Robert Grundke
Enes Sunel
Christian Wittneben
OECD Economic Surveys: Germany 2025
Abstract
After a decade of strong export-led growth, the COVID-19 pandemic, Russia’s war of aggression against Ukraine and rising trade tensions have hit the German economy and emphasised the need to accelerate structural reforms. The recent reform of fiscal rules will allow to raise spending to improve defence capacity and address a large infrastructure backlog. However, to ensure medium-term fiscal sustainability, it should be combined with raising spending efficiency, reallocating spending and broadening the tax base, while addressing rising spending pressures due to population ageing by reforming the pension, health and long-term care systems. To ensure that increasing domestic demand is matched by supply, it is key to address skilled labour shortages and reduce the high administrative burden and barriers to competition, which have weighed on business dynamism, innovation and productivity growth. To deepen capital markets and support access to finance for start-ups, strengthening asset-backed occupational pension funds and fostering financial literacy would help.
1.1.1. The economy is stagnating due to a mix of exogenous shocks and structural factors
After a decade of strong export-led growth, decreasing unemployment, fiscal surpluses and declining public debt, the COVID-19 pandemic, Russia’s war of aggression against Ukraine and rising trade tensions have hit the German economy (Figure 1.1). Supply chain bottlenecks during and after the pandemic and rising trade tensions have affected it more than others. Its manufacturing sector accounts for a higher share of GDP than in many other OECD countries and it is strongly integrated into global value chains, in particular within Europe and with the United States and China. Moreover, although a strong dependency on Russian energy imports was reduced quickly, energy prices remain higher than before the war, lowering the terms of trade and hampering production in energy-intensive industries (Figure 1.2). In addition, high inflation due to supply chain disruptions and high energy prices as well as heightened uncertainty have weighed on domestic demand.
Source: OECD calculations based on OECD Quarterly National Accounts database and OECD Economic Outlook database.
The recent exogenous shocks are compounded by longer-term structural challenges which have already weighed on economic growth before the pandemic started (Figure 1.1, Panel B). High administrative burden and barriers to entry, growth and exit of firms have hampered business dynamism, investment and innovation, including the adoption of digital technologies by firms, weighing on productivity growth (see Chapter 2). Rising skilled labour shortages exacerbated by rapid population ageing and a decline in working hours per worker have weighed on labour supply (see Chapter 3). Complex planning and approval procedures and weak infrastructure planning capacity at the municipal level have hindered public investment in many areas, including in schools as well as transport and digital infrastructure (see Chapter 4). Continuing to address these challenges through a comprehensive set of structural reforms discussed in this Survey is key to revive economic growth and raise living standards. According to OECD simulations, these reforms would allow raising potential GDP per capita growth by about 0.8 percentage points per year until 2035 (Table 1.1). Funding these reforms while at the same time addressing rising spending pressures due to rapid population ageing will require raising spending efficiency, reallocating spending and broadening the tax base (see below).
Average yearly additional growth in GDP per capita during the next 10 years (in percentage points)
Note: The effects of structural reforms are quantified using the methodology of Guillemette and Turner (2021[1]). The set of structural reforms comprises: improving the Product Market Regulation Index to the average of top five performers and the quality of public governance by half of the difference to the average of top five performers; a reduction in labour tax wedges by a quarter of the difference to the OECD average; increasing public investment as a share of GDP to the OECD average and R&D expenditure to the average of top five performers; improving access to adult education to lower the share of adults without completed secondary education or VET degrees to the average of the top five performers and raising spending for active labour market policies by 25%; improving access and quality of childcare and early childhood education by increasing public spending as a share of GDP to the average of top five performers; reducing the distance between educational outcomes of children from the highest and the lowest decile of the household income distribution and average education outcomes to the ones observed in Canada, which is a top performer; linking the legal retirement age to life expectancy from 2031 (increase by one year for each additional year of life expectancy). The scenario for improving educational quality shows the average yearly additional GDP per capita growth from 2025 until 2060, as the effects of changes in educational quality will affect human capital of the workforce with a larger time lag.
Source: OECD Long-term Model.
1.1.2. The economy has weathered the recent crises relatively well
The government has used the ample fiscal space accumulated during the 2010s to set up large support programmes for firms and households which has stabilised the economy during the pandemic and the energy crisis. Pandemic-related support, including grants to firms and the short-term work scheme, amounted to about 5.5% of GDP from 2020 to 2022. Energy price support totalled about 1% of GDP in 2022 and 2.4% in 2023. The strong acceleration of planning and approval procedures for the construction of LNG terminals has enabled a quick substitution of Russian pipeline gas with gas from other sources. The design of energy price support measures preserved energy saving incentives for firms and households, which helped to reduce gas demand by about 20% due to fuel switching and import substitution of some energy-intensive inputs (Moll, Schularick and Zachmann, 2023[2]). Following the explosion of the Northstream gas pipeline in September 2022, these measures were key to avoid a much deeper economic downturn, which had been forecasted by many observers in case of a breakdown of Russian gas supply.
However, a better targeting of support measures at vulnerable households and highly exposed firms could have lowered fiscal costs while facilitating necessary structural change. In particular, the design of grants to firms and the short-term work scheme during the pandemic likely hindered the reallocation of production factors to expanding sectors and firms, thereby weighing on business dynamism and productivity growth (see Chapter 2). To better design and target support measures during the next crisis, policy impact evaluation should improve, which notably requires abolishing legal constraints to access, merge and analyse administrative micro data across levels of government, improving data and IT capacities and fostering a culture of policy impact evaluation (see the previous OECD Economic Survey of Germany and below).
Together with large support programmes, high equity ratios and market power have helped firms cope with higher input and energy prices and the stagnating economy. The average equity ratio of small and medium size firms had strongly increased from 18% in 2002 to 32% in 2019 and stood at 31% in 2024 (KFW, 2024[3]). The average equity ratio of manufacturing firms has risen from 29% in 2019 to 34% in 2023 (Bundesbank, 2023[4]). Moreover, due to strong positions in global markets, many firms were able to pass on higher input and energy prices to foreign consumers and clients, contributing to rising firm profits until the end of 2023 (Figure 1.3, see also the previous OECD Economic Survey of Germany). In domestic markets, market power and high mark-ups have also helped many firms to absorb input price shocks (see Chapter 2). Although firm insolvencies have started to accelerate in 2024, they remain below the pre-pandemic ten-year average (see below).
Gas and electricity prices, January 2021 = 100
1. Producer price index of natural gas when supplied to industry.
2. Producer price index of electricity when delivered to special contract customers.
Source: Federal Statistical Office.
Headline inflation has fallen rapidly and monetary policy started to ease, while core inflation remains sticky. The quick substitution of Russian energy supply and significant energy savings have contributed to a rapid decline of energy prices and falling headline inflation (Figure 1.2, Figure 1.4). Fiscal consolidation in 2024, including the phase-out of energy-price-support measures, has helped to reduce inflationary pressures. The European Central Bank (ECB) has started to ease monetary policy with policy rates declining from 4% in June 2024 to 2.25% in April, while market inflation expectations over the next 12 months are well-anchored at the ECB’s target of 2%. However, core inflation remains high at 3.1% in April due to high services price inflation of 4.5%, driven by strong nominal wage gains.
Rising nominal wages on the back of a tight labour market have supported the purchasing power of households and private consumption (Figure 1.4). Nominal wages per employee increased by 5.4% in 2024, pushing up real wages by 3.1%. The strong increase of the minimum wage from 48% to 60% of the median wage in October 2022 has particularly increased wages for workers in the first quintile of the earnings distribution. However, inflation for lower-income households has been particularly high, mitigating the effects of the minimum wage increase on real incomes (see Chapter 3). In 2023 and 2024, one-off payments of up to EUR 3 000 were exempted from income tax and social security contributions, which has benefitted about 86% of all employees covered by a collective bargaining agreement, with an average bonus payment of EUR 2 680. The phase-out of this tax exemption in January 2025 will help to avoid a wage-price spiral and bring down core inflation. However, the temporary nature of the one-off payments might also partly explain why many households preferred to save a larger part of the additional income, thus mitigating its effects on private consumption. Although the labour market has started to cool, it remains robust (Figure 1.4). Employment continued to increase in 2024 reaching an all-time high of 46.3 million employees. The unemployment rate remains low and vacancies are high relative to historical norms, still signalling skilled labour shortages (see Chapter 3). The slight rise in the unemployment rate since early 2023 is mainly explained by the arrival of about 1.3 million Ukrainian refugees, whose employment rate is relatively low (see Chapter 3).
GDP deflator decomposition by income side, contributions, % points
Source: OECD calculations based on OECD National Accounts database.
1. Harmonised index of consumer prices.
2. Harmonised index of consumer prices excluding food, energy, alcohol and tobacco.
Source: Federal Statistical Office; and Eurostat.
High uncertainty has weighed on investment and private consumption (Figure 1.5). The war in Ukraine has threatened energy security, while at the same time emphasising the need to invest more in defence capacity. Rising trade policy tensions and supply chain disruptions have weighed on investor confidence, particularly in export-oriented manufacturing sectors. This has been compounded by high uncertainty regarding fiscal policy and the design of measures to support households and firms during the green transition. The ruling of the Supreme Court in November 2023, which had declared the use of emergency related borrowing authorisations to finance investments in consecutive years as unconstitutional, led to a reduction of funds available to support firms and households during the green transition and a sudden phase-out of energy support measures, leading to a stronger-than-expected fiscal tightening in 2024. Subsidies for electric vehicles (EV) were phased out in January 2024, which contributed to a large drop in car sales, and plans to reduce grid charges and extend subsidies to reduce energy costs of firms until 2030 were cancelled. Conflicts about fiscal policy, including on how to fund defence spending and military aid for Ukraine, and the design and financing of support measures for the economy and the green transition finally led to the fall of the coalition government in November 2024 and the failure to approve the federal budget for 2025. Although a provisional budget for 2025 extended spending levels from 2024 to 2025, new public investment projects requiring budget approval have been put on hold resulting in tighter fiscal conditions than expected (see below).
Source: http://www.policyuncertainty.com/index.html; https://www.matteoiacoviello.com/tpu.htm on May 19, 2025; OECD calculations; ifo business surveys; GfK.
