Berlin's Budget Plans: German Austerity Program Offers Chance for New Beginning

By SPIEGEL Staff

As Chancellor Angela Merkel's embattled government gets ready to thrash out an austerity program to rein in the budget deficit, fears are growing that stringent cuts might choke off growth and anger voters. But after 50 years of near-continuous spending hikes, there is ample scope for radical savings that would not hurt public services and may even boost the economy.

Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble Zoom
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Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble

The German government is putting the finishing touches this week on an austerity program that offers a chance of a fresh start, not just for the country's complex and bloated tax and welfare system, but also for Chancellor Angela Merkel.

Her ruling center-right coalition plans tax hikes, new taxes and radical savings in areas including defense to rein in the budget deficit starting in 2011, SPIEGEL ONLINE has learned. It aims to finalize its planned savings program at a meeting on Sunday that the government hopes will give it a boost after months of setbacks that have triggered a plunge in public support for it.

According to sources in the coalition of conservatives and pro-business Free Democrats (FDP), the parties are discussing raising the tobacco tax and introducing new levies on nuclear fuel rods, airline ticket purchases and financial transactions. Media reports this week said Defense Minister Karl-Theodor zu Guttenberg is reviewing a possible reduction in the Bundeswehr German army by as many as 100,000 troops to 150,000 and suspending mandatory military service.

The spending cuts and tax hikes are part of Merkel's pledge to foster a new "culture of stability" in Europe by helping to slash the continent's burden of public debt that has plunged the European single currency into crisis.

The Americans don't like the plans. The atmosphere was decidedly frosty at a meeting last week in Berlin between US Treasury Secretary Timothy Geithner and German Finance Minister Wolfgang Schäuble, because the two men fundamentally disagree. Geithner urged the Europeans to spend more and to run up debts to boost economic growth and help the global economy. Schäuble countered that high debts were the root of the turmoil now engulfing the euro zone.

Back to Reality

The meeting didn't just highlight a rift between Germany and the US on economic policy. It also marked a fundamental shift in thinking in Merkel's coalition. Ever since Merkel won re-election in September, her policies have seemed divorced from reality.

Her coalition pledged tax cuts and passed a "Growth Acceleration Law" that accelerated the pace of public borrowing. There was a cut in the inheritance tax, corporate taxes were lowered and the statutory health insurance system got a record injection of tax money. In addition, child benefits were increased. The government decided to put off all the difficult reform policies until after the important state election in North Rhine-Westphalia on May 9. That was a ploy to keep voters sweet, but it backfired.

Merkel's conservative Christian Democrats (CDU) suffered heavy losses in the state and the center-right coalition lost its majority in Germany's upper legislative chamber, the Bundesrat, which represents the interests the country's 16 states, as a result. A poll by the Forsa Institute released on Tuesday showed support for the Christian Democrats and their Bavarian sister party -- the Christian Social Union, which share power at the national level -- at just 30 percent, its lowest level in four years. The slide in support for the CDU and FDP has been greater than any ruling coalition has suffered since the end of World War II.

That is why next Sunday's coalition meeting in the town of Meseberg west of Berlin is so crucial for Merkel's beleaguered government. She needs to ditch a mentality that has prevailed in German administrations for the last 60 years -- to finance public spending programs with borrowed money. It's an approach that is placing a huge burden on coming generations.

Massive Debt Burden

Statistically, every person working in Germany shoulders €43,000 ($52,500) in public debt. Even if the debt mountain doesn't rise any further, that figure will soon reach €48,000 because the working population is shrinking as a percentage of the total population.

It can't go on like this. Germany has already committed itself to two sets of rules that are designed to force the nation to become more frugal. Firstly, the Stability Pact for Europe's monetary union will force the government to reduce the deficit from 5 percent of GDP now to below the 3 percent ceiling by 2013. Secondly, Merkel's previous government, a so-called grand coalition of conservatives and center-left Social Democrats, agreed on a "debt brake," a balanced budget and debt reduction program forcing the government to reduce its structural deficit -- the recurring gap between revenues and spending -- to €60 billion from the current €70 billion.

Now Merkel and Schäuble face the mammoth task of saving €10 billion per year from 2011 onwards to meet those requirements. They must also adapt the cradle-to-grave social welfare system so that it can cope with demographic changes -- namely a population that is expected to shrink considerably in the coming years. In the pension, nursing and health insurance systems, the government has no option but to scale back benefits and find new sources of income.

Germany is at a crossroads. For decades, the nation was accustomed to economic growth and rising benefits. Now Germany must save its way back to health.

The task facing Merkel's coalition is greater than in 2003 and 2004 when the center-left government under then-Chancellor Gerhard Schröder launched its "Agenda 2010," the country's most radical program of welfare cuts since World War II.

Concern Over Political Fallout

In public, the coalition politicians claim to be determined to make wide-ranging cuts. But behind the scenes they are deeply worried that the cutbacks could choke economic growth. How can they shield their own voters from the pain? And is it possible to win elections while imposing cuts?

Trade unions and business lobbies are getting ready to resist any savings that might hurt their interests.

It is clear, however, that after half a century of uninterrupted increases, the catalogue of public spending contains a wealth of dubious items. The state has built ports, bridges and canals that turned out to be unnecessary. It subsidizes industry sectors whose products no one wants and spends billions on defense technology that doesn't work. Instead of motivating the unemployed to find work, it creates incentives to stay at home.

Saving in these areas would in many cases not only be more efficient, but fairer too. Slashing unwarranted financial subsidies often leads to greater economic growth as well as reduced spending. Curtailing tax benefits helps create the simple and fair tax system that the FDP keeps demanding.

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