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Germany's medium-term budget plans for the period 2018-22
foresee measures to boost spending and reduce taxes and
contribution rates to social security funds, with a cumulative
budgetary impact of 2.8% of GDP, or almost 0.6% per year.
The boosting impact on GDP growth is likely to be closer to
0.3% of GDP per year as the government's own projections appear
overly optimistic.
Germany's persisting fiscal caution helps domestic financial
and political stability in the near to medium term, but strong
current revenue growth could have been used more extensively for
investment to boost long-term growth potential.
The German government formed in March following the elections of
September 2017 is taking advantage of the very strong state of
public finances to loosen fiscal policy. The government remains
reticent to make tax cuts, however, enabling it to continue
targeting budget surpluses throughout 2018-22 despite plans for
higher expenditures (see Table 1).
Government budgets for above-average public investment growth,
but consumption-related measures still dominate
The government's public spending plans allow for more investment
while avoiding tax increases - but without planning any significant
tax cuts except in 2021. Indeed, despite domestic and foreign
criticism, both short- and medium-term public finance plans
indicate that Finance Minister Olaf Scholz (SPD) is broadly
continuing the fiscally conservative approach of his predecessor
Wolfgang Schäuble (CDU). The emphasis is on financial
stability in times of robust economic performance rather than
risking an overheating economy that boosts inflation or creates an
asset price bubble.
Additional public expenditures during the current legislative
period 2018-21 plus the year 2022 (also included in medium-term
plans) amount to about 1.7% of a single year's GDP, or an annual
average of 0.35%. In cumulative terms, 0.6% of GDP will go toward
consumption-oriented purposes related to Germany's social welfare
system (old-age care, children, long-term unemployed). Budget
sections that either have a clear investment focus (transport
infrastructure, education, research and development, digital
technology, military) or at least a partial one, such as
agriculture, housing, regional policies, international development,
and humanitarian aid, will receive 0.8% of GDP during 2018-22, and
a separate fund to expand/upgrade digital infrastructure will
contribute another 0.3%. Note the likely post-Brexit need to
enhance Germany's contributions to the EU's next multi-annual
financial framework (2021-27) has not been budgeted for yet.
Overall, the proposals result in planned average growth in fixed
investment by the public sector of roughly 5% during 2018-21,
exceeding the 3.5% average for total spending by territorial
authorities. Given that the share of fixed investment in public
spending was only 6.1% in 2017, current budget plans will
nonetheless only raise this ratio to 6.5% by 2021 - and plans for
2022 only foresee investment growth of 1.5%.
In terms of revenue, the government plans to reduce the
contribution rate for unemployment insurance by 0.5 percentage
point, to relieve employees by reintroducing the employer/employee
equality of contributions to statutory health insurance, and to
raise the basic tax allowance (all from January 2019). Finally,
they intend to curtail the so-called solidarity tax surcharge
(introduced following German reunification) by EUR10 billion in
2021. Cumulatively, these revenue-related measures will lower the
tax burden by 1.4% of GDP during 2019-22, or by 0.35% per year on
average.
Economic assessment of the government's
projections
The government prepared its fiscal projections during the second
quarter (see Table 2 for details). Although assumptions for GDP
growth in 2018 and 2019 now appear too optimistic by 0.4-0.5
percentage points each, upward revisions to recent GDP levels
largely compensate for this. On balance, with official GDP
forecasts for 2020-22 averaging 1.4% (similar to latest IHS Markit
predictions), the resulting forecast of real GDP growth of 1.8% on
average during the period 2016-22 dovetails with our own
assessment. By contrast, IHS Markit forecasts of nominal GDP growth
are somewhat lower than the government's because we anticipate an
average GDP deflator of only about 1.3-1.4% due to a faster
increase in import than export prices during 2018-21 (partly
related to a weaker euro).
