EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 504 final COMMISSION STAFF WORKING DOCUMENT Country Report Germany 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2020) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Summary of the main findings from the MIP in-depth review 3.1.Imbalances and their gravity 3.2.Evolution, prospects, and policy responses 3.3.Overall Assessment 4.Reform priorities 4.1.Public finances and taxation* () 4.2.Financial sector* 4.3.Labour market, education and social policies* 4.4. Competitiveness reforms and investment* 4.5. Environmental sustainability* Annex A: Overview table Annex B: Commission debt sustainability analysis and fiscal risks Annex C: Standard tables Annex D: Investment Guidance on Just Transition Fund 2021-2027 for Germany Annex E: Progress towards the Sustainable Development Goals (SDGs)

References LIST OF Tables Table 1.1:Key economic and financial indicators — Germany Table 2.1:Implementation of 2019 CSRs Table 3.1:Outward spillover heat map for Germany Table 3.1a:Spillover effects of Germany implementing a comprehensive investment package over 10 years Table 3.2:MIP Assessment Matrix Table 4.2.1:Quarterly financial soundness indicators Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth Table E.1:Indicators measuring Germany’s progress towards the SDGs LIST OF Graphs Graph 1.1: Demand components of GDP growth Graph 1.2: Developments in manufacturing

Graph 1.3: New car registrations by fuel type Graph 1.4: Contributions to headline inflation Graph 1.5: Net and gross investment in international comparison Graph 1.6: Real ULC, labour share of GDP/GVA, % Graph 1.7: Change in GDP per head (2010-2017) in Germany by NUTS-2 region Graph 1.8: Current account and component balances Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date Graph 4.1.1: Headline balance (HB), structural balance (SB) and fiscal space Graph 4.1.2: Tax wedge for different income levels, DE, FR, UK, EU-28, 2018 Graph 4.1.3: Structure of environmental tax revenues, 2017 Graph 4.1.3a: Environmental tax scenarios: distributional and equity effects, with and without compensatory measures Graph 4.1.4: Net pension replacement rates for low and high earners (2018) Graph 4.2.1: House prices compared to fundamentals Graph 4.2.2: Current account balance and net lending by sectors Graph 4.2.3: Factors explaining the current account surplus Graph 4.3.1: Employment change by sector, workers in short time work arrangements Graph 4.3.2: Nominal compensation growth: actual and predicted based on economic fundamentals Graph 4.3.3: Years of difference in life expectancy between people with highest and lowest education (at age 40) Graph 4.4.1: Contribution to labour productivity growth, percentage points

LIST OF Boxes Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Germany Box 3.2: Spillovers of a sustained increase in public investment – the case of Germany Box 4.1.3: The 2030 Climate Package Box 4.1.4: The distributional and equity effects of introducing a CO2 price Box 4.3.5: Monitoring performance in light of the European Pillar of Social Rights Box 4.4.6: Investment challenges and reforms in Germany Box 4.5.7: Transformation of the transport sector Executive summary Sustained structural reforms and long-term investment can ensure the sustainability and inclusiveness of Germany’s growth. In its tenth year of expansion, the German economy grew significantly below potential, affected by an interplay of transformations in industry and adverse external factors. At the same time, progress on reforms has been only moderate. On the positive side, the labour market remains very strong, with wages increasing despite the economic slowdown, and measures have been taken to improve incentives to work. However, significant challenges remain, including investment in education, sustainable transport, affordable housing, energy and digital infrastructure. In addition, regulatory and other incentive structures, including taxation, do not appear sufficient to boost inclusive and sustainable growth. While Germany’s income inequality is average, its wealth inequality is high. Improving equality of opportunity, by reinforcing education and training, and addressing inter- and intra-generational fairness issues also through social security systems can contribute to more inclusive growth. ( ) Domestic demand is the sole driver of a slowing economic expansion. The German economy, with its export-oriented manufacturing base, is challenged by persistent global uncertainty, trade tensions and weaker foreign demand for German goods, and by the need to make the transport sector less environmentally harmful. After a 1.5% increase in 2018, GDP grew by 0.6% in 2019. The contribution of net exports was negative as in the year before and growth was driven by domestic demand. Despite weakness in manufacturing, unemployment fell to a record low of 3.2% in 2019. Wage growth has been so far resilient to the economic slowdown. Inflation fell from 1.9% in 2018 to 1.4% in 2019, notably due to a strong decline in energy prices. The general government budget surplus, while still considerable, is diminishing on the back of increased investment, and the public debt continues to fall. In 2018, the general government fiscal surplus reached a record 1.9% of GDP. In 2019, the surplus lowered to 1.5% and is expected to decline further in 2020, due to increased investment and other fiscal measures. For the first time since 2002, the gross debt-to-GDP ratio is expected to have fallen below the Treaty reference value of 60% of GDP. The public debt ratio might decline further as a result of the national debt brake becoming binding also for the Länder as of 2020. This will require them to make no new structural deficits, which further reduces sustainability risks. Meeting sustainability goals and raising growth potential at the same time requires steady long-term investment efforts, in particular in network industries and in education, training, research and innovation. Stronger investment in sustainable transport and electricity infrastructure is crucial to meeting climate, energy and environmental targets. Despite the key incumbent player being largely state-controlled, Germany is still lagging behind in deploying very high-capacity broadband, which could improve productivity growth and boost convergence in regional living conditions. Higher investment in research and innovation can accelerate the pace of transition to a carbon-neutral and circular economy. Higher expenditure on education and skills could make the future labour force more productive and alleviate the impact of demographic ageing. Overall, Germany has made limited ( ) progress in addressing the 2019 country-specific recommendations. There has been some progress in: ·achieving an upward trend in investment, including in research and innovation; ·strengthening conditions for wage growth, reducing disincentives to work more hours and reducing the high tax wedge. Germany has made limited progress in:

·increasing expenditure in education and improving the educational outcomes and skills levels of disadvantaged groups; ·improving investment in digitalisation and very high-capacity broadband, in energy networks, sustainable transport and affordable housing; ·shifting taxes away from labour to sources of revenues the taxation of which would be more supportive to inclusive and sustainable growth, and reducing disincentives to work for second earners; ·reforming the pension system. Germany has made no progress on: ·business services and regulated professions. Germany continues to perform very well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. It has one of the highest employment rates in the EU, low unemployment, including youth and long-term unemployment, and access to healthcare is good. Germany has one of the highest employment rates of women, but the gender gap in part-time employment is high. Educational outcomes differ considerably across regions. Regarding progress in reaching the national targets under the Europe 2020 strategy, Germany is performing very well on the employment rate, on reducing poverty and on investment in R&D. In addition, Germany is close to its national target for early school leaving and share of renewable energy. However, despite the recently adopted Climate Package Germany is unlikely to reach its 2020 national energy efficiency and climate targets by 2020. Germany is not on track to reduce its emissions not covered by the EU Emissions Trading System as set in EU law. With regard to Germany’s progress towards the United Nations Sustainable Development Goals over the past 5 years, Germany shows a declining trend in reducing inequality, but has further improved its strong institutions and justice system. ( ) The main findings of the in-depth review contained in this report and the related policy challenges are as follows: ·The current account surplus declined from its peak in 2015. The current account surplus declined from 8.6% of GDP in 2015 to 7.4% in 2018. In 2019, the downward adjustment paused and the overall current account surplus was 7.7% of GDP (according to preliminary data). Vis-à-vis the euro area it declined to 2.2%, from 2.7% in 2015. The domestic imbalance between savings and investment, which has been growing since 2008, reached a turning point in 2016. Since then, private sector net lending has been coming down, mainly reflecting the decline in the net lending position of non-financial corporations, but was partially offset by an increasing public surplus until 2018. ·Private investment remains solid despite the economic slowdown, but still lags behind infrastructure and housing needs. In 2018 and 2019, private investment increased by 3% in real terms (i.e. adjusted for inflation). Altogether, the private investment share of GDP increased from 18% in 2011-2017 to 19% in 2018-2019. The fastest growing components in recent years have been housing and investment in intellectual property. However, investment is still lagging behind infrastructure (e.g. energy and digital) and housing needs, and the need to adapt to tighter environmental requirements. ·Public investment has continued increasing against the backdrop of a significant investment backlog. Gross public investment increased by around 6% annually in 2015-2017, by close to 9% in 2018 and by close to 7% in 2019 in nominal terms. In real terms, the increase averaged about 4% in 2015-2019 as price inflation for construction works accelerated in recent years. This brought the public investment rate from 2.1% of GDP in 2015 to 2.5% in 2019. Since 2017, total government net investment has turned positive, but it is still negative at municipal level, where the investment backlog remains high at 4% of GDP. ·Higher public investment would generate positive domestic and cross-border spillovers. Substantially increasing the public investment rate can boost output and employment in both Germany and the rest of the euro area. Germany also plays an important role in advancing the single market. However, it is performing below the EU average in the transposition of single market rules. Obstacles include restrictive regulation in business services and public procurement practices. ·Labour productivity growth in Germany shows a long-term declining trend and turned negative in 2018, due to cyclical factors as well as structural weaknesses. The recent decline in labour productivity was mainly driven by a decline in output in manufacturing, and in the automotive sector in particular. Structural factors explaining the long-term decline in productivity include weak growth-enhancing investment, in intangible assets and among small and medium-sized businesses (SMEs) in particular, lack of modern digital infrastructure, demographic developments and shortages of skilled labour, a decline in business dynamism, slow technology diffusion, weaknesses in eGovernment, and low competition in business services. ·Improving resource productivity can be an important driver for future competitiveness, while minimising negative environmental impacts. Despite resource efficiency gains and a relative decoupling of raw material use and economic growth, natural resource use remains at an environmentally unsustainable level. Germany will miss its target of doubling raw material productivity by 2020, and its secondary raw material use rate is below the EU average. Moving to a circular economy can generate cost savings and create jobs, while reducing the environmental footprint. ·Despite the GDP slowdown, overall wage growth continued, as unemployment reached historically low levels. Labour market performance remained remarkably strong, despite the marked slowdown in economic growth. This, however, hides some labour hoarding and diverging trends between services and manufacturing. While job creation in manufacturing and related services halted, hiring continued in construction and most services, particularly in public services. Despite decelerating employment growth and declining labour productivity, growth of nominal and real compensation per employee has accelerated between 2018 and 2019. However, the labour market potential of women and people with migrant background remained underused. ·The tax system relies strongly on labour tax revenues, while taxes supporting inclusive and sustainable growth remain underused. The share of labour tax revenues (56.9% of total tax revenue) is among the highest in the EU. Despite measures taken, disincentives to work persist, including for second and low-wage earners. At the same time, revenues are low from taxes supporting sustainability and inclusiveness goals, such as environmental taxes (4.5%), recurrent taxes on immovable property (1.1%) and wealth and inheritance- related taxes (0.4%). ·The tax system is not sufficiently addressing climate change and environmental degradation. Germany’s environmental tax revenues remain among the lowest in the EU, stemming primarily from energy-related taxes, while revenues from transport fuel taxes and taxes on resources are particularly low. Current price signals across energy carriers and users limit the potential for clean energy technology deployment and emissions reduction. As environmental taxes are typically regressive, their increased use needs to be coupled with policy measures mitigating the impact on the vulnerable population groups. ·The energy transition requires investments in electricity networks, smart sector integration and energy efficiency, and expansion of renewable energy. The lack of appropriate transmission and distribution grid infrastructure is causing financial losses and market distortions in Germany and other EU countries due to congestion and limited flexibility of the electric system. The need for investment in additional transmission capacity is growing. Taxes and levies limit the smart integration of electricity in the heating, transport and industry sectors. The installation of wind turbines show a declining trend.

