[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 19.7.2006

SEC(2006) 990 final

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL

Assessment of the action taken by Germany in response to the Council Decision of 14 March 2006, in accordance with Article 104(9) of the Treaty, for the deficit reduction judged necessary in order to remedy the situation of excessive deficit

COMMUNICATION FROM THE COMMISSION TO THE COUNCIL

Assessment of the action taken by Germany in response to the Council Decision of 14 March 2006, in accordance with Article 104(9) of the Treaty, for the deficit reduction judged necessary in order to remedy the situation of excessive deficit

1. The excessive deficit procedure for Germany

Following evidence of a general government deficit above the Treaty reference value of 3% of GDP in 2002 and based on a recommendation from the Commission, the Council decided on 21 January 2003 that an excessive deficit existed in Germany (Article 104(6) of the Treaty)[1]. In addition, under the terms of the Stability and Growth Pact and based on a Commission recommendation, the Council adopted that same day a recommendation under Article 104(7) with a view to bringing an end to the situation of an excessive deficit. In 2005, the general government deficit in Germany amounted to 3.3% of GDP, according to the data provided by Eurostat based on the report pursuant to Council Regulation (EC) No 3605/93, which Germany submitted to the Commission on 24 February 2006. On 14 March 2006, the Council decided to give notice to Germany, in accordance with Article 104(9) of the Treaty[2], to take measures for the deficit reduction judged necessary in order to remedy the situation of excessive deficit " as rapidly as possible and at the latest by 2007 ". Specifically, the Council requested that " in 2006 and 2007, Germany shall ensure a cumulative improvement in its cyclically-adjusted balance net of one-off and temporary measures by at least one percentage point ". In addition, Germany was invited to " take the necessary measures to ensure that budgetary consolidation towards its medium-term objective of a balanced budget in structural terms is sustained through a reduction in the structural deficit by at least 0.5% of GDP per year after the excessive deficit has been corrected ". Finally, Germany was asked to " submit to the Commission, by 14 July 2006 at the latest, a report outlining the measures taken to comply with this Decision ", which is in line with Article 6 of Council Regulation (EC) No 1467/97, as amended by Council Regulation (EC) No 1056/2005[3], that sets the deadline for the Member State concerned to take measures at four months after the Council decision in accordance with Article 104(9) of the Treaty.

On 5 July 2006, Germany submitted to the Commission a comprehensive implementation report outlining the budgetary developments and plans in order to show compliance with the Council decision.

Article 9(3) of Council Regulation (EC) No 1467/97, as amended by Council Regulation (EC) No 1056/2005, states that, following the expiry of the deadline for a Member State to take measures following a 104(9) decision, "… the Commission shall inform the Council if it considers that the measures taken seem sufficient to ensure adequate progress towards the correction of the excessive deficit within the time limits set by the Council, provided that they are fully implemented and that economic developments are in line with forecasts ". In accordance with this Article, the present communication assesses the action taken by Germany in response to the Council Decision.

2. ACTION TAKEN AS REPORTED BY GERMANY

2.1. Government budget balance

Budget balance in 2006 and 2007

The implementation report submitted by the German authorities is based on the federal budget 2006, which was adopted by the Bundestag on 23 June 2006, and the draft federal budget 2007, which was adopted by the government on 5 July 2006, jointly with the report. Both budgets contain a number of measures, most of them already legislated or at least adopted as draft legislation by the government, which are documented in detail in the report. As regards the macroeconomic scenario as well as the budgetary projection, the report updates the information provided in the latest update of the stability programme, which was submitted by the German government on 22 February 2006.

The implementation report projects the general government deficit at 3.1% of GDP in 2006 and at 2½ % of GDP in 2007 (see Table 1)[4]. The improvement in the structural balance (the cyclically-adjusted balance net of one-off and temporary measures) is estimated by the Commission services on the basis of the data provided in the report at 0.9 percentage point of GDP in cumulative terms in 2006 and 2007.

