Having finally reached the North Atlantic Treaty Organization’s old two per cent target of GDP defence spending in early 2026, Canada now faces a far steeper, and more critical climb: raising that share to five per cent by 2035. Meeting this new goalpost—and boosting military capabilities in an increasingly insecure world—is not a marginal adjustment. It will fundamentally reshape federal finances and force a reconsideration of what Ottawa spends—and how it pays for it.
We lay out the scale of Canada’s commitment and its fiscal consequences in our new C.D. Howe Institute report, and the results are striking. For the federal government, defence spending would, should status quo financial plans hold, not only surge past the annual amounts on direct non-defence program spending, but could rival transfers to other levels of government.
The five per cent pledge has two components. First, core defence spending would rise from the current two-per-cent benchmark to 3.5 per cent of GDP. Second, an additional 1.5 per cent would go toward “dual-use” investments—areas such as infrastructure and capabilities that support military readiness but were not previously counted under NATO definitions. According to the 2025 budget, Canada expects to meet this latter component. Putting this aside for now, the main challenge lies in scaling up core defence spending.
We project that, in meeting our NATO pledge, defence spending should nearly triple over the next decade, approaching $150-billion by 2035. That would make it one of the largest spending items in the federal budget. At a time when concerns about deficits, debt, and long-term fiscal sustainability are already mounting, accommodating such an increase without relying heavily on borrowing will require some hard choices.
Although higher defence spending should generate some broader economic benefits—recent research does find some positive effects, but the size is uncertain—any spillover economic benefits are unlikely to be large enough, or materialize immediately, to meet the defence target without having to make other—hard fiscal choices.
Put simply, Ottawa cannot meet this challenge and maintain its current fiscal anchor—a declining deficit-to-GDP ratio over time. Nor can Ottawa debt-finance this expansion without exposing Canada to the risks that comes with a persistently higher debt load—reduced fiscal flexibility, greater vulnerability to interest rate shocks, and an increased burden on future taxpayers. That leaves two broad levers: raising revenues or restraining spending elsewhere.
Neither option is easy. Canada’s weak productivity growth and modest economic outlook limit the room for large tax increases without undermining competitiveness. At the same time, demographic pressures—particularly population aging—are already pushing up spending on social programs while slow annual workforce growth limits our economic expansion. Layer on global uncertainty and trade conflicts, and the fiscal squeeze becomes even tighter.
In this context, a mixed approach is the most pragmatic path forward. Modest, broad-based revenue measures—such as a one-percentage-point increase in the GST, from five to six per cent, combined with slower growth in non-defence spending, could help create the fiscal room needed.
On the spending side, one area for scrutiny is the level of annual growth in transfers to the provinces and territories. The federal government alone is responsible for financing and for organizing military readiness and capabilities. The provinces and territories, however, are responsible for delivering most health-care and education services. A reduction in the growth rate of provincial and territorial transfers could, for example, be achieved with the federal government encouraging the provinces to increase their HST by one percentage point. This would acknowledge the pressure on Ottawa to fund defence capabilities and at the same time encourage the provinces to more clearly take responsibility for financing Canada’s key social programs.
There is ultimately only one taxpayer in Canada. A balanced financing approach spreads the burden, avoids over-reliance on revenue increases or spending reductions, and preserves the overall structure of Canada’s tax and transfer system, albeit at a leaner scale.
Canadians rightly celebrated reaching the two-per-cent NATO benchmark after years of falling short. But that milestone, while important, was only the beginning. The five-per-cent target represents a far more ambitious commitment—one that will test the country’s fiscal capacity and political will. Yet, meet this challenge we must, as the world is more dangerous than it has been in recent history.
A credible fiscal plan is valuable not only to inform difficult decisions, but also to equip our Defence Department with a reliable frame to go about planning multi-year equipment and personnel decisions. A strong plan would also be meaningful to any organization considering multi-year investments in Canada’s domestic defence industrial capacity, and which are conditioned by broken promises of planned increases to defence spending in the past.
Meeting the spending pledge while maintaining fiscal discipline will require more than incremental adjustments. It demands a clear-eyed assessment of priorities and a willingness to make difficult choices about both spending and taxation to get the job done.
Colin Busby serves as director of policy engagement at the C.D. Howe Institute, where Nicholas Dahir is a research officer.