Since 2022, a broad range of reforms has been conducted, which will positively affect potential growth and living standards in the medium term (Box 1.1). However, after major economic and social disruptions due to the pandemic, the war in Ukraine and the energy crisis, some reforms, particularly related to the green transition, might have also contributed to further public discontent and rising policy uncertainty. In particular, a 2023 draft bill prohibiting the new installation and replacement of irreparably damaged fossil fuel-based heating systems in residential and non-residential buildings to be implemented gradually after 2024 caused public discontent and conflicts within the coalition government, as more than three fourths of households still use fossil-fuel based heating systems. Although the green energy transition is a key policy lever to raise energy security and lower dependency from energy imports, such regulation might have weighed on German households already suffering from the economic and social consequences of the pandemic and the energy crisis (Normenkontrollrat, 2024[5]). As recommended by the previous OECD Economic Survey of Germany, the country should strengthen carbon pricing, including by abolishing tax exemptions for fossil fuels and other environmentally harmful subsidies, while using the additional revenues to support vulnerable households. This would help reduce emissions where it is less costly and raise support for the green transition. Importantly, integrated communication of large structural reform packages is key for raising public acceptance and addressing resistance of interest groups. Making costs and benefits of reforms transparent and combining policy measures so that eventual losses for some parts of the population are adequately compensated can help the successful implementation of reforms. While it is welcome that the new federal government intends to simplify regulation and strengthen carbon pricing and technological openness, the announced reinstatement of previously phased out fossil fuel subsides in agriculture are a step in the opposite direction.
While uncertainty related to US trade policy has strongly increased, domestic policy uncertainty has declined since the federal elections in February (Figure 1.5). This is due in particular to a reform of fiscal rules in March, which will allow for higher defence and infrastructure investment spending (see below), as well as a relatively quick and successful end of coalition negotiations. The policy plans laid out in the coalition treaty of the three coalition partners emphasise the need to strengthen defence and internal security, address the large infrastructure backlog, revive the stagnating economy, modernise and digitalise the public administration, and address skilled labour shortages. To revive the economy, the new government plans to raise depreciation allowances for equipment investments from 2025-27 and lower the corporate income tax from 2028 by one percentage point per year over a period of five years, reduce the electricity tax and network charges, raise subsidies for energy-intensive firms, and support the car industry by increasing subsidies for electric vehicles and the commuter allowance. Labour supply incentives are planned to be raised by exempting additional income from working extra-hours, wage premia to switch from part-time to full-time work as well as earnings of workers above the statutory retirement age from labour taxes. A general reduction of personal income taxes for lower-to-middle incomes is planned from 2027. However, the financing of many of the announced measures remains unclear, in particular as the coalition treaty falls short of addressing the rising spending pressures due to rapid population ageing (see below). With the government having been elected in early May, a budget for 2025 and 2026, including detailed investment plans, as well as a medium-term financial plan should be approved quickly to further reduce policy uncertainty.
The federal government has enacted many reforms related to a broad range of areas since 2022:
Policies to accelerate the green transition (simplifying planning and approval procedures for renewable energy and grid expansion projects, elimination of the electricity surcharge for renewable energy, increased flexibility in sectoral emission targets to allow for compensation by other sectors, higher energy efficiency standards for new constructions and renovations, newly installed heating systems have to run with at least 65% of renewable energy from 2028)
Tax policy (adjusting the income tax schedule to inflation, raising depreciation allowances for investments, raising the threshold until which social security contributions increase progressively (Midi-jobs), reduction of fossil fuel subsidies for agriculture)
Migration policies (skilled migration was facilitated by introducing a job search visa and facilitating work permits and visas for migrants with a job offer, refugees are now permitted to work after 6 months)
Labour market policies (increase of the minimum wage, reform of the basic income support to allow for more fundamental re- and up-skilling of the unemployed, reduction of withdrawal rates of social benefits to improve labour supply incentives)
Education and training policies (introduction of a training guarantee for applicants that have not found a VET position, expansion of aid for trainees and students, increased financial incentives for firms and workers to participate in adult learning, platform to reduce information asymmetries in adult learning market, support programme for disadvantaged schools)
Health policies (hospital network reform partly replacing case-based payments with retention allowances, introduction of the digital patient file, health data access law facilitating the use of health data for research objectives and raising spending efficiency)
Reducing the administrative burden (introduction of stakeholder consultations to improve regulatory quality and reduce compliance costs, reduction of reporting requirements in some administrative procedures, modernisation of the building code, started coordinated simplification and acceleration of planning and approval procedures at the federal and Laender level)
Competition enforcement (a market investigation tool has been introduced to correct for market distortions, such as tacit collusion or vertical integration, which are hard to address with traditional enforcement tools)
Fighting corruption and money laundering (strengthening of the lobby register to include contacts with lower levels of the administration, introduction of a legislative footprint, broadening the definition of corruption for members of parliament)
Defence and national security (an extra-budgetary fund of EUR 100 billion was established to improve the defence infrastructure, while defence procurement was accelerated)
In addition to weak domestic demand, export volumes have stagnated and recently declined below pre-pandemic levels due to several factors (Figure 1.6). Supply chain bottlenecks, which had increased input prices and weighed on manufacturing production and exports during and after the pandemic, have eased since 2022, notably supporting machinery and equipment, automotive and electronic goods industries. However, at the same time, production and exports of energy-intensive industries declined significantly due to increasing energy prices following the war in Ukraine. High interest rates reduced global demand for investment goods, which make up for a large part of German exports (Figure 1.7), and this was compounded by a weak Chinese economy and rising trade tensions. The United States has replaced China as Germany’s most important trading partner outside the EU in 2024. However, recently rising uncertainty related to US trade policy is strongly affecting business expectations, particularly in export-oriented manufacturing (Figure 1.5). At the same time, German manufacturers face increasing competition from Chinese producers in their export markets. Despite a recovery in export markets due to monetary easing, exports volumes have declined in the second half of 2024 and the competitiveness of manufacturers has decreased (Figure 1.8). Rising unit labour costs have also contributed to weaker export performance, emphasising the need to foster business dynamism and productivity growth and address skilled labour shortages to improve international competitiveness (see Chapter 2 and 3). This is also important to attract more foreign direct investment, the inflow of which has decelerated since 2022 (Bundesbank, 2024[6]).
Source: Federal Statistical Office; OECD National Accounts database.
Exports of goods and services, % of total, 2023
Source: OECD calculations based on IMF DOTS Database; UN Comtrade Database; and OECD Trade Statistics.
Manufacturing firms have adjusted to higher input prices and increasing competition from China by shifting towards higher value-added products. In the aftermath of the pandemic, the value of exports has increased much more than volumes, and firm profits strongly increased until the end of 2023 (Figure 1.6, Figure 1.3). Although this was partly due to market power of German exporters in global markets, which allowed them to pass on higher input costs to foreign clients (see the previous OECD Economic Survey of Germany), a shift to higher value-added products has played an important role. Price-adjusted value added in manufacturing has remained above production since the pandemic (Figure 1.6). Production has shifted from producing energy-intensive inputs towards more sophisticated products in the chemical industry. In the automotive industry, scarce and more expensive inputs due to supply chain bottlenecks were rather used for vehicles with a higher value-added content and higher margins. Even before the pandemic, spending for research and development in the automotive industry had increased, signaling a structural shift towards higher value-added products. Across manufacturing sectors, the weight of ICT goods in total production and exports has risen strongly due to strongly rising global and domestic demand for ICT goods.
Note: Export performance is measured as actual growth in exports relative to the growth of the country's export market.
Source: OECD Productivity Database; OECD Economic Outlook database.
Structural change within manufacturing has been complemented with a structural shift of economic activity towards services (Figure 1.9). ICT and business services have strongly increased value-added and employment. The public sector has also expanded value-added and employment, in particular in health and education services. Employment in manufacturing remained relatively constant throughout the pandemic and the energy crisis due to the short-term work scheme and other support measures, but also because of labour hoarding of firms in the context of skilled labour shortages. However, it has recently started to decline by 50 000 jobs in 2024. Structural change and the reallocation of workers to thriving sectors and firms, also within manufacturing, are key for fostering productivity growth and should be facilitated by reducing barriers to entry, growth and exit of firms (see Chapter 2). However, workers should be supported in their transition to new jobs by improving vocational training and adult learning opportunities (see Chapter 3). To address high energy prices and support manufacturing firms in a horizontal way, the government should focus its efforts on accelerating the expansion of renewable energies and the modernisation of the electricity grid (see Chapter 4).
To support export-oriented manufacturing and services sectors in times of rising trade policy uncertainty, in particular related to US tariff and non-tariff barriers, the government should step up efforts to reduce barriers to trade with key trading partners. Within the EU, the potential to further reduce barriers to services trade and strengthen the common market remains high (Dorn, Flach and Gourevich, 2024[7]). Analysis conducted for this Survey shows that further reducing barriers to digital services trade could help raise productivity, also in manufacturing sectors that use these services as inputs (Box 1.2). In Germany, there is also scope to reduce high administrative burden and barriers to entry and growth of start-ups, particularly in services (see Chapter 2).
Gross value added, volume, 2015 = 100
Source: Federal Statistical Office.
A study conducted for this Survey examines the impact of digital services trade restrictions on productivity using an international firm level panel dataset (ORBIS) combined with the OECD Digital Services Trade Restrictiveness Indicator (DSTRI) and novel data on enforcement of the General Data Protection Regulation (GDPR) of the EU. Firm-level productivity is regressed on regulatory stringency in digital services, an index for GDPR enforcement as well as dummy variables for country-sector, sector-year, firm age and firm size, while a second specification uses firm fixed effects. Using data on bilateral services trade flows (BACI) and a gravity model, the study also analyses the impact of services trade restrictions and the GDPR enforcement on service trade flows between countries.
The overall effect from digital services trade restrictions on productivity is negative, with the negative effect being more pronounced for larger firms. In particular, restrictions that hamper data flow and connectivity have a strong negative effect on productivity of firms in all sectors. However, stricter local presence requirements for providing digital services and restrictions related to payment systems have a positive effect on productivity, indicating that they may shield domestic services firms from foreign competition. Stricter enforcement of the GDPR, measured as the number of lawsuits related to GDPR, shows a negative effect on productivity. However, the introduction of the GDPR has increased trade in digital services within EU countries.