According to the report, the revenue-to-GDP ratio would fall slightly in 2006 and 2007. In 2006, tax revenues in percent of GDP increase slightly, which is countered by a decrease in social contributions as a percentage of GDP due to the subdued development of the contribution base. In 2007, the increase in the standard VAT rate by 3 percentage points will boost tax revenues. Again, this is countered by a decrease in social contributions, due partly to a cut in the unemployment contribution rate and partly to the continuing subdued development of the contribution base[5]. Increases and cuts in various direct tax allowances tend to cancel out in 2006 and 2007. Furthermore, in both years other revenues are projected to decrease compared with 2005. The report projects the expenditure ratio to decline by 0.4 percentage points in 2006 compared with 2005 and by about ¾ percentage point in 2007 (see Table 1).

The projected fiscal consolidation is the result of a package of corrective measures adopted since late 2005, the most important of which is the 2007 VAT increase, though this will be partly offset by the reduction in social security contributions. The report also expects substantial savings on monetary transfers, in particular labour market expenditure, and some savings on capital transfers (from the abolition of the subsidy to private housing construction) and on social transfers in kind (new price regulation for medication).

Table 1: Comparison of key macroeconomic and budgetary projections

2004 | 2005 | 2006 | 2007 | 2008 | 2009 |

Real GDP (% change) | Report Jul 2006 | 1.6 | 1.0 | 1.6 | 1.0 | 1 ¾ | 1 ¾ |

COM May 2006 | 1.6 | 0.9 | 1.7 | 1.0 | -- | -- |

SP Feb 2006 | 1.6 | 0.9 | 1.4 | 1 | 1 ¾ | 1 ¾ |

Output gap (% of potential GDP) | Report Jul 20061 | -0.5 | -0.8 | -0.5 | -0.8 | -0.6 | -0.4 |

COM May 20062 | -0.4 | -0.6 | -0.1 | -0.3 | -- | -- |

SP Feb 20063 | -0.6 | -0.9 | -0.7 | -1.1 | -0.7 | -0.4 |

General government balance (% of GDP) | Report Jul 2006 | -3.7 | -3.3 | -3.1 | -2 ½ | -2 | -1 ½ |

COM May 2006 | -3.7 | -3.3 | -3.1 | -2.5 | -- | -- |

SP Feb 2006 | -3.7 | -3.3 | -3.3 | -2 ½ | -2 | -1 ½ |

Primary balance (% of GDP) | Report Jul 2006 | -0.8 | -0.5 | -0.3 | ½ | ½ | -- |

COM May 2006 | -0.8 | -0.5 | -0.3 | 0.3 | -- | -- |

SP Feb 2006 | -0.8 | -0.5 | - ½ | ½ | 1 | 1 ½ |

Revenues (% of GDP) | Report Jul 2006 | 43.2 | 43.4 | 43.2 | 43 | 42 ½ | -- |

COM May 2006 | 43.2 | 43.4 | 43.1 | 43.0 | -- | -- |

SP Feb 2006 | 43.2 | 43.4 | 43 | 43 | 42 ½ | 42 |

Expenditure (% of GDP) | Report Jul 2006 | 46.8 | 46.7 | 46.2 | 45 ½ | 44 ½ | -- |

COM May 2006 | 46.8 | 46.7 | 46.1 | 45.5 | -- | -- |

SP Feb 2006 | 46.8 | 46.7 | 46 | 45 | 44 ½ | 43 ½ |

Cyclically-adjusted balance (% of GDP) | Report Jul 20061 | -3.5 | -2.9 | -2.9 | -2.1 | -1.9 | -- |

COM May 20062 | -3.4 | -3.0 | -3.0 | -2.3 | -- | -- |

SP Feb 20063 | -3.4 | -2.9 | -2.9 | -1.8 | -1.5 | -1.1 |

Structural balance4 (% of GDP) | Report Jul 20065 | -- | -3.0 | -2.9 | -2.1 | -1.9 | -- |

COM May 20065 | -3.5 | -3.1 | -3.0 | -2.3 | -- | -- |

SP Feb 20065 | -- | -3.0 | -2.9 | -1.8 | -1.5 | -1.1 |

Government gross debt (% of GDP) | Report Jul 2006 | -- | -- | 68 ½ | 68 ½ | -- | -- |

