Is Germany Catching Trump’s Tax Disease?
The fiscal policies proposed by Germany’s emerging grand coalition government look very American. Like the US Republicans' recent tax legislation, they are likely to bring limited short-term benefits to a few and huge long-term costs to many more.
BERLIN – After months of negotiations, another grand coalition government – comprising Chancellor Angela Merkel’s Christian Democratic Union (CDU) and a grudging Social Democratic Party (SPD) – is taking shape in Germany. But the new government seems likely to miss the opportunity afforded by Germany’s strong economic and financial situation to pursue much-needed reforms.
In fact, the fiscal policies that Germany’s emerging government is discussing bear a remarkable resemblance to those of US President Donald Trump, whose tax plan, most economists agree, will bring limited short-term benefits to a few, but huge long-term costs to many more. Indeed, the incipient German government is discussing cutting taxes for corporations and the rich, while raising spending on public consumption, especially public pensions.
In the United States, Trump has convinced many of his lower-income supporters that his tax plan will benefit them, not just his wealthy cohorts. A similar feat has been accomplished in Germany, with some powerful lobby groups persuading middle-class voters that they will benefit from a tax cut.
These groups claim, for example, that raising the income threshold for the top marginal tax rate will help middle-income voters, even though the top marginal tax rate is now levied on just 7% of German employees. Similarly, the plan to abolish the tax surcharge on higher incomes (Solidaritätszuschlag), introduced after reunification in the early 1990s, would benefit almost exclusively the top 30% of earners.
This is all the more problematic because the top 30% of earners in Germany are already subject to a lower tax rate than 20 years ago, even though their wealth has increased. The bottom 70% largely pay much more in direct and indirect taxes, despite often having lower incomes.
The arguments for cutting corporate taxes are similarly flawed. Like Trump, German politicians and lobby groups claim that domestic firms need a tax cut in order to stay competitive internationally. Yet Germany’s export companies are undeniably very competitive, and have largely managed to increase their global market share since the 1990s. Moreover, corporate profits have reached record highs in recent years, and while corporate taxes in Germany remain relatively high compared to other countries, they were reduced significantly in the 2000s.
Beyond having only limited economic benefits, the proposed tax cuts in Germany – like Trump’s in the US – represent a huge strain on public finances in the long run. While Germany’s public sector currently boasts a surplus of about 1.3% of GDP, that is largely the result of good luck, not good policy: without low interest rates and a strong labor market, the federal budget would be in deficit.
Yet demographic shifts mean that contingent liabilities for public pensions and health care in Germany will rise sharply over the next decades. Covering these costs will require taxes to be increased substantially and/or for spending to be reduced – precisely the opposite of what the CDU/SPD government is promising.
This does not mean that Germany’s government should not contemplate any tax reductions or spending increases. But, in order to ensure that such changes have the maximum positive impact, without hurting younger generations, they must be designed fundamentally differently.
Arguably, Germany’s biggest economic weakness today is low private investment. With the German corporate sector having run up massive profits for more than a decade, the resources are certainly available. Yet overregulation, heavy bureaucratic burdens, policy uncertainty, poor digital and transport infrastructure, and, in some industries, a lack of skilled workers, are currently impeding investment by companies in new and existing capacity.
The government need not address all obstacles to investment and innovation at once. At the very least, it should create tax incentives for research and development, as well as for equity investments. It should also design provisions to support small and medium-size enterprises, while fighting tax evasion among big firms.
Moreover, Germany’s government should use its fiscal space to invest in education, in particular in pre-schools and primary schools. And it should invest in developing an internationally competitive digital infrastructure and a social security system that ensures labor-force participation and lowers long-term unemployment.
In many ways, Germany’s economy is thriving. But that is no reason for the government to waste its sizable fiscal surplus on economically useless tax cuts and spending increases. On the contrary, the surplus creates an important opportunity to tackle the long-run challenges that Germany faces – an opportunity that Merkel’s next government must not waste.
Germany’s Bland Grand Coalition
In pursuit of another "grand coalition" government, Germany's Social Democrats and Christian Democrats have published a provisional agreement outlining their proposed agenda. But the program party leaders have devised seems to have been inspired by a wish not to offend rather than a desire to confront the country's challenges.
MUNICH – Germany’s Social Democrats (SPD), the Christian Democratic Union, and the CDU’s Bavarian sister party, the Christian Social Union (CSU), have agreed to pursue another “grand coalition” government, and have published a 28-page agreement outlining their proposed policy agenda.
The agreement comes months after an election in which the SPD and CDU/CSU advanced rather different economic-policy views. Whereas the SPD has focused on the need for more redistribution and public spending, the CDU/CSU has promised “tax cuts for all” and a more restrictive refugee policy. The question now is whether a coalition comprising such ideologically divergent forces can truly prepare Germany for the challenges that await it.
In the months and years ahead, German policymakers will need to manage the transition into the digital era, in order to preserve the country’s competitiveness. They must also stabilize the welfare state at a time of rapid population aging. And they must develop a rational migration policy. On top of this full domestic agenda, many are looking to Germany to keep the European Union together.
As many commentators have pointed out, Germany’s new government will benefit from a budget surplus, because the booming economy, coupled with peculiarities of the German tax code, has boosted government revenues over the last four years. Even by pursuing the balanced-budget policy described in its provisional coalition agreement, the government will have room either for more spending or tax cuts amounting to €46 billion ($56 billion) – around 0.3% of GDP – over four years.
According to the coalition agreement, €36 billion of the surplus will be allocated to various outlays such as transfers to families, higher agricultural and regional subsidies, housing-construction incentives, roads and related infrastructure, universities and school buildings, and even the military.
That leaves just €10 billion for tax cuts, which will take the form of reductions in the solidarity surcharge (Solidaritätszuschlag), a special income tax that was introduced in 1991 to finance German reunification. The grand coalition envisions abolishing this tax for everyone except the top 10% of earners, who generate more than half of the revenue from it.
But when one considers the effects of “bracket creep,” the outlook for taxpayers worsens. Unlike most other developed countries, Germany’s tax system lacks an automatic adjustment mechanism to prevent inflation from pushing households into higher tax brackets. And while discretionary adjustments do take place, they hardly provide full compensation to countless households that end up paying more tax than they should.
In fact, at the current rate of bracket creep, Germany’s tax revenues will increase by roughly €50 billion over the next four years. Halving the solidarity surcharge no earlier than 2021 will come nowhere close to offsetting that.
All told, nobody is particularly enthusiastic about the coalition agreement, including the SPD. Despite the coalition agreement’s emphasis on spending, the SPD fears that participating in another grand coalition will further damage its public standing, and drive more of its voters into the arms of the radical left or the far-right Alternative für Deutschland (AfD).
For others, the problem is not politics, but the agenda itself: for all of its specific provisions, it achieves very little. When spread over four years, an additional €2 billion spent on defense, €600 million on universities, and €4 billion on housing will make little difference.
And while the coalition’s plan also promises higher contributions to the EU budget and more spending on the mothers’ pension and low-income households, it does not specify how those increases will be reconciled with a balanced budget.
More fundamentally, the agenda lacks ambition and direction. It neither provides significant relief to the middle class through tax cuts, nor allocates adequate investment for research, infrastructure, or education. And it makes no mention of corporate taxation, even though rate cuts in the United States, and planned cuts in France and the United Kingdom, will inevitably lure investment and jobs away from Germany.
A truly bold policy agenda would require the new government to focus on specific priorities and accept that not everyone can get what they want. Rather than tweaking the margins in a futile attempt to please everyone, the government would set its sights on deeper structural reforms, to lay the foundation for future growth and stability.
For example, Germany spends billions of euros every year on green-energy subsidies. But as the provisional coalition agreement acknowledges, Germany will likely fall short of its target for reducing carbon dioxide emissions by 2020, suggesting that these subsidies have not worked. Fundamental reforms in this area could make Germany’s climate policies both cheaper and more effective. But doing that would require the government to abandon its ideological position and challenge powerful interest groups.
Nevertheless, the coalition agreement does include some promising ideas. For example, it proposes a program to attract skilled workers, and to align Germany’s immigration policies with its economic interests. And although the new government should attach conditions to Germany’s larger EU budget contribution, in order to prevent wasteful spending, its clear commitment to the EU should be welcomed.
There is still time for the coalition partners to revise their program. Surely, they should want to do more than use the current economic upswing to provide piddling handouts to various constituencies (except those paying the most in taxes, of course). Now is the time to start preparing Germany for its future challenges.
While Germany Slept
Many Germans may prefer the modesty and incrementalism that have characterized Angela Merkel’s past chancellorships. But a minority government forced to muster coalitions of the willing to address the critical issues confronting Germany and Europe could escape the constraints of such expectations, enabling much-needed reform.
BERLIN – Few people outside Germany are familiar with the caricature of themselves that many Germans hold in their minds. Far from the aggressive bully of twentieth-century war propaganda, the perfectionist engineer of Madison Avenue car advertisements, or the rule-following know-it-all of the silver screen, the German many picture today is a sleepy-headed character clad in nightgown and cap. Sometimes clutching a candle, this German cuts a naïve, forlorn figure, bewildered by the surrounding world.
This figure is not new. On the contrary, referred to as “Der deutsche Michel” or “the German Michel,” it was popularized in the nineteenth century as a character whose limited perspective causes him to shun great ideas, eschew change, and aspire only to a decent, quiet, and comfortable life.