1.1.3. Rising domestic demand will lead the recovery
GDP will grow by 0.4% in 2025 and 1.2% in 2026 (Table 1.2). Private consumption will increase due to low inflation, higher nominal wages and decreasing domestic policy uncertainty following the formation of a new government. High trade policy uncertainty will hamper investments in export-oriented manufacturing. However, as investment needs due to supply-chain realignments, digitalisation and the green transformation are high, overall private investment will pick up, supported by high equity rates of firms, declining interest rates and decreasing domestic policy uncertainty, including on the financing of measures to support firms during the green transition. Public investment in defence and infrastructure will rise strongly due to the increased flexibility in the fiscal rules and a large investment backlog. However, rising US tariffs and trade policy tensions will weigh on export demand.
The fiscal stance will tighten in 2025 by 0.3% of GDP and expand by 0.9% of GDP in 2026. Due to the fall of the previous coalition government and the failure to conclude negotiations on the 2025 budget, a provisional budget for 2025 extended nominal spending levels from 2024 to 2025. After the formation of a new government, a recent reform of the national fiscal rules will provide significant fiscal space to raise investments in defence and infrastructure during the next years (see below). However, the effects of this reform on public investment will start to materialise in 2026 as the approval of the 2025 budget and detailed investment plans as well as infrastructure planning and procurement procedures will take time. With restrictive fiscal policy in 2025, a large negative output gap and lower energy prices, headline inflation will fall to 2.4% in 2025 and 2.1% in 2026. However, core inflation will remain sticky, reflecting the impact of wage gains amidst skilled labour shortages and rising investment demand.
Annual percentage change, volume (2020 prices)
1. Contribution to changes in real GDP.
2. Percentage of potential GDP.
3. Harmonised consumer price index excluding food and energy, alcohol and tobacco.
Source: OECD Economic Outlook 117 database.
Economic growth perspectives will hinge on the implementation of key structural reforms by the new federal government (see above). If public procurement and infrastructure planning and approval procedures are not accelerated, the implementation of public investment projects will be delayed, reducing GDP growth in 2026. Moreover, if structural reforms to reduce administrative burden and regulatory barriers to entry and growth of firms, particularly in construction and services, are not implemented, the significant demand shock from increased public investment may lead to strongly rising inflationary pressures. Further increases in trade policy uncertainty would hamper a recovery in consumer and investor confidence and hold back private consumption and investment, particularly in manufacturing sectors that are highly integrated in global value chains. On the upside, a quick approval of the 2025 and 2026 budgets and detailed investment plans could raise investor and consumer confidence and accelerate the increase of public investment. A stronger recovery in China could significantly improve exports of investment and other goods.
1.2.1. Financial market risks remain contained
After a period of low insolvency rates during the pandemic and the energy crisis, business failures have increased due to the phase-out of support measures, monetary tightening and a weaker economy (Figure 1.10). However, banks have remained resilient despite their relatively low profitability, which largely reflects high administrative and operating expenses (see below). Banks’ net interest income has increased, as lending rates to firms and households have increased more than bank funding rates. Only about 10% of the increase in policy rates has been reflected in average overnight deposit interest rates (Bundesbank, 2024[8]). Risk-weighted capital ratios are well above regulatory minimums. Low corporate borrowing, high equity rates of firms and a relatively long maturity of outstanding loans to corporates reduce credit risk (Figure 1.10). However, risk weights applied to corporate loans by systemically important banks may understate the vulnerability to rising corporate insolvencies due to continued economic weakness. An additional source of bank vulnerability is duration risk from higher interest rates. Duration risk arises from the decline in the market value of fixed-income securities with longer maturities in response to abrupt increases in market interest rates, resulting in unrealised losses (OECD, 2023[9]). Such unrealised losses have been declining thanks to monetary policy easing, but were still at 6% and 15% of the common equity tier 1 capital of local savings banks and cooperative banks, respectively, in the second quarter of 2024.
Previous monetary tightening has led to a decline in house prices, but the risk of further price corrections is low. The rapid tightening of monetary policy has led to a significant increase in mortgage interest rates and reduced demand for housing, leading to a fall in house prices by 13% in the fourth quarter of 2023 from their peak in the second quarter of 2022 (Figure 1.11). The strong increase in household disposable income, declining debt-to-income ratios, and falling inflation have improved housing affordability and contributed to a slight recovery in housing prices. Monetary policy easing could lead to further declines in mortgage rates during the next quarters, leading to additional price increases. However, vulnerabilities in the commercial real estate markets should be carefully monitored. Commercial real estate prices have fallen by more than 20% since their peak in 2022 (Bundesbank, 2024[8]). The Bundesbank’s price-at-risk analysis suggests that, in contrast to residential real estate, the likelihood of further falls in commercial real estate prices has increased. Tight financing conditions and weak profitability due to a stagnating economy could lead to rising non-performing loans for commercial real estate developers and losses for real estate investment trusts or for banks through the fire sale of commercial real estate collateral (OECD, 2024[10]). Around half of bank loans exposed to insolvency concern the real estate sector (Bundesbank, 2024[8]). While exposure to commercial real estate lending is concentrated among a few lenders, the risks of spillovers to the rest of the financial system should be carefully monitored.
The macroprudential stance should be maintained. In early 2022, the counter-cyclical capital buffer rate was set to 0.75% and the sectoral systemic risk buffer rate at 2% of loans secured by residential real estate. The latter was lowered to 1% in April 2025, due to the partial receding of vulnerabilities in the residential real estate market. Although the easing of monetary policy will reduce pressures on balance sheets of banks, the macroprudential stance should be maintained to address the risks from rising corporate insolvencies and the decline in commercial real estate prices. In the medium term, the authorities should consider moving to a positive neutral counter-cyclical capital buffer approach, as in Sweden, Poland, Spain and the Netherlands (Bundesbank, 2024[8]).
Source: OECD Timely Indicators of Entrepreneurship database; ECB; IMF Financial Soundness Indicators database.
There is scope to improve banking sector profitability (Figure 1.10, Panel C). The banking market is highly fragmented, with numerous small, local savings banks, contributing to relatively low returns to assets in the banking sector. Although significant consolidation has occurred since the early 1990s, it has mainly resulted from territorial reforms merging municipalities or districts rather than competitive pressures. Local savings banks, owned by local governments, are restricted by the regional principle – enshrined in federal-state savings bank laws – which confines their operations to specific geographic areas and shields them from cross-regional competition, creating institutional barriers to consolidation and limiting competition (Hallerberg and Markgraf, 2018[11]). As local savings banks are not listed and risk sharing is ensured through cooperation in Laender-level public deposit guarantee schemes, market-based discipline to incentivise banks to gain greater market share and increase profitability is also weak (De Haan, 2022[12]). Since forced mergers due to territorial reforms have been shown to have increased profitability, lowered borrowing costs for firms and boosted regional investment and employment, the regional principle should be reviewed with a view to strengthen competition and consolidation in the banking sector (Koetter et al., 2018[13]).
Banking sector profitability should also be improved by reducing administrative burden and operative costs through increased digitalisation, particularly in local public and cooperative banks. This would also help improve access to finance for intangible-intensive industries, foster investments in knowledge-based capital and increase business dynamism (Bontadini et al., 2024[14]) (see Chapters 2 and 4). Accompanying increased digitalisation in the banking sector with improvements in the efficiency of electronic payment systems and electronic invoicing would also strengthen tax enforcement and the fight against money laundering by increasing traceability (Bellon et al., 2022[15]).
The linkages between domestic banks and global non-bank financial intermediaries should also be carefully monitored. While the German financial system remains largely bank based (see below), the direct exposure of German banks to global non-bank financial intermediaries has reached 12% of banking system assets (Bundesbank, 2024[8]). An integrated stress testing framework to analyse the spillover of adverse shocks from global investment funds to the German banking system has not yet been developed. Contributing to fill data gaps in the alternative investment fund sector at the EU level would facilitate the monitoring of banks’ exposures to global non-bank financial intermediaries (ESRB, 2024[16]). This should be achieved by transposing the revised EU Alternative Investment Fund Managers Directive into German law and implementing it.
Source: OECD Analytical House Price database; ECB; OECD National Accounts database.
1.2.2. Deepening capital markets would foster access to finance for start-ups
Limited access to finance for innovative start-ups is one factor behind weak business dynamism, hampering innovation, investment, productivity growth and competitiveness (Draghi, 2024[17]) (see Chapter 2). Banks are reluctant to lend to innovative start-ups due to limited collateral, weak cash flows, and a lack of credit history as well as missing expertise to assess the economic viability of intangible investments that underly disruptive innovations. Non-bank sources of finance could fill the funding gap, but they remain weak (Figure 1.12). While venture capital investments increased in 2021 due to the rising attractiveness of digital business models during the pandemic, these effects reversed in 2022-24. The number of deals surpassed pre-pandemic levels in 2024, with cash flow-based German venture capital investments amounting to less than 0.2% of GDP, compared to around 0.5% of GDP in the United Kingdom and the United States (KfW, 2024[18]). In 2024, venture capital investments in start-ups stood at EUR 7.4 billion, still below pre-pandemic levels, with the health, energy and defence sectors accounting for the largest share of deals.
To address the funding gap for start-ups, the federal government and its development bank have strengthened public co-financing of venture capital. The Growth and Innovation Capital for Germany programme, launched in September 2024, mobilises around EUR 12 billion and aims to crowd in private investors to secure a total of EUR 30 billion in innovative start-up financing by 2030. A fund-of-funds (Zukunftsfond) has also been established to increase the participation of institutional investors in the venture capital and private equity markets, as recommended in the 2020 OECD Economic Survey of Germany. However, incentives to crowd in private investments should be further strengthened. For example, in Israel’s Yozma venture capital initiative, the government provided up to 40% of the required venture capital investment and granted private investors the right to buy out the government’s stake at a guaranteed price in the five years following the investment. The programme reduced the share of total public funding for venture capital from 50% to almost zero within 7 years, successfully crowding in private investors (OECD, 2022[19]). Israel recently launched Yozma 2.0, allocating about USD 160 million to leverage total institutional investment of USD 700 million in the financing of innovative start-ups, again by introducing guaranteed buy-out options for the government’s stake, accompanied by loss-sharing arrangements.
Venture capital investments, % of GDP, 2023 or the latest year available
Note: Deal-based statistics. No breakdown available for Japan, Korea and New Zealand.
Source: OECD Entrepreneurship Financing Database.