COM May 2006 | 65.5 | 67.7 | 68.9 | 69.2 | -- | -- |

SP Feb 2006 | 65.5 | 67 ½ | 69 | 68 ½ | 68 | 67 |

Notes: 1 Commission services calculations on the basis of the information in the report. The estimated potential growth for the period 2004 – 2009 is 0.9%, 1.2%, 1.3%, 1.3%, 1.4 % and 1.4%, respectively. 2 Commission services spring forecast. The estimated potential growth for the period 2004 – 2009 is 0.8%, 1.1%, 1.2%, 1.2%, 1.1 % and 1.1%, respectively. 3 Commission services calculations on the basis of information in the stability programme. The estimated potential growth for the period 2004 – 2009 is 0.8%, 1.1%, 1.2%, 1.2%, 1.2 % and 1.2%, respectively. 4 Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures. 5 One-off and other temporary measures (0.1% of GDP in 2004 and 2005). Source: Report by Germany; Commission services’ spring 2006 economic forecasts (COM); Stability programme (SP); Commission services’ calculations |

The fiscal impact of these measures (as a percentage of GDP) compared with a no-policy change baseline is listed in Table 2, showing that the measures in total would have no impact on consolidation in 2006 and would make a contribution equalling 1.1% of GDP to consolidation in 2007, compared with the baseline[6]. This would ensure the correction of the excessive deficit by 2007 at the latest.

Table 2: Fiscal impact of discretionary measures compared with the baseline

2006 | 2007 | 2008 |

% of GDP |

Revenue | -0.08 | 0.60 | 0.76 |

Taxes | -0.08 | 0.97 | 1.12 |

Social contributions | -0.01 | -0.37 | -0.37 |

Expenditure | 0.10 | 0.46 | 0.59 |

Monetary transfers | 0.03 | 0.31 | 0.43 |

Capital transfers | 0.01 | 0.06 | 0.08 |

Public consumption | 0.07 | 0.09 | 0.08 |

Impact on budget balance in total | 0.0 | 1.1 | 1.4 |

(+: balance improving ) Source: Report submitted by Germany |

The report further contains a sensitivity analysis, according to which real GDP growth of ¼ percentage point higher than expected in 2006 would result in the correction of the excessive deficit already this year. In contrast, according to the report, a real GDP growth shortfall of ¼ percentage point in 2006 and of ½ percentage point in 2007 would still ensure the correction of the excessive deficit by 2007.

Budget balance in 2008 and beyond

The measures adopted are of a permanent nature and are expected to contribute increasingly to consolidation compared with the baseline. Accordingly, Germany envisages an improvement of the general government balance by ½% of GDP per year, to a deficit of about 2% of GDP in 2008 and 1½% of GDP in 2009. However, the structural balance (the cyclically-adjusted balance net of one-off and temporary measures) would, according to Commission services estimates on the basis of the data provided in the report, improve by only 0.2 percentage points of GDP in 2008.

The report takes into account that Germany is planning to introduce a reform of company taxation in 2008. While the specific features of the reform are still under discussion, the figures for 2008 and 2009 in the report include provisions for possible revenue shortfalls in the short term from this reform, in the order of 0.4% of GDP annually. The report acknowledges that this would postpone the path of structural consolidation, since the beneficial effects from the reform may materialise only with a lag.

2.2. Government debt

The general government debt amounted to 67.7% of GDP at the end of 2005, and the implementation report expects that the debt-to-GDP ratio will stabilise at 68½% in 2007 compared with 2006.

3. ASSESSMENT OF THE ACTION TAKEN BY GERMANY IN RESPONSE TO THE COUNCIL DECISION

The assessment of compliance with the Council decision under Article 104(9) is carried out against the background of the report submitted by the German authorities, the macroeconomic scenario laid out in the Council Decision and the Commission services' spring 2006 economic forecast.

Following a rate of 1.0% in 2005, the macroeconomic scenario underlying the implementation report projects GDP growth at 1.6% in 2006, 1.0% in 2007, and 1¾% in 2008 and 2009. This scenario is similar to the one underlying the Council decision in accordance with Article 104(9), which had projected real GDP to grow by 1.5% in 2006 (based on the Commission services' interim forecast of February 2006) and by close to 1% in 2007. The Commission services' spring 2006 economic forecast projects GDP growth rates of 1.7% for 2006 and 1.0% for 2007. Current economic developments do not give reason to revise the forecast.

