Do we have to reform the debt brake?
During the Corona crisis with its enormous financing requirements, the federal government suspended the debt brake until at least 2022. When and in what form to return to the debt brake after the crisis is a matter of disagreement among the parties, as well as among academics.
In their election program, the Greens argue for a reform of the debt brake. The debt brake is to be retained for consumer spending, but necessary future investments are to be given more leeway in the amount of net investments. But how sensible is this plan from an economic point of view? Does it restrict fiscal policy flexibility too much? Or, on the contrary, does the proposal not go far enough to finance important investments, for example in infrastructure and climate protection? We talked about this with Anja Hajduk, Vice Parliamentary Party Leader of the Green Party, and Philippa Sigl-Glöckner, Director at the Department for the Future.
The article is part of our New Economy Short Cut series for the Bundestag elections, in which we invite prominent candidates for election to the Bundestag to discuss their party’s promises with regard to the major economic issues of our time. Other panelists are Norbert Walter-Borjans (SPD), Christian Dürr (FDP) and Caren Lay (Die Linke).
Anja Hadjuk explained that her party is clearly in favor of reforming the debt brake. This is necessary, she said, to address the investment backlog in Germany in the face of major future problems such as climate change and digitization. As a result, she said, some economists believe that the debt brake is no longer up to date. The public investment ratio of 2.5% of GDP is very low by international standards. The report recently commissioned jointly by the BDI and the DGB, which identified an investment requirement of EUR 450 billion over the next 10 years, also fits into this picture.
The vice chairwoman of the Green Party presented her party’s idea of expanding and supplementing the debt brake in such a way that investments can be financed on a credit basis. Experts are currently examining the constitutional hurdles to amending the debt brake. One way of extending the debt brake without amending the constitution would be through the “golden rule”. This would involve expanding the financial room for maneuver by means of a large-volume over-year investment fund or funds to municipalities. Because: under the given conditions of the debt brake, the federal budget has holes worth billions. That is why we want to find pragmatic and rule-based solutions. In doing so, however, it was also important to consider the European rules and to maintain Germany’s high reputation on the financial markets.
Philippa Sigl-Glöckner promoted the idea of making full employment the fiscal policy goal instead of the investment rule. In contrast, she was critical of the golden rule proposal, arguing that it was based on the current definition of investment and that it was questionable whether the current spending categories promoted future prosperity for all. Rather, wealth accumulation (pension insurance, social security) takes place through working people, she said. Therefore, he said, fiscal policy should be geared toward the goal of full employment. This would also have the advantage that overheating of the economy in certain areas could be detected in good time – unlike an investment rule.
In their election program, the Greens call for the debt brake to be supplemented by a rule in favor of public investment. The current rules are to be retained for consumer spending, while borrowing for investments that create new public assets is to be permitted in the amount of the net investment. In view of the low level of interest rates and the high rate of return on public investment, the debt brake could thus be designed in a contemporary manner without any loss of sustainability of the future interest burden. The Greens explain why a reform of the debt brake is necessary: “Germany does not need to save, but to invest. The conditions are ideal […] If Germany wants to remain a good country, it must change. It must operate more ecologically in the future and distribute its wealth more fairly. This will require major investments.”
However, not all parties follow this line of argument. The CDU and CSU, for example, call in their election program for a return to the debt brake as quickly as possible without “amendments to the Basic Law to soften it.” Instead, they say, there should be a return to a balanced budget as quickly as possible in order to maintain fiscal flexibility and functional capacity. More room for maneuver could instead come from sustainable growth, he said. However, individual party members had recently called for climate investments to no longer be covered by the debt brake. The FDP is also calling for a swift return to the debt brake and a reduction in Germany’s debt ratio to below the 60 percent mark in accordance with the Maastricht criteria. This is the only way to ensure that Germany remains capable of acting and has sufficient room for maneuver in fiscal policy. The Left Party contrasts with this by calling for the complete abolition of the debt brake. The election program states: “We consider […] the debt brake to be harmful to the national economy and want to abolish it. The SPD’s election program is less clear – the debt brake is not explicitly mentioned here. In the past, however, the party has declared its support for the debt brake, with Olaf Scholz recently saying, “Starting in 2023, the debt brake will be adhered to again. We will grow out of debt just as we did after the financial crisis.”
The political debate was recently fueled by a study by the IW Köln, which suggests that the parties’ election promises cannot be financed with a debt brake that has been exhausted to the maximum.
And the economic debate? Is the debt brake an important component in ensuring fiscal policy leeway? Or is it more a matter of reforms to reduce the German investment backlog and master fiscal challenges? The debate about the debt brake has recently gained momentum, above all due to the Corona crisis and the resulting sharp rise in public debt. However, the debt brake enshrined in Article 115 of the Basic Law has been the subject of controversial debate since its introduction in 2009.
For decades, German fiscal policy was shaped by the idea that the sustainability of public finances should be measured by the debt ratio; the debt ratio, in turn, was best controlled by the annual budget deficit. This approach found its way into the German constitution in 2009 with the introduction of the debt brake. Advocates of the debt brake argue above all that it is an important instrument for ensuring sound budgetary finances because of the high implicit debt in the social security systems and the burden on public finances caused by demographic change. In addition, Germany has an important role model function within Europe. Abolishing the debt brake could be a fatal incentive for other countries to take on even more debt.
Recent research on the debt brake contradicts this view. For example, the target that the ratio of debt to GDP should not exceed 60% is not economically but historically justified (in the early 1990s, this was the level of the average debt ratio in the European Community). At that time, the yield on ten-year federal bonds exceeded the 9% mark. Today, by contrast, it is around -0.2%. Thus, the debt corset misses the challenges of today – especially decarbonization and demographic change. The debt brake leads to an exaggerated reduction in government debt and creates incentives to neglect important public investments in those and other areas.
In order to fundamentally modernize the infrastructure, the DIW recently estimated an additional annual investment requirement of 30 to 150 billion euros in Germany. In addition, the maximum permissible deficit for the federal budget of 0.35 percent of GDP in the event of major economic slumps is too low. Since interest rates have been low for a long time, significantly more government debt can be afforded. Since the sustainability of a country’s debt is measured relative to its economic strength, this allows Germany to borrow cheaply. Therefore, the debt brake must be modified in such a way that it allows urgently needed public investments.
This is contradicted by studies by ifo, according to which there is no evidence that the debt brake has a negative effect on public investment. These had been low above all in the years 2000 to 2008 – before the introduction of the debt brake. Since 2014, the first year of the black zero in the federal budget, on the other hand, they have risen twice as fast as GDP.
A study commissioned by the Forum New Economy from the Department for the Future recently attempted to draw up reform proposals for a modern debt brake. In it, the focus is placed above all on sustainable full utilization of the economy as a sensible goal for fiscal policy.