Increasing the participation of institutional investors in capital markets is key to raise access to finance for start-ups. Well-developed capital markets with a broad participation of institutional investors facilitate the exit of early-stage investors and increases their post-exit returns, encouraging them to take relatively high risks by providing early-stage and growth financing to innovative start-ups (Arnold, Claveres and Frie, 2024[20]). In Germany, however, institutional investors, and particularly pension funds, play a limited role in capital markets (Figure 1.13). While only about 6% of domestic equities were owned by domestic institutional investors in 2023, more than 24% were owned by foreign ones. Between 2019 and 2023, domestic institutional investors financed just over 10% of private equity fundraising, compared to 30% on average in Europe (OECD, 2024[21]).
Strengthening asset-backed occupational pension schemes could help deepen capital markets and contribute to more efficient financial intermediation (Draghi, 2024[17]). Over half of workers are covered by an occupational pension scheme, but the assets managed by supervised occupational pension schemes, including Pensionskassen and Pensionsfonds, and pension funds for workers in liberal professions and life insurers, stood at only 17% of GDP in 2023, compared to around 50% of GDP in the average OECD country (Box 1.3) (OECD, 2024[22]). This relatively low value is related to the fact that about 40% of occupational pension scheme liabilities are based on book reserves, which are firm-specific defined-benefit pension plans that are not supervised by the Federal Financial Supervisory Authority. These liabilities amount to about 12% of GDP, with large companies included in the German stock exchange benchmark index (DAX) accounting for about 60% of these liabilities (Bazzazi, 2025[23]). About 80% of these liabilities of DAX companies are backed by insurance contracts. However, 20% are unfunded as employees’ contributions are retained within the firm for internal investment, and this number is even higher for smaller companies that account for 40% of all pension liabilities based on book reserves. Many employers prefer book reserve schemes due tax advantages, as there is no maximum threshold for subtracting the present value of liabilities from profits to lower corporate income tax payments, and because of lower regulatory costs compared to externally invested funds, which are subject to stricter solvency and liquidity requirements (OECD, 2016[24]).
Ownership structure of total domestic financial assets, 2023, %
Source: Financial Stability Board.
Gradually phasing out book reserves by introducing mandatory enrolment in asset-backed occupational pension schemes for new employees would not only help deepen capital markets but also strengthen social protection while supporting structural change and reducing financial vulnerabilities. Many companies have a funding deficit in their book reserve schemes. Asset provisions set aside for pension payments fell short of pension liabilities by about 5% of market capitalisation for the average listed firm between 2000 and 2017 (Heusel and Mager, 2023[25]). Around 9% of firms had no provision at all. In the event of a firm bankruptcy, employees have only low seniority for their pension claims and the recovery rate for employee pension claims in bankruptcy has been less than 5%. The exposure of employees’ pension claims to the risk of firm failure is instead insured through a mutualisation scheme. However, the contribution rates paid by firms to the mutualisation scheme do not vary with the risk of bankruptcy, making book reserve schemes attractive for firms with a high risk of failure (OECD, 2016[24]). Firms with a funding deficit in their book reserves have shown higher stock market returns than other firms, likely suggesting that a bail-out in case of bankruptcy to ensure pension payments might be expected by the market (Heusel and Mager, 2023[25]). This could distort competition, weakening business dynamism, innovation and productivity growth (see Chapter 2). The lack of portability of assets in book reserves to a new employer reduces accumulation benefits of pension contributions, as in other defined-benefit occupational pension schemes, and might act as a barrier to labour reallocation, hindering structural change. Introducing mandatory enrolment into asset-backed occupational pension schemes for new hires would help deepen capital markets and reduce financial vulnerabilities due to unfunded book reserves. Moreover, minimum funding levels for book reserves should be introduced, as in the United Kingdom and the United States (Heusel and Mager, 2023[25]).
Facilitating greater exposure of asset-backed occupational pension funds to private assets would also help deepen capital markets. German occupational pension funds have one of the lowest equity exposures in Europe at 10%, even after including indirect exposures through investment fund shares (OECD, 2024[21]). They have underperformed those of the best performing OECD countries over the past two decades, with an average annual real return of 1.8%. The low equity exposure is due to a combination of low regulatory limits for investment in private assets and a conservative investment behaviour of pension funds. For example, investment limits for equity, real estate, corporate bonds and private investment funds for the occupational pension scheme Pensionskassen are low at 35%, 25%, 50% and 7.5%, respectively (OECD, 2024[26]). Investment limits in single issuer instruments are also low in all private asset categories. In Denmark, Sweden, Norway, and the Netherlands, where the real returns of asset-backed pension funds have been higher than the OECD average over the past two decades, portfolio limits for these assets are either set at 100% for direct investments or there is no specific limit (OECD, 2024[22]). In all of these countries, investment limits in single-issuer instruments are also higher. Investment and concentration limits for occupational pension funds should be raised for single-issuer private assets, real estate and private investment funds, while ensuring appropriate risk management and governance processes. Moreover, incentives for pension fund managers should be improved to raise equity exposure. Gradually transitioning from defined-benefit to defined-contribution systems, as recently done in the context of collective bargaining in the chemical industry, could help to raise returns. Improving the financial literacy of social partners involved in collective bargaining on pension schemes and regularly informing occupational pension plan holders about the return on their pension savings could help raise incentives for pension fund managers to seek higher returns from their investment portfolios (OECD, 2024[27]).
German insurers participate more in capital markets than pension funds, but they could invest more directly in private assets to support innovative start-ups (Figure 1.13). Financial assets managed by German insurers have reached 50% of GDP by the end of 2023. Compared to European peers, insurers invest less in government bonds, with a portfolio share of less than 15%, and have a strong equity portfolio allocation of almost 30%. However, most investment fund shares are invested in debt, limiting the financing of innovative start-ups. The asset allocation of insurance companies is largely driven by liquidity considerations and regulatory concerns regarding the targeted solvency ratios associated with Solvency II (OECD, 2024[21]). However, Solvency II also allows lower risk-weights for insurers’ investments in long-term equity asset categories, and it does not impose regulatory restrictions on equity or alternative investment fund allocation limits (Arnold, Claveres and Frie, 2024[20]). Reviewing whether the implementation of relevant regulations unduly restricts insurance companies’ investment opportunities, especially in equity, could help unlock a large pool of funds for financing innovative start-ups.
First Pillar – The Statutory Pension Insurance (Gesetzliche Rentenversicherung, GRV)
The statutory pension insurance is the cornerstone of Germany’s pension system and is mandatory for most employees. It covers the risk of income loss in old age and disability and supports surviving dependants via survivors' pensions. It operates on a pay-as-you-go (PAYG) basis, where contributors gain future entitlements, funded by the next generation. Pensions in Germany are generally subject to income tax as well as contributions to health and long-term care insurance. Pension contributions are split equally between employers and employees, each paying 9.3% of gross wages (total contribution rate: 18.6% in 2025). Besides employees, certain self-employed professionals (e.g. craftsmen, artists, authors, midwives) are also mandatorily insured under the state pension scheme. Unlike employees, these self-employed must usually pay the full 18.6% contribution themselves, though flat-rate or reduced rates (for new entrepreneurs) are available. Voluntary public pension insurance is open to other self-employed. Civil Service Pensions (Beamtenpensionen) are not part of the system and are fully tax-funded.
The retirement age is gradually increasing to 67 by 2031: For insured persons born in 1964 or later, the standard retirement age is 67. Individuals with at least 35 contribution years can retire with benefit deductions of 3.6% per year (0.3% per month) of early retirement. Those with 45 contribution years can retire at a full pension two years before the statutory retirement age. Since the abolishment of income caps in 2023, old-age pensions can be claimed fully without any earnings limit. For disability pensions, income limits remain. Individuals who delay retirement will receive a pension bonus of 0.5% for each month beyond the regular retirement age without claiming their pension, amounting to a 6% increase for one year of delayed retirement. Additionally, if the individual continues working, pensions will increase due to the contributions paid during continued employment.
The pension benefit formula is income-related, linking pensions to lifetime earnings through a point-based system. Pension benefits are adjusted depending on national wage and population growth and decline with demographic ageing. Annual expenditures are covered by revenues from pension contributions and federal subsidies. The subsidies cover around 23% of pension spending (approximately 2.5% of GDP in 2024), covering non-contributory pension entitlements and helping to limit contribution rates. Surpluses in the pension system are allocated to a sustainability reserve, and the contribution rate is adjusted based on the reserve's level relative to average expenditures. A 2018 pension reform introduced a “double stop-line”, fixing the minimum benefit level at 48% of average earnings and the contribution rate at 20% of gross wages. The minimum benefit level has been extended to date, avoiding the decline of pensions due to the sustainability factor from demographic ageing. Recent policy plans announced in the coalition treaty envision to maintain the 48% benefit level until 2031, while potentially removing the contribution rate cap.
Parents receive pension points for raising children, without having to make contributions themselves. During the period of child-rearing, insured persons are treated as if they had paid contributions equivalent to those of an average-earning employee. Following two recent reforms (Mütterrente I and II), parents are credited with three earnings points for each child born from 1992 onwards and with 2.5 points for each child born before 1992. One point is equivalent to contributions based on the national average income, so each child increases future pension entitlements by around EUR 100 to 120 per month. Pension expenses for child-rearing periods (Mütterrente) amounted to EUR 21.8 billion in 2024.
Second Pillar - Occupational Pensions (Betriebliche Altersversorgung)
Occupational pensions are voluntary but increasingly widespread, supported by tax incentives and social partner agreements. They are often arranged via direct insurance, pension funds, or pension schemes administered by employers, including book reserves. Around 56% of employees in larger firms participate, but coverage is lower in small enterprises and among low-wage workers. Since 2019, the “social partner model” allows collective bargaining parties to establish defined contribution schemes with minimum employer contributions.
Third Pillar - Private Pensions (Private Altersvorsorge)
Private pension plans are supported through state subsidies and tax deductions. The Riester pension, introduced in 2002 to boost private retirement saving, targets employees eligible for the statutory pension scheme and offers subsidies to top-up contributions. However, uptake has stagnated, with particularly limited uptake among lower-income groups. Roughly 17% of publicly insured workers have no supplementary pension. The Rürup pension is a tax-advantage aimed at the self-employed and high-income earners.
