Tougher taxes likely as two-edged reality catches up with Kohl: John Eisenhammer looks at the stark choices for the German Chancellor trying to meet the heavy costs of unification in a rapidly weakening economy

ONLY TWO years ago the confident 'unification Chancellor' promised blooming landscapes. This week, it was a very different story, as a grim-faced Helmut Kohl called upon Germans to make a 'mighty effort' to prevent the country plunging into economic crisis. Having obstinately shut out reality for months on end, the Bonn government has finally been overwhelmed by the twin forces of a rapidly weakening economy and the exploding costs of unification.

In eastern Germany, signs of sustained recovery are barely identifiable except through the heavily rose-tinted spectacles of the government's 'Upswing East' programme propagandists.

The reality is of bright patches of strong economic activity in service and construction standing out against a sombre backdrop of overwhelming industrial and agricultural devastation, with massive, if largely hidden, unemployment. The demands for western handouts continue to grow. Public transfers to the east amount to some DM170bn ( pounds 70bn) this year. Similar levels of subsidies are expected to continue for some time to come.

But the wheels generating these funds are turning ever more slowly in the west, as the economy slides into recession. Industrial production will fall 2 per cent next year, following a 1 per cent drop this year, according to the Ifo economics institute.

For Wilhelm Nolling, a member of the Bundesbank's central council, 'all the figures show that Germany is moving into a recession. On this occasion it could be very long-lasting and very deep.' Weak world demand, high domestic interest rates and an appreciating mark are taking a heavy toll on western German industry. Household names such as Daimler Benz, Siemens and Volkswagen are laying off workers and introducing short-time working.

For Mr Kohl's government the dilemma could hardly be more acute: sharply declining revenues from the west and sharply rising demands on expenditure from the east. The gaping holes appearing in the budget arithmetic of the Finance Minister, Theo Waigel, finally forced the 'prevarication Chancellor' to go before his Christian Democratic party's annual congress in Dusseldorf this week and tell Germans that the moment of reckoning had come. The performance left delegates bewildered, his centre-right coalition partners confused, and businessmen even more worried and uncertain.

The Chancellor gravely announced that the 'Hour of Truth' had arrived, and then immediately dodged behind a hedge of euphemisms about the government considering 'revenue enhancement' measures.

The prospect of raising taxes, however one puts it, has rarely enthused a party congress. It is particularly hard for the CDU, which was badly bruised in 1991 when it had to introduce a special 'unification solidarity tax', and has been swearing for the past 18 months that there would never be a second tax lie. 'You may not wish to applaud,' the Chancellor said, turning on the delegates, 'but let us be absolutely clear. If we want this ship of state to stay afloat, then we must take the necessary steps.'

There is general agreement that taxes will have to be raised in 1995 to cope with the DM400bn of accumulated East German debts that will then fall on the Bonn budget. But what about getting from here to there? Either people in the west accept significant sacrifices in the form of real wage cuts and public spending reductions, or the tax increases will come 'much sooner and be much steeper', Mr Kohl threatened.

These last words were met with a chorus of disapproval from businessmen, the economic institutes and the leaders of the other coalition parties. Talk of introducing tax increases before 1995 is irresponsible; all efforts must be focused on expenditure cuts, thundered Mr Waigel. The head of the Free Democrats, Otto Graf Lambsdorff, said that raising taxes would soon 'finish off the economy in western Germany, and then nothing will function in the east any more'.

Under such fierce attack, Mr Kohl retreated, telling the CDU congress on its final day that subsidising the east must be met by savings rather than new taxes in the west in 1993 and 1994.

He then confused the situation further by stating that such cuts could not be too severe, for Germany was a 'social market economy, not a market economy'. Perhaps with John Major's tribulations in mind, Mr Kohl singled out western Germany's heavily subsidised miners as an example where cuts would need to be weighed against social considerations.

The fact remains, however, that the government has already to plug a DM15bn gap in its 1993 budget, the result of rising subsidy demands and falling revenues. Mr Waigel did his calculations expecting real growth next year of 2.5 per cent. But Germany's five leading economic institutes have now revised downwards their forecast to 1 per cent, and just 0.5 per cent for western Germany, according to their joint autumn report published this week.

The institutes added that even these modest predictions are based on several optimistic conditions, including recovery in the world economy, western wage settlements below a forecast 3.5 per cent inflation rate and quick, sharp cuts in interest rates. Should this favourable constellation not appear, then Mr Waigel's difficulties will become much more gruesome - for every 1 per cent less in GDP growth, he loses DM10bn of revenues.

The German government faces a stark choice. Either it steels itself to 'do a Thatcher', or further 'revenue enhancements' will soon be needed. Cuts without blood will not see Mr Kohl out of his financial dilemma. So far, however, the government has often talked about reducing subsidies in the west and done nothing about it - an 'absolute scandal' as the economic institutes put it.

Whether Mr Kohl or his fractious coalition government is capable of emulating Baroness Thatcher on public spending is doubtful. It would be contrary to the very nature of the Chancellor, and western Germany's painstakingly consensual political system and society. Which leaves borrowing even more money and probably raising taxes. But as Mr Waigel has stressed, doing so now would be 'poison' for the ailing economy. As order books thin, firms are retrenching. Investment has been sharply cut back. Daimler Benz has already shed more than 10,000 workers this year; Volkswagen plans to cut 13,000 by late 1994. The industry association recently estimated that the total workforce must be cut by 200,000 in the next few years. Deutsche Aerospace has announced cuts of 7,500; the chemical industry expects profits to fall 30 per cent in the current financial year.

Worried about declining competitiveness because of Germany's high costs, firms are also shifting production abroad. This affects not just the big names, such as BMW, which is building its latest production plant in the US, but also those medium-sized firms which traditionally make up the engine-room of Germany's economy. Lemmerzwerke, a wheel manufacturer near Bonn, is shifting production to England, cutting 700 jobs. 'Quite simply, we can produce more cheaply there,' said the manager, Alfred Damian.

Raising taxes would make Standort Deutschland - Germany as an economic and investment centre - even less attractive. As the government agonises and businesses worry, the Bundesbank looks on with growing alarm. There are urgent voices on its central council calling for further cuts in interest rates.

But the hard core remains cautious about going much further than the easing in short-term rates recently initiated. Inflation remains stubborn, and will jump back over 4 per cent when VAT is raised in January. The central bankers want to have a clearer idea of how the government intends to sort out its fiscal mess, and whether the trade unions will hold wage claims down.

Like many others in Germany, they are waiting to know which Truth the heralded hour will bring.

(Photograph omitted)