View from Frankfurt: German parties shape up for brutal fiscal fight

There is a turning point in election campaigns, where the contestants cease dodging and weaving and finally square up to one another. The trigger for this change of pace and pugnaciousness is often a single small word: tax. Although nearly six months remain before the final bell of the general election on 16 October, such a point has already been reached in Germany, as the opposition Social Democrats and the centre-right governing coalition trade punches over who will be the most brutal fiscally.

The fight allows unusually little room for manoeuvre. That taxes need to be increased, and even by how much, is barely disputed. How the burden is to be spread is what is producing the fury. German unification, estimated by the Social Democrats to have cost some DM750bn ( pounds 310bn) between 1990 and 1994, has unsurprisingly sent Bonn's public finances haywire. The ratio of public sector debt to gross domestic product should reach 66 per cent by 1995, up from the low-40s before unification, and has been one of the factors contributing to the Bundesbank's over-cautious approach to interest rate reductions over the past few years. To contain the inflationary risk in the second half of the 1990s, the German government, whatever its hue, has no option but to pursue the difficult course of fiscal consolidation.

This task will not be made any easier, however, by the need for continued massive transfers from the west to the east. Although there is much celebration of the fact that the economy in eastern Germany will expand by 7 per cent this year, the growth is nowhere near self- sustaining. Still bang in the middle of a dramatic restructuring process, the east will remain dependent for some time on western handouts, which this year amount to a net DM150bn. The fiscal pressure is not, therefore, about to be relaxed. But as the electoral contestants do battle over this grim prospect, one has the distinct impression that the German public are the most punch- drunk and almost fatalistic about the looming tax increases. For these increases will be only the latest in an extraordinary series of lunges into German pockets and purses over the past four years.

SOLIDARITY

The pain began in the spring of 1991 with a DM15bn increase in social insurance payments, followed shortly by the first raising of the oil and petrol tax and the introduction of a temporary 7.5 per cent income tax 'solidarity' surcharge. The following year saw VAT increased and a withholding tax on interest income introduced, and so it went on. All in all, the total of taxes and social insurance as a proportion of GDP increased from less than 41 per cent in 1990 to 45 per cent this year. The difference represents an increased taxation burden of around DM130bn.

Not surprisingly, this has contributed to the sharp slowdown in private consumption, the timing of which could hardly have been worse given the German economy's difficulties in hauling itself free of the recessionary mire. But there is also little prospect of consumer spending picking up significantly in the foreseeable future, given the series of tax and social contribution increases in the pipeline. When the centre-right coalition set 1 January 1995 as the date for the re-introduction of the 7.5 per cent 'solidarity' surcharge, it was confident that it would fall upon an economy already recovering strongly. There is rather less optimism now. Furthermore, the first 1 per cent increase in social contributions to pay for the new regime in nursing for the very sick and elderly also begins in January 1995.

INCOME SURCHARGE

The Social Democrats have said they will, if elected, replace the 7.5 per cent 'solidarity' tax with a 10 per cent surcharge on incomes of the top 20 per cent of earners, those with net annual incomes of about DM50,000 per single person, or DM100,000 per married person. Both measures aim to raise around DM28bn next year, and the Social Democrats have said the surcharge should be kept in place until the unification debt has been worked off. The total tax burden as a proportion of GDP would reach more than 26 per cent in 1995, compared with more than 23 per cent in 1990.

But the upheavals will not stop there. For Germany's constitutional court has ruled that, from 1996, the so-called minimum existence income must be free of taxes. Estimated to be around DM13,000 by then, this would be double the current tax-free income allowance, provoking serious juggling of the tax burden. The current battle between the parties is being conducted as if this serious future problem does not exist. Just as bad, the election contestants continue to evade the issue of spending cuts, obviously considering it too explosive at this delicate political juncture. The fact remains that nearly three-quarters of the efforts at consolidating public finances have been directed towards increasing revenues. While certain areas, such as the defence budget, have been hacked, most large items of spending roll on undisturbed. Even the liberal Free Democrats, the great verbal crusaders against continued massive subsidies to unproductive areas of the economy, such as the coal industry, have become mute on this point.

No one is seriously talking about tackling a social security system that has become far too lavish for the means of Germany in the Nineties. However, if the tax proportion of GDP is to be reduced to 23 per cent - the rule-of-thumb level that German practice over the past 40 years has established as desirable - and the heavy brake on private consumption is to be lightened as it needs to be, a real shift towards public spending cuts would seem to be as unavoidable as broken promises after a general election.