Facilitating listing conditions for start-ups would help attract VC investors by improving viable exit options. Although technology companies have accounted for a larger share of initial public offerings than in the rest of Europe, total initial public offerings have amounted to less than 0.2% of GDP per year over the past two decades (OECD, 2024[21]). The high administrative burden and the fragmentation of capital markets in Europe have contributed to the low level of listing activity. The Future Financing Act is welcome as it simplifies the requirements for initial public offerings by reducing the minimum market capitalisation from EUR 1.25 million to EUR 1 million and introducing dual-class shares (up to 10-to-1 voting rights). The extension of the deferral period for taxing employee share ownership and the increase in the maximum annual tax allowances is also welcome as it facilitates the use of stock-ownership option plans by smaller firms. A recent bill aims at further fostering viable exit options for innovative start-ups and should be approved. It facilitates reinvestment in corporate equity by raising the cap on the transfer of gains from the sale of shares in corporations and reduces restrictions for private investment funds to increase their positions in venture capital funds. In addition, eliminating inconsistencies in national insolvency frameworks and lowering the restrictions for individual qualified investors and for institutional investors to invest in foreign assets would help raise liquidity at EU stock exchanges (Arnold, Claveres and Frie, 2024[20]). This should be complemented by establishing a single central counterparty platform and a single central securities depository, and finalising the EU banking union (Draghi, 2024[17]).
Improving financial literacy of households and incentivising funded individual pensions plans is also key to deepen capital markets. German households have one of the highest saving ratios in the OECD, but only a small fraction of the large household savings is invested in capital markets. More than 40% of household savings are in currency and deposits, depriving capital markets of a large funding base. Although German households score relatively well on basic financial literacy indicators and save actively, only 18% of them own an investment product, with around 12% of total household financial assets allocated to stocks and shares (OECD, 2024[28]). Individuals with high levels of financial literacy are also more likely to hold a pension product. Financial literacy initiatives should focus on providing the knowledge and skills needed to navigate an increasingly digital investment landscape and to adequately plan for retirement. Moreover, incentives and conditions for investing in funded pension plans should be improved. Subsidies for contributions to capital-funded pension plans (Riester Rente) were initially successful in increasing participation, but high fees and low returns have curbed further participation. Introducing caps to limit fees, while extending eligibility for subsidies to the self-employed, could help raise incentives for individuals to participate in capital markets (OECD, 2024[21]). Moreover, abolishing mandatory minimum guarantees for these defined contribution schemes, which explain why most plans have taken the form of insurance-based products with low returns, could help make them more attractive. Alternatively, introducing a standardised investment product with an opt-out option, as for example done in Sweden, could help lower costs and raise returns and participation in funded individual pension schemes.
1.3.1. The fiscal stance is projected to tighten in 2025 and strongly ease in 2026
After a decade of fiscal surpluses and strongly decreasing public debt, the fiscal balance turned negative due to pandemic- and energy-crisis-related fiscal support (Table 1.4). This support was mainly funded by the federal level, strongly increasing the federal deficit, while the fiscal balances of the Laender remained contained. The national debt brake was suspended during 2020-23 due to the pandemic- and energy-crisis related emergency situations, and then reinstated in 2024. The reinstatement led to a contractionary fiscal stance in 2024, which will further tighten in 2025, supporting ongoing disinflation (see above). The tightening fiscal stance is mainly due to a strong reduction in the federal deficit, while the deficits of the Laender and the municipalities as well as the social security and health insurance fund have strongly increased in 2024 (see Chapter 4 and below).
The fiscal tightening at the federal level in 2024 partly reflects the impact of the November 2023 Supreme Court ruling that declared the use of emergency related borrowing authorisations to finance investments in consecutive years as unconstitutional. The ruling has led to a reduction of available funds in the Climate and Transformation Fund (KTF) by EUR 60 billion and the closure of the energy support fund, which led to the earlier phasing out of energy price support measures in January 2024. Spending from the KTF was reduced by a quarter to 1% of GDP in 2024 and by half to 0.6% of GDP in 2025. The planned spending of 1.9% of GDP in 2024-25 from a special defence fund has not been affected by the ruling, as this fund has been enshrined in the constitution by a two-third parliamentary majority. The fiscal tightening in 2025 is also related to the fall of the coalition government and the failure to conclude negotiations on the 2025 budget. While a provisional budget for 2025 extended spending levels from 2024 to 2025, planned but not yet approved public investment projects for 2025 were put on hold, including projects financed by the KTF.
General government, % of GDP
1. Defence; public order and safety; housing and community amenities; recreation, culture and religion; environment protection.
Source: Federal Statistical Office; OECD National Accounts database; and OECD Economic Outlook database.
In 2026, the fiscal stance is expected to ease strongly due to a recent reform of national fiscal rules. The reform of fiscal rules approved in March allows to raise spending for defence and public investment during the next years to address a large infrastructure backlog. Spending exceeding 1% of GDP in the areas of defence, civil protection, intelligence services, protection of IT systems, and support for states attacked in violation of international law will be exempted from the fiscal rules. A special infrastructure fund financed by public debt issuance will provide up to EUR 500 billion for additional investment in infrastructure and the green transformation over the next 12 years. Out of this new fund, EUR 100 billion will be allocated to the KTF to support the green transformation and the energy transition by funding public investment and fiscal incentives for private investment. EUR 100 billion will be allocated to the Laender and municipalities, which are responsible for a large share of public investment projects (see Chapter 4). Moreover, the structural deficit ceiling for sub-national governments will be raised from 0% to 0.35% of GDP, which combined with the ceiling of 0.35% of GDP for the federal government raises the general government structural deficit ceiling to 0.7% of GDP.
The effects of this reform of the fiscal framework on public investment will start to materialise only from 2026, as the formation of a government, the approval of the 2025 budget and detailed investment plans as well as their implementation will take time. To ensure a quick and efficient implementation of public investment projects, it is key to further simplify and accelerate infrastructure planning and approval as well as procurement procedures, improve cost-benefit analysis and policy impact evaluation and strengthen the capacity of local public administration (see Chapters 2 and 4 and below). To avoid rising inflationary pressures due the fiscal demand shock, the reform of national fiscal rules should be combined with structural reforms to reduce administrative burden and barriers to firm entry and growth, particularly in the construction and services sectors, and address skilled labour shortages (see Chapters 2 and 3).
1.3.2. Creating fiscal space to finance rising spending for defence and public infrastructure is key for ensuring medium-term fiscal sustainability
The increased flexibility in the fiscal rules to address large public investment needs is welcome. In 2024, net public investment has been among the lowest across OECD countries and the quality of public infrastructure has strongly deteriorated during the last decade (Figure 1.14) (SVR, 2023[29]). Recent studies estimate that addressing the large public infrastructure backlog will require additional investment of EUR 40 to 60 billion (1% - 1.5% of GDP) per year until 2035, including public investment to accelerate the green transition and raise energy security (Dullien et al., 2024[30]; BDI, 2024[31]). Moreover, spending pressures to improve defence capacities have strongly increased due to Russia’s full-scale invasion of Ukraine. Defence spending in the core budget should increase from 1.2% in 2024 to at least 2% of GDP in 2028 to reach the current NATO target, as resources in the special defence fund established in 2022 will be depleted in 2027. The increased flexibility in fiscal rules will allow to temporarily finance part of these urgent spending needs through increased borrowing.
However, to ensure medium-term fiscal sustainability, the increased flexibility of fiscal rules should be combined with reforms to raise spending efficiency, reallocate spending and broaden the tax base, including by reducing tax expenditures and strengthening tax enforcement (as recommended by the previous OECD Economic Survey of Germany). This is even more important as fiscal pressures will strongly rise during the next years due to the retirement of large cohorts and rising life expectancy (Figure 1.15). Without reforms, spending on pensions, health and long-term care is projected to rise by about 1.4% of GDP by 2030, and by about 3.5% of GDP by 2045. In addition, costs for interest payments have risen to 1.1% of GDP in 2024 and are projected to further rise during the next years, while the repayment of pandemic- and energy-crisis related debt will start in 2028, putting additional pressure on the federal budget.
Source: OECD National Accounts database; and OECD calculations.
Public spending on health and pension, % of potential GDP, baseline scenario
Note: The graphs show baseline projections for Germany based on latest policy announcements and following the methodology of Guillemette and Turner (2021[32]).
Source: OECD Long-term Model.
Simulations conducted for this Survey show that issuing public debt to finance additional spending (exceeding 1% of GDP) to raise defence spending to 2.5% of GDP and using the new debt-financed infrastructure fund to spend about 1% of GDP for infrastructure investments over the next 12 years, while fully using the general government structural deficit limit of 0.7% of GDP, would increase the debt-to-GDP ratio to about 81% by 2045 (Figure 1.16, Panel A). Moreover, this scenario already implicitly assumes that rising spending pressures due to ageing, which increase to about 3.5% of GDP by 2045, are addressed by reforming the pension, health and long-term care systems (see below). If these additional spending pressures are not addressed, the public debt-to-GDP ratio would increase to about 128% of GDP in 2045. Thus, it is essential that debt-financing of increased defence and infrastructure spending over the next few years is combined with a gradual fiscal consolidation that puts public debt back on a declining path. Complying with the EU fiscal rules by debt-financing additional defence spending of up to 1.5% of GDP during 2027-30 after activating a national escape clause, and then reducing the structural deficit by 0.5% of GDP in 2031 would allow to stabilise public debt. The gradual decrease of the structural deficit to 1.7% of GDP by 2031 would require an improvement in the structural primary balance from 2024 until 2031 by 1.2% of GDP, which could be achieved by implementing the tax and spending recommendations suggested in Table 1.5. In this scenario, the increased spending of about 1% of GDP per year out of the new infrastructure fund needs to be financed by fiscal adjustments, as the national escape clause does not allow to exclude it from the deficit limit according to EU fiscal rules. If this scenario of fiscal adjustment is combined with structural reforms recommended by this Survey (Table 1.1), the public debt-to-GDP ratio would fall below 60% by 2039.
The sustainability of public debt is sensitive to interest rate movements. In the scenario “Complying with EU fiscal rules”, interest rate payments would increase from 1.1% of GDP in 2024 to 1.9% in 2031 and 2.7% in 2045. In 2031, the structural deficit of 1.7% of GDP would already be fully used to pay for interests, and in 2045 the structural primary balance would need to reach 1% of GDP to be able to finance interest payments. In a scenario, where interest rates increase by 100 basis points, a consolidation to a structural deficit of 1.7% of GDP in 2031 would not be enough to stabilise public debt (Figure 1.16, Panel B). Thus, to build fiscal buffers and insure against the risks of rising interest rates, it might be necessary to further adjust the structural deficit by 0.5 percentage points in 2032, which would require a total fiscal adjustment of the primary structural balance of 1.7% of GDP in Table 1.5.
