Germany’s economy: Hurry up and cut those taxes

Date: 21/06/03

The government wants to pep up the economy by bringing forward tax cuts

IN AN attempt to kick-start Germany's stalled economy, Chancellor Gerhard Schröder is preparing to lop an additional €25 billion ($30 billion) off income taxes from the beginning of next year, in the hope that the country's nervous consumers will open their wallets. Yet that will increase the risk that, for the third year in a row, the public deficit of Europe's biggest economy will be wider than the limit of 3% of GDP set by the European Union's stability and growth pact.

The finance minister, Hans Eichel, has suggested that tax cuts of €18 billion, planned for 2005, be brought forward and combined with cuts of €7 billion already planned to take effect in January next year. Mr Schröder, who had hitherto ruled out such a move, now says he is ready to consider it, provided that Mr Eichel makes up for the shortfall in revenue by chopping state subsidies and not simply by increasing public borrowing or raising taxes elsewhere. A firm decision is expected by the end of this month.

Mr Eichel suggested making the necessary savings by, among other things, slashing grants to home buyers, dropping tax exemptions for night-shift and Sunday workers, cutting coal subsidies, and ending tax breaks for commuters. Despite last year's deficit of 3.6% of GDP, which could grow even wider this year (and will very probably exceed the deficit limit again next year), Mr Eichel insists that the government is still right behind the stability and growth pact.

Others aren't so sure any more

But Wolfgang Clement, the superminister for economics and labour, now hints that Germany's government should press for a looser interpretation of the pact. He says that the 3% limit is “flawed”, as it fails to take into account the cost of German reunification. He points out that net public transfers of some €75 billion, nearly 4% of GDP, still flow into Germany's former communist east every year. Germany, he admits, is now unlikely to balance its books until 2008, two years later than originally planned.

Almost everyone, bar a few senior Christian Democrats, has welcomed Mr Eichel's plan to bring forward the final stage of the government's tax-reform package that was passed in 2000. The top rate of income tax would, under the new plan, come down in January from 48.5% to 42% (instead of 47%), while the bottom rate would drop from 19.9% to 15% (instead of 17%). Compared with the rates that applied when Mr Schröder took office in 1998, this amounts to a cut of 11 percentage points both at the top and at the bottom. Mr Schröder has already brought corporate taxes down from 52% to 38.7%.

But most economists doubt whether Mr Eichel's latest proposals, if implemented, will move the creaking economy out of its doldrums. They fear that much of the hoped-for rise in consumer spending will be cancelled out by bigger government payments for unemployment and welfare, by higher taxes on tobacco, by the bigger contributions that patients are due to make towards state health care, and by Mr Eichel's most recent proposals to cut subsidies and end tax breaks.

Optimists hope the sweetener of income-tax cuts may encourage left-wing MPs and the trade unions to swallow the bitter medicine being doled out by Mr Schröder through his labour-market and welfare reforms. After winning overwhelming support at a congress of his own Social Democrats earlier this month for his “Agenda 2010”, as his overall reform package is known, Mr Schröder has now won equally strong backing at a more recent gathering of the Greens, his government's junior coalition partners. He will also be chuffed by this week's decision by trade union leaders to abandon out-and-out resistance (including demonstrations and strikes) to the reforms in favour of fresh talks with his government.

• Primary Source