ifo Viewpoint 255: The Future of Germany’s Debt Brake
The recent ruling by the Federal Constitutional Court has reignited the debate over Germany’s debt brake mechanism. Amid growing calls for reform, some critics advocate its complete abolition, while others propose exempting investments from the debt brake. Let us examine these suggestions.
One might wonder why a constitutional rule on government debt is necessary, instead of letting the parliamentary majority decide on borrowing. The key argument for debt rules is that democratic processes often lead to more government debt than is economically wise. To keep the state effective long-term, there needs to be enough flexibility, especially for borrowing during crises. Germany has managed this well in past crises, whereas other European countries have struggled with rising interest rates and high debt.
Debt Brake: A Test for Government Priorities
In every government coalition, there are conflicts over spending priorities – whether it is additional social benefits, tax reductions, or support programs. These are often addressed by temporarily increasing budget deficits. Over time, this can lead to excessive borrowing, narrowing future financial options, intensifying resource conflicts, and reducing flexibility. Debt rules are meant to mitigate this.
But living at the expense of the future is not just about accumulating debt. Often, governments cut spending that would benefit the future to increase current financial flexibility. This includes investments in infrastructure, education, research, and efforts in climate protection and biodiversity preservation, which are often overlooked due to short-term budgeting strategies.
Investment Exceptions: A Logical Step?
Some critics of the current debt brake argue it does not differentiate between types of expenses financed by debt. They propose a “golden rule” allowing public investments to be financed through debt. The rationale is that if the government creates assets through investments that benefit the future, then it is reasonable for future taxpayers to share in their financing. This approach uses the fact that government debt can help distribute the financial burden over time. Moreover, public investments might boost future economic output, generating tax revenues to service the debts.
This seems reasonable, but effectively, it suggests allowing new debt only for net public investments. Regular maintenance or replacement of existing assets should not be financed with new debt to avoid a continuous increase in debt levels.
Should we then shift to a rule that permits debt for net investments? There are two main challenges. Firstly, distinguishing public investments from consumption expenses is difficult. While public construction projects are clearly investments, history shows that projects like water parks and regional airports have often imposed high follow-up costs on future generations, contributing little to productivity growth.
Education and the Investment Rule
Furthermore, using a narrow definition of investment overlooks some crucial areas. Education spending, although an investment in the future, largely involves personnel costs. Even with clear distinctions, the determination of net investments would need to consider depreciation. Given the demographic trend of more elderly people leaving the workforce than young people entering, the stock of human capital is declining. Here, depreciation exceeds investments, so a net investment rule would not permit debt financing for education, even with significant increases in educational spending. Spending on research and development counts as investment too, yet gauging depreciation here presents a complex challenge. When it comes to climate protection, figuring out net investments means sizing up the current capital stock against a backdrop of future scenarios – scenarios that are not only unknown but also shaped by political decisions.
In a reform process, there would be substantial political pressure to classify many types of public expenditures as investments. There would also be significant leeway in calculating depreciation. Consequently, such a reform would likely weaken the debt rule leading to permanently higher budget deficits. The urgency to address important reforms, like retirement or the reduction of environmentally harmful subsidies, would decrease, which could disadvantage young people.
The Strength of the Current Debt Rule
The current debt brake takes a different approach. It does not try to distinguish between investment and consumption spending. For significant government debt financing outside emergencies, one of two conditions must be met: either the expenditures are clearly for investment and can be financed through stakes in either public or private ventures. Then debt can be used. Or the expenditures enjoy broad societal support and a two-thirds majority in parliament is reached, as was the case with special debt for the Bundeswehr following the Russian attack on Ukraine. This framework ensures policymakers usually face the tough but necessary task of setting priorities among various government expenditures or tax burdens, maintaining enough leeway for emergencies, which may become more frequent due to global political circumstances.
Clemens Fuest
Professor of National Economics and Finance
President of the ifo Institute
Veronika Grimm
Professor of Economics and Head of the Chair of Economic Theory at Friedrich-Alexander-Universität Erlangen-Nürnberg (FAU)
Member of the German Council of Economic Experts
Published under the title “Deutschland in der Haushaltskrise: Hat die Schuldenbremse eine Zukunft?“, Der Tagesspiegel, December 4, 2023