Gross government debt, % of GDP (Maastricht definition)
Note: The “Complying with the national fiscal rule” scenario uses the projected real growth and interest rate paths from the baseline of the OECD Long-term model and assumes that the structural budget deficit reaches 3.2% of GDP in 2027 and remains constant until 2037, reflecting the recent reform of fiscal rules, including the full use of the 0.7% of GDP general government structural budget deficit limit and the debt-financing of additional defence and infrastructure spending of 1.5% and 1% of GDP, respectively. In the absence of structural reforms, this scenario abstracts from the potential growth effects of increasing defence and infrastructure spending. The structural budget deficit declines to 2.2% of GDP in 2038 after the depletion of the special fund for additional infrastructure spending and remains constant thereafter. This implies that the structural primary balance improves from a deficit of 1% of GDP in 2024 to a deficit of 0.7% of GDP in 2037, switches to a surplus of 0.3% in 2038 due to the phase-out of the infrastructure fund and reaches a surplus of 0.5% of GDP over the projection horizon. The “Complying with the EU fiscal rules (after a four-year escape clause)” scenario assumes that during 2027-30, the full use of the 0.7% of GDP general government structural budget deficit limit and the debt-financing of additional defence spending of 1.5% GDP is allowed under EU fiscal rules due to the activation of the national escape clause so that the structural budget deficit remains constant at 2.2% of GDP until 2030, is reduced to 1.7% of GDP in 2031 and remains constant thereafter. This requires that the structural primary balance reaches a surplus of 0.2% of GDP in 2031 and approaches 1% of GDP over the projection horizon. The “Complying with the EU fiscal rules and structural reforms” scenario builds on the previous scenario and includes the impact on government debt of a comprehensive set of structural reforms and recommendations, which lead to a 0.8 percentage points higher real GDP growth per year over the projection period relative to the baseline scenario of the OECD Long-term model (Table 1.1). The scenario “Not addressing rising spending pressures due to ageing” builds on the “Complying with the national fiscal rule” scenario, but assumes that pension, health and long-term care related spending is assumed to be debt-financed, leading to a deterioration in the structural primary balance of 3.5 percentage points of GDP until 2045. In the “Higher interest rates” scenario, interest rates increase by 100 basis points over the projection period relative to the “Complying with the EU fiscal rules (after a four-year escape clause)” scenario. In the “Lower GDP growth rates” scenario, nominal GDP growth is lowered by 0.5 percentage point over the projection period relative to the “Complying with the EU fiscal rules (after a four-year escape clause)” scenario. Following the methodology of the European Commission, general government financial assets remain constant at their nominal 2024 level in all scenarios.
Source: OECD Long-term model; and OECD calculations.
1. The effects of reforms related to prioritising spending and raising spending efficiency at all levels of government are difficult to quantify using available methodologies, but would significantly contribute to increasing fiscal space.
2. The estimate for the fiscal impact of improved public procurement procedures is derived from an OECD study which has estimated the gains in spending efficiency to be about 1 percentage point of GDP, if risk assessment and analysis of market capacity for infrastructure contracting decisions are improved across all levels of government by applying the OECD Support Tool for Effective Procurement Strategies (STEPS) (Makovšek and Bridge, 2021[33]; OECD, 2021[34]).
Note: Feedback effects of structural reforms on tax revenue are not included in the calculations. For example, the lowering of labour taxes or higher spending to improve training and adult learning policies would increase employment rates and the quality of human capital, which would increase economic growth but also raise tax revenues and lower the required net spending for these reforms.
Source: OECD calculations based on the OECD Long-term model.
Increasing spending efficiency and better prioritising spending
To ensure fiscal sustainability in the medium term, rising defence and public investment spending should primarily be financed by better prioritising spending and raising spending efficiency (see the lower part of Table 1.5). Public spending has strongly increased during the pandemic and energy crisis and still remains about four percentage points of GDP higher than during the 2010s. The overall tax burden stood at 38.1% of GDP in 2023, which is about four percentage points of GDP higher than the OECD average. As discussed in the previous OECD Economic Survey of Germany, accelerating the digitalisation of the public administration, strengthening policy impact evaluation and the use of spending reviews in budgeting procedures, and fostering joint procurement across levels of government have large potential to raise spending efficiency (see also Chapter 2 and 4). In addition, reforming the pension and health systems is essential to reduce spending pressures due to population ageing. This should include coupling the retirement age to life expectancy and continuing to increase efficiency in the hospital sector and digitalise health services (see below). There is also room to lower government consumption, which has increased in recent years due to rising public employment and wages, including by better cooperation and bundling of tasks across municipalities and accelerating the digitalisation of the public administration. As shown by OECD simulations using a dynamic general equilibrium model calibrated to the German economy, increasing public investment by reducing social transfers, including for pensions, and government consumption, while keeping the spending for education and health constant, could significantly contribute to raising economic growth (Figure 1.17, Box 1.4).
Percentage point change in long-term real GDP per capita resulting from compositional shifts in the expenditure or revenue structure, holding total government revenue and expenditure in terms of GDP constant
Note: In Panel A, “other expenditure” refers to the sum of three expenditure items: spending for health and education, government consumption and social transfers, including pensions. In Panel B, consumption taxes refer to VAT and excise duties. Labour taxes refer to the sum of taxes paid by employees and employers. See Box 1.4 for further details.
Source: Sunel (forthcoming[35]).
Better integrating the spending review framework into the regular budget process, creating a culture of impact evaluation and improving the necessary data infrastructure and IT capacities are key to improve spending efficiency and support the prioritisation of spending (Tryggvadottir, 2022[36]). The federal government introduced spending reviews in 2015, and they have been done regularly since then. However, their impact on the budget and role in aligning spending with policy objectives remains limited. Budget allocations are determined through a top-down approach with few linkages to policy impact evaluation, and within the allocated spending ceilings ministries retain a high degree of independency (Tryggvadóttir, Park and van den Akker, 2024[37]). Although each ministry is required by the budget law to define policy objectives of programmes and conduct ex-ante and ex-post impact evaluation, weak monitoring capabilities hamper the enforcement of this requirement. As a result, budgeting procedures in the ministries focus more on inputs, that is whether timelines are met and budgets are spent, rather than performance outcomes of policy programmes (Deloitte and ZEW, 2024[38]). Introducing a centralised digital monitoring tool to inform about the performance outcomes of policy programmes would be an important step forward. This should be combined with broader spending reviews that have clear savings targets, as for example done in Denmark, Canada and the Netherlands. This could reinforce the top-down budgeting approach and incentivise ministries to use performance information and policy impact evaluation to prioritise spending. Thereby, performance budgeting efforts should be closely aligned to the spending review framework to better identify information gaps and inefficiencies in spending. In addition, providing assistance to raise awareness and improving data and IT capacities for policy impact evaluation in the respective auditing or budgeting units of the ministries is key.
Similar efforts to introduce performance-based budgeting should also be pursued by the Laender. This would help raise general government efficiency, as an increasing share of spending of the Laender is financed by the federal level, weakening accountability and incentives for spending efficiency (see Chapter 4). Improving policy impact evaluation could also help to enhance peer learning opportunities between and across levels of government. A comprehensive reform of the data sharing infrastructure and corresponding regulation, which complicates accessing, linking and analysing administrative data by the authorities, is key to facilitate evidence-based policy making (Riphahn, 2023[39]; Bachmann, Peichl and Riphahn, 2021[40]). Implementing the planned research data act and the mutual recognition in the implementation of data protection legislation across the Laender would be important first steps (see Chapter 2).
The study conducted for this Survey calibrates a dynamic general equilibrium model to the German economy and complements previous empirical work on the effects of compositional shifts in government expenditure and revenue. The model assumes a closed-economy environment with a representative household, a representative firm and a government. The household maximises preferences over consumption flows and leisure, earns wage, dividend and transfer income, and decides how much to save in firm shares. The representative firm maximises the present value of future dividend flows by deciding how much to invest and demand labour. The government taxes wage and dividend income, household consumption and corporate profits. Each of these taxes affects the optimal decisions of private agents and finances spending on government consumption, which does not influence the production of goods, public investment, investment in education and health, and transfers to households. A balanced budget is assumed throughout. Spending on health and education increases human capital measured as the efficiency of the hours of labour supplied. Public investment increases the public capital stock, which increases the productivity of the private factors of production used by firms.
The model is calibrated with German data to reflect the various main macroeconomic variables averaged over the period 2000-19. In the next step, policy experiments are run in which the government expenditure or revenue structure (defined by the shares of budget items in total expenditure/revenue) is changed, while the total size of government (the ratio of total expenditure or revenue to GDP) is fixed at its level in the initial state of the economy. If more than one expenditure/revenue item is allowed to change to finance the revenue decrease due to a change in another item, compensating relative changes compared to the pre-policy state are equally distributed across items. For example, in the left bar of Figure 1.17 Panel A, all three items decrease in proportion to their size before the policy change to compensate for the increase in public investment expenditure. In the expenditure side experiments, the revenue structure is fixed at its initial level, and vice versa. The policy experiments lead to a change in the level of GDP per capita or welfare in the long term, because, for example, a change in the structure of government spending affects how much expenditure is split between more productive and less productive expenditure. Similarly, a change in the structure of government revenue, implying changing labour, corporate and consumption tax rates, affects the consumption, saving, labour supply and investment decisions of the private sector.
Source: Sunel (forthcoming[35]).
Broadening the tax base and shifting the tax burden away from labour
Structural reforms to improve spending efficiency should be combined with broadening the tax base and shifting the tax burden from labour towards capital income, wealth and consumption. The tax mix is highly skewed towards labour taxes, with a much lower contribution of property, capital and corporate income and value added taxes to total tax revenues compared to other OECD countries (Figure 1.18). These high labour taxes reduce labour supply incentives, while labour shortages are high, and thus should be reduced by decreasing personal income tax rates (see Chapter 3). This could be financed by increasing revenue from property taxes, reducing tax expenditures in inheritance, capital and corporate income, environmental and value-added (VAT) taxation, increasing excise duties on alcohol and tobacco, and strengthening tax enforcement (see the previous OECD Economic Survey of Germany) (see the upper part of Table 1.5). According to OECD simulations, such a shift in the tax structure could also raise GDP growth (Figure 1.17). Reducing corporate income taxes instead of labour taxes would have a lower effect on GDP growth. In this context, the reductions of personal income taxes for lower-to-middle incomes announced in the coalition treaty are welcome, but the financing of such a measure remains to be specified. Likewise, the announced accelerated depreciation rules for investments and the reduction in corporate income taxes will likely raise incentives to invest but also further reduce revenue from capital income.
