VZCZCXRO0255
PP RUEHIK
DE RUEHRL #1600/01 3521200
ZNR UUUUU ZZH
P 181200Z DEC 09
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 6092
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCNFRG/FRG COLLECTIVE PRIORITY
RUEHDF/AMCONSUL DUSSELDORF PRIORITY 0261
RUEHFT/AMCONSUL FRANKFURT PRIORITY 8345
RUEHAG/AMCONSUL HAMBURG PRIORITY 0350
RUEHLZ/AMCONSUL LEIPZIG PRIORITY 0255
RUEHMZ/AMCONSUL MUNICH PRIORITY 2221
RUEHC/DEPT OF LABOR WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 BERLIN 001600 
 
SENSITIVE 
 
STATE FOR EEB (NELSON, HASTINGS), EEB/IFD/OMA 
(WHITTINGTON), DRL/ILCSR AND EUR/CE (SCHROEDER, HODGES) 
LABOR FOR ILAB (BRUMFIELD) 
TREASURY FOR SMART, ICN (NORTON), IMB AND OASIA 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PREL GM
SUBJECT: GERMAN TAX CUTS AND BUDGET DEFICIT: THE LAST HURRAH 
 
REF: BERLIN 0840 
 
BERLIN 00001600  001.3 OF 002 
 
 
¶1. (SBU) SUMMARY:  The German budget deficit looks set to 
reach 6 percent of GDP in 2010, thanks to a drop off in tax 
revenues, to a spike in crisis-related spending, and now, to 
the first tranche of tax cuts fulfilling the new coalition 
government,s pre-election campaign promises.  EU and 
constitutional requirements, however, will force the 
government to start implementing its fiscal "exit strategy" 
in the near future.  Officials seem to be pinning their hopes 
on the idea that economic growth resulting from the new 
stimulus will generate higher tax revenues, eventually 
leading to lower deficits.  Yet the flood of red ink may make 
it difficult for Merkel's government to push through the 
second phase of its tax cuts next year as planned.  In 
fiscally conservative Germany, running budget deficits is 
never a crowd pleaser, regardless of economic conditions. 
END SUMMARY. 
 
MAKING HISTORY 
-------------- 
 
¶2.  (SBU) On December 17, 2009 Chancellor Merkel's cabinet 
approved a 325 billion euro budget for FY 2010 that marks 
Germany's highest postwar federal deficit.  Officially 
totaling 85.8 billion euros )- almost double the 2009 
deficit -- the actual shortfall will be more like 100 billion 
euros once bank bailout and stimulus measures are factored 
in.  Moreover, the EU Growth and Stability Pact, which limits 
member states to deficits of no more than 3 percent of gross 
domestic product (GDP), takes into account state and local 
deficits.  Through this lens, Germany could be looking at a 
consolidated deficit of around 144 billion euros in FY 2010, 
or 6 percent of GDP. 
 
¶3. (SBU) According to Finance Ministry officials, around half 
of Germany's budget shortfall is attributable to the steep 
drop off in tax revenues. (REFTEL)  Much of the extra 
spending is earmarked for the Labor Ministry.  The falling 
number of full-time employed and the costs of 
government-sponsored schemes, such as the "short-shift" 
("Kurzarbeit") program, eat into the budget of the National 
Employment Agency, which is to receive 16 billion euros. 
While military spending will dip by 0.1 percent, expenditures 
for foreign and development assistance are to increase by 6.5 
percent.  The federal government will provide health 
insurance companies with an additional 7.5 billion euros of 
assistance and the pension funds with 80 billion euros.  Debt 
service has become the fourth biggest line item in the budget 
with almost 11 billion euros.    As a result of the FY 2010 
budget, Germany's national debt will rise from 73 percent to 
78 percent of GDP next year. 
 
NOT SO FAST 
----------- 
 
¶4. (SBU) Germany is one of 14 member states currently subject 
to EU excessive debt procedures; it has until 2013 to get its 
deficit below 3 percent of GDP.  Finance Minister Wolfgang 
Schaeuble has vowed tough austerity measures in order to 
comply.  Further down the road, Germany faces an additional, 
self-imposed restriction, known as the "debt brake."  This 
constitutional balanced budget amendment requires Germany's 
structural deficit to fall to no more than 0.35 percent of 
GDP by 2016.  Thomas Szewczyk, head of the Bundesbank's 
Berlin office, told us the government would need to start 
reducing its deficit in 2011 by around 10 billion euros a 
year every year until 2016.  Despite the potential 
countercyclical effects of fiscal consolidation, the 
Bundesbank sees Germany's "debt brake" as an important part 
of its "exit strategy" from extraordinary measures taken to 
combat the economic crisis.  Many ordinary Germans are wary 
of the inflationary consequences of debt, and also support 
the amendment's aims. 
 
FULFILLING CAMPAIGN PLEDGES 
--------------------------- 
 
 
BERLIN 00001600  002.3 OF 002 
 
 
¶5.  (SBU) Despite the record deficit, Merkel's Christian 
Democratic Union (CDU)/Christian Social Union (CSU)-Free 
Democratic Party (FDP) coalition pushed through on December 
18 a controversial new stimulus plan or "growth acceleration 
law" worth 8.5 billion euros.  A second installment worth 19 
billion euros is envisaged for the FY 2011 budget.  The first 
phase includes additional family allowances and a drop in the 
value-added tax (VAT) on hotels and restaurants.  The cuts 
ran into stiff opposition from federal states, particularly 
structurally weak Schleswig-Holstein and Saxony, which feared 
a loss of state tax revenue.  Only after the federal 
government gave assurances of additional money for education 
and the like in coming years did enough states relent for the 
bill to pass.  Several states led by Social Democratic Party 
(SPD) governments, however, are threatening to challenge the 
constitutionality of the new measure in court. 
 
¶6. (SBU) When asked how the government squares the tax cuts 
with mounting fiscal pressures, Andreas Nicolin, an economic 
advisor at the Chancellery, explained that stronger growth 
resulting from the measures should generate higher tax 
revenues and help balance the budget.  Leading German 
economists have sharply criticized the plan, however, saying 
the cuts will actually do little to boost growth, while 
exacerbating the dire fiscal situation. 
 
COMMENT 
------- 
 
¶7. (SBU) While next year's deficit is clearly of historic 
proportions, Germany's fiscal outlook is not in especially 
bad shape compared with several other EU member states. 
Still, EU and constitutional restraints mean the government 
will have to start trimming as soon as possible.  Merkel's 
coalition pushed through the first installment of tax cuts 
mainly out of an obligation to follow through on a campaign 
pledge to cut taxes.  Finance Minister Schaeuble and others 
recognize that fiscal consolidation has to start in earnest 
with the FY 2011 budget, however, so the second installment 
of tax cuts worth 19 billion euros could be a difficult sell. 
 As defenders of the EU Growth and Stability Pact, Germany 
also wishes to set a good example for laggards such as Greece 
and Spain, according to Finance Ministry contacts.  Even if 
the economic situation worsens, it could be politically more 
popular to cut the deficit than to stimulate the economy with 
further deficits.  For his part, Schaeuble has already begun 
laying the rhetorical groundwork for the coming fiscal 
consolidation, pledging to do whatever was necessary to get 
the German house in order. 
MURPHY