3.1. Government budget balance

Budget balance in 2006 and 2007

The Commission services’ spring forecast projected the general government deficit at 3.1% of GDP in 2006 and 2.5% of GDP in 2007. The effects of budgetary developments after the cut-off date seem to be roughly neutral on balance, so that the deficit projection does not need to be revised at present[7]. Thus, the budgetary projection for 2006 and 2007 provided in the report seems plausible. The Commission’s current assessment of economic and budgetary developments in Germany indicates that the correction of the excessive deficit by the deadline set by the Council would be ensured.

At 43% of GDP for both years, the revenue ratio is similar to the Commission estimate. This is also true for the composition of revenues[8]. The projected decline in the expenditure ratio from 46.7% of GDP to 46.2% of GDP in 2006 and to 45½% of GDP in 2007 is also similar to the Commission services' projections. The February 2006 update of the stability programme, however, had planned the expenditure ratio to be reduced to 45% in 2007. The update had not specified in detail all the measures envisaged for the correction of the excessive deficit. In contrast, the implementation report contains such a list of measures (their impact is summarised in Table 2). However, compared with the projections provided in the update, the expenditure increase in the general government budget apparently originates from higher social benefits. The stability programme update had assumed the planned reform of the health care system to rein back expenditure growth[9], which, following the report, does not seem to apply to the extent estimated. Also, labour market expenditure, notably that for long-term unemployed ( Arbeitslosengeld II ), seems to overshoot the budgetary plans of February 2006, with repercussions into 2007.

On the basis of the growth projections of the Commission services' spring forecast, the improvement in the structural balance in cumulative terms in 2006 and 2007 is estimated to amount to 0.8 % of GDP[10], which is somewhat lower than, but still close to, the structural adjustment of 1 percentage point recommended by the Council. It would nevertheless ensure the correction of the excessive deficit in 2007 by a sufficient margin.

As the implementation report details, the process of passing the consolidation measures into law is well advanced, but a significant proportion of them have yet to enter into force. A rigorous budgetary execution would especially be needed to address the higher-than-expected social transfers.

Budget balance in 2008 and beyond

According to the implementation report, the general government deficit is planned to continue decreasing after the expected correction of the excessive deficit by 2007. Indeed, the adopted measures are of a permanent nature. The updated stability programme set the medium-term objective at budget balance in structural terms, which, however, it did not expect to achieve within the programme period. According to Commission services’ calculations based on the data provided in the report, the improvement in the structural balance would fall short of the 0.5 percentage point benchmark in 2008.

The report estimates the budgetary risk from the planned (but not yet fully specified) reform of company taxation, to be implemented in 2008, at 0.4% of GDP. This had not been taken into account in the update of the stability programme, on the basis of which the Commission estimated a structural improvement of 0.3 percentage points in 2008[11]. In its opinion on the updated stability programme of 14 March 2006[12], the Council therefore invited Germany to ensure “that the announced reform on corporate taxation does not jeopardise the fiscal consolidation”.

3.2. Government debt

According to the Commission services' spring 2006 economic forecast, the government debt ratio is projected to rise from 67.7% of GDP in 2005 to 68.9% of GDP in 2006 and 69.2% of GDP in 2007. The small difference between the Commission services' forecast and the projection provided in the implementation report, which foresees a stabilisation of the debt at 68½ % in 2006 and 2007, might be due to a different projection of privatisations and similar transactions, which are undertaken by budgetary authorities in Germany to meet national budget rules expressed in cash statistics[13].

The Commission services' spring forecast, as the implementation report, only covers the evolution of the debt up to 2007. Beyond that year, given the expected increase in nominal GDP growth and the reduction on the overall deficit, the debt should start declining over time. The updated stability programme, which did not yet include the higher deficit for 2008 and 2009 due to the company tax reform, envisaged for those years a reduction in the debt ratio to be achieved through "stock-flow adjustments", which were however not specified in the update. As already stated by the Council in its opinion of 14 March 2006, “the evolution of the debt ratio might be less favourable than projected in the programme, given the risks to the budgetary targets […]. In view of this risk assessment, the debt ratio may not be sufficiently diminishing towards the reference value.” As noted above, risks about the budgetary targets for the years after 2007 remain, including now possible revenue shortfalls from the company tax reform which would slow the pace of debt reduction. Ensuring for the years after 2007 larger surpluses than currently envisaged in the primary balance to accelerate the achievement of the medium-term budgetary objective would by contrast hasten the pace of debt reduction.