Although the higher average GDP deflator in the government's
projections tends to expand the gap between the absolute level of
revenues and that of expenditures and therefore boost budget
surpluses, this is more than offset in our view by factors such as
the delayed formation of a federal government after the September
2017 election and the dearth of spare planning capacity in the
bureaucracy that will restrain expenditure growth during
2018-20.
Fiscal impulse of measures agreed
The Ministry of Finance has also assessed the fiscal impulse
delivered to public-sector budgets and thus implicitly also
economic growth (details see Table 3 below). Overall, the measures
for 2018-22 are estimated to deliver a cumulative fiscal impulse of
2.8%, or an annual average of almost 0.6%. As most measures only
impact from 2019 onwards, the average for 2019-22 is 0.7%. IHS
Markit notes that the new fund for digital infrastructure, not
included in the table, will add another 0.07% of GDP per year
during 2018-22. The table also uses a narrow definition of public
investment, its cumulative impulse at 0.4% of GDP during 2018-22
thus representing only about one-seventh of all fiscal measures
(excluding the digital infrastructure fund). The contribution to
future GDP growth potential is thus quite small. Nevertheless, when
adding the public consumption and tax cut components of the
totality of fiscal impulses and assuming a public expenditure
multiplier of roughly 0.75, the net boost to demand and therefore
GDP growth can initially be put at 0.5% per year during
2019-22.
This preliminary result needs to be qualified, however. Firstly,
Länder or local governments frequently do not fully translate
extra transfers they receive from the federal government into
additional spending. Secondly, the distribution over time is skewed
towards later years given the cut in the solidarity tax only in
2021. The projected annual impulse to GDP thus rises from less than
0.4% in 2019-20 to almost 0.7% in 2021-22. Thirdly, the delayed
passage of a budget for 2018 has created a negative fiscal impulse
this year because the administration was forced to operate on
(lower) 2017 spending levels during the first half of 2018.
Fourthly, after several years of above-trend GDP growth, the
economy is running near fully capacity in 2018, displaying a
growing shortage of skilled labor and a lack of spare planning
capacity in the bureaucracy that will delay public infrastructure
projects. Thus, the fiscal multiplier will be below average during
2019-22, some of the fiscal impulse being lost to the domestic
demand deflator. In sum, the fiscal boost to GDP should be closer
to 0.3% rather than 0.5% annually.
Outlook and implications
Germany's grand coalition government for the legislative period
2018-21 has not faced much political pressure for any dramatic
about-turn in economic and/or fiscal policy. Nevertheless, budget
plans reflect pressures related to the refugee crisis, calls from
abroad to help reduce the large current-account surplus by
stimulating domestic demand, and the need to take structural
measures to cope with challenges related to demographics, transport
and IT infrastructure, energy supply, housing, income inequality,
education, and R&D.
The new fiscal measures are purportedly aimed at tackling these
structural tasks rather than having a cyclical impact.
Nevertheless, most measures boost consumption, creating a fiscal
stimulus effect on GDP that IHS Markit would put at roughly 0.3%
per year during 2019-22. Trade uncertainty additionally restrains
near-term investment potential because of protectionist risks to
supply chains related to US and UK trade policy.
IHS Markit expects German GDP growth moderation in the coming
years due to slowing global growth, Germany's own capacity
constraints, and the foreseeable European Central Bank switch into
monetary tightening mode. As such, the government's (cautious)
shift towards a looser fiscal policy appears well timed, although
an even greater emphasis of government measures on investment
rather than consumption would have been desirable for long-term
growth prospects.
Germany's only gradual shift towards more expansionary fiscal
policy supports the country's debt sustainability. Although the
high degree of policy continuity may reduce near-term benefits to
economic growth and employment, it also reduces the risk of
economic overheating and will help in a longer 5-10-year outlook,
given the country's ageing demographics and the need to adjust its
energy supplies. Nevertheless, the government has also missed an
opportunity to support future strong performance through expanded
strategic investment.
Posted 16 October 2018 by Timo Klein, Principal Economist - Western Europe