Government debt interest costs rising across Canada

In the years leading up to COVID, and during the pandemic, federal and provincial governments across Canada benefited from historically low interest rates, which made it relatively inexpensive to borrow money. However, economic circumstances changed rapidly when Canada experienced its highest levels of inflation since the 1980s and the Bank of Canada was forced to increase its policy interest rate from 0.25 per cent to 4.50 per cent between March 2022 and January 2023.

Within a higher interest rate environment, it’s no longer relatively inexpensive for governments to borrow money to pay for their spending. The costs of servicing debt have risen considerably compared to what governments paid only a short time ago.

Take the federal government as an example. When interest rates dropped to near historic lows in 2020 during the initial stages of COVID, the annual cost to service federal debt declined by 16.6 per cent from the prior year and totalled $20.4 billion in nominal dollars. But this trend did not last for long.

When interest rates spiked in 2022, debt interest costs began rising rapidly again. According to the spring federal budget, debt interest will cost $34.5 billion in 2022/23 and reach $43.9 billion in 2023/24. To put this in context, the cost to service federal debt is on track to more than double over a three-year period from 2020/21 to 2023/24.

Consequently, Ottawa will spend almost as much on debt interest this year as what it spends on the Canada Health Transfer ($49.4 billion), which is money the federal government sends to provinces to help fund health-care services. The government also spends more on interest costs than it spends on the Canada Child Benefit and national daycare programs combined ($31.2 billion).

Similar stories emerge in provinces including British Columbia, Alberta and Ontario. The costs to service their debt have grown markedly since 2020, though much less than it did for the federal government. B.C. will spend more on interest costs ($3.2 billion) than it does on provincial transportation or social assistance payments in 2023/24. The revenue Alberta collects from post-secondary institution tuition fees and fuel taxes aren’t enough to cover its debt servicing costs ($2.8 billion) in 2023/24. Interest costs in Ontario ($14.1 billion) currently consume more revenue than provincial post-secondary education.

Of course, the burden of government debt interest falls on Canadian families today and in the future. Governments pay debt interest through general revenue, which ultimately comes from Canadian taxpayers. As government interest costs rise, this diverts money away from services such as health care, education and social services.

Higher interest costs can also contribute to larger deficits. A deterioration in federal and/or provincial finances could lead to further downgrades in the debt rating for Canadian governments and an increased risk premium attached to our debt. This can lead to a vicious cycle of larger and larger budget deficits and more debt accumulation. Canada experienced this vicious cycle during the 1990s debt crisis when federal interest costs consumed roughly one out of every three dollars of revenue.

So, since interest rates will likely remain elevated for the foreseeable future, what should governments do to combat rising interest costs?

Simply put, they must do a much better job at controlling, and even reducing, program spending and returning to balanced budgets. Only three provinces plan to run surpluses this year even though all 10 experienced an influx of revenue and eliminated emergency COVID programs.

Interest costs are taking a substantial bite out of Canadian government budgets, with the costs ultimately borne by taxpayers. Ottawa and the provinces must be more responsible with their finances, otherwise the costs for Canadians will only grow higher.