·Transformation of the transport sector can address air pollution, mitigate climate change and improve productivity. The transport sector has done particularly badly at cutting emissions of both greenhouse gases and local air pollutants, which has meant that Germany has fallen behind in meeting its target under the Effort Sharing Decision setting national emission targets for EU countries between 2013 and 2020. The transformation of the transport sector can be facilitated by stronger investment in clean public transport and infrastructure, including in alternative fuels such as hydrogen and e-fuels. In addition, appropriate incentive structures are needed for clean, safe and better-performing mobility solutions, which would encourage technological competition and spur innovation. ·The lack of affordable housing has become a major challenge. The housing cost overburden rate is one of the highest in the EU. House prices rose by half over the last decade, suggesting overvaluation in the bigger cities and an increasing risk of a housing bubble. Policy measures mitigate rental price increases, but do not keep pace with the demand for affordable housing. The annual target for new housing agreed on by the country’s governing coalition was not met. Other key structural issues analysed in this report, which point to particular challenges for Germany's economy, are the following: ·The banking sector suffers from low profitability. Capitalisation ratios are satisfactory, but German banks face challenges related to their cost structure. Consolidation efforts are needed, as a fragmented market structure weighs on profits. The disruption initiated by fintech and bigtech may further squeeze revenues. There is also a need to strengthen macro-prudential tools. ·Overall, Germany’s social protection system is well-developed, but increasingly affected by demographic developments. Demographic change is expected to challenge the sustainability and the adequacy of pensions. Furthermore, the large gap in life expectancy across socio-economic groups, combined with the relatively low pension net replacement rates for low-income earners compared to other countries,raises the issue of intra-generational fairness.. Healthcare efficiency can be improved by consolidating the hospital sector, focusing more strongly on prevention and care integration, providing the same price signal for the same treatment, and better use of eHealth. ·Challenges in equality of opportunity persist also in the education and training system. Germany is spending less of its resources on education than it did in the past and also at a rate below the EU average, even though the country is particularly affected by automation and immigration. Inequalities in educational attainment persist, with socio-economic and migrant backgrounds still exerting a strong influence. Teacher shortages threaten the provision of quality education. · The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for the period 2021-2027, includes a Just Transition Fund, a dedicated just transition scheme under InvestEU, and a new public sector loan facility with the EIB. It is designed to ensure that the transition towards EU climate neutrality is fair by helping the most affected regions in Germany to address the social and economic consequences. Key priorities for support by the Just Transition Fund, set up as part of the Just Transition Mechanism, are identified in Annex D, building on the analysis of the transition challenges outlined in this report. 1. Economic situation and outlook Economic growth The economic expansion slowed sharply in 2019. Growth has been uneven and fragile since 2018, following the pattern of export growth and held back by the pronounced weakness of manufacturing activity. After a rebound to 0.5% in Q1 2019, the economy contracted by 0.2% in Q2 and narrowly avoided a technical recession in Q3 (+0.1%). Overall investment increased robustly early in the year (by 1.6%), but weakened in the subsequent quarters (‑0.3% and ‑0.1%). For the year as a whole GDP increased by just 0.6%, slowing further compared to the buoyant growth averaging 2.2% in 2014-2017. Graph 1.1:Demand components of GDP growth Source: European commission The domestic side of the economy remained resilient and employment reached a new record high. Despite the weakness in activity and deteriorating business sentiment, the labour market remained strong. Job growth continued in the services sector. Layoffs in industry remained contained, as companies try to avoid losing skilled workers and to stay fit for an upswing. Wages continued to grow. This helped consumption growth stay relatively steady at 0.4% quarter on quarter on average. Public consumption supported growth. The buoyant growth in construction continued. There was a mixed picture in services, with public and consumer services showing resilience, while business-related services, including transport, remaining weak. Germany’s economy is expected to see muted growth in 2020 and 2021. Consumption should continue benefitting from stable employment and ongoing wage increases. Even if constrained by capacity, construction activity is expected to continue expanding. Equipment investment should strengthen as export activity normalises as expected in a few quarters. The ten-year expansion is set to continue. However growth is expected to remain subdued at just above 1% in 2020 and 2021 and thus well below the potential estimated at 1.4% for 2019-2021. These prospects are subject to downside risks. Risks for exports and investment relate to global growth and trade uncertainty, sectoral structural issues (e.g. in the auto sector). Planning and implementation capacity in the public sector could constrain the further expansion of public investment. Recent strong wage growth has boosted the saving rate and this trend could be reinforced if consumer confidence deteriorates. Graph 1.2:Developments in manufacturing Source: Eurostat, German Association of the Automotive Industry (VDA) Manufacturing weakness is weighing on economic growth. Export growth slowed considerably and the production side of the economy weakened further in 2019. In Q4 manufacturing continued to decline for the sixth consecutive quarter since early 2018. The car-manufacturing sector is undergoing a structural transformation and production is depressed while equipment manufacturers are adversely affected by the impact of trade conflicts and weakening global trade on investment demand. Graph 1.3:New car registrations by fuel type Source: German Federal Motor Transport Authority Car production in Germany has shrunk considerably, while German carmakers produced more abroad. The automotive industry is Germany's most important manufacturing sector and accounts for about 22% of manufacturing value added, 4.7% of total value added and about 4% of employment. Through its complex value chain, it has a significant impact on the overall dynamics of manufacturing (Graph 1.2). The industry is experiencing a significant decline in domestic production. The production of 5.1 million vehicles in 2018 represented a 9.3% decline from 2017. At the same time, German companies increased their production abroad by 3.7%, to 11.2 million. The domestic trend continued in 2019: domestic production tumbled by another 5% to 4.7 million and reached a level close to the lows seen in 2009 (Graph 1.2), while production abroad continued at the same level of 11.2 million cars. The prospect of a swift recovery is dimmed by the current “wait-and-see” attitude of potential car buyers. The decline in new car registrations in Germany and the EU in general has been driven largely by falling demand for diesel cars. Demand for diesel cars has declined while the share of alternative-fuelled cars is increasing slowly. In the first half of 2019, registration of new diesel cars in the EU dropped 17% year on year, after an 18% year on year drop in 2018. Following the 2015 diesel scandal and reinforced plans for reducing emissions through stricter regulations, the demand for cars with traditional internal combustion engines, and diesels in particular, is falling. Several Member States and cities have adopted ambitious plans to reduce air pollution, including by restricting diesel entry into city zones. Some countries plan to ban sales of new petrol and diesel cars in a decade or two. In Germany the number of new registrations of diesel cars stabilised in 2019 after a drop since the diesel scandal (Graph 1.3). Hybrid vehicles and electric vehicles are clearly the fastest growing segment in new car registrations, but as a proportion of total cars in use, their share is still very low, below 1%. Demand is switching above all to hybrid cars, (of which plug-in hybrids are a small part), rather than purely electric driven models. This could help bridge the performance gaps of the electric vehicles currently available while still getting the transition to low-emission local and long-distance road transport underway (see Box 4.5.7). Graph 1.4:Contributions to headline inflation Source: European Commission

