Germany's Social Democrats (SPD), the Christian Democratic Union (CDU), and the CDU's Bavarian sister party, the Christian Social Union (CSU), have agreed to pursue another "grand coalition" government, and have published a 28-page agreement outlining their proposed policy agenda.
The agreement comes months after an election in which the SPD and CDU/CSU advanced rather different economic-policy views. Whereas the SPD has focused on the need for more redistribution and public spending, the CDU/CSU has promised "tax cuts for all" and a more restrictive refugee policy. The question now is whether a coalition comprising such ideologically divergent forces can truly prepare Germany for the challenges that await it.
In the months and years ahead, German policymakers will need to manage the transition into the digital era, in order to preserve the country's competitiveness. They must also stabilise the welfare state at a time of rapid population aging. And they must develop a rational migration policy. On top of this full domestic agenda, many are looking to Germany to keep the European Union together.
As many commentators have pointed out, Germany's new government will benefit from a budget surplus, because the booming economy, coupled with peculiarities of the German tax code, has boosted government revenues over the last four years. Even by pursuing the balanced-budget policy described in its provisional coalition agreement, the government will have room either for more spending or tax cuts amounting to €46 billion ($56 billion) - around 0.3 per cent of gross domestic product (GDP) - over four years. According to the coalition agreement, €36 billion of the surplus will be allocated to various outlays such as transfers to families, higher agricultural and regional subsidies, housing-construction incentives, roads and related infrastructure, universities and school buildings, and even the military.
That leaves just €10 billion for tax cuts, which will take the form of reductions in the solidarity surcharge (Solidaritätszuschlag), a special income tax that was introduced in 1991 to finance German reunification. The grand coalition envisions abolishing this tax for everyone except the top 10 per cent of earners, who generate more than half of the revenue from it.
But when one considers the effects of "bracket creep," the outlook for taxpayers worsens. Unlike most other developed countries, Germany's tax system lacks an automatic adjustment mechanism to prevent inflation from pushing households into higher tax brackets. And while discretionary adjustments do take place, they hardly provide full compensation to countless households that end up paying more tax than they should.
In fact, at the current rate of bracket creep, Germany's tax revenues will increase by roughly €50 billion over the next four years. Halving the solidarity surcharge no earlier than 2021 will come nowhere close to offsetting that.
All told, nobody is particularly enthusiastic about the coalition agreement, including the SPD. Despite the coalition agreement's emphasis on spending, the SPD fears that participating in another grand coalition will further damage its public standing, and drive more of its voters into the arms of the radical left or the far-right Alternative für Deutschland (AfD).
For others, the problem is not politics, but the agenda itself: for all of its specific provisions, it achieves very little. When spread over four years, an additional €2.0 billion spent on defence, €600 million on universities, and €4.0 billion on housing will make little difference.
And while the coalition's plan also promises higher contributions to the European Union (EU) budget and more spending on the mothers' pension and low-income households, it does not specify how those increases will be reconciled with a balanced budget.
More fundamentally, the agenda lacks ambition and direction. It neither provides significant relief to the middle class through tax cuts, nor allocates adequate investment for research, infrastructure, or education. And it makes no mention of corporate taxation, even though rate cuts in the United States, and planned cuts in France and the United Kingdom, will inevitably lure investment and jobs away from Germany.
A truly bold policy agenda would require the new government to focus on specific priorities and accept that not everyone can get what they want. Rather than tweaking the margins in a futile attempt to please everyone, the government would set its sights on deeper structural reforms, to lay the foundation for future growth and stability.
For example, Germany spends billions of euros every year on green-energy subsidies. But as the provisional coalition agreement acknowledges, Germany will likely fall short of its target for reducing carbon dioxide emissions by 2020, suggesting that these subsidies have not worked. Fundamental reforms in this area could make Germany's climate policies both cheaper and more effective. But doing that would require the government to abandon its ideological position and challenge powerful interest groups.
Nevertheless, the coalition agreement does include some promising ideas. For example, it proposes a programme to attract skilled workers, and to align Germany's immigration policies with its economic interests. And although the new government should attach conditions to Germany's larger EU budget contribution, in order to prevent wasteful spending, its clear commitment to the EU should be welcomed.
There is still time for the coalition partners to revise their programme. Surely, they should want to do more than use the current economic upswing to provide piddling handouts to various constituencies (except those paying the most in taxes, of course). Now is the time to start preparing Germany for its future challenges.
Clemens Fuest is President of the Ifo Institute and Professor of Economics at the University of Munich.
Copyright: Project Syndicate, 2018.
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