Heading for budgetary brake-down?!
Dear Reader,
Another week, another crisis.
This time it’s the turn of Germany’s state finances. In my latest newsletter for members I went into the backstory of why Olaf Scholz set up an enormous shadow budget to finance his government’s climate policies - and how a dramatic ruling by the constitutional court has brought that house of cards crashing down.
The court ruling - that €60 billion transferred into a climate fund from an older pandemic fund breached three separate constitutional principles - has created a vortex at the centre of German politics, with all kinds of spending pledges at risk of being sucked in.
Indeed, the wording of the ruling makes it likely that a whole host of shadow budgets set up by Scholz and his finance minister, Christian Lindner, could be affected. The total damage? well over €200 billion.
To give you some idea of just how significant this is, the regular federal budget for this year was around €460 billion. In other words, the money that has disappeared overnight is close to half of Germany’s entire federal spend in a typical year.
Olaf Scholz’ government now has a little over three weeks to figure out how to make ends meet for the current budget and for the following years. The solutions are all ugly. Radically cut welfare programmes like unemployment benefits and child support, cancel the huge subsidies set up to pay for the energy transition, or find creative (legally risky) ways to take on new debt. What’s your favourite?
On Thursday, Finance Minister Lindner announced he would declare a state of emergency for this year, making it the fourth year in a row that German governments have suspended normal budgetary rules to help them cope with crises that emerged during that time.
How did it come to this? German governments are restricted in how much they spend by something called the Schuldenbremse (debt brake).
A short history of the debt brake:
The financial crisis of 2008 led to concerns that even rich western countries could become swamped with unserviceable levels of national debt if they didn’t take care of their finances. Germany responded by creating a clause in its constitution that would prevent any future government from running up excessive debt.
The clause - known colloquially as the Schuldenbremse - limited governments to taking on new debts of no more than 0.35% of GDP in any given year.
In the words Peer Steinbrück, the man who invented it:
“My main motive was this: as a duty to future generations, we shouldn’t let governments slip into debt so as to avoid (inner-governmental) arguments and cost-cutting measures… Politics needs rules for solid public finances because politicians have a tendency to cut taxes or distribute social gifts in order to gain popularity.”1
At the same time, Steinbrück recognised that the debt brake could be too restrictive during a major crisis. So he included a clause that allowed for the brake to be suspended when “natural disasters or other extraordinary emergencies beyond the control of the state significantly affect the state's financial position.”2
For a decade, everything went swimmingly.
With the economy booming, so much cash flowed into the treasury via tax receipts that the government could proudly proclaim that it had balanced its books while taking on no new debt (something called the Schwarze Null). Thus the size of the public debt in relation to GDP went down.
Then came the pandemic…
The decision to lock down the country, taken in March 2020, and repeated the following winter cost hundreds of billions of euros. There was no chance that could be borne by the regular budget alone.
So, the debt brake was suspended for the first time ever.
Finance minister at the time, Scholz stepped in front of the press to declare that he would fire a “bazooka” of cash to stop German firms going bust.
Then came 2021, another year of lockdowns... and another suspension of the debt brake (this time Scholz christened his spending package his “Wumms” or boom).
Hello 2022. Bye bye lockdowns… hello Putin and bye bye Russian gas. Another crisis, another year in which the debt rules are suspended and mammoth new debts are taken on to pay for a cap on gas prices (this time Scholz calls it his “Doppel-Wumms!” or double boom).
What about this year? Covid has turned into a sniffly cold and the peak of the energy crisis seems to be behind us.
But, with the energy price cap still in place, government spending is well above the level set by the debt brake.
And the same thing is going to happen next year… and the year after…
To name just a few policies that the government can’t strictly afford: There is the €10 billion promised to Intel so that it builds a chip factory in Magdeburg; €10 billion to help people pay for the heat pumps that are going to become compulsory starting next year; the tens of billions promised to heavy industry to cap their energy bills; the billions being poured into paying for an entirely new electricity grid based on wind and solar.
The government’s preferred solution seems to be to keep suspending the debt brake year after year.
It’s not that simple though. Suspending part of the constitution can get you into a lot of trouble with the country’s highest court - the Bundesverfassungsgericht.
Anyone who wants to suspend the debt brake has to come up with a legitimate crisis. So, what is it this time?
The finance ministry is reportedly planning to use the Ukraine war as its justification for a last-minute suspension in 2023. That seems plausible: most of the money from the shadow budget has gone into paying for the cap on energy prices.
But what about in 2024 and 2025?
Listening to people in the Green party, one gets the impression that they want to use the “climate crisis” as a justification. But it is uncertain whether that would convince the constitutional judges. While the exemption covers “natural disasters”, it was really intended to tackle short-term crises when the economy is suffering from a supply shock.
Ultimately, climate change is a crisis that takes place over a span of decades. Accepting it as a justification for suspending the debt brake in reality equates to abolishing the debt brake.
Another option that has been put forward is a reform that would allow governments to take on new debt as long as it is spent on investments in infrastructure.
Critics of the Schuldenbremse argue that you just need to look around you to see the damage that it has wrought.
Germany’s once-envied rail system is now the punch line to a bad joke; autobahn bridges are crumbling and the roads are buckling; bureaucrats still relied on fax machines during Covid; school are understaffed; the grid for transporting renewable energy is still in its infancy.
One could go on…
Even the father of the Schuldenbremse, Peer Steinbrück, has called for a reform of the system, saying that “we live in a different era to 2009, one with an extremely high need for investment”.
There are a few problems, though.
Firstly, the Schuldenbremse is written into the constitution, which means that changing it requires a two-thirds majority in the Bundestag. That in turn means that the ‘traffic light’ coalition would need the votes of the centre-right Christian Democrats (CDU) to get the reform through.
But the CDU are in no mood to compromise.
They are having too much fun watching the government squirm. Plus, they argue that tax intakes across all levels of the German government are going to smash the trillion euro barrier next year. Surely, there is plenty of money there for a government that has its priorities straight?
Top of the CDU’s axe-list is the new Bürgergeld welfare system, which ran €2 billion over budegt already this year. The CDU claim it costs the treasury twice by encouraging people not to take up tax-paying work.
What’s more, the CDU say, Germany has only been able to afford the crises of the past few years because it saved up money while they were in power under Angel Merkel. Discretion is the better part of valour, they say. After all, who knows what surprises the future may hold?
Beyond party politics though, it seems to me that no one has convincingly explained how a reformed debt brake would work. A government that is allowed to book investments as shadow budgets could just load the books, so that welfare gifts and tax cuts are on the regular books, while bridges and tech subsidies are off books.
Put another way, a government that can cordon off some of the costliest parts of its budget won’t face any pressure to reform its increasingly imbalanced pension system.
Thus, the problem that the Schuldenbremse was created to resolve would rear its ugly head again…
What members are reading
Interview with ‘Die Zeit’ 23.11.23
https://www.bundesfinanzministerium.de/Content/DE/Glossareintraege/S/Schuldenbremse.html?view=renderHelp
Two valid points there -
(1) infrastructure spending should indeed be a separate category of bond financing, and many countries treat it separately (and/or finance it through provincial or municipal bonds).
(2) While *one-time, targeted subsidies* can have a specific role (in the case of Intel at Magdeburg) in getting or keeping a specific employer or potentially at some part of an industry that is deemed critical to national security (and securing EU / German chip production independent of Asia does count, since China is getting ever-more capable of taking Taiwan), subsidizing whole sectors' energy prices simply isn't economically sustainable .
-If cheaper energy were available then no subsidies would be necessary. Funnily enough, three high-quality, baseload, carbon-free sources got turned off last year...
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