Sunday, October 31, 2010

Germany: Maastricht convergence as early as next year

The free fall is being followed by a steep ascent. After the deep recession ripped a huge hole in government coffers, the growth spurt is bringing rapid relief. The outlook – above all for tax revenues - has improved considerably of late.

To comply with the debt rule, the federal government has passed substantial austerity measures from 2011. Additional support comes from the low interest rate level. A one percentage point decline in the average interest rate translates into annual savings of EUR 18bn.

The starting position for the development of the budget has, therefore, improved drastically since last year. For this year, we expect only a slight further increase in the deficit to 3½% of GDP, and for 2011 the Maastricht criterion is already likely to be undercut.

Consequently, also the debt ratio moves towards a sustainable path again. In the short term, the creation of the "Bad Banks" for WestLB and Hypo Real Estate will, however, trigger a further increase in the debt ratio by up to 10 percentage points, to 85% of GDP by year-end.

Strong economy seeing taxes flow again
The free fall is being followed by a steep ascent. With the exceptionally strong growth dynamic in the spring, the German economy has put itself clearly at the front of the European growth train, while GDP in many other countries posted only meager growth or even contracted further. And while the data currently available for
the quarter that has just ended show that the pace of growth has slowed considerably, it nevertheless remains robust .

The rapid economic recovery also has tangible consequences for the fiscal situation of the public sector. The deep recession, during which GDP contracted by a total of 6.6%, was namely a massive strain on the public coffers – even independent of the fiscal packages. Despite relatively stable employment numbers, the sharp decline in the total numbers of hours worked as well as the dramatic slump in corporate profits
drove transfer expenditures higher and, at the same time, ripped a huge hole in the revenue side. According to
calculations by the OECD, the cyclical elasticity of the German fiscal budget in the past was roughly 0.511.

That means that a 1% decline in GDP triggers a 0.5 percentage point increase in the deficit ratio (in % of GDP), i.e. the financial crisis has increased the deficit by more than 3 percentage points.

Recently, this gratifying development has also had an increasingly positive impact on the monthly data for the most important sources of tax revenues. The numbers for the corporation tax as proxy for corporate tax revenues show a clear trend reversal with a still rising trend. Wage and income taxes have stabilized despite the permanent, tangible tax breaks passed as part of the fiscal program, and VAT revenues are rising moderately but steadily as private consumption increasingly rebounds.

In the last official bi-annual tax projection from May, the committee of experts still assumed that this year would see overall tax revenues decline by a strong 2.6% yoy to EUR 510.3bn, on top of the record decline of 6.6% already in 2009.

Fiscal program has lifted the structural deficit appreciably
The far-reaching fiscal program that the federal government passed during the deep recession has triggered a strong increase in the structural – i.e. adjusted for cyclical influences –deficit. Alongside the two fiscal packages passed by the Grand Coalition, government finances are also coming under pressure from the "Growth Acceleration Act" passed by the current conservative government and from the rulings handed down by the Federal Constitutional Court on the standard commuter deduction and the tax deductibility of health insurance contributions. The tax breaks for households and firms as well as the government investment
programs total just over 3½% of GDP for the years 2009 and 2010.

Many of the measures are permanent in nature and  will, therefore, increase the structural deficit on a sustained basis. After the auto scrapping premium and the one-time child benefit already expired last year, basically the only major measure scheduled to expire this year is the accelerated depreciation option for corporate investments. Above and beyond that, the investment in the future program with a total volume of EUR 13.3bn expires officially at the end of the year. The federal government’s share of EUR 10bn is, however, off budget and is booked to the so-called investment and redemption fund.

Consolidation begins in 2011
In addition to the cyclically-induced improvement of the budget situation, the federal government has passed a raft of austerity measures from 2011 to comply with the debt rule anchored in the Basic Law. While there are indications that on their implementation there will be some changes to the original plans, the consolidation volume targeted for next year totaling approximately EUR 11bn is likely to be almost reached. Overall, the package of measures is designed to lower the structural deficit of the federal government by over
EUR 27bn or 1% of GDP by 2014.

Beyond the consolidation measures for the federal budget agreed on at the austerity summit (Sparklausur), the
government has also decided to reduce the deficits in the social security system. Alongside the decision taken some time ago to partially raise the contribution rate for unemployment insurance again from 2.8% to 3.0%, the contribution rate for statutory health insurance will be raised at the beginning of 2011 from 14.9% back to 15.5% of gross income. Both contribution rates had previously been lowered during the crisis as part of the economic stimulus program, at the expense of federal subsidies.

Full report: Germany: Maastricht convergence as early as next year

No comments: