TCS Daily

Land of the Lost

By Nico Wirtz - July 5, 2005 12:00 AM

If you thought raising taxes and pick-pocketing taxpayers was the exclusive domain of Germany's Social Democrats, it is time to think again.

Once elections are on the horizon, politicians tend to indulge in populism. The latest outgrowth of this is the proposal of Gerhard Schröder's Social Democrats and their Green coalition partners to levy a special tax on the wealthy. This populist tax-and-spend attitude has energized Angela Merkel's Christian Democrats -- but not in the way one might expect from a conservative party. Instead of arguing against further tax increases on Germany's taxpayers, many of the big shots in the CDU are now coming up with tax hike schemes of their own, the most popular one these days being an increase in the country's value added tax (VAT).

The CDU seems to be oblivious to the fact that only a few things hurt low income workers and the less fortunate members of society more than raising Germany's VAT. Furthermore, any increase in the VAT will only further damage Germany's weak overall economic performance.

All warnings regarding the long-term implications of Germany's tax-and-spend mentality and appeals for a policy of fiscal sanity have been falling on deaf ears. Even worse, the CDU, the party that would make up the lion's share of a new German government in September, seems oblivious to the country's financial crisis. Neither the SPD/Greens nor the CDU seem to have realized that Germany does not face a revenue problem -- the country faces a spending problem.

All three levels of government -- federal, state and local -- have amassed a staggering mountain of debt, now totaling roughly €1.5 trillion -- three times the country's total tax collection (€445 billion).

The problem starts at the federal level. The government takes in about €190 billion every year, but spends €254 billion, of which €39 billion alone is to pay off the national debt, another €78 billion to keep Social Security somewhat afloat, and another €30 billion for various programs for the unemployed. The deficit of about €60 billion is routinely financed with new debt. It does not take an advanced degree in economics to understand that spending such as this is unsustainable. The reality is: the German government is financially immobile and virtually bankrupt. Expenditures have been exceeding revenue for years and the German taxpayers are squeezed dry.

All of this will have profound implications for Germany's economic development over the next couple of years. After a brief period of relative success, Germany again finds itself at the bottom of Europe's economic ladder. For 2005 and 2006, Germany's economic output is projected to be the lowest of all 25 EU member states. With projected economic growth rates of 1.5 percent for 2006, Germany will continue to lack in economic performance. This is even more striking when compared to growth projections for 2006 for the United States (3 percent) and the EU average (2 percent).

When the Social Democrats call for soaking the rich these days, they neglect the fact that already 10 percent of the country's taxpayers shoulder more than 50 percent of the tax burden, while 50 percent of taxpayers pay less then 10 percent of the overall tax bill. Another aspect often overlooked is the fact that a tax on one is a tax on all: Politicians and citizens alike may pretend or actually think that a tax negatively affects only a certain class of people, yet it must be understood that every tax negatively affects everyone.

Rather than calling for higher taxes, lawmakers should work to reduce government's influence and meddling in the economy. In doing so, they would help unleash private initiative and an entrepreneurial spirit. Yet, unfortunately for German taxpayers, irrespective of who might win possible early elections in September, this approach is nowhere to be seen, at least not within the ranks of the current governing coalition or the Christian Democrats.

Among the CDU leadership and the party's rank-and-file, raising the VAT seems to be a foregone conclusion; the only question is how much. Anything in the range of three or four percentage points seems likely. Already, Gerhard Stratthaus (CDU), finance minister of the State of Baden-Württemberg, argues that increasing the VAT by one percent is not enough. "The government," so he laments, "may not restrict its own freedom of action."

Such thinking clearly confirms that Germany's body politic still believes the problem to be on the revenue side, and not on the spending side.

Leading German research institutes such as the Foundation for Market Economy/Frankfurter Institute beg to differ. They estimate that an increase of the VAT from 16 to 20 percent could cost the country about 500,000 jobs and reduce Germany's gross domestic product by as much as 1.5 percent -- something the Institute for the German Economy in Cologne describes as nothing but disastrous for the country.

It's the spending, stupid; but unfortunately this message has not yet resonated, neither with the body politic, nor, unfortunately with the general public. Watchdog organizations like the American Citizens Against Government Waste are non-existent. The Bund der Steuerzahler does publish an annual "Schwarzbuch" (piglet book) listing government waste, but it gets almost no public attention.

Against this background, the fact that the CDU/CSU is so eager to raise taxes should not be surprising.

The German population is known to display a sensitive nerve when it comes to perceived injustices in the German tax code favoring "the rich". Poll after poll in recent months has shown a majority of Germans favoring an additional tax hike on the wealthy, while at the same time opposing further cuts in the country's welfare system.

This general sentiment brings a lot of pressure to bear on the CDU/CSU, particularly after the proposal by SPD/Greens to levy a special and very popular tax on the rich. Although opposed to such a tax, the CDU/CSU is eager to increase the VAT instead and postpone the once supported idea of a reduction in the top tax bracket from 42 percent to 36 percent. All in all, this proposal is no better than the special tax on the rich. All things considered, the CDU/CSU does not have the political backbone to significantly reduce Germany's tax and regulatory burden.

Once more, only Germany's Free Democratic Party (FDP) has been willing to confront the SPD/Greens, as well as the FDP's likely coalition partner -- the CDU/CSU -- on these issues. The FDP has realized that meaningful reform of Germany will only be possible by limiting federal spending and severely reducing the reach and scope of government. The FDP's proposal includes tax cuts averaging €17 billion to €19 billion, financed without a hike in the VAT or other taxes. In order to make such reductions possible, the Free Democrats have promised to slash government spending, to eliminate subsidies and promote further privatization/liberalization of the economy. From the FDP's perspective, and this is where they differ substantially from the CDU/CSU, getting money back to the taxpayers is more important than just simplifying Germany's tax laws.

The Free Democrats seem to be the only political force in Germany who realize that prolific government spending has to stop. The jungle of various direct and indirect subsidies must be severely trimmed and taxes must be reduced.

If Germany finally simplified its heavily convoluted tax code, and slashed special privileges and the more than generous benefits for its public sector employees, much could be accomplished. Couple this with a reduction of Germany's horrendous bureaucratic apparatus and the redundancies therein, and you would free enough capital and establish maneuverability to finally tackle the country's fundamental problems.

Those moves would allow for generous tax relief, enabling people to spend more, thereby stimulating economic growth. As a result, the German federal government would gain room to finally start paying off Germany's skyrocketing national debt. This would be a first step to reform and would free "social" programs from government dominance and inefficiency. With more money for the people to spend as they see fit, it will be much easier to push for choice in health care, education and retirement planning, and ultimately come to an "ownership society".

Schröder's Agenda 2010 to some extent preached greater self-reliance but failed to deliver. With special elections coming up, one should hope that the influence of cooler heads inside and outside the Free Democratic Party prevails. As recent developments show, taxpayers cannot look to the Christian Democrats for free-market solutions. Hopefully, a German government under FDP participation will have a greater, more visible classical liberal handwriting than the one from 1982 to 1998.


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