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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.
In reducing expenditures, priority should be given to improving government efficiency, as this would allow spending cuts without diminishing the quality and availability of public services.
In addition, the government should further cut back grants, as they are still high by international standards, and give consideration to further reducing government consumption expenditure. Proposals in this direction had been made by the previous government and more recently by research institutes.
The government should broaden the tax base by further phasing out tax concessions. In doing so, the government should also review the current application of the reduced VAT rate. In cases where the reduced rate amounts to an implicit subsidy without clear justification, it should be phased out. In cases where a reduced rate can be justified, it should be verified that the desired objectives cannot be achieved more efficiently through other means. In this regard, the recent reduction in the VAT rate for hotel services seems inappropriate and should be reconsidered.
In the past, pensions were increased by more than should have been the case based on the indexation rule, which increased public expenditures. The government should avoid such discretionary changes and resist pressures not to recover the additional costs associated with past interventions through lower pension increases in the future. The fiscal consolidation needed to ensure sustainability and also imposed by the new budget rule limits the room for subsidizing the public pension system from the general budget.
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:
- An increase in taxation of land and buildings could be achieved by further raising the tax rates, though any such decision has to be taken at the municipal level. Moreover, to make the tax more equitable, the government should move closer towards market prices as the basis for evaluating the tax base of the land and building tax (Grundsteuer) rather than relying on the values determined in 1964 (1935 for the eastern Länder). Concerns about an eventual short term adverse effect on house and land prices of such measures have to be balanced against the long term benefits of a more growth friendly tax structure.
- Depending on the size of any tax structure reform, a revision of the VAT system should be considered.
- The government may also give consideration to raising environmental taxes further. However, since the primary objective of such taxes is to reduce pollution by changing the behaviour of economic agents, they are associated with an intended erosion of the tax base and should thus not be a key element of a revenue raising strategy.
Composition of tax revenues
% of GDP, 2007
Source: OECD (2009), Revenue Statistics.
How to obtain this publication
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.
The complete edition of the Economic Survey of Germany is available from:
For further information please contact the Germany Desk at the OECD Economics Department at email@example.com.
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.