, and local authority debt, amounts to C$1.9 trillion, which is equivalent to 92% of GDP. Ten years ago, the proportion was 67%, so government borrowing has jumped 50% since 2007.

However, this still compares favorably to the rest of the G7, where debt now averages 122% of GDP, though this figure is skewed by Japan’s extraordinary leverage.

Canada and Germany are the only G7 nations that still boast AAA credit ratings. Ongoing budget deficits and a growing government debt pile will eventually weaken Canada’s credit standing, but fortunately that is not on the immediate horizon.

Budget Boosters and Busters

One key point to note is the rather conservative assumptions built into the Canadian government’s budget forecasts.

Real economic growth, which is the main driver of tax revenue, is estimated at 1.9% for 2017 and 2.0% for 2018. This compares to considerably higher estimates provided by the International Monetary Fund and other forecasting agencies, so such growth should be readily achievable.

We have selected some of the other key points from the budget worth noting:

1. The $23 billion annual allocation to the country’s child-care benefit helps support families, while also contributing to consumer spending power in remote areas of the country. This was specifically mentioned by North West Co. Inc. (TSX: NWC, OTC: NWTUF), one of our Dividend Champions, in its most recent earnings results.
2. Soaring home prices in some of Canada’s biggest cities have prompted calls for further government intervention. In a rather meek response, the budget allocates $40 million to Statistics Canada to develop and implement a housing statistics framework that would provide up-to-date information on purchases and sales, including the degree of foreign ownership. StatCan is expected to start publishing initial data in the fall of this year.
3. Corporate and income tax: Although the Liberal government has been planning a comprehensive tax review, it was not forthcoming in the budget. Apart from a minor tweak to tax credits for oil and gas exploration, no major tax changes were announced.
4. Infrastructure spending: The federal government reaffirmed its plans to invest more than C$180 billion in Canada’s infrastructure through 2028. The government had previously allocated C$14 billion of such spending in its 2016 budget, but it was slow to get off the ground. Construction and engineering companies should eventually benefit from the additional spending, but for now they still have spare capacity following the resource sector’s crash.
5. Infrastructure bank: The government has been promoting the establishment of a Canadian Infrastructure Bank, which would leverage an initial $35 billion commitment of public funds to attract private capital. The budget did indicate that the government will soon propose legislation establishing the Canadian Infrastructure Bank, with the goal of having it operational later this year.
6. The government also hopes to further Canada’s standing as an international hub for innovation. To this end, the feds plan to spend aggressively to support research and commercialization of innovative developments and to give workers the skills they need to be competitive in the “new economy.” This includes high-growth sectors such as advanced manufacturing, clean technologies, digital industries, healthcare, and biotech. In particular, the government hopes to increase exports of goods and services by 30% by 2025. Canada already scores well on many global innovation rankings including:

1. 1^st in the OECD for the most highly educated workforce.
2. 1^st in the Group of Seven (G7) for overall business cost competitiveness.
3. 2^nd in the G7 for openness to trade and investment.

We do not disagree that governments play an important role in creating an environment where businesses feel comfortable to invest and grow. However, large government deficits and mounting debt piles will eventually lead to higher taxes. And that, in turn, could eventually dampen economic growth.