Flood Damage: Postponement of Tax Relief was Premature

Economic expectations for 2003 are significantly worsened by the expected tax cuts being postponed due to the flooding catastrophe. From a political point of view, it is understandable that in the middle of an election, neither government nor opposition wish to promote unpopular cuts in public spending. But it is exactly this which would be the adequate answer to the upcoming extra costs caused by flood damage.

Given that the affected regions contribute only a very small share of the German GDP, direct effects on the economy due to production losses are not significant. Furthermore, the positive effects of aid, granted for rebuilding communities following flooding, might well be limited to regional and sectoral effects without having greater impacts on the overall economy. The most significant effects on the economy are more likely to emerge from the now finalised fiscal solution - a tax relief on 6.9 billion euros scheduled for January. This will now be delayed by one year. In an already precarious economic climate with falling optimism, this is likely to inhibit private consumption. In addition, employers still face rapidly growing social security contributions. Health insurance providers are unable to avoid increasing contributions, and according to estimations of the BfA (former German pension authority), contributions to the statutory pension insurance will rise from 19.1 to 19.3 percent on the first of January.  That is the exact same time when the next increase of Ökosteuer (green tax) will come into effect.

On balance, the decision to delay tax relief will mean that 2003 will be subject to an increased tax burden. One consequence for economic policy will be that private consumption in 2003 is unlikely to be sufficient to propel growth.

The political debate currently offers no alternative form of flood aid than tax financing. The assumption that tax relief is the most suitable solution, however, seems somewhat premature. It is true that creating more debt is in no way a feasible option; current levels of debt are already approaching the three-percent limit imposed by the stability pact. Whilst Germany might hope for special treatment from Brussels in this respect, this would simply cause further damage to the stability pact. Financing by debt is therefore not an option. It is also the case that public investment should not be further cut. Nevertheless, the decision to provide flood aid by postponing tax relief can be considered premature for two reasons:

Firstly, the degree to which the public budget will be burdened is far from certain. Each day, we hear different, contradictory predictions of the amount of damage which will be caused to the overall economy. Such predictions do not, however, consider the burden which will be placed on public households. Companies and private persons, as well as insurance providers and banks will suffer significant credit losses.

Secondly, no one has seriously considered whether many German citizens would be willing to make sacrifices which could serve to cut expenditure. Voters who accept tax raises for flood victims might also be open to cutting subsidies and reassessing social spending for the same purpose.

Politicians in the government as well as from the opposition are currently sending the clear message that exceptional spending must be financed through tax. Spending cuts in other sectors are not an option, not even in exceptional circumstances. This constitutes a clear contradiction to the usual consensus that reductions in the public spending ratio should have priority. All in all, the apparently small range of fiscal policy options which may be exploited to deal with the current flood catastrophe demonstrates how important it is to consolidate spending in the long term.

Contact

Dr. Friedrich Heinemann, Phone: 0621/1235-149, E-Mail: heinemann@zew.de

Prof.  Dr. Robert Schwager, Phone: 0621/1235-215, E-Mail: schwager@zew.de

Daniel Radowski, E-Mail: radowski@zew.de