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Germany Has Narrowly Swerved Budget Disaster – but Its Debt Taboo Still Threatens Europe

Germany’s long-held aversion to debt and its collective piety about fiscal discipline is finally catching up with it. An immense political and budgetary crisis that threatened to unravel Olaf Scholz’s coalition and derail the country’s climate strategy was narrowly averted in the early hours of Wednesday. But the country’s legally binding “debt brake”, the source of the month-long political crisis, remains in place.

After tense day-and-night negotiations between the coalition partners, an 11th-hour deal means the German government finally has a budget for 2024. But the fix will lead to an entirely unnecessary round of austerity in the middle of a sharp economic downturn. It could also undermine Germany’s – and by extension Europe’s – climate and energy transition and its economic recovery and restructuring.

The crisis began on 15 November with a bombshell ruling from Germany’s constitutional court. It found that the coalition’s new €60bn climate fund fell foul of a constitutional and political sacred cow: the Schuldenbremse, or brake on new government debt. The ruling upended Germany’s 2024 draft budget and cast doubt over the governing coalition’s survival.

This is because the climate fund is fundamental to both the 2021 agreement underpinning the three-party coalition and the future financing of Germany’s ambitious climate and energy transition. But it drew on reallocating emergency debt left over from pandemic relief, an accountancy trick designed to bypass the totemic but increasingly onerous debt brake.

This hard fiscal rule was enshrined in the constitution in 2009 and was intended to contain public debt by limiting the budget deficit to 0.35% of GDP, thereby capping the debt that either the federal government or the Länder (federal states) can issue in any given year. Legally binding fiscal discipline may be an article of faith and an important unifying myth in Germany, but the reality is that in practice, politicians pay only lip-service to it. Since its entry into force under Angela Merkel, the rule has been repeatedly circumvented by all governments.

In 2017, under the watch of the Merkel-led “grand coalition” of the Christian Democratic Union (CDU), the Christian Social Union of Bavaria (CSU) and the Social Democratic party (SPD), parliament allowed the federal government to cover some of the costs of the 2015 refugee arrivals, via big transfers from central government to state governments and municipalities. This reform drove a coach and horses through the 2009 constitutional settlement.

After Covid struck in 2020, the debt brake was suspended, justifiably under the rules, as a national emergency. This led to the creation of a substantial fund outside the federal government’s budget, and it was from unspent money in this emergency pot that the new climate funding was to be drawn. The brake was again circumvented because of the war in Ukraine, to allow for Scholz’s promised Zeitenwende and the setting up of a €100bn defence fund. A proliferation of such exceptional financing vehicles means there are now some 29 funds, which have together created a considerable amount of fiscal space to bypass the constitution.

A protest by the climate action group Last Generation in Berlin, Germany, 25 November 2023

Spotting a political opportunity, the opposition CDU challenged the climate fund’s constitutional legality in 2022, hoping to undermine Scholz’s coalition and force a return to a tighter fiscal policy. The court’s ruling last month exceeded the CDU’s expectations – although it now threatens to backfire on the party given that some CDU-led states face serious budgetary challenges if they can no longer access climate funding.

That says a lot about the politics surrounding the supposed sanctity of fiscal discipline. The debt brake has been under duress for years, but few political leaders are prepared to openly challenge a measure that enjoys overwhelming public support.

The constitutional court’s ruling left Scholz’s “traffic-light” (SPD-Green-FDP) coalition with a range of unpalatable short-term options, and each carried a high political cost.

The compromise attempts to minimise cuts to climate policy but the disputed climate and transformation fund will be cut by €45bn between 2024 and 2027. This is not just a domestic issue: it also raises questions about Germany’s insistence on tight fiscal rules within the European Union and the future of climate policy in Europe.

The pro-business Free Democratic party (FDP) would certainly have quit the coalition, triggering an early election, if Scholz had invoked an emergency to suspend the fiscal rule again. Under the compromise, the rule will remain in place for 2024 – although another emergency could be invoked if need be, so the political risks surrounding the issue will remain. The FDP is currently conducting an internal referendum on whether to stay in or leave the coalition.

The compromise also means that severe budgetary cuts for 2024 and 2025, including to German social spending, are now inevitable. This came at the insistence of the FDP finance minister, Christian Lindner, who is under pressure to hold the line on belt-tightening.

Scholz could have opted to establish a new climate fund, enshrined in the constitution, following the precedent of his defence fund. This would have allowed him to preserve the illusion of a functioning constitutional debt brake while extending the practice of bypassing it. There was clearly no time to put a proposal of this sort on the table right away, but it remains an option in 2024-25.

A better alternative to all of the above would be to open a frank political conversation about reforming the debt brake altogether. Even conservative political leaders are starting to realise that it is becoming untenable. A number of conservatives have now openly expressed support for an intelligent reform. But this has been such a political taboo for so long that there are barely any workable ideas around.

A distant silver lining is the hope that this court ruling and the ensuing controversy have done enough to confront the German political class with its own hypocrisies on public debt. In a previous historic ruling in 2021, the constitutional court found that Germany’s climate law was not doing enough for future generations and was potentially violating their fundamental rights.

So there is a growing contradiction: on the one hand the court says Germany needs to be more ambitious on climate action, on the other it says that the new climate fund is unconstitutional. This is not the court’s fault: it is correctly reading the rules created by the fiscal straitjacket.

Only a much bolder climate policy and a different policy on balancing budgets can reconcile the contradiction. If mainstream political parties (including the CDU) want the climate transition they claim to support, they have the two-thirds majority of the Bundestag required to change the constitution. Given the rise of the Alternative für Deutschland (AfD) and with elections looming in 2025, they should seize the moment, because time is probably not on their side.

  • Shahin Vallée is a senior research fellow at the German Council for Foreign Relations

Source : The Guardian