Inflation Inflation should remain moderate. Consumer price inflation has been running below wage growth, which is supportive of purchasing power. Having been close to 2% in 2018, the Harmonised Index of Consumer Prices inflation declined to just above 1% in the second half of 2019. Not taking into account volatile energy and unprocessed food prices, it hovered around 1.4% throughout 2019. Inflationary pressure is expected to remain contained and inflation not to change significantly, reflecting the moderate level of domestic demand projected. Graph 1.5:Net and gross investment in international comparison Source: European Commission, AMECO database Investment Public investment has continued increasing against the backdrop of a significant investment backlog, and is likely to increase further with the 2020 budget. Gross public investment increased by around 6% annually in 2015-2017. It then grew by close to 9% in 2018 and close to 7% in 2019 in nominal terms. In real terms the increase averaged about 4% in 2015-2019 as price inflation for construction works was high (more than 4.5% on average) in 2017-2019. This raised the public investment rate from 2.1% of GDP in 2015 to 2.5% of GDP in 2019. In 2017 and 2018, total government net investment turned positive for the first time since 2012 (0.12% of GDP, compared to 0.03% for the euro area). In 2018, this development was driven by municipal investment, where, however, net investment remains negative and needs to catch up with depreciation. The investment gaps identified by municipalities remain high at € 138.4 billion. Data for January-September 2019 suggest that, investment growth intensified at the level of municipalities. Private investment remains solid despite slowing economic growth. Private investment increased strongly in real terms in total (3%) and across most asset types in 2018 (housing 3%, equipment 3.9%, other investments 4.7%). Only non-residential construction investment growth remained subdued. In 2019, real investment continued increasing somewhat more slowly (2.4%). Non-residential investment picked up speed, while equipment investment growth weakened. Altogether, private investment’s share of GDP increased to 19.2% in 2019. The fastest growing components in recent years have been housing (see Section 4.4) and other investment (comprising essentially research and development and other intellectual property). Equipment and non-residential construction have seen their shares of investment change little. The aggregate net investment rate remains relatively low by historical and international standard. The gross investment rate increased to 21.7% in 2019, the highest level since 2001. It has also been above the level in the rest of the euro area since 2010. By contrast, following a globally relevant trend, Germany’s net investment rate has been declining over the long term, possibly reflecting factors like the rapid capital accumulation as economies were rebuilt after the Second World War. It has remained subdued since the turn of the century after an initial post-unification surge. Currently it ranges around the average for the rest of the EU15 (the 15 countries which were Member States before the 2004 enlargement of the EU) but significantly below the levels for peers like the US or France. For example, irrespective of the generally high quality of transport infrastructure, the effects of insufficient infrastructure investment in recent years continue to be felt, adding to concerns about road maintenance and congestion, also in view of Germany’s role as a transit country, north-south but also east-west. Investment in transport infrastructure in recent years has stayed constant below 0.6% of GDP. Germany’s highly developed infrastructure would benefit from a consistent and long-term-oriented effort to maintain it and keep it up-to-date. Labour market Labour market performance remained remarkably strong, despite the marked slowdown in economic growth. The unemployment rate continued to decline, stabilising at a post-reunification low of around 3.2% 2019. The employment rate for the 20-64 age group is up by about 1 percentage point from a year before, at 80.5% in the third quarter of 2019, one of the highest in the EU. Still, employment growth has been slowing, and companies in the manufacturing sector increasingly rely on short-time-work arrangements to avoid dismissals (see Section 4.3). While labour shortages are still apparent in some sectors, Germany does not fully use the labour market potential of some groups and female part-time work remains among the highest in Europe. Graph 1.6:Real ULC, labour share of GDP/GVA, % Source: Destatis, European Commission Aggregate wage growth increased in 2018 and 2019, while a deceleration is expected for 2020. Gross nominal wages and salaries per employee increased by 2.5% in 2016, 2.6% in 2017 and 3.2% in 2018 and 2019, driven by the increasingly tight labour market. These developments come after a prolonged period of wage moderation during which wages did not keep up with productivity and external imbalances accumulated (see Section 4.3) and wage growth, both nominal and real, is expected to ease again slightly in 2020. A drop in labour productivity growth, coupled with wage increases, contributed to increasing unit labour costs. As employment levels remained high while production declined in the manufacturing sector and job growth continued in the non-tradable sector, overall productivity growth turned negative in early 2018 (see also Section 4.4.1). While labour productivity declined by 0.3% in 2019, nominal compensation of employees increased by 3.3%, leading to a unit labour cost increase of 3.6%. This contributed to some rebalancing of the German economy vis à vis the rest of the euro area. The real effective exchange rate appreciated, due partly to the nominal effective appreciation of the euro. Social developments While the risk of poverty or social exclusion continues to decline moderately, rising income inequality raises concerns. In 2018, 18.7% of the population were at risk of poverty or social exclusion. This was a further small improvement from 2017 (19%) and the peak reached in 2014 (20.6%). In addition, in the past five years Germany made significant progress in reaching the SDG 1 (People at risk of poverty or social exclusion). Similarly, the disposable income of households continued to grow. Yet, in 2018 the income share of the bottom 60% of the population fell by 2.5% compared to the previous year, while the top 20% saw their income share increase by 3.7%. In 2018, the richest 20% of households had a disposable income five times higher than that of the poorest 20%, with an increase in this gap observed since 2017, flagging as “to watch” according to the Social Scoreboard. Still, this ratio is in line with the euro area average. Wealth inequality remains high: in 2017, the richest 10% of households possessed around 55% of total net wealth, and the Gini coefficient for household net wealth was 74%. This was slightly below its value in 2014 (76%) but remained well above the level for the euro area as a whole (68.5% in 2014) (Bundesbank, 2019). The uneven profile of property ownership and steeply rising house prices (see Section 4.2 and 4.4) are likely to have been strong contributing factors to this trend, while the tax system plays some role in addressing Germany’s high wealth inequality (see Section 4.1). Graph 1.7:Change in GDP per head (2010-2017) in Germany by NUTS-2 region Source: Eurostat Regional disparities Regional disparities in Germany have steadily decreased since 2001, especially between the east and west of the country, but the gap between the most and least developed regions of the country remains wide. Even though they have caught up in the last three decades, the least developed regions remain in the east. GDP per inhabitant of the eastern regions in 2018 represented 74.7% of the west German level, with the difference narrowing over the last decade. Nevertheless, between 2010 and 2017 GDP growth per capita exceeded 2.3% in several German regions, such as Oberfranken and Unterfranken in Bavaria, Chemnitz and Thuringia. However, other Eastern regions like Mecklenburg-Western Pomerania (1.0%) and Berlin (1.1%) have been growing at a slower pace than the rest of the country (1.8%) and the EU economy (1.2%). (see Graph 1.7). Regional disparities across Germany also exist with regard to competitiveness, productivity, investment, unemployment rates and demographic developments (see Section 4.4). Graph 1.8:Current account and component balances Source: German Bundesbank, European Commission External sector The gradual decline in the current account surplus since 2015 temporarily paused in 2019. The current account surplus for 2019 stood at 7.7% of GDP. Compared to 2018, the trade surplus increased by 0.3 pp. of GDP reflecting cheaper energy imports and weak demand for imported inputs by the manufacturing sector. The primary income balance increased by 0.1 pps. The services balance and the secondary income balance remained unchanged.

