4 German public finances: deficit shrinks moderately
The general government deficit ratio is expected to decline moderately in 2024 and 2025. This is the result not of a restrictive austerity policy, but of the discontinuation of crisis assistance. On balance, the general government deficit ratio could range between 1½% and 2% of GDP in 2025, having stood at 2.4% in 2023. The same period will see around 1½% of GDP in burdens from temporary crisis assistance measures being taken out of the budget. The expiry of the energy price brakes in 2024 should do the most to relieve pressure on the government budget. The inflation compensation bonuses, which are exempt from tax and social security contributions, will subsequently expire in 2025 as well. On balance, these will be replaced by pay components subject to tax and social security contributions, which will generate additional revenue. In other areas, however, the budgets are likely to deteriorate. For example, the high inflation rates of recent years are still reflected in additional expenditure on the likes of administration and general costs or employee compensation. Pension expenditure will also rise significantly. Furthermore, the Federal Government announced new, in some cases deficit-increasing measures as part of its growth initiative.
The central government deficit is also likely to shrink. The Federal Government is budgeting for a total deficit of €113 billion for the core budget and off-budget entities in 2024. This is expected to decline to €87 billion in 2025. However, current expectations put the federal deficit in 2024 significantly below the planned figure. As things stand today, the Armed Forces Fund and Climate and Transformation Fund, in particular, will turn out more favourably. By contrast, deficits could be higher in 2025. For example, the more favourable developments in 2024 could open up more scope for deficits for 2025 (via higher reserves). In addition, the Federal Government’s draft budget estimates are fairly tight, and relatively high savings are to be achieved in the course of implementing the budget (a residuum spending cut).
In order to expand the scope of the debt brake, Deutsche Bahn is to receive additional equity instead of grants. This raises questions from an economic perspective and further distances the debt brake from the EU fiscal rules. Overall, Deutsche Bahn is to receive injections of €10½ billion in capital from central government’s core budget in 2025 for infrastructure investment. This is €4½ billion more than initially decided in July. Whether the switch will be adequate from an economic perspective depends on whether an appropriate return is to be expected on the equity capital. It would not make good sense if central government’s return turned out to be financed by central government itself via future burdens on the federal budget (e.g. via higher federal grants). In any case, it would be important to make it transparent how Deutsche Bahn intends to generate the return in the future with the new equity. This switch in how Deutsche Bahn is financed distances the debt brake further from the EU rules it is supposed to safeguard. The EU rules refer to the general government sector as defined in the national accounts. This includes the infrastructure component of Deutsche Bahn. Its investments therefore increase the national accounts deficit, irrespective of whether central government books financial transactions (such as capital injections) or grants in the core budget.
For sound public finances, it is important that the debt brake retains its binding effect. Reform that moderately increased a binding credit limit would be acceptable, however. In this context, the Bundesbank has proposed a moderate increase in the credit limit if the debt ratio is below 60%. A capped golden rule could be used to open up targeted, limited additional scope to borrow for net investment as well.
Germany remains tasked with rigorously tackling its economic policy challenges. The Federal Government’s growth initiative is addressing the right issues in many cases. Its goals include incentivising employment and investment, a reliable energy supply, and efficient, less bureaucratic public administration. However, some of the prospective measures do not match the goals, and in some cases more far-reaching steps are needed. For example, additional partial tax subsidies make tax law more complicated and more susceptible to creative tax practices, add red tape, and stress the country’s public finances. One strategy that works in the opposite direction would be to limit or eliminate tax exemptions and reductions combined with a lowering of general tax rates. One easily understood measure would be if employees no longer had to pay unemployment and pension insurance contributions after they reach the statutory retirement age. This is because, for these employees, the employer contribution represents a special levy in some cases under the existing system. In the interests of keeping older people in jobs, it would make sense to remove some of the incentives for early retirement. Even if the statutory retirement age after 2030 becomes linked to life expectancy, this would support a longer working life. These measures would alleviate the strong demographic pressure on pension finances and the federal budget.
The new EU fiscal rules are facing their first test: budgetary requirements must be sufficiently ambitious to promote sound public finances in the euro area. The stated objective of the rules is to lower high deficit and debt ratios. This is because sound public finances in the Member States are important for a stability-oriented euro area. They increase its crisis resilience and support the monetary policy of the Eurosystem. The onus continues to be on the European Commission and ECOFIN to ensure that fiscal requirements are sufficiently ambitious. The budget limits for the first planning periods will be agreed by the autumn.