Will Germany Manage to Balance its 2015 Federal Budget? A Government Never Needs to Pay off its Debt

Germany’s Federal Minister of Finance, Wolfgang Schäuble, plans to reduce the country’s budget deficit this year to seven billion euros. In 2015 he hopes to eliminate the deficit altogether. How realistic are these goals and what do they mean for Germany? Friedrich Heinemann, head of the Research Department "Corporate Taxation and Public Finance" at the Centre for European Economic Research (ZEW), provides insight.

Dr. Friedrich Heinemann is Head of the Research Unit "Corporate Taxation and Public Finance" at the Centre for European Economic Research (ZEW). He also teaches economics at the University of Heidelberg. His research interests include empirical public finance, fiscal competition and federalism in Europe. In addition to his active involvement in various research consortia, Heinemann is on the board of the Arbeitskreis Europäische Integration and a member of the Scientific Board of the Institut für Europäische Politik (IEP) in Berlin.

Is Wolfgang Schäuble’s objective of eliminating the annual deficit next year overly optimistic?

No. Current circumstances make it easy for the federal and state governments to balance the budget next year. German jurisdictions are riding a wave of rising tax revenues and historically low interest rates. There would be much cause for concern if the budget could not be balanced under such favourable conditions.

In response to its current account surplus, European partners are demanding more government stimulus from Germany. Is this the wrong time to balance the budget?

For the eurozone as well as for Germany, it is important that the federal government breaks even in 2015. The coming years will test the credibility of the new debt brake in the German constitution. This rule takes effect in 2016 at the federal level and in 2020 for Germany’s states. Accordingly, the federal government will serve as a role-model for the states, and one hopes they will follow its lead. The same applies to the rest of Europe, too. As part of its strong push for the European Fiscal Compact, Germany called for national deficit limits; an inability to follow its own principles would damage its credibility. In terms of growth policy, the main priority is increasing investment. Deficits are not necessary to achieve this; cuts in other areas will do. The eurozone requires one thing most of all for new growth: it must create confidence that its member states will not become insolvent in the future.

Germany’s economy is very strong right now, yet many risks still exist globally. Can Germany avoid new deficits if its economy weakens?

If China experiences a hard landing and the global economy slumps, the German treasury would take a hard hit. But even if the global economy remains stable and the eurozone continues to recover, there is no guarantee that Germany’s public-sector budgets will stay in the black. The country’s aging population will strain budgets in coming years and decades, requiring substantial spending cuts.

Is deficit reduction or elimination the tipping point for bringing down government debt?

Generally, private individuals are expected to pay back their debt by retirement, or at the latest before death. Every bank takes this factor into account when deciding whether to grant a personal loan. Governments have no such natural end to their credit relationships. For all intents and purposes a state never needs to pay off its debt. As long as the economy continues to grow, governments need only avoid new deficits to reduce the ratio of debt to GDP. Thus, if German governments respect the debt brake permanently and avoid new deficits, Germany can in fact reach such a tipping point. 

Germany’s national debt has been growing for decades. Presently it exceeds two trillion euro. What is the limit above which a country can no longer service its debt?

Absolute figures like “two billion euro” do not tell us anything. The important thing is the ratio of national debt to GDP. But here too no clearly defined limit exists; many other questions play a role as well: What is the state of a country’s assets such as the quality of its infrastructure? What is its growth potential? What are the available conditions for financing? Is a country’s debt held by short-term or long-term creditors? Are debt holders domestic or foreign? What is the potential for increasing tax revenues? Many such questions must be answered to assess the sustainability of government debt. The general picture for Germany is currently very rosy, with most credit rating agencies rightly giving Germany top marks. What Germany needs to do is defend its good reputation.