Les obsessions de la politique budgétaire allemande Séminaire

Les obsessions de la politique budgétaire allemande Séminaire économie de la mondialisation Achim Truger, IMK in der Hans-Böckler-Stiftung www. boeckler. de

Tax cuts and budget consolidation The two fatal obsessions of German fiscal policy since 1998 Séminaire économie de la mondialisation, OFCE Paris, 7 December 2009 Achim Truger, IMK in der Hans-Böckler-Stiftung www. boeckler. de

Aims of the presentation n Inform you about German fiscal policy and its economic and social effects including recent developments n Give you an insight into the – often very strange – debate on fiscal policy in Germany n Identify the two main driving forces („obsessions“) of German fiscal policy: tax cuts + budget consolidation 3

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts 4

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts 5

Annual GDP-growth in % Source: EU-Commission (2009) 6

Pro-cyclical fiscal policy 7

Total government expenditure (% of GDP) Source: EU-Commission (2009) 8

(almost) world champion in expenditure restraint! Source: EU-Commission (2009) 9

Government employment (% of total employment) Source: ILO 10

Massive dismantling of the welfare state n pension cuts while at the same time subsidising private saving („Riester-Rente“) n cuts in unemployment benefits and duration („Hartz IV“), stricter enforcement n cuts in public health insurance n deregulation in employment protection and labour market laws n large-scale privatisations 11

Inequality on the rise 12

Unintended, but nevertheless bad n most of the decline occured under the red-green government n it was unintended, because the aims and hopes were to boost growth and emloyment and fight inequality n it resulted from deficiencies in (macro-)economic thinking in Germany n n 13 macroeconomics is irrelevant. Keynesianism is refuted and has to be fought against structural reform is all that is needed to fight unemployment and small government to boost growth

Unintended, but nevertheless bad The two „obsessions“: n growth policy is equated with tax cuts n fiscal policy is equated with budget consolidation macroeconomic side effects are ignored 14

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts? 15

Red Green Tax Cuts n Income Tax: in three major steps (2001, 2004 and 2005) marginal tax rates were substantially lowered n Business Taxation: In 2001 a major transition to a new system occured. The maximum marginal rate for profits decreased from 51. 8 % to 38. 6 % for corporations and 54. 5 % to 45. 7 % for nonincorporated business n Family taxation: child benefits / tax free allowances were increased n Ecological Tax Reform (almost revenue neutral) 16

Income Tax schedule: Marginal and average rates 1998 and 2005 in % 17

Expensive reforms… Revenue effects of income, business and family tax reform in Bill. Euro as compared to 1998 tax law 18

…and their effects 19

Overall revenue losses from redgreen tax policy 20

. . but the opposition has a brillant idea: More tax cuts ! 21

. . but the opposition has a brillant idea: More tax cuts !!! Revenue Effects of Tax Reform Proposals made in 2003 to 2005 according to different estimates in Bill. Euro in 2005 CDU CSU FDP Kirchhof SVR CDU/ CSU – 26, 2 – 11, 0 – 27, 8 – 26, 4 – 1, 5 – 13, 3 Finance – 25, 3 – 12, 7 minister (– 31, 5) (– s 16, 0) (trans. ) – 14, 5 (– 23, 9) – 11, 4 (– 42, 9) – 4, 0 (– 9, 5) –– –– Bach et al. 22

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts 23

The Grand Coalition after 2005: some lessons learned… n recognised that further tax cuts were not possible if the budget was to be consolidated n switched to a more revenue sided consolidation strategy n Raised the value added tax by 3 points n Decided to postpone the tougher steps to 2007 and hope that by then the recovery would be strong enough n After the recovery expenditure growth on all federal levels was normalised 24

Only partial compensation for red-green revenue losses 25

High risk strategy 26

… with some serious drawbacks… n Given that nobody knew if the recovery was under way the negative fiscal stance for 2007 was extremely risky n the distributional effects of the tax measures were negative as there was only a compensation of 2/3 by lower contributions to unemployment insurance (from 6. 5 to 4. 2 %) and other social contributions were slightly increased n (by the way not very nice further move into the mercantilist direction…) 27

… with some serious drawbacks… n Public revenue was weakend from 2008 on by the next „big“ business tax reform (maximum statuatory rate down to 29. 8 percent for all business profits) n Revenue of the unemployment insurance, the federal labour agency, was weakend by further aggressive cuts in the contribution rates: from 4. 2 % to 3. 3 % in 2008 and then to 2. 8 % in 2009 the agency is deeply in deficit now and calls for expenditure cuts have been around… 28

