German balanced budget amendment

Germany's balanced budget amendment, also referred to as the debt brake (German: Schuldenbremse), is a fiscal rule enacted in 2009 by the First Merkel cabinet. The law, which is in Article 109, paragraph 3 and Article 115 of the Basic Law, Germany's constitution, is designed to restrict structural budget deficits at the federal level and limit the issuance of government debt. The rule restricts annual structural deficits to 0.35% of GDP.

The debt brake is controversial among economists. It is supported by a German strand of economics, ordoliberalism, while other economists have challenged the rule.

History

The amendment was enacted because the nation's debt-to-GDP ratio exceeded the 60% threshold fixed in the Maastricht Treaty, primarily a result of the heavy payments to reconstruct former communist Eastern Germany after reunification and a loss of tax revenue during the Great Recession. The law required a change to the constitution and in 2009, it was approved with a two-thirds majority both by the Bundestag and the Bundesrat, under the Grand coalition of the First Merkel cabinet. At the federal level, the law limited the budget deficit to 0.35% of the GDP beginning in 2016 and German states that approved the law were prohibited from taking on debt after 2020. Three states, Berlin, Mecklenburg-Vorpommern and Schleswig-Holstein, did not establish the law in their constitutions. In the years prior to the Covid pandemic, the law helped reduce Germany's debt to 59.5% of GDP. The balanced budget amendment is not absolute and allows the country to exceed the borrowing limits during a national emergency or a recession.

The amendment was suspended in 2020 to allow the country to deal with the costs of the COVID-19 pandemic in Germany and was set to come back into force in 2023.

Although the mechanism was successful in its stated goal, reducing government borrowing, it was criticized by left-of-center parties including the Social Democrats and the Greens, which suggested that the law limited necessary government investment. During the 2021 German federal election campaign, the Greens proposed reforming the rule to allow spending on infrastructure, healthcare and education. In 2022, the government, led by Chancellor Olaf Scholz, succeeded in obtaining the two-thirds majority necessary to amend the debt ceiling to allow Germany to establish a 100 billion euro defense fund that would not be subject to the restrictions. The change was spurred by the 2022 Russian invasion of Ukraine.

In December 2021, via an amendment to the original budget for 2021, the ruling traffic light coalition reallocated €60 billion of unused funds intended to combat the COVID-19 pandemic to its Climate and Transformation Fund (KTF) for climate and green industry projects. On November 15, 2023, the Federal Constitutional Court, having been prompted by the opposition CDU/CSU conservative alliance, ruled this maneuver to be unconstitutional. The ruling prompted a discussion about whether the amendment in its current form would still be appropriate, with even some conservatives calling for a reform to raise the relatively weak level of investment, compared to European neighbors, which had prevailed for several years. On November 27, the cabinet agreed to extend the lifting of the amendment to 2023.

Discourse

The German debt brake has been both lauded and criticized by economists and policymakers alike. Critics argue that the debt brake constraines the government's ability to respond flexibly to economic downturns. Moreover, some contend that the strict austerity measures enforced by the debt brake hinderes long-term growth prospects by causing underinvesting in infrastructure, education, and innovation.

The German Council of Economic Experts (GCEE)

The German Council of Economic Experts (GCEE) has advocated for a pragmatic reform aimed at enhancing the flexibility of fiscal policy while safeguarding debt sustainability. Firstly, they propose spreading the process of returning the structural deficit to its regular limit over multiple years following the application of the exception clause. Secondly, they suggest that the annual limit for the structural deficit should be contingent upon the level of debt. If the debt falls below a specified threshold, a higher structural deficit would be permissible. Lastly, the experts recommend methodological changes in estimating potential output, a crucial part of calculating the structural deficit.

Discourse among German economists

The debt brake has been controversial since its introduction. At that time numerous German economists spoke out against the introduction of the debt brake in a public letter. German professors remain divided about this issue. A recent report from the Ifo Institut in Munich shows that 48% of economics professors oppose a reform of the debt brake, 44% support a reform, and 6% want to abolish it all together. 2% of economists are undecided.

Positions of Germany´s major parties

The Schuldenbremse, or debt brake, has been a pivotal point of contention among major German political parties, displaying diverse economic perspectives on fiscal policy. The positions of these parties regarding the debt brake demonstrate their differing priorities, concerns, and approaches to managing public finances.

CDU/CSU

The conservative parties, CDU/CSU have historically been a strong advocate of the debt brake. They view it as a necessary tool for maintaining fiscal discipline and ensuring the long-term sustainability of public finances. For the CDU/CSU, the debt brake represents a commitment to responsible governance, as it limits the accumulation of government debt and promotes balanced budgets. They argue that reducing government borrowing fosters economic stability, encourages private sector investment, and ultimately strengthens Germany's position within the European Union. Moreover, the CDU/CSU emphasises the importance of honouring budgetary commitments to future generations, framing the debt brake as a mechanism to safeguard their interests.

At the start of 2024 a debate has sparked within the CDU about a reform of the debt brake. Especially. some Ministerpräsidenten have recently advocated for a reform.

FDP

The Free Democratic Party (FDP) generally supports the debt brake. However, with some reservations. While the FDP acknowledges the importance of fiscal responsibility, it advocates for a more flexible interpretation of the debt brake to accommodate economic fluctuations and crises. The party emphasizes the need to strike a balance between debt reduction and strategic investments in areas such as infrastructure, education, and innovation. Also, the FDP advocates for structural reforms aimed at enhancing Germany's economic competitiveness and productivity, viewing them as essential for achieving sustainable budgetary outcomes in the long run.

SPD

The Social Democratic Party (SPD) has a nuanced relationship with the debt brake. While the SPD initially supported its implementation, the party has since become divided over its effectiveness and implications. Some rather conservative factions within the SPD remain supportive of the debt brake, arguing that it promotes fiscal discipline and credibility in financial markets. However, other more left-leaning parts of the party criticize its firm framework and argue that it negatively influences the government's ability to respond effectively to economic downturns or invest in green technologies and welfare programs. These critics advocate for reforms to make the debt brake more flexible.

Bündnis 90/Die Grünen

Bündnis 90/Die Grünen has also expressed mixed views on the debt brake. While the party recognizes the importance of sustainable fiscal policy, it raises concerns about the social and environmental implications of austerity measures enforced by the debt brake. Bündnis 90/Die Grünen emphasizes the need for investments in renewable energy and climate adaptation to address the looming threat of climate change. They argue that prioritising debt reduction over these priorities neglects crucial long-term investments in sustainability and economic growth.

Die Linke

The Left Party (Die Linke) opposes the debt brake altogether, viewing it as a neoliberal austerity measure that undermines social welfare and intensifies inequality. Die Linke advocates for alternative approaches to fiscal policy that prioritize public investment, wealth redistribution, and social justice. They argue that austerity measures enforced by the debt brake disproportionately impact marginalised communities and slow down efforts to achieve inclusive and sustainable economic development.

AFD

The right-wing party AFD (Alternative für Deutschland) is in favor of the debt-brake.

See also

• Debt-to-GDP ratio
• Structural and cyclical deficit
• Government budget balance
• Government-Household analogy