4. Conclusions

On current information, it appears that Germany has taken action representing adequate progress towards the correction of the excessive deficit within the time limits set by the Council, namely by 2007 at the latest.

In particular, Germany has adopted a comprehensive package of corrective measures since late 2005, which, if fully implemented and effective, would ensure that the deficit falls below the 3% of GDP reference value by 2007. The reduction in the cyclically-adjusted deficit, excluding one-off and other temporary measures, in cumulative terms in 2006 and 2007 is estimated to be close to that recommended in the Council Decision.

In view of the above assessment, the Commission considers that no further steps in the excessive deficit procedure of Germany are needed at present.

In line with the Council decision, the measures adopted are of a permanent nature, which should ensure that the nominal deficit remains well below 3% of GDP beyond 2007. However, on current information, the adjustment in the years beyond 2007 falls short of the improvement in the structural balance of 0.5 percentage point of GDP required by the Council in order to rapidly achieve the medium-term objective of a balanced budget in structural terms.

The Commission will continue to closely monitor budgetary developments in Germany in accordance with the Treaty and in consideration of the reporting requirements for Germany as stipulated in the Council Decision according to Article 104(9) of 14 March 2006.

[1] All documents pertaining to the excessive deficit procedure for Germany can be found on the following website: http://europa.eu.int/comm/economy_finance/about/activities/sgp/edp/edpde_en.htm.

[2] OJ L 126, 13.5.2006.

[3] OJ L 209, 2.8.1997 and OJ L 174, 7.7.2005.

[4] Note that, except for a few variables in 2006, the report (as well as the stability programme updates) uses rounded figures.

[5] In the health care system it is assumed that balance would be restored by 2007, brought about to equal extent by higher revenues and expenditure reductions.

[6] The report points out that this would not be equivalent to the structural adjustment because the total impact of the legal measures are compared with the baseline, whereas the structural adjustment takes a year-on-year view.

[7] Because of the usual assumption of unchanged policies after the cut-off date, the Commission services spring forecast did not take into account the recently adopted law on tax law changes 2007 ( Steueränderungsgesetz 2007 ), which contains cuts in tax allowances such as the reduction in the allowance for commuters, contributing about 0.1% of GDP of further savings in 2007. However, higher revenues are balanced out by the additional expenditure planned in the recently adopted draft law on the new support for child-raising ( Elterngeld ) and risks in budgetary execution, notably higher-than-projected transfers to long-term unemployed ( Arbeitslosengeld II ) and higher health care expenditure, that have appeared after the publication of the forecast.

[8] On 12 July 2006, the government sketched out measures in the health care system, among them a rise in the contribution rate by 0.5 percentage point as from 2007. This has also been projected in the Commission services' spring forecast as the health insurers' response to expenditure developments.

[9] For a detailed discussion, see the Commission services' technical assessment of the stability programme update, available at:http://ec.europa.eu/economy_finance/about/activities/sgp/country/commwd/de/com_de20052006.pdf

[10] This is somewhat lower than the figure in the report (based on Commission services' calculations given the data in the report according to the commonly agreed methodology). The difference is explained by somewhat higher values for potential growth in the German projection, which influence the output gap and, hence, the cyclical adjustment.

[11] As a result of the customary rounding applied by Germany when presenting budgetary projections, this is not visible in Table 1, where the deficit projections remain seemingly unchanged at 2 % for 2008 and 1½ % for 2009. However, while in the Stability Programme of February, the projections were at the lower end of the rounding range, they are now at the upper end in both years.

[12] OJ C 82, 5.4.2006.

[13] For example, as from 2006, companies have to carry forward their monthly social contributions from the middle of the following month to the end of the month when the payment is due. This will lead to thirteen instead of twelve cash payments in 2006, providing temporary cash relief until 2007 to the social security systems. While this is budget neutral in ESA95 accounting rules – leading to a deficit in the social security systems – net borrowing in cash terms will be substantially reduced, which would dampen the growth of gross debt.