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts 29

After some hesitation until November 2008: a tiny stimulus package… 30

…but then in January 2009: A substantial stimulus package 31

…plus some additional measures 32

Unbelievable: conscious counter-cyclical action is back after 25 years… 33

Not that bad in international comparison Source: OECD (2009) 34

Not that bad in international comparison Source: OECD (2009) 35

Not that bad in international comparison Source: OECD (2009) 36

Not that bad in international comparison 37

Not that bad in international comparison 38

Not that bad in international comparison 39

But no change of the general paradigm Fiscal Policy: n important improvement compared with last recession n overall reaction slightly better than EMU-average n but again weaker than in the U. S. n and certainly not enough to counter the recession n German government prevented international co-ordination 40

But no change of the general paradigm The serious drawbacks: n (Business as usual with respect to wages and monetary policy) n Tax cuts in the stimulus packages are permanent and will permanently weaken public revenue by about 1 percent of GDP n terrible medium term drawback: the „debt brake“ which will be gradually phased in from 2011 onwards 41

The grand coalition‘s revenue gains… 42

… have already disappeared 43

The „debt brake“ n ‚structural‘ deficit < 0, 35 % of GDP n Federal level 0. 35 % ceiling from 2016 n „Länder“ 0. 0 % from 2020 n cyclical deficit according to cyclical adjustment method by EU-Commission n discretionary policy only allowed in very special circumstances n transition period from 2011 to 2016/2020 when ‚structural‘ deficits have to meet the target 44

The „debt brake“: errors in construction… n relies almost completely on built-in stabilisers n but built-in stabilisers will be counteracted because cyclical deficit will be calculated according to technocratical cyclical adjustment method by EUCommission serious procyclicalities n transition period from 2011 to 2016/2020 when ‚structural‘ deficits have to meet the target very dangerous 45

Dangerous transition to the „debt brake“ n German fiscal policy will switch to restriction in 2011 irrespective of the economic situation n This may be to early for the recovery n (and it will certainly be wrong if European and global economic imbalances are to be tackled) n If there are no tax increases (which almost everybody has ruled out…) then expenditure restraint will have to be brutal again: nominal total expenditure growth not much higher than 1% 46

Dangerous transition to the „debt brake“ n with good luck due to the endogeneity of „structural deficits“ prospects may brighten substantially if the recovery comes soon, is strong and lasts some years n With bad luck due to the endogeneity of „structural deficits“ prospects may darken even more if the recovery is weak and a period of stagnation follows n In the second case: If governments react with even more fiscal restriction to meet then more ambitious deficit ceiling in 2016/20 then a viciuos circle might occur 47

Contents n Introduction n Germany‘s poor economic and social performance over the last 10 years n Red-green tax reforms (1998 -2005) and their consequences n Fiscal Policy under the Grand Coalition I (2005 to 2008) – some lessons learned? n Fiscal Policy under the Grand Coalition II (2008 to 2009) – a return to Keynesian fiscal policy? n Fiscal Policy under the new conservative-liberal government: Debt brake and aggressive further tax cuts 48

Believe it or not… In this situation the new government announces n an immediate growth acceleration programme = further permanent tax cuts of about 8. 5 bn. Euros. . n Half of it goes into higher child benefits/allowances n 2 bn go into lower business taxation n 0. 5 bn. to lower inheritance taxes n 1 bn. to reduced vat rate for hotels IMK estimate of one-off growth effect: 0. 2 % of GDP 49

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Believe it or not… In this situation the new government announces n Further permanent tax cuts for the income tax of 20 bn. from 2011 onwards! n If really enacted in total public revenues will be permanently decreased by about 30 bn. Euros (1. 2 % of GDP) per year. 51

3. Short-run economic policy reactions 52

Prospects for the future n The government would have to be extremely lucky to get through with this without dramatic further expenditure cuts on all federal levels and/or compensating tax increases and/or breaking the debt brake n There may be different scenarios. However, it is very likely that the poor German performance with respect to growth, welfare state and distribution will go on. 53

Is there a way out? n extreme luck… n getting rid of the debt brake…. …. but it‘s in the constitution! But even given the debt brake there is a way out: n in general: increase taxes and restore the government‘s ability to act!! n consolidate the budget and n stop expenditure restraint. Drive up public investment in education, research, ecological and traditional infrastructure… 54

Once again: The two obsessions n an obsession with budget consolidation n an obsession with tax cuts n Both obsessions are dangerous on their own n But in combination they are fatal and have proven to be so If the obsession with budget consolidation cannot be cured …. then at least cure the obsession with tax cuts! 55

Merci beaucoup! 56