Cablegate: German Tax Cuts and Budget Deficit: The Last Hurrah

VZCZCXRO0255
PP RUEHIK
DE RUEHRL #1600/01 3521200
ZNR UUUUU ZZH
P 181200Z DEC 09
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 6092
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCNFRG/FRG COLLECTIVE PRIORITY
RUEHDF/AMCONSUL DUSSELDORF PRIORITY 0261
RUEHFT/AMCONSUL FRANKFURT PRIORITY 8345
RUEHAG/AMCONSUL HAMBURG PRIORITY 0350
RUEHLZ/AMCONSUL LEIPZIG PRIORITY 0255
RUEHMZ/AMCONSUL MUNICH PRIORITY 2221
RUEHC/DEPT OF LABOR WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 BERLIN 001600

SENSITIVE

STATE FOR EEB (NELSON, HASTINGS), EEB/IFD/OMA
(WHITTINGTON), DRL/ILCSR AND EUR/CE (SCHROEDER, HODGES)
LABOR FOR ILAB (BRUMFIELD)
TREASURY FOR SMART, ICN (NORTON), IMB AND OASIA
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PREL GM
SUBJECT: GERMAN TAX CUTS AND BUDGET DEFICIT: THE LAST HURRAH

REF: BERLIN 0840

BERLIN 00001600 001.3 OF 002

1. (SBU) SUMMARY: The German budget deficit looks set to
reach 6 percent of GDP in 2010, thanks to a drop off in tax
revenues, to a spike in crisis-related spending, and now, to
the first tranche of tax cuts fulfilling the new coalition
government,s pre-election campaign promises. EU and
constitutional requirements, however, will force the
government to start implementing its fiscal "exit strategy"
in the near future. Officials seem to be pinning their hopes
on the idea that economic growth resulting from the new
stimulus will generate higher tax revenues, eventually
leading to lower deficits. Yet the flood of red ink may make
it difficult for Merkel's government to push through the
second phase of its tax cuts next year as planned. In
fiscally conservative Germany, running budget deficits is
never a crowd pleaser, regardless of economic conditions.
END SUMMARY.

MAKING HISTORY
--------------

2. (SBU) On December 17, 2009 Chancellor Merkel's cabinet
approved a 325 billion euro budget for FY 2010 that marks
Germany's highest postwar federal deficit. Officially
totaling 85.8 billion euros )- almost double the 2009
deficit -- the actual shortfall will be more like 100 billion
euros once bank bailout and stimulus measures are factored
in. Moreover, the EU Growth and Stability Pact, which limits
member states to deficits of no more than 3 percent of gross
domestic product (GDP), takes into account state and local
deficits. Through this lens, Germany could be looking at a
consolidated deficit of around 144 billion euros in FY 2010,
or 6 percent of GDP.

3. (SBU) According to Finance Ministry officials, around half
of Germany's budget shortfall is attributable to the steep
drop off in tax revenues. (REFTEL) Much of the extra
spending is earmarked for the Labor Ministry. The falling
number of full-time employed and the costs of
government-sponsored schemes, such as the "short-shift"
("Kurzarbeit") program, eat into the budget of the National
Employment Agency, which is to receive 16 billion euros.
While military spending will dip by 0.1 percent, expenditures
for foreign and development assistance are to increase by 6.5
percent. The federal government will provide health
insurance companies with an additional 7.5 billion euros of
assistance and the pension funds with 80 billion euros. Debt
service has become the fourth biggest line item in the budget
with almost 11 billion euros. As a result of the FY 2010
budget, Germany's national debt will rise from 73 percent to
78 percent of GDP next year.

NOT SO FAST
-----------

4. (SBU) Germany is one of 14 member states currently subject
to EU excessive debt procedures; it has until 2013 to get its
deficit below 3 percent of GDP. Finance Minister Wolfgang
Schaeuble has vowed tough austerity measures in order to
comply. Further down the road, Germany faces an additional,
self-imposed restriction, known as the "debt brake." This
constitutional balanced budget amendment requires Germany's
structural deficit to fall to no more than 0.35 percent of
GDP by 2016. Thomas Szewczyk, head of the Bundesbank's
Berlin office, told us the government would need to start
reducing its deficit in 2011 by around 10 billion euros a
year every year until 2016. Despite the potential
countercyclical effects of fiscal consolidation, the
Bundesbank sees Germany's "debt brake" as an important part
of its "exit strategy" from extraordinary measures taken to
combat the economic crisis. Many ordinary Germans are wary
of the inflationary consequences of debt, and also support
the amendment's aims.

FULFILLING CAMPAIGN PLEDGES
---------------------------

BERLIN 00001600 002.3 OF 002

5. (SBU) Despite the record deficit, Merkel's Christian
Democratic Union (CDU)/Christian Social Union (CSU)-Free
Democratic Party (FDP) coalition pushed through on December
18 a controversial new stimulus plan or "growth acceleration
law" worth 8.5 billion euros. A second installment worth 19
billion euros is envisaged for the FY 2011 budget. The first
phase includes additional family allowances and a drop in the
value-added tax (VAT) on hotels and restaurants. The cuts
ran into stiff opposition from federal states, particularly
structurally weak Schleswig-Holstein and Saxony, which feared
a loss of state tax revenue. Only after the federal
government gave assurances of additional money for education
and the like in coming years did enough states relent for the
bill to pass. Several states led by Social Democratic Party
(SPD) governments, however, are threatening to challenge the
constitutionality of the new measure in court.

6. (SBU) When asked how the government squares the tax cuts
with mounting fiscal pressures, Andreas Nicolin, an economic
advisor at the Chancellery, explained that stronger growth
resulting from the measures should generate higher tax
revenues and help balance the budget. Leading German
economists have sharply criticized the plan, however, saying
the cuts will actually do little to boost growth, while
exacerbating the dire fiscal situation.

COMMENT
-------

7. (SBU) While next year's deficit is clearly of historic
proportions, Germany's fiscal outlook is not in especially
bad shape compared with several other EU member states.
Still, EU and constitutional restraints mean the government
will have to start trimming as soon as possible. Merkel's
coalition pushed through the first installment of tax cuts
mainly out of an obligation to follow through on a campaign
pledge to cut taxes. Finance Minister Schaeuble and others
recognize that fiscal consolidation has to start in earnest
with the FY 2011 budget, however, so the second installment
of tax cuts worth 19 billion euros could be a difficult sell.
As defenders of the EU Growth and Stability Pact, Germany
also wishes to set a good example for laggards such as Greece
and Spain, according to Finance Ministry contacts. Even if
the economic situation worsens, it could be politically more
popular to cut the deficit than to stimulate the economy with
further deficits. For his part, Schaeuble has already begun
laying the rhetorical groundwork for the coming fiscal
consolidation, pledging to do whatever was necessary to get
the German house in order.
MURPHY

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