Tax cut warning

In the wake of the resounding election triumph, Guido Westerwelle’s pro-business Free Democrat (FDP) party are poised to exert pressure on Chancellor Angel Merkel’s conservatives to agree to deep tax cuts to kickstart Europe's largest economy.

But that may be easier said than done. The two centre-right parties will need to bridge differences on a range of policies including unemployment, education and energy. But tax cuts might prove to be the most tricky negotiation.

On Monday, Merkel made clear she would not shift far to the right to accomodate the FDP.

"You know me. I have been like this for some time. I do a bit for everyone but I do not change with the colours of a coalition," she told reporters, adding the conservatives wanted to be the main party of the center ground.

FDP aims for ambitious tax overhaul

The FDP has campaigned for a simplified German tax system and a total reduction of 35 billion euros. Germany has just emerged from its deepest recession in 60 years but the recovery has been fragile and with public debt soaring, the partners will find it hard to meet their tax-cut promises.

“We will see tax cuts because that was the main topic of the liberal FDP party in the campaign so they now have to deliver,” Carsten Brzeski, senior economist with ING bank in Brussels, told Deutsche Welle.

“There will be some quick relief for households, families and businesses but it won’t be as substantial as the FDP wish for and the soonest we could expect it to happen would be the second half of 2010, early 2011," he said.

Brzeski warned that the ballooning budget deficit would sharply curb the government's ability to take on tax reform. “The room for manoeuvre with public finance is not so big and Merkel burned her fingers during the last election with this topic. So we will not get this tax reform," he said.

That view was echoed by Ullrich Heilemann, director of the Institute of Empirical Economic Research at the University of Leipzig.

“I don’t think there will be dramatic changes for the simple reason that the leeway to do something is rather small and the main task is to get the German economy on track one way or another," Heilemann said.

"Budget constraints will prevent any changes that will fall onto deficit. You can make structural changes but you cannot do much to decrease the deficit," he said.

Germany urged to rethink economic policy

Germany was the world’s biggest exporter of goods last year but stagnant consumer spending at home and a slump in world trade has battered the economy. There has been pressure at home and abroad for Germany to cut back its reliance on exports and implement tax cuts to boost consumer spending.

Despite being the junior partner in the coalition, the FDP will take confidence from its best ever result in a general election, winning 14.6 percent of the vote and push for quick tax cuts to revive the economy.

But Heilemann said Chancellor Merkel’s trademark caution in financial affairs will scupper Westerwelle's hopes for swift reform.

“Merkel's general principle has been let’s wait and see and hope the rest of the world is expanding and will lift Germany’s economy again and I don’t think there will be a shift in this paradigm,” he concluded.

With the budget deficit in Germany expected to reach six percent of gross domestic product (GDP) in 2010 – twice the European limit – and federal borrowing set to hit a new high next year, the new partnership will find it difficult to strike a balance between reducing state debt and consolidating the budget, at the same time as stimulating growth.

Not to mention dealing with unemployment figures which are set to hit 4 million by 2010.

Heilemann said neither the conservatives nor the FDP had any clear-cut solutions to revive the economy.

“If you go through the German press and look at the election campaign nobody really bothered how to improve the performance of the Germany economy,” he said.

Author: David Sharp

Editor: Sonia Phalnikar