July 21, 2005,
Don’t expect a supply-side transformation of the German economy even if, as predicted, the Christian Democrats, led by Angela Merkel, win the coming general election. Indeed, where else but in Old Europe could the purported “conservative” political party launch an election campaign by proposing to raise taxes? As one observer quipped, “We shouldn’t be talking about Maggie Merkel just yet.”
Germans are due to go to the polls Sept. 18, a year ahead of schedule. With a commanding 20-point lead in voter surveys, the Christian Democrats are odds-on favorites to form the next government, which would make Merkel Germany’s first female chancellor. A physicist by training, Merkel gained notoriety during her party’s slush-fund scandal of the late 1990s when she became the first cabinet member to break with Chancellor Helmut Kohl, her political patron. She was named head of the Christian Democratic Union (CDU) in April 2000.
Adhering to the politics of austerity and unwilling to dismantle a century-old, cradle-to-grave welfare state, Merkel’s newly published campaign “manifesto” puts fiscal concerns ahead of economic ones. Curbing the budget deficit through tax increases is preferred to stimulating the economy via tax cuts. Thus, while stressing the need for job creation, a 2-point hike in the value-added tax (VAT) to 18 percent is the focal point of Merkel’s campaign.
German politico-economic thinking clearly is mired in static analysis, with too much emphasis on such considerations as government debt and budget deficits and too little stress on business creation and capital spending.
General government debt reached a post-unification high of 66 percent of GDP last year, while government budget deficits have been running at 3.7 percent to 3.8 percent of GDP for the past three years (compared with a 1991-2000 average of 2.3 percent) in violation of EU rules limiting deficits to no more than 3 percent of GDP. The experience of Britain and the U.S. over the past 25 years indicate that tax cuts would soon fill the Germany’s fiscal coffers through the mechanism of incentive-based growth in personal and corporate incomes, yet these supply-side lessons seem lost on Merkel and friends.
With economic policymaking taking a back seat to budgetary bookkeeping, German taxpayers shouldn’t expect too much in the way of post-election income-tax relief. Merkel’s manifesto tellingly fails to reiterate an earlier CDU pledge to trim the top marginal income-tax rate from 42 percent to 39 percent. Instead, using a pay-as-you-go formula better suited to household budgets than governmental ones, Merkel, as chancellor, intends to offset any income-tax cut by eliminating existing tax breaks. The result would likely be little or no net change in Germany’s crippling income-tax burden.
Merkel also plans to renege, at least partially, on an agreement reached with Chancellor Gerhard Schroeder in April to trim the corporate tax rate from 25 percent to 19 percent. She now proposes to cut the rate by only 3 percentage points to 22 percent. She advocates closing tax loopholes in order to make the rate reduction revenue neutral, meaning corporations wouldn’t get much if any net tax relief. Merkel further wants to reintroduce capital-gains taxation on the sale of certain corporate shareholdings, albeit at a lower rate than before.
The manifesto’s few encouraging proposals would reduce the cost of unemployment insurance for both employees and employers, with the aim of making it less costly for businesses to hire new workers. Other reforms would make it easier for businesses to fire workers, who are now virtually immune from dismissal. The reforms further would allow companies to opt out of binding national wage agreements meted out between various industry representatives and unions.
German workers are among the world’s most expensive. According to a recent OECD study, the average German manufacturing worker’s marginal tax rate, including income and social security taxes, is a whopping 40.5 percent. Adding the employer’s social security contributions brings the marginal rate up to 50.7 percent for the average German manufacturing wage earner with no dependents. It’s small wonder, then, that unemployment is nearing the five-million mark.
Numerous polls show a decided lack of confidence among consumers and businesses. Consumer confidence, by some measures, has been in negative territory since June 2001. Business and economic confidence, too, have sagged. The National Institute of Research’s IFO Business Climate Index generally has been edging downward since January 2004, as has the Centre for European Economic Research’s ZEW Indicator of Economic Sentiment.
None of this bodes well, of course, for Schroeder and his fellow Social Democrats. Nevertheless, were his party to win in September, Schroeder has pledged to hike the top marginal income tax rate from 42 percent to 45 percent while, at the same time, increasing subsidies and transfer payments. Most notably, he wants to raise the Elterngeld subsidy to an entire year’s salary for parents who leave work and stay home to look after newborns.
Sadly, neither of Germany’s leading political parties is attacking the economy’s main problem i.e., anemic private capital investment. Real gross fixed capital formation in Germany in 1992-2004 rose as much as 9.8 percent year-on-year but also fell as much as 9.6 percent. The changes in real capital investment throughout the period actually averaged a negative 0.03 percent. Real year-to-year GDP growth during the same 13-year span consequently averaged a mere 1.2 percent.
Fixed investment per German worker in the 2005 first quarter was a miserly €2,405 (or about $2,900), almost unchanged from a quarter earlier and down about 1 percent from a year earlier. Per-worker investment was roughly 15 percent below the €2,844 peak reached in the 2001 opening quarter.
Germany’s massive governmental claims on the economy, largely to finance its behemoth welfare state, contribute mightily to this debilitating capital expenditure shortfall. In post-unification Germany, total public-sector receipts have been equivalent to 44 percent, on average, of nominal GDP and 45 percent of national income, while the central government’s receipts alone have averaged 27 percent of GDP. By contrast, during the same 1991-2004 period, all U.S. government receipts, including federal, state, and local, averaged 30 percent of GDP and U.S. federal government current receipts alone averaged 19 percent of GDP.
The German private sector needs breathing room if the economy is ever to revive substantially. And that primarily means reducing the government’s onerous tax take and the public sector’s sizeable claims on the economy. Frau Merkel might take a cue from her eastern neighbors and propose, among other things, a low, flat tax on incomes.
William P. Kucewicz is editor of GeoInvestor.com and a former editorial board member of the Wall Street Journal.