The basic idea behind the debt brake is simple: apart from severe recessions, the state’s expenditure should be financed by its current income. Since governments tend to spend more money than they collect through taxes, the constitution must limit new borrowing.
And so in the spring of 2009 the federal and state governments wrote in the Basic Law that – after a few years of transition – the structural deficit of the federal government should not exceed 0.35 percent in relation to the gross domestic product in the future.
And since the federal states waived their intended leeway of 0.15 percent, they were not given any structural leeway for new borrowing. The debt brake can be suspended in the event of special events such as natural disasters or severe recessions such as those caused by the corona pandemic. The additional debts then incurred must, however, be repaid as planned – which limits the future financial leeway.
This is the situation in which the future traffic light coalition is. In their exploratory paper, the SPD, Greens and FDP point out at various points that overall there is a high need for investment and that they are willing to make the necessary state investments and at the same time to stimulate private investments. All three parties suggest that state investments are always good spending – which in turn means that state consumption is a priori less good.
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But that need by no means be the case: On the one hand, costs that are almost regularly out of hand in public building projects are hardly an indication of particularly well-invested tax revenues – even if this drives government investment spending up. On the other hand, investments in public construction, such as the expansion of childcare facilities, are pointless and worthless without additional staff.
Not all investments are investments
In addition, the investments of 62 billion euros reported in the federal budget for the year 2021 only cover a good eight billion euros in real property investments. The far greater part are investment grants to other local authorities or private institutions.
Even the Baukindergeld, which expired last spring, was part of the federal investment spending, although these funds were also used when only a used property changed hands.
It is also the vagueness of the investment term that explains the large discrepancy that exists between the 50 billion euros in federal investments reported by the Federal Ministry of Finance for 2020 and the 28 billion euros that the Federal Statistical Office reports under this item in the national accounts. In short, not all expenses that can be declared as investments are what is commonly understood as investment.
With this in mind, it makes sense that the debt brake makes no distinction between apparently good debt for investments and apparently bad debt for consumer spending.
The Basic Law gives parliament a free hand as to whether a government uses its current income to hire more police officers to increase internal security, or whether to invest the money in the construction of a new airport, a research facility or in new company cars.
In view of this uncertainty, it is appropriate to be skeptical about the establishment of state investment funds or investment companies in order to be able to circumvent the provisions of the debt brake and thus the Basic Law – regardless of whether this debt rule is considered a wise regulation.
Government should not only set new priorities – it should also cut old ones
It is now undisputed that the decarbonization of the economy, the digitalization of administration and the aging of society represent truly great challenges for politics that will cost a lot of money – both in terms of investment and consumption.
It is just as undisputed, however, that there are numerous subsidies and tax breaks whose steering effect is questionable from today’s perspective. The fine art of governance should not, however, be limited to setting new priorities, but equally to saying goodbye to outdated priorities and thus canceling subsidies.
Prof. Bert Rürup is President of the Handelsblatt Research Institute (HRI) and Chief Economist of the Handelsblatt. For many years he was a member and chairman of the Advisory Council as well as an advisor to several federal and foreign governments. You can find out more about the work of Professor Rürup and his team at research.handelsblatt.com.
If there is consensus among the future governing parties that there is no potential for savings and that the state needs more money in order to be able to cope with all previous and all upcoming tasks, broad tax increases would be an appropriate way of solving financing problems.
Although this was ruled out in the exploratory talks, it could be changed. The government is by no means faced with the only alternative of either investing via borrowing or observing the Basic Law and foregoing investments.
Of course, one of the repressed truths is that the Basic Law can also be changed. On average, there are three to four amendments to the Basic Law in each legislative period. This requires two-thirds majorities in the Bundestag and Bundesrat, which requires a cross-party consensus.
What was possible when the debt brake was introduced does not have to be ruled out today. Finally, the federal states that are governed by the Union are also groaning at the rigid budget requirements set out in Article 109 of the Basic Law.
Debt isn’t always bad
The starting point for unbiased considerations should be that debts are not bad a priori, as the current debt brake implies. Virtually no company forego the use of outside capital, even “profit machines” like Apple or Microsoft issue bonds.
As long as the creditors have no doubt that long-term stock corporations or states can redeem their bonds at the end of the term by issuing new bonds, there is no need to repay these debt volumes.
It is not the level of the debt-to-GDP ratio that is the decisive factor for a state’s resilience to creditors, but rather its ability to easily service interest payments due from current income.
A suitable measure of this ability is the interest-tax ratio, i.e. the share of interest expenditure in tax revenue. There is therefore much to be said for setting a statutory upper limit on debt to this quota. While this rate was around 15 percent in Germany in the mid-1990s, it is currently around two percent, and the trend is falling.
Now interest rates will surely rise again at some point, also in Germany. But the federal government has correctly used the low interest rate phase that has persisted for several years to secure its financing in the long term, for example through ten- or even 30-year government bonds. Other countries like Austria have even issued 100-year bonds.
It would therefore take many years for a turnaround in interest rates to have a noticeable impact on public budgets and the state would have enough time to adjust its spending behavior to this development.
Such a debt brake based on the interest-tax ratio would be the wiser option, as it would be directly related to the scope for financial policy action. In addition, the phase of low interest rates could be used to improve growth prospects with government investments and the associated modernization of the government capital stock.
The SPD, Greens and FDP, on the other hand, want to spend more money, forego tax increases and stick to an incorrectly designed debt brake. You can write that in an exploratory paper, but this is certainly not the basis for a smart and solid coalition agreement.
More: Rejection of tax cuts – and yet there is still hope for a reform