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12/16/2009

Peter Harry Carstensen -- a member of Germany's center-right Christian Democratic Union (CDU) and the governor of the northern German state of Schleswig-Holstein -- has always had trouble with numbers. During his state's parliamentary election last summer, he showed a tendency to get big numbers mixed up and admitted that he sometimes loses track of things. "With all those millions and billions," Carstensen said apologetically, "you sometimes get a little confused."

Now it's fall, and the easygoing governor has apparently learned a lot since the summer. In recent weeks, the former agriculture teacher has played the financial expert. He has provided Chancellor Angela Merkel with extremely detailed calculations meant to support his contention that his state -- which , like Germany's federal government, is controlled by a coalition of the CDU and the Free Democratic Party (FDP) -- has a lot of problems with Berlin's proposed economic growth-acceleration law.

The legislation would cost Carstensen's cash-strapped state €70 million ($103 million). That figure includes Schleswig-Holstein's share of the costs of a higher childcare allowance, a more generous tax abatement for dependent children, financial relief for businesses and benefits for hotels. Carstensen believes that this is too much of a burden for a state that is already €24 billion in debt and that has to pay about €1 billion a year in interest on this amount. Indeed, he wants the federal government to compensate his state for the additional financial burden the new legislation would impose.

By the end of last week, Merkel was still refusing to yield to Carstensen's attempts at extortion. As she put it, even if the draft legislation failed in the Bundesrat, Germany's upper legislative chamber, it would still end up in the mediation committee, whose proportional representation would give her coalition an advantage.

A Must-Win Situation

Merkel's new coalition government has already gotten off to a shaky start. If her first parliamentary bill failed to get through the Bundesrat the first time around, Merkel would be seriously damaged.

Since Merkel wants to avoid this at all costs, she's busy searching for an alternate solution. For several weeks, her staff has been trying to figure out a way to make Schleswig-Holstein happy enough to drop its resistance to the plan. They've considered a number of measures, such as providing additional federal funding for education or increasing the federal government's share of funding for the state's coast guard.

No matter how the vote in the Bundesrat goes on Friday, the premier of Merkel's coalition government is already an utter failure -- not just because of the manner in which the draft bill materialized, but also because of its content. On the one hand, it became clear that the coalition between Merkel's Christian Democratic Union (CDU) and the business-friendly Free Democrats (FDP) is far from a closed and determined formation. In fact, many coalition members in parliament, the Bundestag, including Speaker Norbert Lammert (CDU), have voiced their concerns about the proposed law, and there have also been audible grumblings within the Bundesrat. "No one can make policy against the established rules," said Peter Müller (CDU), the governor of the western state of Saarland.

Germany's Highest Debt in Postwar History

In the past, sound government finances were seen as the core responsibility of a middle-class coalition. Now the CDU/FDP coalition's plans seem out of date. The government wants to lower taxes and increase social benefits like the childcare allowance, despite the fact that it is expected to face the highest level of new debt in postwar German history, even without the proposed measures. This is not what responsible fiscal policy looks like.

But what was particularly damaging to the undertaking is the complaisance with which the new administration, despite an already strained budget, has sought to accommodate special-interest groups, such as hotel owners. Under the proposed legislation, the hotel industry would pay a reduced value-added tax (VAT) rate in the future, which is yet another subsidy that counteracts the goal of tax simplification.

At least the government, responding to weeks of criticism, and at the instigation of the FDP-controlled Economics Ministry, has significantly trimmed its plans for additional tax cuts for 2011 and thereafter.

Although Economics Minister Rainer Brüderle characterized the undertaking as "non-negotiable" in an interview with SPIEGEL, officials at his ministry have been significantly more restrained. The draft of the new annual economic report for 2010, with the working title "Devoting New Energy to Shaping the Future," announces new relief starting in 2011, but with considerable restraint. "In a further step, the federal government will flatten the so-called small and medium-sized business belly of the income tax," the report states.

More revealing than what the classified draft document announces is what it conceals. Not a word is mentioned about a differential tariff, the core demand of the FDP tax concept, and the relief volume of roughly €20 billion is not repeated. The growth acceleration law, the document states more generally, will provide "an additional contribution to solidify the upturn and reduce obstacles to growth."

Tax Cut Plan 'Dubious'

Experts are not as euphoric in their assessment of the coalition partners' plans. All of the government's advisory panels -- from the central bank to the federal audit office to the council of economic experts -- have condemned the plans outright. "Promises of tax cuts without sound funding to offset lost revenue, as described in the coalition agreement, are dubious," the economic experts write in their latest annual report.

In truth, the pretentious title "Growth Acceleration Law" is nothing but an official attempt to deceive. Granted, the package does include measures designed to make it easier for companies to invest. But it consists primarily of social policy measures, including a monthly €20 increase in child benefits and an increase in the allowance for dependent children.

In its annual economic report, the government praises the family policy measures for "increasing purchasing power." But that's only half of the equation. Some of the additional money families with children receive will go toward savings. While this doesn't mean that it becomes lost to the economy, the money will also have no impact on consumption.

Besides, the additional benefits for families will translate into a loss of at least some revenue for municipalities. "Every billion in income tax revenue reductions directly affects local finances," says Bernhard Elsemann, treasurer of the western city of Oberhausen. This in turn translates into budget shortfalls for amenities like swimming pools and libraries, as well as for public works projects like road construction.

Elsemann's counterpart at the federal level, Finance Minister Wolfgang Schäuble (CDU), has no intention of cutting any expenses to come up with his €4.6-billion share of the Growth Acceleration Law. Instead, he plans to borrow the entire amount.

In doing so, he will only drive up the government's already massive new debt. In the coming year, the federal government will take on a record €85.8 billion in new debt. Its magnanimity will cost the government additional hundreds of millions of euros to service the debt in the future.

Even those who stand to benefit from the package do not have unconditional praise for the government. People sense that today's debts will be tomorrow's taxes.

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• Part 1: With Tax Cut Plan, Merkel's Government Off to False Start
• Part 2: 'Government Debt Costs Taxpayers Billions Today'