The transformation of the automotive sector is reflected in the evolution of the trade balance. Net automotive exports continued to decline and account for much of the decline in the trade surplus since 2015. This trend continued in recent quarters as automotive imports increased further while exports declined or stagnated relative to GDP. This reflects both the global slowdown in overall demand for cars and the relocations abroad of a sizeable share of the production of German-branded cars. Public finances Despite weakening growth, the budget surplus remains considerable and the fiscal position favourable, while government debt continues its downward path. Germany’s public finances benefited over recent years from the favourable economic situation, with tax revenues growing more strongly than expected and interest payments declining fast due to the low interest rate environment. Having peaked at 1.9% of GDP in 2018, the headline balance declined to 1.5% in 2019, reflecting the effects of fiscal measures and to some extent the slowdown in the economy. Nevertheless, in 2019 the fiscal position, as measured by the structural budget balance over the medium-term budgetary objective at currently ‑0.5% of GDP, remained favourable. It is set to decline gradually in the coming years, as tax revenues are projected to increase less strongly and the implementation of government measures increases overall expenditure (European Commission, 2019a) (see also Section 4.1). Overall, Germany performs well in achieving the Sustainable Development Goals. According to Eurostat’s Sustainable Development Goals (SDGs) indicators (see Annex E), Germany has been making progresses on most goals over the past 5 years. It is particularly the case for “Peace and justice” (SDG 16) and “Decent work and economic growth” (SDG 8) and “Partnerships for the goals” (SDG 17). In addition, most outcomes are above the EU average for “Good health and well-being” (SDG 3). On the other hand, some deterioration can be observed in reducing inequality (SDG 10), in sustainable transport (SDG 9) and most indicators remain below the EU average for “Responsible consumption and production” (SDG 12). Table 1.1:Key economic and financial indicators — Germany Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, Autumn forecast 2019 otherwise); Deutsche Bundesbank; Destatis 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, Germany has made at least “some progress” with 54% of all its country-specific recommendations. However, 46% of the country-specific recommendations (CSRs) recorded ‘limited progress‘ or ‘no progress‘ (see Graph 2.1). Compared to 2014-2017, Germany’s implementation of CSRs has improved recently, though only to a limited extent, and is now roughly in line with the average progress made by other Member States. Graph 2.1:Overall multiannual implementation of 2011-2019 CSRs to date Source: European Commission Public finances have kept improving and measures have been taken to increase public investment. Yet, further efforts to address the savings investments imbalance would be welcome. Between 2011 and 2019, Germany’s fiscal position improved considerably, in line with CSRs from the early 2010s regarding compliance with the medium-term budgetary objective and reducing debt. The good fiscal position also created room to intensify investment, and the public investment rate increased from 2.1% of GDP in 2015 to 2.5% of GDP in 2019. Still, a significant investment backlog remains, with investment gaps persisting in particular at municipal level in education and infrastructure. Progress towards efficient market structures has been moderate. While the competition law framework was improved, little has been done to open up public procurement and allow more entry into business services and regulated professions, even though complaints abound about a lack of capacity. Barriers to competition in railways have been reduced only to a limited extent. Improvements in network industries such as telecommunications, energy and transport, have been limited overall, reducing consumer welfare and endangering future competitiveness and sustainability targets. Investment needs in energy transmission and distribution infrastructure are increasing, but there is currently no systematic and comprehensive tracking of investment needs in different types of energy networks and at different levels of government. The labour market has performed well , but more efforts are needed in view of demographic change. Continuing the trend since 2011, employment and wage levels improved in 2019 even as the economy slowed. Labour market incomes have improved through the introduction of the statutory general minimum wage, as well as through efforts to reduce taxes on labour and disincentives to work. Overall, Germany has made limited progress with regard to the 2019 country-specific recommendations (CSRs) ( ). Some progress has been made towards achieving sustained growth in public and private investment and strengthening conditions to support higher wage growth — two CSRs closely related to the euro area recommendations about fostering investment and supporting wage growth (see Table 2.1). There have been certain efforts to reduce the labour tax wedge, most notably the abolition of the solidarity surcharge for most taxpayers from 2021. Yet taxes on labour remain high, while some of the potential remains underused to raise tax revenue from sources more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes. There has been no progress in promoting competition in business services and the regulated professions. A pending law to reintroduce conditions for practising 12 craft professions even reverses a reform of 2004. Limited progress has been recorded in improving the educational outcomes and skill levels of disadvantaged groups. The results of the 2018 OECD Programme for International Student Assessment (PISA) underlined the need for further action in this regard as underachievement in all disciplines increased compared to 2015. At the request of a Member State the Commission can provide tailor-made expertise through the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2018, Germany has received such support in the form of three projects. In 2019, the Commission provided the authorities with support to establish a large-cases unit in the German statistical system to ensure adequate coverage in the national statistics of multinational business groups with high economic impact. Also in 2019, work started on defining the IT infrastructure for this solution and building capacity for its successful implementation. Table 2.1:Implementation of 2019 CSRs Source: European Commission (2) The assessment of CSR1 does not take into account the contribution of the EU 2021-2027 cohesion policy funds. The regulatory framework underpinning the programming of the 2021-2027 EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework (MFF.) Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Germany In absolute numbers, Germany is one of the main beneficiaries of EU support. EU cohesion policy funds( I ) amount to €30.3 billion under the current Multiannual financial Framework (covering 2014-2020), equivalent to around 0.1% of Germany’s annual GDP. By the end of 2019, some €27.6 billion (around 91% of the total amount planned) was allocated to specific projects and €13.7 billion (45% of the total amount planned) was reported as spent by the selected projects, showing a level of implementation above the EU average. ( II ) The allocation from the rural development policy, including the national contributions, totals €14 billion( III ). By the end of 2019, €7.4 billion (52%) was reported as spent, in line with the EU average. While reducing economic, social and territorial disparities, EU cohesion policy funding also tackles structural challenges in Germany. Cohesion policy programmes for Germany have allocated €6.2 billion for smart growth, €3.5 billion for sustainable growth and sustainable transport and €7.9 billion for inclusive growth. In 2019, following the performance review( IV ), an additional €1.5 billion were made available for Germany for performing priorities. EU cohesion policy funding has made a valuable contribution to Germany’s economic transformation. Through the promotion of research, technology and innovation, but also environment-friendly economic development and SMEs, substantial progress has been made since 2014. By end 2018 the European Regional Development Fund (ERDF) has supported 18,300 businesses and 2,000 start-ups. Furthermore, it has contributed to the creation of over 6,700 new jobs in enterprises and improved infrastructures for more than 2,400 researchers. Cohesion policy has also helped de-carbonise Germany’s economy as projects decreased emissions with 73,500 tonnes of CO2-equivalent annually. In addition, EU support has promoted integrated urban development for over 1.4 million people in 130 cities. The European Social Fund (ESF) provided EU added value in fostering sustainable and quality employment, combating social exclusion and discrimination and boosting investments in skills and education. Funds disbursed between 2015 and 2018, have helped more than 1.3 million beneficiaries, mainly long term unemployed people (over 180,000), disadvantaged people (over 150,000), people with a migrant background (over 390,000) and young people/ those not in education, employment or training (over 100,000). EU rural development policy has contributed to strengthening of rural economies in Germany. Between 2015 and 2018, the EAFRD supported more than 5,000 farmers invest in restructuring and modernisation of their agricultural holdings, thus enhancing the competitiveness of the agricultural sector. Furthermore, 321 local action groups have been established to foster local development in rural areas, covering over 63% of the German rural population. The fisheries fund and other EU programmes also contribute to addressing the investment needs. The European Maritime and Fisheries Fund (EMFF) is supports Germany with €286 million (including the national co-financing). In addition, Germany benefits from other EU programmes, such as the Connecting Europe Facility, which has allocated €2.2 billion to strategic transport networks, and Horizon 2020, which allocated EU funding of €7.1 billion (of which about €921 million to 1,500 SMEs). EU funds already invest substantial amounts on actions in line with the Sustainable Development Goals (SDGs). In Germany the ESI funds are supporting 12 of the 17 SDGs. Up to 97% of the expenditure is contributing to these. 3. Summary of the main findings from the MIP in-depth review The 2020 Alert Mechanism Report concluded that a new in-depth review should be undertaken for Germany to assess the persistence or unwinding of the imbalances that affect it. In February 2019, Germany was identified as having macroeconomic imbalances (European Commission, 2019b). The imbalances identified related in particular to excess savings and weak private and public investment. This chapter summarises the findings of the analyses in the context of the macroeconomic imbalance procedure (MIP) in-depth review that are set out in various sections of this report. ( ) 3.1. Imbalances and their gravity