But Michel has now made a comeback. And who can blame him? Germany now boasts a booming economy, near full employment, rising wages, and content unions. The financial crisis is long forgotten, public budgets are under control; and the 2015 influx of migrants has been relatively well managed.
What bad news there is – industrial scandals (like that at Volkswagen), airline bankruptcies, endlessly delayed infrastructure projects – does little to dampen the general sense of safety and wellbeing enjoyed by Germany’s Michels. The only real threat, it seems, is the world outside Germany’s borders.
In this sense, last autumn’s election campaign was perfectly suited to Germany’s Michels. “A land where we live well and happily,” the campaign slogan of Chancellor Angela Merkel’s Christian Democratic Union (CDU), resonated with them, as did the rather provincial and mostly empty messages of rival parties. With the exception of the right-wing populist Alternative für Deutschland (AfD), the parties displayed a rote civility and drowsy acceptance of consensus that pacified the electorate.
After the election, the real politicking began, but even then, pains were taken to obscure those activities from Germany’s Michels. Indeed, though party officials had been in place for some time, they waited until the votes were cast before putting their cards on the table, and even then did so behind closed doors. Even the leaks from these closed-door coalition talks were so well managed that they created the illusion that the “Sondierungsgespräche” – that is, the preparatory talks among party officials – were politically rather harmless.
But Germany’s political class, like its ordinary Michels, are in denial. The soporific federal elections, the breakdown of coalition talks among the CDU, its Bavarian sister party the Christian Social Union (CSU), the Greens, and the Free Democrats (FDP), and the timid dance between the CDU and the Social Democratic Party (SPD) since then all point to a serious deficit in German politics.
The truth is that the various party platforms, meant to inform the electorate and provide a basis for coalition talks, reveal a shocking lack of imagination and paucity of new ideas. Second-order issues are presented as red lines, with largely technical questions – for example, about refugee family reunions, a new health insurance scheme no one asked for (Bürgerversicherung), or the role of the federal government in funding education – taking center stage.
Considering the state of Europe and the world – and the hopes many outsiders are pinning on German leadership – these issues seem rather marginal. But the real problem is that they are distracting from larger issues relating to, say, the euro, security and defense, migration, infrastructure, and taxation.
Lacking any forward-looking political visions, German politics has degenerated to tactical plays being carried out by established players. The CDU, in a War of the Roses with the CSU, can live neither with or without Merkel, while the SPD is unsure of itself and fears further political decline. None of this bodes well for a country whose parliament has already been diminished, after these three parties, during their eight years forming a coalition government, marginalized the opposition and failed to build up new leadership cadres.
Coalition agreements in Germany have always been elaborate documents of a quasi-contractual nature. But there is a growing tendency to plan out four years of governing, with leaders then using legislative periods not to debate laws, but rather to enact previously agreed policies.
Moreover, no major reform has been successfully implemented in Germany since the 2000s, when Chancellor Gerhard Schröder pushed through labor-market reforms. No forward-looking reforms of the caliber of Schröder’s Agenda 2010 were even attempted under Merkel in over a decade.
The CDU/CSU and the SPD are now pursuing a grand coalition that would keep Germany roughly on the same path it has taken during the last eight years. The 28-page agreement that will allow formal coalition talks to proceed is overly detailed, technocratic, unambitious, and lacks vision.
It is thus unsurprising that, though CDU/CSU and SPD negotiators have touted the deal as a breakthrough, many, especially in the SPD, are unhappy with the outcome, with some calling for renegotiation. The SPD now faces a choice: at its special party congress this weekend, its leaders must decide whether to join yet another grand coalition government that promises more of the same, or move into opposition, probably triggering new elections.
But there is another option, which many have ignored: a CDU-led minority government, with Merkel as chancellor. Freed of stifling coalition agreements with a reluctant SPD or a coldly calculating FDP, Merkel could choose her cabinet based on competence and vision, rather than party politics. She could even appoint ministers from other parties.
Most important, Merkel could finally tackle the important issues that have fallen by the wayside in recent years, to which the current coalition agreement pays only lip service. This means cooperating with French President Emmanuel Macron to move the European project forward; modernizing Germany’s public administration system; preparing the labor force for digitization; and tackling immigration issues.
Parliament is integral to success on any of these fronts. Mainstream parties must embrace the kind of open and constructive debate that nurtured parliamentary democracy in the Federal Republic’s early years, rather than remaining focused on political tactics.
Michel may prefer the modest policy initiatives and incrementalism that have characterized Merkel’s chancellorships. But a minority government forced to muster coalitions of the willing to address the critical issues confronting Germany and Europe could escape the constraints of Michel’s expectations, freeing German politics from party tacticians and enabling real and much-needed reform. In other words, the modicum of political insecurity Germany faces today may well be just what the country needs to give rise to new ideas and voices, and a better future.