Re-building our Military Will be Expensive, but Create Opportunities

Lack of defence spending hits the spotlight

In 2014, members of the North Atlantic Trade Organization (NATO) reinforced their commitment to spend over 2 per cent of nominal GDP on defense, with 20 per cent of that going towards new equipment.¹ Since Russia’s full-scale invasion of Ukraine in February 2022, many allies moved to meet that target, or in some cases beyond.² (See Chart 1.)

Canada is part of a shrinking list of NATO members not meeting the 2 per cent target. With spending on defence at only 1.37 per cent of GDP in 2024, and only 18.6 per cent of that amount directed toward new equipment—Canada is one of only two countries missing both the total target and the target for spending directed towards new equipment. Prime Minister Carney did announce plans to reach the 2.0 per cent target within the next year, by increasing recruitment efforts, boosting solider pay and setting up the foundations for future procurement.³ However, reaching the goal is increasingly viewed as insufficient, and discussions are moving towards increasing the target to 3.5 and maybe even as high as 5.0 per cent.

Chart 1

Many NATO members have increased defence spending

(defence spending as a share of GDP)

Source: NATO.

The risks to Canada for not fulfilling its commitment include weakening relationships with other member states. The unfolding global trade war is a stark reminder of the importance of maintaining strong bargaining chips in foreign affairs. But the risks go beyond diplomacy. Concerning trends among disruptive states challenging the international order (e.g. Russia), and the Arctic becoming more accessible because of climate change, mean that Canada needs to act to secure its own borders. Disruptive policymaking by our most trusted ally only increases this urgency.

There are many challenges on the way to rebuilding Canada’s military. The first is fiscal, finding the required dollars will require hard choices. As well, potentially doubling or more the size of our military will create labour pressures in other industries. We will also need an industrial policy, to build up our domestic manufacturing capacity for a wide array of military products. And we don’t have the luxury of time to achieve these goals.

From here to there: Finding the money to reach our desired future state

Using our latest forecast for the Canadian economy, we estimate defence spending would need to increase by $92 billion in 2030 to reach a target of 3.5 per cent of GDP, as is being considered by many NATO countries.⁴ Reaching that amount over the next five years will take considerable planning, and some tough decisions. The longer the horizon to reach the target, the larger the increase that will be required. By 2035, defense spending of 3.5 per cent of GDP would amount to $118 billion.

Taking these challenges into account, there are 3 broad fiscal levers the federal government can use to increase its spending on national security. Given the size of the required spending increase, some combination of the three will be required, and real trade offs will need to be made, both in the near-term and long-term.

Increase the deficit

Given that the Federal government’s current fiscal plan already calls for deficits through fiscal years 2028–29, any additional defense spending on top of current plans would naturally cause larger deficits and a bigger debt burden.

Added deficits of this size would have serious consequences for Canada’s fiscal trajectory. The country currently has favourable debt metrics compared to many other advanced countries, with the federal debt to GDP ratio at just 42 per cent. If the full $92 billion required to meet our target in 2030 was added to the deficit, Canada’s fiscal situation would worsen substantially. The fiscal deficit in 2030 would rise substantially, and the higher debt load would have consequences for the country’s finances for decades to come.

Put it all together, and what’s clear is Canada cannot simply debt-finance our way to meeting our long-term defense aspirations and commitments. Debt financing will be part of any solution, but the government must tread carefully. Increasing the nation’s debt by too much would fiscally constrain the government, reduce its capacity to provide stimulus during a crisis, and cause major long-term issues. Closing the entire defence spending gap through debt alone is an unrealistic solution. 

Raise taxes

If the goal is to build out the military without substantially increasing our debt levels, raising taxes is another option. However, given the sheer dollar value that needs to be raised, raising taxes alone would cause tax rates to move much higher, and are likely not politically feasible.

As an example, if taxes were used alone to reach the 3.5 per cent target ($92 billion extra spending in 2030), total tax revenue would need to increase by over 15 per cent. In terms of line items, this is equivalent to just over a 30 per cent of personal income tax revenue, nearly all corporate tax revenue, and 20 per cent of excise tax revenue. As well, we estimate that a 1 per cent increase on the GST rate from 5 per cent to 6 per cent would increase the government’s revenues by around $11 billion annually, barley a tenth of the required sum.

Ultimately, tax increases that would fully cover the $92 billion would stifle the economy, and lower revenues in other ways. This means that the needed increase in military spending cannot be handled through revenue increases alone.

Reduce spending

Given the amount of extra taxes required to raise funds for defense is likely too large, and that the government needs to be careful with debt, cutting non-military spending is the last tool that can be used try to find money for higher defense spending.

A $92 billion increase in defense spending in five years would require a decrease in other expenses of over 15 per cent (based on the latest budget estimate of $608.7 billion on spending in fiscal year 2028–29). However, this figure understates the scale of the challenge.

For example, in fiscal year 2028–29, transfers to persons is estimated to account for 27 per cent of spending, while transfers to other levels of government, which includes health and social transfers, account for another 20 per cent. Given these make up programs Canadians depend on, it’s unlikely that meaningful cuts in these areas will be popular. There are also caveats on the remaining spending. For example, $64.3 billion would go to public debt charges—even without any further increase in defense spending pushing debt levels higher.

