July 5, 2007
German Fiscal Policy: Pro-cyclical again
This week, the German government has been debating its budget for 2008. While everyone in the grand coalition seems to be content that finance minister Peer Steinbrück has managed to increase spending, cut taxes and cut the deficit at the same time, there are signs that the government is repeating the mistakes of the red-green government: As I argue in today’s Financial Times Deutschland (full German text here), fiscal policy is turning pro-cyclical once again.
The impressive improvement of the German budget situation (the Kiel institute sees a balanced budget for the government as a whole – including social security, states and municipalities – already in 2007) is more a result of strong tax increases than of very recent spending restraint. Especially corporate taxes have risen strongly. From 2005 to 2006, revenue from the “Körperschaftsteuer”, the federal tax on corporations, has risen by almost 60 percent.
Spending, on the other hand, has been low thanks to falling transfers to the unemployed. Beyond these monetary transfers, Steinbrück’s predecessor Hans Eichel has kept a lid on spending, but Steinbrück has relaxed the stance again. Government spending ex transfers has been growing on average by 0.5 percent from 2002 to 2005, but has picked up since. The Kiel institute now sees an increase by 2.3 percent this year and 3.4 percent next year.
Add to this a cut in unemployment contributions planned for the beginning of 2008 and the corporate tax reform which will cost € 6.5 bn in the first year after enactment according to the federal ministry of finance (and up to € 10 bn according to critics) and you again have a clearly pro-cyclical fiscal policy. This can also be seen by the fact that the Kiel institute now sees a growing headline deficit for 2008 (0.1 percent of GDP instead of a balanced budget in 2007) – and this in the wake of a strongly expanding economy.
The danger is that the money is again missing for a sensible stabilization policy once the boom ends. Germany might then again go for pro-cyclical budget consolidation – the same mistake which has helped keep the country in quasi-stagnation from 2002 to 2005.
Eurozone Watch has long argued that the governance structure of EMU is prone to pro-cyclicality in fiscal policy. Given that recent economic research hints that pro-cyclicality might actually hurting the long-term growth prospects, this is more than a mere nuisance.
Comments(2)
Good and timely point.
Three points to avoid damage from pro-cyclical policy:
- Change the European setting by making Maastricht criteria symmetric
- Put in place a European re-distribution mechanism (as Sebastian usually proposes)
- Coordinate macroeconomic poilicies across Europe and between players
Best,
Ulrich
[...] We start from the observation that fiscal policy once again is turning pro-cyclical in a number of European countries. Germany is cutting corporate taxes and increasing discretionary spending at a moment when the economy is growing with rates close to 3 percent (see our post here). France’s new president Nicolas Sarkozy is cutting income taxes for home buyers and overtime payment in a boom, providing an ill-timed boost to the economy (see post here) and the Italian government has just increased their deficit target from 2.3 to 2.5 percent of GDP inspite of strong tax revenues (the money supposedly will go into more social spending). [...]