Wed. May 18th, 2022

Germany’s new government want to do two mutually exclusive things – increase investment while adhering to Germany’s strict government debt rules. Reconciling the two can be one of the most difficult tasks they face.

But Olaf Scholz, the incoming chancellor, is confident he can make the circle square. The coalition agreement he unveiled last month contains a smorgasbord of schemes to raise funds without violating the “debt brake” – Germany’s constitutional restriction on new loans.

The opposition dismissed them as “tricks” and warned some jurists that they could harm the German constitutional court.

But others think, put together, it’s a reasonable plan of action.

“These measures, if fully implemented, will ensure that the coalition has enough money to do everything it needs to do,” said Jens Südekum, professor of international economics at Düsseldorf’s Heinrich Heine University. “If their agenda fails, it will not be due to a lack of cash.”

The coalition formed after national elections in September brings together three parties, Scholz’s Social Democrats, the Greens and Liberals, who are not natural allies.

The Greens campaigned on a promise to relax the debt brake and invest € 50 billion a year over the next 10 years to modernize Germany and make it carbon neutral. The Liberal Free Democrats (FDP) have said they will blocks any attempts to increase taxes or make any changes to the debt brake, which was introduced in 2009 after the global financial crisis blew a hole in Germany’s public finances.

Although their positions seemed incompatible before the election, the two managed to come up with very creative solutions to satisfy both sides.

One of them intends to transform the KfW, a state-owned development bank, into an “innovation and investment agency”, recapitalize it and use its extensive balance sheet to utilize private investments in green energy and digitalisation.

“The KfW will, among other things, be able to provide low-price loans to homeowners to insulate their homes or improve their energy efficiency,” said Südekum.

The KfW has already granted almost € 70 billion in state-guaranteed loans to German companies under a coronavirus support scheme launched at the start of the pandemic. This is excluded from official debt calculations, which means the scheme could serve as a model for financing other areas of the economy such as digitalisation or green energy, a close Scholz ally said.

Tree map showing how the German government plans to raise funds for investment.  Additional financial expenditure for the government, 2022-2025 Total - up to € 176 billion G1954_21X

Similarly, the coalition wants to allow state-owned companies such as Deutsche Bahn and BImA – the Federal Real Estate Institute – to incur debt that can be used for investments. It is already clear that Scholz considers BImA, a state agency that manages 460 000 hectares of state property, to be crucial for the implementation of one of the SPD’s key objectives – the construction of 400 000 new flats per year, of which 100 000 are subsidized by the state .

Another proposal involves tinkering with the rules of the debt brake, and especially the “cyclical component”, which determines how much leeway the government has to raise debt depending on the state of the economy.

The key here is the “output gap” – the difference between GDP and a measure of the economy’s potential: changing the way it is calculated can increase the amount of loans allowed under the debt brake. According to one estimate, this could enable the government to raise an additional € 10 billion a year.

Lars Feld of Freiburg University, a former government adviser, rejected the proposal as “Pippi Longstocking Economy – I make the world the way I want ”. But the new government clearly thought it was important enough to be included in its coalition agreement.

And the idea may eventually resonate far beyond Germany’s borders. “If Germany really reforms this rule, it will probably be introduced in the debate on the reform of the EU’s fiscal rules,” said Philippa Sigl-Glöckner of Dezernat Zukunft, a brainstormer, one of the forerunners of the proposal. “The EU uses the same calculation on potential output as Germany does.”

All the proposals to circumvent the debt brake come at a time when the rule is not being implemented: it was suspended last year to allow the government to increase spending during the coronavirus pandemic and will only come into effect in 2023.

One of the most controversial proposals in the coalition agreement is that ministers take advantage of this suspension to go on one last big borrowing mood. The debt incurred will be flushed into a “climate and transformation fund” to finance investments. This fund can also receive some of the € 240 billion new loans approved for 2021, but not actually raised.

But the idea proved controversial. “Debts incurred during the pandemic have a specific purpose, which is to deal with the economic consequences of the corona crisis,” said Hanno Kube, professor of public law, public finance and tax law at Heidelberg University.

Obtaining new loans and placing them in the climate fund invites “the question of whether there is enough connection with the [coronavirus] crisis. And there you enter something of a gray zone ”.

The coalition agreement also contains other ideas to raise more funds. The legalization and taxation of marijuana will help a bit, and ministers also plan to abolish a number of state subsidies, such as those for company cars with diesel engines. The timetable for repaying the large debt incurred during the pandemic will also be extended, relieving budgetary pressures.

It is also predicted that planned tax revenues will come in much higher than initially expected – an average of € 15 billion more per year over the next four years – which will give the new government more room to spend.

But for some, the complex proposals discussed underscore the absurdity of the debt brake and the need for fundamental reform of an arrangement that has survived its usefulness.

“You really have to ask yourself why we still have this rule when so much effort is put into circumventing it,” Sigl-Glöckner said.

Additional Reporting by Martin Arnold in Frankfurt

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