Olaf Scholz plots a way round Germany’s debt rules

Germany’s new government wants to do two things that seem mutually exclusive — increase investment while sticking to Germany’s strict rules on public debt. Reconciling the two could turn out to be one of the hardest tasks it will face.

But Olaf Scholz, the incoming chancellor, is confident he can square the circle. The coalition agreement he unveiled last month contains a smorgasbord of schemes for raising funds without violating the “debt brake” — Germany’s constitutional cap on new borrowing.

The opposition has dismissed them as “tricks”, and some legal scholars are warning they could fall foul of Germany’s constitutional court.

But others think, taken together, they add up to a reasonable plan of action.

“These measures, if fully enacted, will ensure that the coalition has enough money to do everything it needs to do,” said Jens Südekum, professor of international economics at Düsseldorf’s Heinrich Heine University. “If their agenda fails, it won’t be due to a shortage of cash.”

The coalition formed after national elections in September brings together three parties, Scholz’s Social Democrats, the Greens and liberals, who are not natural allies.

The Greens campaigned on a promise to relax the debt brake and invest €50bn a year over the next 10 years to modernise Germany and make it carbon-neutral. The liberal Free Democrats (FDP) said they would block any attempts to raise taxes or make any changes to the debt brake, introduced in 2009 after the global financial crisis blew a hole in Germany’s public finances.

Though their positions seemed irreconcilable before the election, the two managed to come up with plenty of creative solutions to satisfy both sides.

One of them envisages turning the KfW, a state-owned development bank, into an “innovation and investment agency”, recapitalising it and using its expanded balance sheet to leverage private investments in green energy and digitisation.

“The KfW would be able to, among other things, provide low-price loans to homeowners to insulate their houses or improve their energy efficiency,” said Südekum.

The KfW has already granted almost €70bn of state-guaranteed loans to German businesses under a coronavirus support scheme launched at the start of the pandemic. These were excluded from official debt calculations, meaning the scheme could serve as a model for financing other areas of the economy such as digitisation or green energy, said one close Scholz ally.

Similarly, the coalition wants to allow state-owned companies such as Deutsche Bahn and BImA — the Institute for Federal Real Estate — to take on debt that could be used for investments. It is already clear that Scholz sees BImA, a government agency which manages 460,000 hectares of state property, as crucial to implementing one of the SPD’s key goals — the construction of 400,000 new flats a year, 100,000 of them subsidised by the state.

Another proposal involves tinkering with the rules of the debt brake, and in particular the “cyclical component”, which determines how much leeway the government has to raise debt depending on the state of the economy.

Key here is the “output gap” — the difference between GDP and a measure of the economy’s potential: changing the way this is calculated could raise the amount of borrowing permitted under the debt brake. According to one estimate, this could allow the government to raise an additional €10bn a year.

Lars Feld of Freiburg university, a former government adviser, has dismissed the proposal as “Pippi Longstocking economics — I make the world as I like”. But the new government clearly thought it important enough to include in its coalition agreement.

And the idea could end up reverberating far beyond Germany’s borders. “If Germany really reforms this rule, it’s likely to feed into the debate about reforming the EU’s fiscal rules,” said Philippa Sigl-Glöckner of Dezernat Zukunft, a think-tank, one of the progenitors of the proposal. “The EU uses the same calculation on potential output as Germany does.”

All the proposals for getting round the debt brake come at a time when the rule is not being enforced: it was suspended last year to allow the government to increase spending during the coronavirus pandemic and will only come back into force in 2023.

One of the most controversial proposals in the coalition deal is for ministers to take advantage of this suspension to go on one last big borrowing binge. The debt raised would be squirrelled away in a “climate and transformation fund” to finance investments. This fund could also receive some of the €240bn in new borrowing that was approved for 2021 but not actually raised.

But the idea has proved controversial. “Debts taken on during the pandemic have a specific purpose, which is to deal with the economic consequences of the corona crisis,” said Hanno Kube, professor of public law, public finance and tax law at Heidelberg University.

Raising new borrowing and putting it in the climate fund invites “the question of whether there is enough of a connection to the [coronavirus] crisis. And there you enter something of a grey zone”.

The coalition deal contains other ideas, too, to raise more funds. The legalisation and taxation of cannabis will help a bit, and ministers also plan to abolish a number of state subsidies, such as those for company cars with diesel engines. The timetable for paying off the huge debts taken on during the pandemic will also be extended, easing pressure on the budget.

Also, planned tax revenues are forecast to come in much higher than initially expected — €15bn more a year over the next four years on average — which will give the new government more leeway on spending.

But for some, the complex proposals being discussed underscore the absurdity of the debt brake and the need for fundamental reform of an arrangement that has outlived its usefulness.

“You really have to ask yourself why we still have this rule if so much effort is going into getting round it,” said Sigl-Glöckner.

Additional reporting by Martin Arnold in Frankfurt

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