With debt at 74% of GDP and rising, governments face hard choices they are not yet making, a new C.D. Howe Institute report warns
Canada's combined federal and provincial net debt-to-GDP ratio stood at approximately 74 percent as of the fall of 2026, well below its 1996 peak but far above the 53 percent recorded before the 2008 global financial crisis and the 65 percent recorded before the COVID-19 pandemic in 2019.
According to a new C.D. Howe Institute Commentary, Canadian governments have drifted into a state of "fiscal complacency," and the consequences of staying there could be severe when the next major economic crisis arrives.
The October 8 report, authored by Christopher Ragan, a Max Bell Foundation Senior Fellow at the Institute for Research on Public Policy, draws on five premises about public debt and government behaviour to argue that Canada urgently needs to reduce its debt ratio - not because a crisis is imminent, but precisely because one eventually will be.
"The problem is that this post-crisis behaviour is politically challenging in democracies because it requires governments to do unpopular things when there is no obvious crisis," Ragan writes in Commentary No. 730. "As a result, governments are often complacent."
Three zones of fiscal health
Ragan's framework divides the public debt landscape into three zones. At debt ratios below roughly 67 percent of GDP, governments sit in the "fiscal prudence" zone - capable of absorbing a large shock without triggering a borrowing crisis.
Between approximately 67 and 95 percent lies the "fiscal complacency" zone, where borrowing remains manageable but the political will to address it is typically absent. Above roughly 95 percent, governments enter "forced austerity" - the zone Canada nearly reached in 1995 and 1996, when the combined debt ratio hit 99 percent and bond yields rose sharply in response.
Canada today sits firmly in the middle zone. The combined federal and provincial net debt ratio has climbed from 65 percent in 2019 - just before the COVID-19 pandemic - to approximately 74 percent as of autumn 2026, based on Ragan’s calculations and TD Economics data.
The report notes that during the two most recent crises (the 2008 global financial crisis and the COVID-19 pandemic) the combined debt ratio increased by an average of approximately 17 percentage points. If a comparable shock were to occur today from a starting point of 74 percent, Canada would be pushed dangerously close to the red zone where investor confidence begins to erode and borrowing costs rise.
“Reducing debt is difficult because the choices are difficult. Spending cuts can slow the economy, while higher taxes are unpopular and can affect incentives. And even when governments run surpluses, taxpayers soon ask why they are paying more in taxes or receiving fewer services,” Ragan said in comments provided to Wealth Professional. “But if we don’t make those choices, rising debt-service costs will leave governments with even less room to act.”
Why current spending pressures make this worse
Ragan identifies several significant spending pressures on the horizon that will make debt reduction even harder. Federal debt-service payments already amounted to roughly $55 billion in 2025, according to the report - approximately 10 percent of government spending, exceeding total annual federal health transfers to the provinces.
Ahead lie further costs: rising expenditures on elderly support programs and healthcare as the population ages; public investment in trade infrastructure to diversify away from the United States; and, most significantly, a permanent increase in defence spending to meet Canada's renewed NATO commitments. Based on the federal 2025 budget, Ragan notes, only a small portion of these future increases has yet been incorporated into the fiscal framework.
The report challenges the notion that Canada's geopolitical challenges justify debt-financed spending on the same terms as past crises. Unlike the two world wars, the Great Depression, the 2008 financial crisis, and the pandemic - which were all viewed as temporary events - Canada's new strategic environment, driven by shifting US foreign policy, rising Chinese and Russian assertiveness, and threats to Canadian sovereignty, is more likely to be permanent.
If new spending commitments persist for decades, Ragan argues, financing them through borrowing rather than taxation or spending reallocation is difficult to justify.
"Temporary increases in government spending are reasonable candidates for deficit financing," the report states. "Permanent increases require more enduring adjustments in taxes or other spending."
The low-rates gamble Canada cannot rely on
Some observers have argued that Canada can safely continue running deficits as long as the real interest rate on government debt remains below the rate of economic growth (a condition referred to in academic literature as r < g) which would cause the debt-to-GDP ratio to decline over time even without primary surpluses.
Ragan is skeptical. Citing work by economist Kenneth Rogoff in his 2025 book Our Dollar, Your Problem (Yale University Press), the report notes that the recent period of historically low real interest rates is more likely a short-lived phenomenon than a structural new normal. Rogoff identifies several reasons to expect real rates to rise: growing investments to address climate change, military spending increases driven by geopolitical tensions, and the energy demands of artificial intelligence, among others.
The International Monetary Fund has also warned that global government gross debt (equal to approximately 80 percent of global GDP in 2015) is projected to exceed 100 percent of GDP by 2030 (IMF, Fiscal Monitor: Putting a Lid on Public Debt, 2024). The IMF explicitly links rising global debt to upward pressure on interest rates.
On the Canadian side, the interest rate on 10-year government bonds increased by approximately 250 basis points between the end of 2021 and 2026. Research by Salmon (2025), cited in the report, finds that each one-percentage-point increase in the US debt-to-GDP ratio raises long-term government bond yields by an estimated 4.6 to 6.1 basis points. With Canadian bond yields closely tied to global rates, Ragan cautions that governments should not assume the favourable interest rate environment will persist.
What governments should do
Ragan identifies three broad approaches to addressing the debt challenge and is candid about the political difficulty of each.
The easiest politically is to continue financing new spending through borrowing. The report acknowledges this is the most likely path given current fiscal complacency, but warns it shifts the burden to future generations and increases the risk of the forced austerity scenario.
The second approach is to raise revenues - through higher taxes or asset sales. Higher taxes are politically unpopular and can dampen investment in an environment where Canada's business investment has been weak for over a decade, the report notes.
The third, and in Ragan's view most appropriate, approach is to reduce lower-priority spending to make room for higher-priority commitments. While the federal government has announced plans to cut operating expenditures by 15 percent within three years, the report notes that major transfers to provinces and individuals are excluded from the exercise - significantly limiting its fiscal impact, as assessed by Lester (2025) in a separate C.D. Howe Institute E-Brief.
"Now is the time for governments across the country to think carefully about their fiscal options," the report concludes. "At a minimum, Canadians and their governments need to be discussing these issues in an honest and transparent manner."
For financial advisors and wealth managers advising clients on Canadian fixed income, government bond duration, and long-term financial planning, the trajectory of Canada's public finances is a material consideration — one that the C.D. Howe Institute's latest research suggests deserves closer attention than it is currently receiving.
“Canada is not in a fiscal crisis today, and that’s precisely why we should be acting now,” Ragan said in comments provided to Wealth Professional. “We need to gradually reduce our debt ratios and rebuild our fiscal room, so governments can borrow and spend when the next crisis hits.”
