€500 billion — and still not enough
Germany’s pension system is swallowing the federal budget
Dear Reader,
There is a simple and unavoidable truth about modern life in Germany: working lives are too short, and retirements are too long — far too long. The imbalance between the two is structural — and it is widening.
As life expectancy rises, the gap between what is paid into the pension system and what is taken out inevitably widens. That is not ideology; it is arithmetic. Governments have two ways of closing that gap. They can raise contribution rates, reducing disposable income and increasing labour costs. Or they can hold contributions steady and quietly transfer ever larger sums from the federal budget to prop up the system.
In times of surplus, the second option is politically irresistible. And so that is the path Germany chose.
During the 2010s, the demographic time bomb had not yet detonated. The baby boomers were still in work, and the high tide of globalisation was delivering large gains for German industry. The state ran persistent surpluses. Everyone knew the problem was coming. But instead of using those years to take the deeply unpopular step of raising the retirement age to 70, successive governments simply channelled more money from the federal budget into the pension system.
That strategy has now run its course.
As the baby boomers retire, pension spending has surged. Total expenditure in the statutory system rose from around €276 billion in 2015 to over €400 billion in 2024. Contribution income did rise as well — from roughly €207 billion to just over €300 billion — but nowhere near enough to keep pace.
The difference has been made up by the federal government. Transfers have risen by tens of billions and now rank among the largest items in federal spending.
For a time, this could be sustained. But the broader economic environment has deteriorated sharply. The shock of Russia’s invasion of Ukraine drove up energy costs. Competition from China has eroded the profitability of German industry. And the return of protectionism in the United States has further darkened the outlook. Growth has stalled, consumption is weak, and new spending pressures — above all on defence — have emerged.
The result is a fiscal squeeze. The state can no longer assume that rising tax revenues will quietly absorb rising pension costs.
This was the central dilemma facing Friedrich Merz after last year’s election. Would he attempt to reverse years of political cowardice by pushing through structural reform — raising the retirement age and increasing labour supply? Or would he choose the easier path: more debt?
We now have our answer — even if its full consequences are only beginning to emerge.
Even before formally taking office, Merz used a majority in the outgoing Bundestag to secure €500 billion in additional borrowing, to be spent over the coming decade. He framed the move as a response to a changed geopolitical reality, presenting it as necessary to safeguard Germany’s security and modernise its infrastructure.
He also made a crucial promise: that this would be additional spending on infrastructure — not a way of freeing up money in the core budget.
That promise has not held.
This week, two economic institutes published assessments of how the funds have been used — and both reached similar conclusions. The Munich-based Ifo Institute found that only around five cents of every euro has gone towards additional infrastructure investment. The rest has effectively been used to plug gaps elsewhere in the budget. The Cologne Institute for Economic Research (IW) arrived at a slightly less stark figure, but the underlying picture is the same.
“The government has used nearly all of the debt-financed funds for other purposes — namely, to plug budget gaps,” said Clemens Fuest, head of the Ifo Institute.
What those studies do not say explicitly — but what the numbers strongly suggest — is that a significant share of this “relabelled” spending is indirectly financing Germany’s rising pension burden.
Germany is now financing its pension system not just through workers and taxpayers — but increasingly through debt.
At the same time, policy decisions made under Merz have increased long-term pension costs. The commitment to maintain the pension level at 48 per cent of average wages, combined with expanded credits for parents who took time out of the workforce, is projected to add hundreds of billions of euros in additional spending over the coming decades.
The symmetry is striking: a €500 billion debt package on one side, and a comparable expansion of pension obligations on the other.
The trajectory is clear. Debt servicing and pension subsidies are on course to become the dominant items in the federal budget — crowding out everything else.
The government will try to push ever more people into full-time work (who knows what that’ll do to birth rates?) to fill the gap. But that’s presuming that companies keep investing here, a prospect that seems increasingly unlikely so long as taxes and insurance contributions remain high.
To be fair, Merz still has three years in office. Earlier this month, campaigning in Baden-Württemberg, he said he could “imagine” linking the retirement age to life expectancy rather than fixing it at a specific number.
It was hardly a war cry against the single largest driver of Germany’s decline. But then, Merz knows that the baby boomers are his last solid voting bloc — and if he angers them, future CDU majorities will be slimmer still, if they exist at all.
We will see what his imagination produces in the months ahead.
News in Brief
Friedrich Merz has ruled out any German participation in the Iran war, saying that the conflict is “not a matter for NATO”. Donald Trump has been pressuring NATO allies to help secure the Strait of Hormuz against Iranian attacks on civilian shipping. Merz has been categorical that Germany will not send naval vessels to the narrow waterway while US missiles are flying. He has, however, left the door open to Germany doing so once the conflict ends. His exact wording was: “As long as the war continues, we will not take part in ensuring freedom of navigation in the Strait of Hormuz by military means.” If Trump suddenly declares victory and the attacks stop as quickly as they started — something we certainly should not put past him — that would immediately change the dynamic. If Iran refused to reciprocate and kept blocking the busy waterway, Merz would suddenly face intense pressure to act, not just from Trump but from drivers and factory owners too.
Die Linke, Germany’s hard-Left party, is embroiled in a bruising internal row over its stance on Israel. One senior figure quit the party this week after a branch in Lower Saxony voted to condemn modern Zionism as a form of apartheid and as culpable in genocide. Andreas Büttner, who rejects the accusations against Israel, said he was leaving the party after being subjected to intimidation that included an arson attack on his private property. Meanwhile, party grandee Gregor Gysi — the last leader of the GDR’s SED party — has come under attack after saying that an influx of members with migrant backgrounds posed “a danger” to the party’s support for a two-state solution. Some 200 party members have signed a letter calling on Gysi to apologise for “reproducing racist narratives”.
Ahead of state elections in Rhineland-Palatinate on Sunday, the CDU has moved ahead of the SPD in polling, by 28 per cent to 26 per cent. The SPD currently governs the south-western state. In local elections in Hesse at the weekend, the CDU maintained its majorities in most local councils, although the AfD were the evening’s big winners, increasing their vote share across municipalities in the central state to 16 per cent.