In the run-up to last week’s federal budget, the Carney government’s messaging focused largely on Canadian sovereignty. Sure enough, the budget documents tabled in the House of Commons by Finance Minister François-Philippe Champagne, titled Masters of Our Destiny, outline an ambitious — some might say “audacious” — plan to raise long-term growth, strengthen Canada’s defence and security capabilities, and enhance economic independence. This realignment of spending priorities reflects the harsh reality that the comfortable assumptions on which Canadian strategic planning has rested since the end of the Cold War simply no longer hold.
Rather than sheltering under the security umbrella of a friendly hegemon and the protection of a rules-based international order, Canada and like-minded partners now realize that they cannot take that order for granted — that the hegemon may no longer be benign. In fact, under the Trump administration, the United States has blatantly threatened the sovereignty of its allies and actively weakened the rules-based order it created eight decades ago in the wake of global war.
But threats to sovereignty can take several forms, including economic coercion. The US president has made clear his intention to shift manufacturing production from Canada to the United States, using tariffs as his preferred policy instrument. The Canadian government’s response to the economic coercion implicit in Donald Trump’s tariffs is to reduce Canada’s dependence on the United States by expanding and developing new export markets in other countries. And as the budget documents argue, modest progress has already been made on that account, with goods exports to non-US markets now more than 50 percent above their 2024 average. At the same time, Budget 2026 outlines a bold strategy to boost growth by fuelling an investment boom — or what the finance minister enthusiastically calls an investment “supercycle” — with a productivity mega tax deduction.
The goal here is to ensure that resources (plants, equipment and, most importantly, labour) idled by production disruptions caused by US tariffs are quickly and seamlessly re-employed. In a market economy, this process occurs automatically since wages and prices eventually adjust to restore full employment. However, that process can be socially disruptive in a low- or no-growth environment, as displaced workers face extended periods of unemployment and the prospect of wage cuts. In this respect, the budget’s emphasis on growth, along with measures to support workers adversely affected by the Trump tariffs and households struggling with rising grocery and housing costs, aims to boost resilience. A growing, resilient economy that benefits all citizens is better able to withstand external shocks that reflect economic coercion aimed at undermining Canadian sovereignty.
The Limits of Tax Incentives
Raising productivity is clearly a laudable objective: It is key to the higher long-term growth the government hopes to unleash. And yet, however worthy an objective, considerable caution should be exercised in basing long-term fiscal planning on tax incentives to achieve it. The reason for this caution is that, while economics has much to say on what impairs productivity growth — macroeconomic instability, ill-defined or arbitrarily enforced property rights, excessively high tax rates — it is less definitive on how to stimulate productivity growth. Generous tax incentives may help, but they are not a panacea. The Canadian experience with the Scientific Research Tax Credit (SRTC) in the 1980s, for example, suggests that unless such measures are carefully designed and effectively implemented, they may have limited effectiveness and/or entail a high fiscal cost.
Although Budget 2026’s proposed mega productivity tax deduction avoids the most egregious problems associated with the SRTC and limits risks to the fiscal framework, prudence is nevertheless warranted with respect to assumptions regarding its likely effectiveness. This is because uncertainty can act like a de facto tax on long-term decision making. Investments that would be profitable under one scenario may be wholly unprofitable under another — and in the presence of uncertainty as to which scenario will prevail, firms may opt not to invest until the fog of uncertainty clears.
This option-value-of-waiting effect lies at the heart of Trump’s economic threat to Canadian sovereignty. By instilling uncertainty about the profitability of investing in Canadian manufacturing plants and workers, he hopes to lure production to the United States. Meanwhile, the competitiveness of Canadian firms erodes as they delay investments in the face of policy-induced uncertainty, leading to the loss of export markets abroad and market share at home. The mega deduction should mitigate these effects, particularly if the results of the US mid-term elections constrain the president’s most disruptive impulses and result in a tariff truce. But it would be imprudent to blithely assume that it guarantees an investment supercycle.
There is, after all, another threat to sovereignty — one that is self-inflicted. This is the loss of fiscal autonomy that follows a severe deterioration in public finances, resulting in steadily rising interest payments on the public debt that absorb an ever-increasing share of government revenues. This risk is likely negligible over the medium term, given upward revisions to nominal GDP — the key driver of revenues — and the modalities of the budget process, which bases growth projections on the average of private-sector forecasts.
That said, going beyond the next two years or so, the government must ensure that its own investments are aligned with the defence, security and resilience priorities it has identified. And the very considerable revenues allocated to the mega deduction should animate productive investments that raise productivity growth and not merely fund tax boondoggles. The SRTC is a reminder of how quickly a well-intentioned incentive can become the latter. Ottawa cannot remove the uncertainty Washington creates, but it can make sure its own fiscal choices don’t add to it.