The German economy’s persistently large current account surplus reflects among others a subdued level of domestic demand relative to income. While there is a continuing shift towards more domestic demand-driven growth, the overall shares of consumption and investment remain relatively low, given the resilient labour market, favourable financing conditions and infrastructure investment needs. As a result, the current account surplus remains considerably above what could be inferred from fundamental factors, in particular population ageing and the associated provision for old age, Germany’s high manufacturing intensity and its competitive exports (see Section 4.2). The subdued net investment share of GDP continues to put at risk Germany’s future growth potential, and has implications for the euro area. Private investment is lagging behind infrastructure and housing needs. This is reflected in short-term pressures, observed for example through increases in house prices and rents. Even if the gross investment rate in 2018 exceeded the euro area average (21.2% vs 20.8%), the net investment share remains subdued and significantly below that of leading developed economies (e.g. US and France). This could act as a drag on potential growth. Public investment has picked up, but a still large investment backlog, with depreciation still exceeding new investment at municipal level, will take longer to make up. Meanwhile, the savings rate has been increasing even as interest rates fell to historic lows. Wage growth continued and disposable incomes expanded, but a large part of these impulses fed to savings rather than consumption, despite the lower return on savings. Precautionary saving for future risks (Rodriguez-Palenzuela, 2016) is an important savings motive. In addition, inequality of income and wealth contribute to high private savings, as high earners have a particularly high savings rate (Brenke and Pfannkuche, 2018). Moreover high corporate savings partly reflect the savings of wealthy German households accumulated within firms due to preferential tax treatments for example within the inheritance and gift tax system (IMF, 2019). Enhancing confidence in the future, and recalibrating the tax system, reducing inequality, could be thus ways to strengthen consumption. Combining investment policies with structural reform is a potentially powerful tool. Stronger investment in innovation, quality education and skills, very high-speed broadband networks, sustainable transport, electricity infrastructures and affordable housing, could be combined with a set of structural reforms to unleash productive potential. Reducing taxes on labour could increase the labour supply. This would contribute to potential growth in two ways: directly, by improving labour’s growth contribution, and indirectly, by helping the realisation of investments at a time when the availability of labour remains a constraining factor for production. Reducing barriers to competition in the construction sector and related professional services could help to alleviate capacity constraints, and raise both short-term growth and long-term potential. This would be of crucial importance especially as population ageing intensifies and immigration may slow down. Growth-enhancing policies could also have positive spillovers for the other EU countries. 3.2. Evolution, prospects, and policy responses The current account surplus remains at levels still considerably above 6%. Following a gradual decline since 2015, the trade balance has widened again in 2019, due to weak demand for imported inputs in manufacturing and cheaper energy imports. The primary income balance also improved somewhat, while the negative services balance and secondary income balance remained unchanged. The current account surplus continued to edge down vis-à-vis the euro area to 2.2%, from 2.7% in 2015. Table 3.1:Outward spillover heat map for Germany Source: IMF, OECD, TiVa, BIS and Commission services The large current account surplus currently reflects savings in the household and public sectors alone, as the non-financial corporate sector no longer has a positive net savings position. While companies’ savings contributed to the current account surplus before 2017, now they have a slightly moderating impact. This reflects increases in corporate lending and corporate investment and a reduction in corporate savings as a result of rising unit labour costs, compounded lately by the recession in manufacturing. By contrast, while consumption’s share of GDP remained unchanged, the household savings rate increased, propped up by rising labour incomes, and is expected to stay high in the coming years, remaining the highest in the euro area. Wage growth is expected to slow down closer to the euro area average, being less conducive to rebalancing. The public sector’s net lending position peaked at 1.9% in 2018, and is expected to gradually decline, while remaining in surplus. Given the size of the German economy and its strong trade and financial linkages, there are potentially sizeable spillovers to other EU countries. Germany’s strong exports make it a key trading partner for all EU countries. Indeed, imports from Germany exceed 20% of GDP in some countries, including Luxembourg, Czechia, Hungary and the Netherlands, and are above 10% of GDP in Austria, Slovakia, Belgium, Slovenia and Poland (see Table 3.1). High trade volumes also reflect the fact that German companies operate and invest in other Member States, resulting in integrated value chains. Developments in the car industry reveal the complex nature of the resulting linkages across countries: the weak demand for cars in 2018 resulted in a production decline in Germany, while German companies actually increased production in other EU countries. This production shift now seems to have bottomed out but it is clear that the ongoing structural change in the car industry will have significant implications also for production facilities across the EU. Financial linkages are on average smaller than trade linkages, yet for some countries they are very strong. The countries with the strongest financial links, Luxembourg and the Netherlands, saw their linkages strengthen considerably further. More recently, Germany has taken some important policy steps to address its macroeconomic imbalances, but more efforts will be needed in the coming years to fully address them. There have been policy advances in the area of public investment, though municipal level investment is still lagging behind. There have also been some smaller advances as regards investment in digital infrastructure, reducing disincentives to work and promoting wage growth. However, it remains to be seen if policy action has been decisive enough to produce the desired outcomes. Box 3.2: Spillovers of a sustained increase in public investment – the case of Germany The European Commission’s QUEST model( V ) was applied to simulate the impact of increasing public investment by 1 percentage point of GDP over a period of 10 years. Such a policy would largely go in the direction of the proposal of a study commissioned by the German Trade Unions and the Employers’ Association (Bardt et al., 2019) to implement an investment programme totalling €450 billion over the next 10 years (around 1.3% of GDP annually). This is the estimated additional investment required to meet Germany’s investment needs in the areas of decarbonisation, digitalisation, transport, education and research and development. The simulation assumes that no neutralising fiscal measures (e.g. tax increases or expenditure cuts) are implemented( VI ). The output elasticity with respect to the public capital stock is assumed to be 0.12, which is a mid-range estimate (Arslanalp et al., 2010). Monetary policy is assumed to retain its accommodative stance at the zero lower bound for the first 2 years and gradually normalise afterwards. A sustained increase in public investment would have positive domestic and cross-border spillovers. Public investment tends to have a larger output multiplier than public consumption due to the impact on long-term output and wealth. As illustrated in Table 1, under the stipulated assumptions, increasing the public investment rate in Germany boosts output, employment and price dynamics in both Germany and the rest of the euro area, without exacerbating imbalances. There is also a frontloading of GDP effects. It derives from a real interest rate decline under the zero lower bound and expected positive long-term income effects from capital build-up even under an evenly distributed stimulus. It would weaken if the duration of stimulus were reduced. The accommodative monetary policy is essential to realising of sizeable positive spillovers in this simulation exercise. Assuming a prolongation of the accommodative stance beyond 2 years could result in even stronger effects on the GDP of the rest of the euro area. This gain is associated with the export demand effects from a stronger depreciation of the euro, and with a strengthening of the real interest rate decline. Conversely, a monetary contraction would neutralise the spillovers onto the rest of the euro area or make them negative. On the other hand, at typical average debt maturity, debt costs would be affected only slowly by a gradual normalisation of monetary policy. The debt stock increases during the 10 years of stimulus, but (together with the assumed low financing costs) the impact of the package on the debt-to-GDP is strongly mitigated in the long term by rising tax revenue and growth in nominal GDP. Table 3.1a:Spillover effects of Germany implementing a comprehensive investment package over 10 years Source: European Commission This simulation complements earlier QUEST simulations designed to model a demand stimulus or structural reforms. Earlier simulations include an increase in public investment and a reduction in personal income tax (European Commission, 2017a), increases in expenditure on R&D and education (European Commission, 2018a), and implementation of structural reforms to close performance gaps (European Commission, 2019b). Table 3.2:MIP Assessment Matrix Source: European Commission 3.3. Overall Assessment The adjustment of the current account surplus has been limited so far, but a gradual decline is set to continue while the surplus level remains elevated. With the persistent weakness and uncertainty in the external environment, growth is expected to be driven primarily by domestic demand in 2019-2021. According to the draft budgetary plan, implementation of measures to increase public investment is set to continue. Private investment is also expected to remain solid amid strong housing demand and, more importantly, due to the need to adopt new technologies. A comprehensive, long-term investment programme in Germany could reduce the external imbalance and would considerably increase GDP. More progress is needed to reduce the investment backlog and to support the long-term prosperity of the country. An investment programme could contribute to these. Moreover it could largely counterbalance an expected decline in potential growth. In addition, it would also have positive spillover effects on other euro area countries (see Box 3.2) ( ). 4. Reform priorities 4.1.Public finances and taxation* ( ) Public finances

Despite the economic slowdown in 2019, German public finances recorded a solid general government surplus and public debt fell below the 60% of GDP reference value, thus complying with the Stability and Growth Pact. Since 2014, the government sector achieved headline balance surpluses that have increased over time to peak at 1.9% of GDP in 2018. This surplus has declined to 1.5% in 2019, and is projected to decline markedly further in the next 2 years, to a nearly balanced budget position. The structural balance is also expected to decline over the same period, but to remain in a clear surplus. Several government measures to reduce taxes and increase spending are projected to have an expansionary fiscal stance over the period 2019-2021, according to the Commission 2019 autumn forecast (European Commission, 2019a). Public debt continues its downward path and is expected to have fallen below the 60% of GDP Maastricht threshold in 2019, for the first time since 2002. Public debt is expected to decline further in the coming years. For a debt sustainability analysis and associated fiscal risks see Annex B. Germany has accumulated considerable fiscal space in recent years, which starts being used and could be used further to sustain the upward trend in public investment. 