Debt and taxes: a bit of German perspective

This morning, a little international perspective on Canada’s federal deficit, and the inevitable debate Canadians must have about taxes.

News from Germany is that Chancellor Angela Merkel’s cabinet has approved a budget plan today that would see Europe’s biggest national economy take on US$121 billion in debt this year, US$436 billion from 2010 to 2013.

By my arithmetic, Canada’s projected deficit of C$50.2 billion (or around US$46 billion) is a little less than 40 per cent of Germany’s, about in line with the size of the Canadian gross domestic product compared to German GDP.

The big difference, however, is the starting point. Germany’s debt, measured against the size of its economy, is now about double Canada’s. German debt-to-GDP stands at around 60 per cent, roughy where ours was back in 1995, when the Liberals began wrestling Canada’s deficits into submission. Today, Canadian debt-to-GDP is around 28 per cent, the lowest among G7 countries.

Anyone who was around Ottawa in the early 1990s will share a bit of my sense of how strange it is to think of Canada entering a tough economic slog with the advantage of a relatively clean balance sheet. Back in the late-Mulroney, early-Chrétien days, Germany was the stolid, sensible country—inflation-adverse and fiscally cautious. By comparison, we looked like maniacs or children—willing to accept absurd public spending, punctuated by bouts of awful inflation.

The point of this is not to suggest Canadian can afford to sit back now and say, ‘What the heck, we’re plunging into debt again, but not as deep as everybody else.’ The point is to suggest we have a clear advantage to exploit, courtesy of Jean Chrétien and Paul Martin. Here’s something I think we should have learned from their years: first you fix your fiscal situation, then you reward yourself with lower taxes—not the other way around.

The debate over the relationship between tax levels and fiscal probity is about to be played out in a big way in Germany. In a few months, Germans will vote in an election, and Merkel’s Christian Democrats are promising tax cuts. Not surprisingly, Der Spiegel reports that her ruling party is now debating internally whether that could possibly still make sense, given the swelling German debt problem.

Here’s my guess: in Germany, Canada, and most other developed nations, taxes probably need to rise for a few years sometime soon after this recession ends. Governments will need the money to get their balance sheets back in shape. Given Canada’s relatively strong position going into this rough patch, a tax hike here wouldn’t need to last as long as in other countries.

Canadians learned, or should have, in the key 1995 to 1999 years that if they stomach somewhat higher taxes than they might like during a period of government fiscal retrenching, the payoff comes soon enough. Governments in Ottawa, with no more deficits to worry about, began delivering major tax cuts starting in 2000.

It’s possible, I suppose, that the recovery will be so strong that economic growth alone will spin off tax revenues sufficient to fix the federal books without any politically awkward rate increases. Usually, however, life doesn’t sort itself out so conveniently, and some projections I’ve seen are for lower tax revenue increases in the next few years than Ottawa raked in back in the good old nineties. I suspect most Canadians would accept straight talk on this likelihood.

Maybe that’s what Michael Ignatieff was trying to do when he let slip, just that once, that ruling out tax increases would be irresponsible. Maybe Stephen Harper was edging, ever so gingerly, toward a more honest rhetoric on taxes when he said, on delivering his recent economic quarterly update, not that his Conservatives pledged never to raise taxes, but only that he “does not foresee” increases.

It’s a start.

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