The newly elected leader of Germany’s (AAA/Stable) conservative party, Annegret Kramp-Karrenbauer, has proposed the introduction of pre-emptive tax cuts due to lower than expected growth in 2018 of 1.5% and only moderate growth projections for 2019 (of between 1.4%-1.8%). A popular proposal among the conservatives is the complete and more timely abolition of the solidarity surcharge (0.55% of GDP).

Scope believes that Germany’s structural surplus (0.15% of GDP in 2018) is currently sufficiently large to allow for a degree of fiscal easing; however, tax cuts have only a limited impact in stimulating growth in the economy for several reasons, says Bernd Bartels, analyst at Scope.

“Those with the greatest need for income support pay little or no taxes today, so lower taxes benefit those who are more likely to have decent jobs anyhow given the tight labour market for high-skilled positions,” says Bartels. This partly reflects demographic change as baby-boomers exit the labour market.

“The fiscal multiplier effect is consequently fairly modest as high-income-earners usually spend less of their discretionary income gains on consumption,” he says.

Germany’s economy would benefit more from measures, first, to increase investment to raise the country’s low growth potential and, secondly, to stabilise the pension system.

Why investment?

1. Investment is urgently needed into digital and transport infrastructure: Germany ranks among the weakest in Europe and the OECD on available high-speed internet connections; in addition, state-owned railway company Deutsche Bahn AG has insufficient resources for necessary investment into its networks and trains
2. Compared to peers, gross public investment in Germany ranks one percentage point below that of France (3.4% compared to 2.35% of GDP in 2018), remaining especially weak in the area of fixed assets expenditure (0.3% of GDP in 2017)
3. Tax incentives for private investment in the domestic economy could help to stimulate growth in a weaker macroeconomic environment

Why the pension system?

1. The baby-boomer generation is retiring, and this amplifies the gap between those paying into and receiving from the public pension system.
2. Given ultra-low interest rates, the government could create a debt-financed state fund, similar to that of Norway’s sovereign wealth fund (financed by petroleum revenues), to lower the pension burden for younger workers that otherwise face higher contributions.
3. Less pressure on the working-age population to accumulate pre-cautionary savings could support growth and consumption in the long run.

Pursuing tax cuts comes at a politically sensitive time, with Germany governed by the fragile coalition of the CDU and the Social Democrats. Pushing tax cuts might break up the coalition or alternatively lead to more fiscal compromises, among them social spending to satisfy the SPD ahead of European and regional elections in Eastern Germany. “This would further reduce fiscal space and increase the burden further for younger generations,” says Bartels.