2018 also marked the peak in fiscal space of 1.9% of GDP, calculated as the difference between the structural balance of 1.4% of (potential) GDP and the medium-term budgetary objective (MTO) of -0.5% of (potential) GDP. Fiscal space is on average present at all levels of government. While the federal government is expected to largely use its headline surplus and return to balanced budgets, the state and local governments, at aggregate levels, still have reserves to boost public investment and overcome the investment backlog especially at municipal level. However, investment barriers in the form of constraints in planning and construction capacities persist. With the measures announced by the government up until 2021, the fiscal space could be reduced to 1.0% of GDP, which could be used to further strengthen public investment. The latter reached 2.5% of GDP in 2019, above the long-term average since 2000 of 2.2% of GDP. However, more efforts are needed to reduce the investment backlog, especially at municipal level, including increased absorption of federal funding provided for investment support ( ). Graph 4.1.1:Headline balance (HB), structural balance (SB) and fiscal space Source: European Commission, Destatis, Draft Budgetary Plan 2020 Having a long-term vision for investment could facilitate sustainable and inclusive growth and help improve predictability and planning certainty for businesses and local communities. Trade unions and employer associations have recently agreed on the need for a long-term perspective on public investments in areas such as decarbonisation, digitalisation, transport and education. The yearly investment need was estimated at €45 billion over 10 years (Bardt et al., 2019). This represents an increase by more than half of the current public investment total of around €85 billion in 2019. The €450 billion package over 10 years would need to be specially allowed for and permitted to increase the current federal debt, which stands at €1 trillion. According to the social partners and their research institutes, the low interest rate environment offers a unique opportunity for a debt-financed investment programme. Furthermore, capacity constraints could be alleviated by giving incentives to companies from all over the EU to bid for lucrative German contracts. According to the German Economic Institute (IW), the creation of a special federal investment budget (‘Föderaler Investitionshaushalt’) responsible for the €450 billion investment package would not require a change in the constitution, as it would be in line with the debt brake. According to the social partners and their research institutes, the legally independent special budget should be bound to new, additional tasks, and there should not be expenditure shifts from the main federal budget (Hüther, 2019). Having a long-term investment plan could create continuous demand for public construction projects. It could give planning certainty to construction companies and municipalities to increase their capacities for managing public investment projects, also by hiring engineers at competitive salaries. It could also ensure that public investment does not decline in an economic slowdown due to consolidation efforts. Taxation Tax revenues in Germany continued to grow, with a major part coming from labour taxation, while taxes more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes, remain underused. In 2018, tax revenues reached 40.1% of GDP, which was the highest level since 2000, slightly below the euro area-19 (40.5%) and above the EU-28 (39.2%) averages. Germany’s tax revenue structure is characterised by its relatively high reliance on labour tax revenue (56.9% of total tax revenue, which remained relatively stable over recent years). This is among the highest in the EU (the EU average is 49.4%), and is largely driven by the level of social contributions (39.3%). At the same time, revenues from indirect taxes are relatively low (27.0%), including VAT (17.5%) and environmental taxes (4.5%, with revenues slightly but continuously decreasing since 2005). The same is true for recurrent taxes on immovable property (1.1%) and inheritance taxes (0.4%). The share of revenues from taxes on capital stock and on capital income of households is significantly below the EU average. Germany’s tax burden on labour is high, particularly for low-income earners. The tax burden on labour, as measured by the tax wedge, is among the highest in the EU (51.3% against the EU average of 43.8% for a single worker earning the average wage), see Graph 4.1.2. In particular, the tax wedge for low-income earners (42.3% against the EU average of 31.8% for a single worker earning 50% of the average wage) is high. The progressivity of Germany’s labour taxation is lower than in most EU Member States (European Commission, 2020). This is largely due to the limited progressivity in social security contributions. Graph 4.1.2:Tax wedge for different income levels, DE, FR, UK, EU-28, 2018 Source: European Commission Tax and benefits indicators database Certain features of the German tax-benefit system result in disincentives to work in the lower-income segment. Despite some improvements in recent years, the interplay of income taxes, social security contributions and transfer withdrawals leads to very high effective marginal tax rates ( ) of 100% and more for certain income categories (Peichl et al., 2017). This results in strong disincentives for people to increase their working hours (the intensive margin), or — for the jobless — to start working ( ). This is particularly an issue for people in part-time occupations (predominantly women), and goes against considerations of efficiency and fairness (see Section 4.3). The 2019 increase in the midi-job threshold, above which full social security contributions are paid lowers the tax burden below the threshold, yet effects merit monitoring, as for some groups the marginal effective tax rates increase (European Commission, 2019b). Germany’s environmental tax revenues remain among the lowest in the EU. Increased use of environmental taxation could help internalise environmental costs, incentivise more efficient use of resources and contribute to the achievement of SDGs 3, 7, 11 and 13. It could also provide short-term tax revenues, which can be used for compensatory measures to improve the distributional impact of environmental taxes and their acceptance among the population. Germany’s environmental tax revenues relative to GDP remain among the lowest in the EU (in 26th place in 2018), accounting for 1.8% of GDP (EU average 2.4% of GDP), a decline from 2.4% in 2005. Environmental tax revenues in Germany stem primarily from energy-related taxes (82.8% of environmental tax revenue), including the energy tax (69.2%) and electricity tax (11.8%). The implicit tax rate on energy in Germany fell from €222.2 per tonne of oil equivalent (toe) to €202.9 between 2006 and 2017, while the EU average grew from €192.9 to €236.1 per toe. Tax revenues from transport fuel taxes and taxes on resources are particularly low in Germany compared with other EU countries. Germany has no pollution-related tax revenue (Graph 4.1.3). As environmental taxes are typically regressive (European Commission, 2020), it is important to accompany their increased use with policy measures, including labour tax cuts and cash benefits, that alleviate their impact on vulnerable populations. Box 4.1.4 models the introduction of a CO2 tax, including possible compensation mechanisms, which goes beyond the CO2 pricing chosen by the government. Furthermore, as environmental taxes aim to change behaviour, which would, over time, result in the erosion of the associated tax base, an expansion of the tax base and a gradual increase in tax rates could ensure stable revenues. Current price signals across energy carriers and users limit the potential for deploying clean energy technologies and reducing emissions. Taxes and levies (including the levy to finance subsidies for the producers of renewable energies) on electricity are currently higher per unit of energy than those on other energy carriers such as petrol and diesel, natural gas and heating oil in Germany (Kemfert et al., 2019). This limits the smart integration of electricity into the heating, transport and industry sectors. The situation is unlikely to change significantly over the coming years, despite planned reductions in electricity charges in support of the production of renewable energies. Exemptions for energy-intensive companies from the renewable surcharge add to the electricity bill of other industrial consumers and households. Furthermore, like many other EU Member States ( ), Germany imposes a lower nominal marginal tax rate on diesel fuel for private road usage than on unleaded petrol and the ratio of diesel to petrol excises is significantly below the EU average. This is done even though the former has a higher carbon content and greater negative impact on ambient air quality ( ). This is true for both the tax per litre and the tax per tonne of CO2 emissions (European Commission, 2020). One might argue that the German tax system offsets this advantage for diesel fuel (at least partially) through higher car circulation taxes on diesel cars. According to the Federal Audit Office, the diesel privilege triggers revenue shortfalls in the amount of €9.5 billion annually, of which roughly €8 billion can be attributed to the lower energy tax rate for Diesel and €1.5 billion to the value added tax (Bundesrechnungshof, 2017). Taking into account the higher circulation tax for diesel cars, the net revenue shortfall from the diesel privilege is estimated at about €1.5 billion annually. However, the circulation taxes do not affect the extent to which a car is actually used once it is owned and available (i.e. the marginal cost of driving a car). To serve policy objectives of environmental sustainability, it would be preferable to tax transport fuel consistently based on consumption, reflecting the associated externalities in terms of carbon emissions and air pollution. Simplifying Germany’s tax system could help make the business environment more investment-friendly. The tax system remains relatively complex, which contributes to comparatively high compliance costs for businesses. Both statutory rates and effective average tax rates on corporate income are relatively high in Germany (European Commission, 2019c). Given that many businesses will not benefit from the abolition of the solidarity surcharge, this situation remains unchanged. Similarly, the debt bias in corporate taxation remains high (European Commission, 2019b). Graph 4.1.3:Structure of environmental tax revenues, 2018 Source: Eurostat Recent tax reforms The government agreed on the abolition of the solidarity surcharge for large parts of the population, and this is expected to help spur job creation and private consumption. The solidarity surcharge (an additional 5.5% on top of the personal/corporate income tax rate) was introduced in response to additional fiscal needs stemming from German unification ( ) and was intended to be temporary in nature. The German Bundestag abolished the surcharge for about 90% of taxpayers currently paying it, and reduced it for a further 6.5% of taxpayers by substantially increasing the threshold of the tax-free allowance, starting from 2021 ( ). The reform is expected to create more than 100,000 additional jobs (in full time equivalents) and generate a substantial fiscal stimulus. While this reform will through these cuts increase the progressivity of the upper tail of the income tax system, income inequality as measured by the Gini index will likely increase slightly, as the reform will benefit the (upper) middle class more than the bottom of the income distribution (Blömer et al., 2019). As part of the recently agreed Climate Package, Germany will introduce a CO2 price with a proposed price path which can help the attainment of its medium-term climate targets, but which might also have a regressive effect. The Climate Package is expected to increase the cost of pollution, lower costs for less-polluting transport modes and give more incentives to promote the use of building insulation and less-polluting types of heating (Projektgruppe Gemeinschaftsdiagnose, 2019). While initially set at a low entry price for 2021 (10 €/tCO2), the CO₂ price was raised to €25, gradually increasing in stages to €55 by 2025. Evaluations by economic research institutes found that the moderate CO2 price initially proposed by the government for transport and buildings would not be sufficient to reach the 2030 target for reducing emissions not covered by the EU emission trading system (DIW, 2019). Evaluations also pointed out a regressive effect of the proposed CO2 pricing mechanism (DIW, 2019). The regressive effect is expected to be partially reduced through a substantial reduction in the renewable electricity surcharge. Box 4.1.3: The 2030 Climate Package The coalition government agreed on a 2030 Climate Package that is mainly composed of a proposal for a federal law on climate protection and a 2030 climate protection programme that contains a list of sectoral policies aimed at achieving Germany’s 2030 greenhouse gas emission reduction target. In the meantime, most of the corresponding legislation has been adopted by the German Parliament. The law on climate protection makes legally binding the national greenhouse gas reduction target of at least 55% by 2030, compared to 1990. The law also sets the long-term objective of climate neutrality by 2050. The law further apportions the overall emissions reduction targets into sectoral emission budgets between key sectors of the economy, in particular, energy, buildings, transport, industry, agriculture and waste management. Compliance with these sectoral annual emission budgets is allocated to the federal ministry responsible for the respective sector. In case of failure, the lead ministry must present an emergency adjustment programme of measures to reach future targets. The law also provides for an annual monitoring process under the leadership of a governmental body (‘Klimakabinett’) ( VII ) as well as the creation of a commission of independent experts to monitor progress in reducing emissions and advise the government on actions and impact assessments. As part of the 2030 federal climate protection programme, a CO2 pricing system will be introduced in the transport and heating sectors - the so-called national emission trading scheme (nETS). The government’s proposal was criticised for its lack of ambition and its distributional impact (DIW, 2019; MCC and PIK, 2019). The German Parliament agreed to raise the level of environmental ambition and the volume of compensatory measures. The CO2 price will be phased in gradually, starting in 2021 at €25/ t-CO2 (initial proposal €10). Afterwards, the fixed price will annually increase to reach €55/t-CO2 in 2025 (initial proposal €35). The maximum amount of emissions decided in 2026 will be set to decrease annually in line with German climate targets. The emission certificates will be traded on a national emission market, separate from the EU ETS. From 2026 the price of the emission certificates will be set by the market between a minimum of €55/t-CO2 and a maximum of €65/t-CO2. An evaluation of the law is foreseen for 2025 to determine whether a price corridor for the following years after 2026 is reasonable or necessary Several initiatives listed in the 2030 Climate Package aim to partly compensate final consumers and economic agents for increased energy prices. First, a large part of the income generated by the nETS is planned to be used to reduce electricity charges and levies In particular, the surcharge on renewable electricity for households and small businesses will be gradually decreased. Second, between 2021 and 2026 long-distance commuters (as of 21km of distance) will have an additional possibility to reduce their taxed income (‘Pendlerpauschale’). This extra fiscal benefit of 5 eurocents per km will be increased to 8 eurocents per km in 2024 to 2026. Third, housing benefits will be increased by 10%. However, a large part of the additional revenue will go to the federal budget to finance additional climate and energy measures. In addition, the Climate Package includes a long list of sectoral policies aimed at reducing sectoral emissions. For example, in the buildings sector, Germany plans to increase tax support for refitting heating systems. To facilitate the exchange of old heating oil burners, new heating systems will get a subsidy of 40% of the cost. At the same time, after 2026 it will not be allowed to fit a new oil heating system (as long as an alternative exists). In the transport sector, electro-mobility will be supported across the board. The goal is to have 1 million electric vehicle (EV) charging points available across Germany by 2030. The creation of EV charging infrastructure at commonly used private properties will be supported. The premium scheme for electric, hybrid and fuel cell vehicles will be extended to cover the purchase of vehicles costing less than €40,000. Public transport investment, creation of new cycling routes, modernisation of ports and inland waterways, support to rail transport (Deutsche Bahn), digitalisation and development of new motor fuels (e.g. based on hydrogen) are among the initiatives listed. From 2021, the motor vehicle tax for newly registered vehicles will be related to their CO2 emissions per km. To make train journeys cheaper and flying more expensive, VAT on train tickets are reduced from 19% to 7% from 2020 on and it will not be possible to sell air tickets below a minimum price (to prevent the price falling below the levels of charges and taxes). The transformation of German industry will be supported by, among other things, investment programmes, higher minimum standards in eco-labelling and the national decarbonisation program, which targets in particular high-emitting sectors. Battery cell production will be supported. With regard to energy, Germany will phase out coal in power stations by 2038. By 2030, Germany should get 65% of its energy from renewable energy sources. The Climate Package includes also initiatives in other sectors, such as (more climate-friendly) agriculture, waste management, an increased role for R&D and hydrogen, CO2 storage and implementation of the sustainable finance strategy. The 2030 Climate Package has been welcomed as a step into the right direction but criticised for its distributional impact, showing that low-income households would be more affected than those with high incomes. Germany’s Council of Economic Experts has advocated carbon pricing for some time as the most cost-effective measure to reduce greenhouse gas emissions, but warned against a too-low CO2 price strategy (German Council of Economic Experts, 2019a). Germany’s leading economic institutes called for CO2 prices in line with those of the EU’s emissions trading scheme (EU ETS) for economic efficiency reasons. According to the German Institute for Economic Research, the low price of CO2 and low price cap initially proposed would not have reduced emissions in line with the proposed climate objectives for 2030 (DIW, 2019) ( VIII ). The study also analysed the distributional impact of the programme and revealed that despite compensatory measures such as the reduction in the surcharge on renewable electricity or the increase in the commuting allowance, low-income households would be more impacted than high-income households. Although this study assessed a government proposal with a considerably lower level of ambition, concerns about the distributional effects remain. This is mainly due to the further increased Pendlerpauschale which benefits richer households proportionally more than those on lower incomes. An assessment made by the Berlin climate research institute MCC and the Potsdam Institute for Climate Impact Research (PIK) came to a similar conclusion that the climate protection programme initially proposed by the federal government is unlikely to be sufficient to achieve the 2030 climate targets. Policymakers were advised to make four specific adjustments: (i) raise the level of ambition for the carbon price; (ii) improve the social balance; (iii) integrate the programme more closely with EU-level action; and (iv) introduce an effective monitoring process (MCC and PIK, 2019). However, the net effect might still be regressive as the long-distance commuter tax rebate, which benefits high-income earners, will increase significantly. The success of the Climate Package will also depend on a multitude of additional measures. The package includes numerous measures beyond CO2 pricing (see Box 4.1.3), but their effectiveness and efficiency are unclear. The new approach of ‘ex post’ adjustment for meeting sector targets might lead to delayed action. In addition, the intended beneficial effect will be dampened by the continuation of environmentally problematic fossil fuel subsidies. In 2016, €9.5 billion went to fossil fuel energy support (BMF, 2019).

In 2019 the government adopted draft legislation to reform Germany’s immovable property tax in response to a ruling by the Constitutional Court. In its ruling of 10 April 2018, the Federal Constitutional Court declared the way in which properties are valued for the purposes of the immovable property tax (Grundsteuer) to be unconstitutional as the tax had been calculated based on outdated property values ( ). The government aimed at a revenue-neutral reform that would comply with the ruling. Furthermore, the administration of the reform is intended to remain relatively simple, with limited distributional ramifications. In principle the amounts of immovable property tax due will continue to be based on property values, although regional governments may opt out and apply a different valuation method. The draft legislation envisages a fundamentally unchanged valuation method. First, the immovable property will be valued for tax purposes ( ). Then, this value will be multiplied by a uniform factor (basic federal rate: Steuermesszahl) and another multiplier (Hebesatz). Box 4.1.4: The distributional and equity effects of introducing a CO2 price This box presents hypothetical CO2 tax scenarios in transport and heating and discusses their distributional effects. Environmental taxation, including CO2 pricing, can help internalise externalities from environmental degradation, incentivise more efficient use of resources and contribute to sustainability goals (see Section 4.5). Transport and heating were also targeted by the recently adopted carbon pricing policy as part of the 2030 Climate Package. While the aim of this box is not to assess the exact policies included in that package (for the assessment, see Box 4.1.3), it nevertheless provides an illustration on the effects of the introduction of a CO2 price and ways to design it to avoid regressivity. Studies show that such taxes are typically regressive, as those on low incomes spend a higher proportion of their income on environmental taxes (Hassett et al., 2009; Grainger and Kolstad, 2010; Edenhofer et al., 2019; DIW, 2019; German Council of Economic Experts, 2019a), and high-income earners have a much higher CO2 footprint than low-income earners. While the average household in the lowest income decile emits on average about 7 tonnes of CO2 per year, the average household in the fifth income decile emits almost twice that amount. In the top income decile, the carbon emissions are almost three times higher than in the lowest decile. However, this increase in CO2 emissions is disproportionate to income, as the average net equivalent income of the top income decile is almost six times that of the bottom decile ( IX ) (German Council of Economic Experts, 2019a). These findings justify redistributive measures to counteract the regressive distributional effects of environmental taxes. Based on the EUROMOD Indirect Tax Tool, the distributional effects of the introduction of CO2 prices of €60, €120 and €350 per tonne are simulated, with and without compensatory measures ( X ). As the aim is to assess the ‘overnight’ distributional effect of introducing a CO2 tax, the simulation assumes that households continue to consume the same quantities of all goods as before. While this assumption is plausible in the short term, the tax is intended to have steering effects that will ultimately lead to behavioural change and a reduction in CO2 emissions, and hence in tax revenues. The first scenario uses an average price of €60 per tonne of CO2 that comes on top of the excises currently in place, in line with the current CO2 price in Finland. In the second scenario a more ambitious price of €120 per tonne of CO2 is introduced on top of the excises, in line with the CO2 price for example in Sweden. The third scenario of €350 per tonne of CO2 existing excises are replaced by a CO2 price, reflecting a scenario that achieves net zero greenhouse gas emissions in ETS sectors by 2050 (European Commission, 2018b). The additional revenue in the first scenario is spent entirely on compensatory measures in a budget-neutral way. Two types of compensations are considered: a lump-sum cash benefit to all households and a targeted cash benefit for households that spend at least 15% of their disposable income on energy consumption. The benefits for a one-person household amount to €18.0 per month in the lump-sum scenario and €42.1 in the targeted scenario ( XI ). Graph 4.1.3a: Environmental tax scenarios: distributional and equity effects, with and without compensatory measures Source: European Commission, Joint Research Centre, based on the EUROMOD model The results confirm that the impact of a CO2 tax is regressive, but also indicate that well-designed compensatory mechanisms can lead to an overall progressive effect. Without compensatory measures, the regressive effect is stronger the higher the CO2 price. As a result, adjusted disposable income decreases in the range of 0.7%-1.9% in the tenth decile and in the range of 1.7%-5.2% in the bottom decile in the scenarios without compensation. The introduction of a cash benefit renders the reform progressive, leading to a gain in adjusted disposable income for households until the third decile in the case of a lump-sum benefit and until the fifth decile in the case of a targeted benefit (see Graph 1). Inequality and the at-risk-of-poverty rate are reduced where compensatory measures are in place. Inequality, as measured by the Gini coefficient, increases in the scenarios without compensatory measures as the price of CO2 rises. It decreases in the case of the targeted cash benefit and stays roughly the same if a lump-sum compensation is in place. The at-risk-of-poverty rate evolves