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Tuesday, August 12, 2003

German Government Banking on a Strong Recovery

The latest news from the German Finance Ministry only serves to underline the limited room for manouevre which the German government has right now. The hope seems to be that the combined effect of a short - but not especially sharp - shock to consumption in the form of a tax cut, plus the ongoing 'structural reforms' will be enough to shake the German economy out of its lethargy. This, in any event, I doubt. So the question is, if the 'play' doesn't work, what next?

The German government's refinancing plan will cost taxpayers an additional euro 10.6bn ($12bn, £7.5bn) a year from 2005, according to a government proposal. The refinancing proposal, to be presented to the cabinet on Wednesday, includes tax cuts and reductions in subsidies, and aims to increase government revenues by euro 5.5bn next year. Hans Eichel, the German finance minister, plans from 2004 to cut subsidies to home-builders and commuters in addition to cutting subsidies for farmers.

The accompanying budget law entails bringing forward tax cuts from 2005 to 2004, which will see a one-off euro15.6bn tax relief for the taxpayer. At the same time, however, the government is pressing ahead with the long-term cuts in state subsidies from next year to finance the tax reform. This will see the government's revenues improve substantially from 2005, as the shortfall in tax revenues will already have been absorbed. The budget law still has to be passed by the Bundesrat, the upper house of parliament, where the refinancing plan may face opposition from the Christian Democrats.

If the tax reforms are brought forward but the refinancing package is blocked, parliament would have to approve an even higher debt burden; the government's decision to bring tax cuts forward to next year will cause a shortfall in revenues, adding further strains to stretched finances. According to Mr Eichel's proposal, seen by FT Deutschland, the federal government's budget consolidation efforts would increase state revenues by euro 10.6bn in 2005, by euro 11.2bn in 2006 and by euro 12.9bn in 2007. By bringing the tax reform forward by a year the government hopes to give the ailing economy a nudge. The government's ambitious reform drive and accelerated tax cuts have helped improve depressed sentiment in the eurozone's largest economy. The tax-cut plans have put pressure on the EU's stability and growth pact. Berlin admits it could break the pact for the third year in 2004, calling into question whether the deficit ceiling of 3 per cent of GDP still holds.

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