General government tax revenues, % of total, 2023 or latest available year
Note: Income of personal or unincorporated enterprises is subject to personal income tax and related revenue is classified under “Income taxes, individuals”. Revenue from the German local business tax (Gewerbesteuer) is classified under “Income taxes, corporate”, if the firm is incorporated, and under “Income taxes, individuals” otherwise. Similarly, revenue received from withholding taxes on dividends and interest is classified under “Income taxes, corporate”, if the income is received by incorporated firms, and under “Income taxes, individuals” otherwise. Revenue from taxes on property includes revenue from gift and inheritance taxes as well as recurrent taxes on immovable property, among others.
Source: OECD Tax Revenue Statistics database.
Allowance thresholds for gift and inheritance taxes and exemptions for business assets should be reduced, while extending instalments for tax payments. Although taxes on wealth and its transfer, such as inheritance and gift taxes, likely create less distortions than labour or capital income taxes and contribute to raise the equality of opportunities, Germany makes little use of them (OECD, 2021[41]; Scheuer and Slemrod, 2021[42]; Guvenen et al., 2019[43]). Moreover, wealth inequality is high compared to other OECD countries, mainly because of the high concentration of home and business ownership (Schularick, Bartels and Albers, 2022[44]). Reducing tax allowances for gifts to family members, which are among the highest across OECD countries, and accounting for tax exempted gifts when applying tax allowances for inheritance could significantly contribute to raising tax revenue and improving equality of opportunities (OECD, 2021[41]). Moreover, generous inheritance and gift tax exemptions for business assets including shares result in tax expenditures of up to EUR 10 billion per year, which are highly regressive (Jirmann, 2022[45]; BMF, 2021[46]). The objective of these exemptions is to prevent the forced split-up of large family-owned firms due to liquidity issues and ensure the successful continuation of family management of firms providing well-paid jobs. However, an empirical evaluation of the 2009 German inheritance tax reform, which had strongly expanded tax exemptions for family business successions, concluded that the less generous system before 2009 had not jeopardised business succession of family firms due to liquidity issues (Houben and Maiterth, 2011[47]). Moreover, these tax exemptions facilitate tax avoidance schemes that allow to declare private wealth as business assets and lead to very low effective inheritance and gift tax rates for wealthy households (Trautvetter and Schwarz, 2021[48]). Limiting tax exemptions to business assets below a value of EUR 26 million, as foreseen by a 2016 reform but not implemented due to existing loopholes, and lowering personal tax allowances could be combined with decreases in tax rates and would still significantly raise revenue (Grabka and Tiefensee, 2017[49]; Bach, 2021[50]). To address concerns about forced liquidation of family-owned firms, instalments for tax payments could be further extended.
Generous tax expenditures for capital income from selling or renting existing buildings, which distort capital allocation, contribute to rising housing prices and increase inequality, should be abolished or better targeted to incentivise the expansion of housing supply. This could raise up to EUR 12 billion per year (Fuest, Hey and Spengel, 2021[51]; Bach and Eichfelder, 2021[52]). Capital gains from selling real estate are fully exempted from personal income tax, if the property has been held for more than 10 years, leading to revenue losses of around EUR 6 billion per year. Moreover, taxable rental income is reduced by overly generous tax depreciation allowances that strongly reduce tax burden on immovable property (Bach and Eichfelder, 2021[52]). Profits of real estate companies are fully exempted from the Gewerbesteuer, which is a municipal-level corporate income tax with an average rate of 15%, entailing a revenue loss of around EUR 5 billion (see Chapter 4). Loopholes also allow real estate holdings to avoid paying the tax on land acquisition (Bach and Eichfelder, 2021[52]). Finally, real estate property above 299 apartments is automatically classified as a business asset and exempted from the inheritance tax, which is not the case for smaller properties, leading to revenue losses of about EUR 1 billion (Bach and Eichfelder, 2021[52]). In combination with low interest rates, the generous tax treatment of real estate has attracted many institutional and private investors to the German real estate market, leading to misallocation of capital. As this beneficial treatment was not only granted for new constructions, but also for investments into the existing housing stock, they contributed to strongly rising property prices. This has also exacerbated the concentration of real estate assets in the hands of the highest income-decile and crowded-out many middle-class households searching for owner-occupied property (Fuest, Hey and Spengel, 2021[51]). Increasing recurrent taxes on immovable property, which are low compared to other OECD countries, can also help raise revenue and at the same time support municipal finances (see Chapter 4).
Reducing VAT reductions and exemptions and establishing transparent criteria for remaining ones would raise tax revenue and improve tax fairness (OECD, 2022[53]). The share of taxes on goods and services in total tax revenue is significantly lower than in the average OECD country (Figure 1.18). This is mainly due to high VAT reductions or exemptions, including for real estate, financial and insurance services, education services, and gold, silver, precious stones and art pieces (Trautvetter, 2020[54]). Many of these tax expenditures are likely distortive or regressive, but transparency is weak and impact evaluations are missing for many of these measures (Aliu, Grundke and von Haldenwang, 2023[55]). A subsidy report is published every other year that covers a specific set of tax expenditures and includes evaluations for half of the reported measures. A report by the environmental agency of the federal government has identified environmentally harmful tax expenditures and subsidies, which amount to about EUR 65 billion per year, which is more than estimates presented in the subsidy report (Burger and Bretschneider, 2021[56]). Conducting a comprehensive review and impact evaluation of existing tax expenditures as recommended by the previous OECD Economic Survey of Germany could help to better prioritise the use of public resources at all levels of government, as tax expenditures tend to be scrutinised less than direct spending which is inspected in yearly budget negotiations. In this context, some of the announced tax policy measures in the coalition treaty would not contribute to lowering tax expenditures. Reducing the value added tax for restaurant services and increasing tax expenditures for diesel used in agriculture as well as the commuter allowance are costly, while impact evaluations for these measures have shown their distortive effects.
Relatively low revenue from taxes on goods and services is also related to low statutory tax rates and weak tax enforcement. Excise taxes on alcohol and tobacco are low compared to other OECD countries and raising them would not only improve revenue but also contribute to better health outcomes (see below). Raising the statutory VAT rate would also help raise revenue. Moreover, estimations of the VAT gap by the European Commission indicate that Germany loses around 9% of VAT revenue, equivalent to EUR 22 billion each year, related to tax fraud and evasion schemes. Although this share is about average across EU countries, progress in tax enforcement has been weak since 2011, as the number of VAT inspectors and VAT-related inspections declined, and the IT infrastructure and the coordination between enforcement authorities of the Laender and with European enforcement agencies are still weak (see the previous OECD Economic Survey of Germany). Introducing the obligation to use electronic cash registers and automatic e-invoicing for all firms and setting a maximum threshold for cash payments would be important steps to reduce VAT evasion as well as money laundering. Spain, Italy, Hungary and Chile, for example, have successfully implemented mandatory electronic invoicing at the national level (OECD, 2022[57]).
This should be complemented by improving the estimation of domestic tax gaps for all tax types as well as incentives for the sub-national governments to raise tax enforcement. In Germany, domestic information on tax gaps is not available, mainly due to data protection and IT issues, which are exacerbated by the decentralised tax administration system and strict tax secrecy rules (BMF, 2020[58]). Tax collection and enforcement is under the responsibility of the Laender, including for federal and co-participated taxes, which is a unique feature of the German system compared to other federal countries like the United States or Australia (see Chapter 4). This in combination with the federal fiscal equalisation scheme also reduces incentives for the tax administrations of the Laender to improve tax enforcement, as only a small share of additionally collected tax revenue will accrue to the sub-jurisdiction (see the previous OECD Economic Survey of Germany). Reducing effective tax rates by underinvesting in tax enforcement might also serve to attract firms and wealthier households to the sub-jurisdiction, similar to detrimental international tax competition (Troost, 2016[59]; BMF, 2004[60]; OECD, 2021[61]). Establishing an independent fiscal institute and the necessary data sharing and IT infrastructure to collect and publish information on tax gaps, including at the Laender level, would help ensure an objective and independent analysis of tax data while maintaining high data protection standards (as discussed in the previous OECD Economic Survey of Germany). This should be combined with including targets on tax enforcement capacities in the binding guidelines for the tax administrations of the Laender and making the guidelines as well as data on the capacity of tax administrations publicly available to hold Laender governments accountable. If Laender specific tax gap estimates become available, performance targets for tax administrations based on these estimates could be introduced in the guidelines.
1.3.3. Further improving the fiscal framework
Although the recent reform of the fiscal framework is welcome, there is a risk that it delays some needed fiscal adjustments. The constitutional reform mentions that the new infrastructure fund should finance additional investments and keep an adequate level of investment spending in the core budget, but this is to be defined in a specific law. Clearly defining what investment means is key to ensure an efficient use of scarce fiscal resources. As a high share of the infrastructure backlog relates to maintenance and replacement of existing infrastructure, the law implementing the fund should make sure that such spending can also be financed. Moreover, defence spending stood at 1.2% of GDP in 2024 and including other spending exempted from the fiscal rules by the reform, such as spending for civil protection, intelligence services or protection of IT systems, this share rises to 1.5% of GDP. As any spending for these budget items above 1% of GDP will be exempted from fiscal rules, this allows financing other non-defence related core budget spending of about 0.5% of GDP by public debt. Avoiding such fiscal slippage is key to reduce the necessary fiscal adjustments in the future (see above). Moreover, the implementation of allocations from the infrastructure fund to Laender and municipalities could be used to help build a necessary consensus on simplifying and harmonising regulations and administrative procedures across and between levels of government and encourage the bundling of tasks across municipalities (see Chapter 2 and 4).
