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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Germany published on 26 March 2010.
Public finances are worsening rapidly
Until the onset of the economic crisis, public finances had improved markedly as the general government budget deficit narrowed to close to balance in 2007 and 2008. However, the fiscal deficit widened considerably in 2009, owing to the working of the automatic stabilizers and the launch of fiscal stimulus packages in late 2008 and early 2009. The worsening of the fiscal balance is set to continue, not least due to the introduction of further tax cuts in 2010, with the deficit projected to rise to above 5% of GDP in 2010. To realize the proposed measures of the coalition, while at the same time adhering to the European and national fiscal rules, appropriate offsetting measures have to be specified and implemented.
The new fiscal rule needs some fine tuning to be effective
As the previous fiscal rule had failed to sufficiently restrain the build up in government debt over the past decades, the government introduced a new – also constitutionally enshrined – fiscal rule in 2009, constraining the structural budget deficit to 0.35% of GDP by 2016 for the federal government and requiring balanced structural budgets for the Länder by 2020. A transition path will ensure steadily decreasing, structural deficits in the meantime. Based on sound forecasts, the new fiscal rule is likely to help bring public finances back to a sustainable path, but some elements of it are not yet fully specified – the cyclical adjustment mechanism for sub federal governments for example – or not fully satisfactory and should be fine tuned once experience has been gained with the new rule. It would help now to strengthen the stability council, which is meant to monitor budgetary developments, including by providing additional inputs from experts or institutions that are independent of the government. Moreover, the government should move towards a top down approach to federal budget formulation. Finally, it should ensure through proper prioritisation that an appropriate level of public investment is maintained in implementing the rule.
Compliance with the new rule requires sizeable consolidation
Economic projections for 2010 imply that the federal government’s structural deficit has to be reduced by around half a percent of GDP per year during the transition phase 2011 16. While in 2011 the phasing out of several of the fiscal stimulus measures will help to meet this target, additional consolidation effort will be needed in subsequent years. Since empirical evidence suggests that the adverse growth effect of consolidation is likely to be less severe if it is achieved through spending cuts rather than tax hikes, a reduction in expenditures should be the preferred way to achieve consolidation. Given the magnitude of the consolidation required, the expenditure cuts will need to be very ambitious. Moreover, the spending cuts will likely have to be accompanied by revenue raising measures. Here, priority should be given to base broadening measures.
The tax structure could be improved
Empirical evidence suggests that indirect taxes, notably those on real estate and consumption are least damaging to long term economic growth. To improve the structure of the tax system, the government should consider raising the share of indirect taxes in total tax revenues, e.g. by further phasing out tax concessions, while reducing the still high burden from distortionary taxes and contributions on economic activity:
Composition of tax revenues
% of GDP, 2007
Source: OECD (2009), Revenue Statistics.
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
Eine Druckversion des Policy Brief in deutsch (pdf Format) kann ebenfalls heruntergeladen werden. Es enthält die Gesamtbeurteilung und die Empfehlungen, aber nicht alle oben gezeigten Grafiken.
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The OECD Secretariat's report was prepared by Felix Hüfner and Isabell Koske under the supervision of Andreas Wörgötter. Research assistance was provided by Margaret Morgan.