Germany’s fiscal faux pas

Keep your eye on one thing and one thing only: how much government is spending, because that’s the true tax. … If you’re not paying for it in the form of explicit taxes, you’re paying for it indirectly in the form of inflation or in the form of borrowing. The thing you should keep your eye on is what government spends, and the real problem is to hold down government spending as a fraction of our income, and if you do that, you can stop worrying about the debt. 

The sage words of Milton Friedman could not be more relevant as Germany, a nation famed for its fiscal discipline, is just about to ditch its constitutional debt brake. The siren call of massive spending on defense and infrastructure has the government poised to loosen the purse strings, potentially bypassing the very mechanism designed to prevent runaway debt. But for the diligent German taxpayers, footing one of the highest tax bills in the developed world, a nagging question arises: if core state functions now demand a debt splurge, what exactly has their hard-earned cash been funding all along?

Germany’s debt brake at a crossroads

Germany’s Schuldenbremse, or debt brake, that fiscal straightjacket introduced in 2009 by Angela Merkel’s government, aimed to keep borrowing in check. By constitutionally limiting new debt, it was meant to safeguard future financial stability. Now, proposals are afoot to either weaken or outright ignore this rule for defense and infrastructure. While the necessity of this investment is undeniable, this pivot raises eyebrows and legitimate concerns about a potential slide towards less prudent fiscal management.

A state’s primary duty is the security of its citizens, both from external threats and internal chaos. Germany, a key NATO player, is understandably boosting defense spending to meet the target of 2 percent of gross domestic product (GDP). The 100 billion-euro Zeitenwende (turning point) fund highlights the urgency. Yet, the fact that a high-tax nation like Germany needs to bend its debt rules for defense suggests a history of underfunding, leaving a modernization backlog. Even with these measures, fully meeting NATO obligations remains a question mark. Domestically, while not solely a matter of budget, a reported rise in terrorist incidents and violent crime might make one wonder if current resource allocation for intelligence agencies and law enforcement is hitting the mark.

A modern economy thrives on solid infrastructure, another core service the state should ensure. Germany’s autobahns, once a source of national pride, now face congestion and aging bridges. At the current pace, fixing structurally deficient bridges could take over five decades – a testament to deferred maintenance. The extensive Deutsche Bahn is plagued by delays, with punctuality hitting a two-decade low in 2024, largely due to outdated infrastructure. Even in the digital realm, while 5G coverage is near-universal, Germany lags in fiber-optic deployment, ranking second to last in the European Union. The energy transition, while vital, also presents grid stability challenges. This widespread infrastructure deficit screams of years of underinvestment despite hefty tax revenues.

A state’s responsibility extends to a quality education system. However, public opinion on school quality in Germany is declining. PISA scores reveal a worrying trend of weaker performance in mathematics, reading and science. A significant teacher shortage is a major concern for many Germans. These issues point to potential inefficiencies in resource allocation within the education sector as well.

Germany’s vaunted social welfare system is increasingly reliant on substantial borrowing, raising serious questions about its long-term fiscal viability. This concern is further amplified by the gradual erosion of the state pension system, effectively undermining the retirement provision of those who have diligently contributed. Rather than attracting foreign high-performers who could bolster the system, Germany appears to be pursuing a “lock-in” strategy, exemplified by the 2024 exit tax on investment gains. This measure, a direct challenge to personal wealth, signals a troubling willingness to target citizens’ assets.

Although operating under vastly different economic conditions, historical precedents such as the 1948 currency reform serve as stark reminders that property rights can be compromised in the face of mounting national debt. These developments collectively paint a disquieting picture: a state potentially sacrificing its fundamental obligation to protect citizens’ property and freedom to address deficiencies in its other core responsibilities.

High taxes, underfunded services: Where is the money going?

Faced with fiscal challenges, other nations have explored different avenues. The United States has seen proposals for spending cuts across various sectors and actively sought alternative revenue streams. Argentina, grappling with economic turmoil, has implemented drastic public spending cuts. Germany’s primary response, however, seems to be embracing debt rather than prioritizing significant spending cuts or innovative revenue generation.

With a 38 percent tax-to-GDP ratio in 2023, Germany demonstrates one of the most formidable capacities for revenue collection in the world. Yet, this achievement is shadowed by government expenditure which already reached 48 percent of GDP in the same year. This fiscal paradox – high revenue, persistent funding gaps for basic services – prompts a critical inquiry: What has the money been spent on, and why, given the substantial tax base, is debt financing necessary to fulfill core state responsibilities?

The proposed abandonment of the debt brake and the embrace of massive borrowing for fundamental state responsibilities demand serious reflection. Are we witnessing a necessary investment in our future, or a symptom of past fiscal mismanagement and a reluctance to make tough choices?

To close with another apt statement by Milton Friedman:

There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40 percent of our national income. 

Given that Germany’s government expenditure is already nearing 50 percent of GDP and can only trend upwards with these new debt plans, this observation feels less like a critique and more like an understatement of how German citizens’ tax money is spent. If those significant contributions fail to adequately fund core state functions like security, infrastructure, education and the protection of personal liberties, German taxpayers have a right to ask: where is their money going?

This essay was originally published here: https://www.gisreportsonline.com/r/germany-debt-brake/