Increased flexibility in fiscal rules should be combined with more transparency in fiscal accounts to strengthen the fiscal framework. Despite the reinstatement of the debt brake in 2024, which limited the structural fiscal balance of the federal and Laender governments to 0.35% and 0% of GDP, respectively, and the strengthening of fiscal rules by the ruling of the constitutional court in November 2023, the fiscal deficit according to EU rules stood at 2.8% of GDP in 2024. This is because the net spending from special funds is not reflected in the federal deficit relevant for the debt brake anymore, although it appears in the fiscal balance according to EU fiscal rules (see the previous OECD Economic Survey of Germany). Moreover, the fiscal balance of the Laender has strongly deteriorated from a surplus of 0.38% of GDP in 2022 to a deficit of 0.64% in 2024. This is because some Laender have not reinstated their debt brake or started to use net spending from their own extra-budgetary funds, which were created in 2023 and funded through additional borrowing when the debt brake was suspended. The recent inclusion of state-owned enterprises (SOEs) providing public transport into the government sector in the national accounts has also increased deficits for Laender and municipalities. Borrowing through SOEs is in many other cases still not reflected in government deficits. In addition, the large heterogeneity in accounting and fiscal rules across the Laender makes it increasingly difficult to compare the financial situation of sub-national governments (Bundesbank, 2024[6]).
As recommended by the previous OECD Economic Survey of Germany, net spending of all extra-budgetary funds should be gradually included into the core budget at the federal and the Laender level. Including structural investment spending in key policy areas such as defence, digital and green infrastructure or education in the core budget would help to facilitate the necessary political discussions on how to finance important investment needs, which spending to prioritise and how to raise additional revenue. This is particularly important as fiscal pressure from pension and health systems will strongly increase over the coming years and repayment for the debt issued during the pandemic will start from 2028. The inclusion of extra-budgetary funds into the core budget should be combined with a transparent quantification of contingent liabilities associated with the quasi-fiscal activities of federal and sub-national SOEs, such as development banks, the public rail company or other SOEs (IMF, 2022[62]; Asatryan, Heinemann and Nover, 2022[63]).
The constitutional court ruling from November 2023 has strengthened the principles of Jährlichkeit (annuality) and Jährigkeit (annual validity) of the federal budget, limiting the possibility of allocating funds to finance infrastructure investments in future years. Although specific legal provisions exist that allow the administration to enter into multi-year contractual obligations (commitment appropriations), a carry over of funds to future years is generally not possible, with some exceptions for defence procurement. Introducing multi-year budgeting could improve fiscal planning related to longer-term commitments, such as public investment projects but also commitments like the defence spending quota or a stable benefit replacement ratio for pensions. Extending the possibilities for roll-over of funds to the next fiscal year could also help raise spending efficiency. Current budgeting rules set incentives to spend funds before the end of the fiscal year, which could lead to large inefficiencies and lower quality spending (Liebman and Mahoney, 2017[64]). Another option to facilitate public investment within the current fiscal framework is to increase equity-injections or transfers to public companies such as the rail operator, the highway or housing infrastructure agency or the public development bank. Establishing a permanent infrastructure fund financed by steady revenue streams, such as toll revenues, could help ensure stable funding for public investment in roads and railways. Spending could be allocated for maintenance, replacement, and expansion, as in Switzerland, to avoid prioritising new construction over maintenance. Alternatively, autonomous, revenue-financed infrastructure corporations, like Austria's ASFINAG, could operate outside the debt brake while aligning with EU fiscal rules, ensuring user preferences shape infrastructure development (SVR, 2024[65]).
1.3.4. Stabilising pension, health and long-term care systems to ensure long-term fiscal sustainability
Without further policy changes, rapid population ageing will increase yearly public spending on pension benefits by around 2 percentage points of GDP until 2045 (Figure 1.15). As labour taxes are already among the highest across OECD countries, weighing on labour supply incentives, these spending pressures should not be addressed by further increasing social security contribution rates (see Chapter 3). However, recent reforms and reform plans are not sufficient to stabilise the pension system and transfers from the general budget to the public pension system have increased to about 2.5% of GDP in 2024. After the 2007 decision to gradually raise the retirement age to 67 until 2031, the introduction of generous early retirement options, which allow individuals with at least 45 working years to retire without loss of pension entitlements as well as relatively low benefit reductions for individuals with at least 35 working years have reduced incentives to work longer (see Chapter 3 and Box 1.3). In 2018, a minimum threshold for the replacement rate (48%) and a maximum threshold for the contribution rate (20%) were fixed until 2025. The new coalition treaty intends to fix the minimum threshold for the replacement rate until 2031 and raise benefits for mothers with children born before 1992 who have low pension entitlements (Box 1.3). Implementing these plans would raise spending pressures substantially and further reduce fiscal space for public investment and other key expenditures (Bundesbank, 2022[66]).
Creating the conditions for older workers to work longer is key to stabilise the public pension system in the medium term (Figure 1.19, Box 1.3). This requires reducing fiscal incentives for early-retirement, improving working conditions and adult learning opportunities for older workers, and raising incentives to continue working beyond the statutory retirement age (see Chapter 3). Simulations using the OECD Long Term Model show that raising the effective retirement age by phasing out incentives for early-retirement, while keeping pension entitlements constant, would be most effective in stabilising the pension system and reducing fiscal pressures, when compared to other policy scenarios such as raising immigration or the labour force participation of women. Increased migration and higher labour supply of women are, however, key for addressing skilled labour shortages (see Chapter 3). Linking the legal retirement age to life expectancy from 2031 onwards, when the statutory retirement age will have reached 67, is a necessary step to stabilise the pension system in the longer term. This could be complemented with a reduction of pension benefits, which should be combined with a guaranteed minimum pension or an increase in the existing basic income support for old age to reduce the risk of old age poverty (OECD, 2023[67]). Making funded individual pension schemes (Riester Rente) more attractive and strengthening asset-backed occupational pensions would help complement public pensions and deepen capital markets (see above).
Including public servants and the self-employed in the statutory pension insurance system could help stabilise the system and increase fairness (Box 1.3). Public servants are insured in a separate system and receive higher benefits compared to the statutory public system, which also reduces labour mobility (see the 2016 OECD Economic Survey of Germany). Including them in the statutory system would increase pension contributions, but due to their longer life expectancies and above-average wages it would only provide short- to medium-term relief. However, it could help lower barriers to labour mobility (see Chapter 2). Including the self-employed in the public pension system would have stronger effects on the sustainability of the public pension system. Around 3 million self-employed individuals in Germany currently lack mandatory retirement coverage and often face significant savings gaps, which leads to high costs for the basic income support system for old age as they will need to be supported when they retire (SVR, 2023[29]). Mandating pension contributions for new self-employed individuals or setting an age limit for inclusion could help reduce "free-rider" behaviour, strengthen the public pension system, and reduce costs of tax-funded basic income support.
Germany’s long-term care (LTC) insurance system, funded through pay-as-you-go contributions, faces significant challenges due to rising costs driven by demographic changes, medical advances, and expanding service coverage. By 2040, LTC expenditures per insured individual are projected to increase by over 90%, with population ageing alone accounting for a 23% rise (BMWK, 2022[68]). This would push contribution rates to between 4.4% and 5.2% of gross wages, adding further pressure to already high labour taxes weighing on labour supply. On the other hand, as nearly half of the care for older people is provided informally and predominantly by women, who care for spouses or parents, improving the supply and funding of long-term care services is key for strengthening the formal labour market participation of women (see Chapter 3). Limiting the increase of LTC benefits, raising spending efficiency in institutionalised care and encouraging personal savings for care-related expenses would promote generational fairness and help reduce financial pressures on the public LTC system. Spending efficiency should be increased by strengthening home-based professional care, as the share of individuals with low or moderate care needs allocated to institutionalised care is much higher than in other OECD countries (OECD, 2024[69]). Moreover, gradually increasing transfers from the core budget to strengthen the care reserve fund would help prevent strongly rising contribution rates. This could be combined with introducing a mandatory supplementary private care insurance, which is capital-funded and complemented with targeted tax-funded support for low-income groups (BMWK, 2021[70]).
Public spending on pensions (% of GDP)
Note: The graphs show the effects of different scenarios for public spending on pensions in Germany using the methodology of (Guillemette and Turner, 2021[1]). The scenario “Increasing full time work of women” assumes that the share of women working part time is reduced to the one in Sweden (reduction from 35 to 15 percentage points) until 2035. The scenario “Raising the effective retirement age” assumes that the effective retirement age increases by 0.6 years until 2032 relative to the baseline (and by 1.3 years until 2045), while pension entitlements do not increase with longer working lives. The scenario “Coupling the legal retirement age to life expectancy from 2031” assumes an increase of the legal retirement age by one year for each additional year of life expectancy, while keeping the average benefit replacement ratio constant. The scenario “Increasing migration” assumes net migration inflows over the projection horizon of 400 000 migrants per year (from 2026 onwards), whereas the baseline assumes the Destatis baseline of 206 000 migrants per year).
Source: OECD Long-term Model.
The public health insurance faces strong financial pressures due to demographic changes, increased medical progress and treatment costs, and lifestyle-related diseases. The scope to increase spending efficiency is large, as health spending per capita is among the highest across the OECD, while health outcomes are only about average (OECD/European Commission, 2024[71]). Over-capacity in the inpatient care sector is contributing to severe labour shortages, while the case-based payment system has led to overtreatment lowering spending efficiency and likely reducing treatment quality. A recent hospital reform has the potential to enhance spending efficiency by consolidating the inpatient care sector and focusing on gains from specialisation of hospitals in specific treatments, while partly replacing the case-based system with allowances for hospitals to retain capacity. The successful restructuring of the hospital landscape will require significant investments in buildings and equipment, for which the Laender are responsible and which remained weak in recent decades. Moreover, as some hospitals will have to close, it is key to strengthen outpatient and digital care services to ensure coverage of primary care and the allocation of patients to specialised hospitals according to their needs. The introduction of the electronic patient file is a big step forward and, if fully implemented in the outpatient and inpatient care sector, will significantly increase treatment quality and spending efficiency by avoiding duplication of examinations and laboratory tests as well as incompatibility of different treatments. So far, fragmented implementation due to low awareness of health personnel, concerns of health provider associations and limited interoperability of existing IT systems hinder its full implementation, although standardised interfaces have been recently established and made mandatory. Preventive care should be strengthened by fostering awareness of life-style related diseases and excise duties on alcohol and tobacco products, which are low compared to other OECD countries, should be increased. Increasing transparency on prices and discounts in public procurement of medicines and improving competition enforcement could help contain strongly increasing spending for medicines (Seldesjachts et al., 2024[72]; Berndt, Grill and Schumann, 2024[73]).
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