Realistically, there is about $240 billion (operating expenses and other transfer payments) that could be considered for cuts. Other transfer payments are related to tax credits, subsidies and other government supports. While these could be cut, we view tax credits as important to grow the economy, and so the government would need to tread carefully. Operating expenses, which are projected to reach $127 billion, would be one area to reduce—but this already includes planned military spending which limits the ability to cut here even further.

In all, while cutting spending would seem the obvious area for the government to find money to boost military spending, an account-by-account view of current spending priorities indicates why the Federal government has had so much trouble balancing the books lately—it’s simply hard to find areas to cut that the electorate would support. And even cutting operating expenses, which has been touted as an option, would be difficult given these already include military spending. It would require major reductions in the non-military public service to be able to increase military spending in a deficit-neutral way.

Achieving a higher military spending goal will take time

No single fiscal option presents itself as an obvious solution to increasing our military spending, and as a result sacrifices will need to be made. The most likely path is to attempt to boost revenue growth through growth friendly policies and targeted tax increases, reducing projected spending growth in non-critical areas, and accepting that debt loads will need to increase. The plan, ultimately, will need to accept that reaching the target will take time. While some needs are rapid, taking time to reach the total increase in spending will allow us to build fiscal room for a long-term shift in spending priorities.

Defence procurement: The what and how

Three trends are shaping what Canada needs

Finding an ideal path to increase defence spending, while keeping the economy and our finances in good shape, is only to part of the challenge. Canada must also decide what equipment is needed and find an appropriate procurement strategy to build defence capabilities quickly.

In terms of what equipment is needed, the Department of National Defence released a renewed vision for Canada’s defence strategy in 2024.⁵ The plan identifies three trends that will influence Canada’s defence planning in the years ahead:

Key equipment needed to protect Canada from these trends include submarines, helicopters, satellite ground stations, and improved cyber capabilities, all which aim to improve monitoring, and ultimately secure Canadian borders.

The need to expand our military provides a strategic opportunity for Canada. The magnitude of the needed increase in spending means that we are in a strong negotiating position. It will be imperative for Canada to use this position to extract benefits across its full spectrum of foreign policy issues—including trade. This means, as much as possible and respecting our needs for certain capabilities, Canada should seek to build domestic capacity, retain as much intellectual property as possible, and use procurement to strengthen our alliances. To put the size of the opportunity into perspective, Canada’s $92 billion military spending shortfall (compared to the 3.5 per cent target in 2030) represents about a sixth of our current imports from the U.S.

Expanding our procurement footprint

Canada’s defence procurement policy should be aligned with its broader foreign policy strategy. This is shaping up to include:

Several of our European allies are global leaders in designing and producing military equipment. Canada can support their industries by purchasing equipment “off the shelf,” while also supplying them with critical minerals and other inputs. France, Germany, Italy, the United Kingdom, and Spain, for example, are all NATO members and among the top ten arms exporters in the world. Collectively, these countries have accounted for over a quarter of all global arms exports over the past half decade.  

Over the past five years, the U.S. has accounted for 43 per cent of all arms exports globally.⁶ The U.S. also remains an ally. Therefore, it is likely that Canada’s procurement strategy will continue to involve purchasing equipment from the United States as well. Given the current challenges in Canada–U.S. relations, our procurement strategy may be a means to improving those relations.

A long-term vision: Building at home

Internalizing the supply chain for defence equipment would boost the domestic economy by creating jobs and keeping government dollars in the country. It also reduces the reliance on other nations. The federal government has taken steps to build equipment domestically. An example is the National Shipbuilding Strategy. The program was launched fifteen years ago to build vessels in Canada, creating Canadian jobs while supplying the Royal Canadian Navy and Canadian Coast Guard with marine equipment. While the project came with some cost and time overruns, it was an example of seeking out a maximum multiplier for the domestic economy.

Canada has plenty to draw from in building up synergies between its military, procurement and industry. We are home to immense natural resources, many of which are key components in defence equipment. For example, our country is the fourth largest producer of aluminum globally, a material that tops NATO’s list of 12 defence-critical raw materials.⁷ We also have advanced manufacturing capacity for defence related equipment and supplies. For example, our well-developed aerospace industry supplies the U.S. with parts the F-35 fighter jets they build and sell around the world.

Building more equipment at home, and increasing our capacity to do so, should be the end goal. This will require significant commitment from governments in terms of funding, polices, and regulation. Unlocking critical minerals, for example, is an important step for both supplying allies with materials and expanding our own building capabilities long term, something that has proven to be challenging due to slow project approvals and environmental concerns. Strategic procurement is another tool to get us to our end state. With our big envelope of military spending over the next decade, we need to ensure that a key benefit is increased domestic intellectual property, and production capabilities.

Recommendations

Overall, increasing our defence capabilities is a complex and difficult task, but something we need to act quickly on given the rapidly changing political landscape. At the same time, we need to use our shortfall strategically to advance our foreign policy efforts and build a domestic military base. We recommend that Canada and the federal government use the following strategy to increase our national security:

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