Canada and Germany offer a cautionary tale of two budgets

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Justin Trudeau and Olaf Scholz are both centre-left politicians whose governments depend on the support of a small progressive party to survive. This is a major reason Canada’s Liberal Prime Minister and Germany’s Social Democratic Chancellor have spent the past couple of years pitching new policy initiatives that are close to progressive hearts.

Those days now appear to be over. Mr. Trudeau and Mr. Scholz both suddenly face stark spending options.

Mr. Scholz’s “traffic-light coalition” with the left-leaning Greens and centre-right Free Democrats is in danger of collapsing after Germany’s top constitutional court last week struck down the government’s plan to reallocate €60-billion ($89.6-billion) in unspent emergency pandemic funds on climate-change initiatives and industrial subsidies.

The ruling blew a gaping hole in Mr. Scholz’s 2024 budget and forced him to slap an immediate freeze on new spending. The fate of billions in promised subsidies for green energy and silicon-chip factories is now up in the air.

The fiscal straitjacket in which Mr. Scholz finds himself is the result of Germany’s constitutionally entrenched “debt brake,” known as Schuldenbremse, which prohibits the government from running deficits of more than 0.35 per cent of the country’s gross domestic product. The rule was suspended during the COVID-19 pandemic, but its reinstatement has left Mr. Scholz in a bind.

On Thursday, German Finance Minister Christian Linder said he will table a proposal next week in the Bundestag to suspend the debt brake for 2023. If it passes, the government can get around the court ruling, at least in the short term. The Greens are likely to support the measure. But the proposal could face stiff opposition, including from within the ranks of Mr. Linder’s Free Democrats.

Meanwhile, Mr. Trudeau’s government tabled a fall economic statement this week that included an uncharacteristically hawkish (for the Liberals) vow to run deficits of no more than 1 per cent of GDP. Considering that the deficit hit 14.9 per cent in 2020-21 and 3.9 per cent the following year, the Trudeau Liberals are clearly playing against type here.

Granted, the 1-per-cent pledge is not set to not kick in until 2026-27. Even so, if the Liberals are serious, keeping the promise would preclude them from launching new spending initiatives in the interim that would involve recurrent expenditures beyond 2025.

As such, the deficit pledge essentially amounts to a freeze on new spending. It would require the Liberals to run increasingly large program-spending surpluses to offset ballooning interest payments on the federal debt. The latter are projected to surge from $35-billion this year to $61-billion in 2028-29. The Liberals will not only need to refrain from new programs – they will also need to better control the costs of existing ones.

Six highlights from the fall economic statement as Canadians struggle with affordability issues

So much for the national pharmacare program that the New Democratic Party is seeking in exchange for its continued support of Mr. Trudeau’s minority government. The Parliamentary Budget Officer projects that a federal-provincial universal drug plan would cost $13.4-billion in 2027-28. Ottawa would need to pick up most of the tab.

So much for more subsidies for electric-battery plants in Canada. The PBO estimates that Ottawa is on the hook for $26.9-billion of the $43.6-billion in federal, Ontario and Quebec government subsidies already promised to Volkswagen, Stellantis and Northvolt to build battery plants here.

To be sure, Mr. Trudeau has a lot more wiggle room than Mr. Scholz. The Liberal promise to limit future deficits to no more than 1 per cent of GDP is not entrenched in any law. It could be broken if political or economic circumstances warranted. The Liberals could be tempted to use a relatively mild recession as an excuse to go back on their pledge.

Not without consequences, mind you. Markets are counting on the Liberals to keep their promise. If they do not, Canada would lose fiscal credibility and investors would demand a bigger interest-rate premium on federal bonds.

Mr. Scholz is in a much bigger pickle. By most accounts, Germany’s economy has slipped into a recession and a sudden freeze in new government spending is certain to exacerbate the downturn. Critics argue the country’s debt brake, which was adopted in 2009, has prevented it from adequately investing in public infrastructure in recent years.

Still, German fiscal responsibility has enabled its peer countries in the European Union to borrow their brains out. Italy and France are running budget deficits of more than 4 per cent of GDP. Spain is not far behind. Since these countries share a common currency, the euro, lower borrowing by Germany helps keep a lid on the overall amount of outstanding euro-denominated debt. Germany’s sacrifices have kept the euro zone intact.

Germany’s government probably spends too little, while Canada’s spends too much. Each is now at a crossroads. Each needs to work on finding a better balance.