in a similar way (see Graph 1). While the basic federal rate will be the same across all of Germany, the multiplier — and therefore the amount of tax ultimately due — will be determined by local authorities. Still, the Länder will have the possibility to diverge from federal legislation. For example, Bavaria has already stated its intention to use land values instead of property values to determine the relevant tax base. The reform did not aim to raise additional tax revenues from property owners, and thus missed the opportunity to shape the tax system in a way that is more conducive to inclusive growth. Recurrent taxes on immovable property are generally considered a relatively efficient tax, given the immobility of the tax base (European Commission, 2020). In addition, taking account of the relatively low rate of home ownership in Germany and its unequal distribution, recurrent property taxes may also contribute to a fairer distribution of the tax burden. However, even after the reform, tax revenue from immovable property is expected to remain relatively low as the government envisaged a revenue-neutral reform. Furthermore, the reform did not restrict the possibility for the owner to include the taxes due in the utilities to be paid by the tenant. This makes the tenant the de facto entity on whom the tax is imposed. ( ). Wealth-related taxes account for a small part of revenues. The inheritance and gift tax in Germany yields only about €6 billion a year, corresponding to an average effective tax rate of only about 2% ( ) largely due to exemptions for business assets. Also, since 1997 Germany no longer applies its wealth tax legislation as it discriminated against non-real-estate wealth. Thus, while revenues from wealth-related taxes in Germany have declined over the years, the accumulation of wealth has increased substantially, wealth concentration is very high in international comparision (Bach and Thiemann, 2016; Bach et al., 2019) and also the share of wealth that is inherited as opposed to accumulated has increased significantly from about 20% (as a percentage of total wealth) in the 1970s to about 50% in 2010 (Brülhart et al., 2018). Healthcare Inefficiencies in healthcare persist. In 2017, Germany spent €4,300 per person on healthcare (11.2% of GDP), the highest in the EU (EU average €2,884). At the same time, avoidable deaths from preventable and treatable causes are close to the EU average and higher than in many other western European countries. The German healthcare system continues to be very hospital-centric. Hospital bed density in 2017 (8 beds per 1,000 people) was higher than the EU average (5). Also the average hospital stay, at 8.9 days, is comparatively long and day surgery is not as common as in the majority of EU Member States. The quality of healthcare suffers from a highly fragmented system, with many services provided in small and often inadequately equipped hospitals. A stronger focus on prevention and care integration could bring efficiency gains. Inefficiencies in the healthcare system also arise from the legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of the solidarity-based statutory health insurance scheme. It also allows doctors to charge patients with private health insurance more than those covered by the statutory scheme, which incentivises overprovision of health services. Pension system The retirement of the baby boomer generation is affecting Germany more than other EU countries, putting considerable pressure on public finances. By 2040, the country is expected to be facing one of the largest increases in spending on public pensions in the EU (up by 1.9 pps of GDP), while the public pension benefit ratio is expected to fall to 37.6%, according to the 2018 Ageing Report. The long-term fiscal sustainability risk has increased from low to medium, reflecting a softening of the initial budgetary position, which however remains favourable. This yields an increase in the S2 level (by 0.5 pps) to 2.2, slightly above the 2.0 medium risk threshold (Annex B) ( ). Graph 4.1.4:Net pension replacement rates for low and high earners (2018) Source: OECD, 2019a Demographic developments also have implications for the adequacy and fairness of pensions. Since 2005, pension increases are linked to the pension sustainability factor, which measures the change in the number of contributors relative to the number of pensioners. While in 2019 this led to an additional pension increase of 0.6%, from 2020 it is projected to be negative with an average reduction in pensions of 0.5% per year until 2033 (BMAS, 2019). At the same time, net pension replacement rates are already relatively low, especially for low-wage earners (56.1%, against an EU average of 69.8%, see Graph 4.1.4). Furthermore, life expectancy varies between socio-demographic groups and is lower for low-income earners than for high-income earners, as also reported in the Federal Government Report on Poverty and Wealth (BMAS, 2017). As a result, the annualised compound return of expected pensions compared to their earlier contributions is currently higher for high-income earners than for low-income earners (Haan et al., 2019; Breyer and Hupfeld, 2009). The latest reform from July 2019, which maintained benefits for certain low-income earners (‘midijobbers’) while reducing contributions, and the planned introduction of Grundrente that aims at providing a contribution-period based top up to benefitlong-term insured low-income earners, are partly addressing the issue of intra-generational fairness as they entail benefits for low-income earners above the normal accrual rate. The principle of intra-generational fairness could be further strengthened in the Grundrente by basing the contribution years on full-time equivalents. This would avoid treating those that worked part-time in relatively well-paid jobs the same as those that have worked their entire life full time in badly paid jobs. Fiscal framework Through extension to the Länder level, the national debt rules are becoming even more binding. Since 2016 the fiscal rules of the national ‘debt brake’ (Schuldenbremse) were already fully applicable to the federal level, requiring a structural deficit not higher than 0.35% of GDP. From 2020 on, the ‘debt brake’ applies also to the Länder level, requiring the budgets of the states to be balanced without new debt. Structural deficits are no longer allowed. Germany continues to conduct spending reviews to increase the efficiency and effectiveness of government spending. Since 2015, the country has held yearly cycles of spending reviews targeting specific policy areas and ministries. The review cycle for 2018-2019 analysed the ‘management of receivables’, whereas the ongoing fifth review cycle for 2019-2020 focuses on ‘further education, re-entry and start-up of a new business’. ‘Green’ budgeting does not seem to be factored into budget planning in Germany. Although internationally there is a trend towards identifying the ‘green’ contribution of fiscal policy measures within budgetary documents, this does not seem to be the case in Germany yet. While a comprehensive view may be missing, the policy impact could still be analysed for specific climate and environment policy-related actions. This is a much more restricted approach than for example in France, where a first attempt is being made to coherently present how ‘green’ the French budget is. The French ‘yellow book’ covers both budgetary information and policy strategies, and also features an impact assessment on households and businesses (République française, 2019). Similarly, in Italy the presentation of ‘green’ items represents a long-standing practice in the budgetary documents. 4.2. Financial sector* 4.2.1.Banking sector The banking industry needs to adapt to the challenging times ahead. Banks will have to accelerate consolidation and reorient their business strategy in the foreseeable future of ultra-low interest rates ( ). While further cost-cutting is necessary, the financial sector needs to invest more in IT infrastructure to modernise day-to-day business. The disruption initiated by fintech and bigtech may squeeze revenues, while consumer preferences and the regulatory environment may also change ( ). The sector as a whole needs to adapt to a rapidly changing environment and develop a strategic vision in order to remain viable.

Profitability in the banking system remains low on aggregate, despite Germany’s years of continued economic expansion. The past years of economic growth have helped banks to keep non-performing loan ratios low, while the low interest rate environment contributed to lower funding costs. However, profitability has been dented by the decline in lending interest rates combined with an over-reliance on intermediation income, over-capacity stemming from splintered bank networks, compliance cost, an old IT infrastructure that needs costly overhauls. Still, banks have managed to remain profitable on aggregate by realising hidden reserves, increasing the maturity transformation, increasing credit flows and taking on higher risks during the past years. Relying on these factors appears more difficult in the future. Profitability differs widely between banking types. German banks’ profitability has been low for decades, as saving banks and cooperatives are stakeholder banks that do not operate primarily for profit. By contrast, savings banks and cooperatives are currently more profitable than big commercial banks and Landesbanken. For the banking system as a whole, the return on assets in 2018 was 0.23%, the lowest in Europe after Greece. ( )The return on equity (RoE) after tax was 2.4%, with pronounced differences between banking groups: 8.2% for cooperatives, 7.3% for savings banks and 1.1% for commercial banks, while Landesbanken recorded a loss in aggregate, with -3.9%. The latter has been influenced by Nord LB’s 2018 €2.4 billion loss mainly stemming from off-loading non-performing shipping loans. Consequently, the public bank received a capital injection of €2.8 billion. Low profitability calls for an overhaul of cost structure. High costs were a major driver of low profitability. German banks’ cost/income ratio fell from 75.9% in June 2018 to 73.6% in June 2019, still somewhat above the EU average of 64.5% in both years. Over those 12 months, Landesbanken and big commercial banks’ cost/income ratio rose 130 basis points to 83.2%. Consolidation progresses still have a long way to go. With 1,603 banks, Germany has a crowded banking market, which is shrinking by around 3% annually, while the number of branches is falling faster (by 7.4% in 2018) (Bundesbank, 2019). Over 2018, the number of savings banks (386) and cooperative banks (878) declined by 1% and 4% respectively, while Germany now only counts 5 Landesbanken as 2 changed their legal nature and are now classified differently by the Bundesbank. Mergers across pillars remain difficult, also because their legal set-up differs. Salaries and pension liabilities account for half of banks’ expenses. In 2018, pension liabilities’ discount rate was reviewed for the first time since 2005. Given the much lower discount rate, pension liabilities increased commensurately. Yet, thanks to limited bankers’ bonuses, and shrinking headcounts, overall staff cost fell 0.7% over 2018. Credit growth has facilitated private investment, while also increasing banks’ leverage. In 2018, the stock of mortgages increased by 4.6%, consumption loans by 5.1% and corporate loans by 5.3%. Outstanding bank credit to the private non-financial sector increased to EUR 1,1 trillion at the end of September 2019. Growth accelerated to 5.4% from 4.5% a year earlier. Outstanding credit increased by 3.2 pps to 89.3% of GDP in the year ending in September 2019. Thus, private debt is growing again relative to GDP while it remains well below its peak in 2001 at 103% of GDP. Table 4.2.1:Quarterly financial soundness indicators Source: ECB-CBD2 Consolidated Banking, data German banks still depend predominantly on intermediation income. It accounts for three quarters of their total income, while in several other euro area jurisdictions non-interest income constitutes about half of aggregate revenue. Over 2018, loan stock increased by 4.9% but intermediation income rose by only 1.3% - feeble growth given that deposits go largely unremunerated. Although the German banking system as a whole kept the average intermediation margin above 1%, there were stark differences across banking pillars. Savings banks and cooperatives had an average margin of 1.73% and 1.8%, respectively, whereas commercial banks’ margin amounted to 0.77%. Banks pass on negative interest rates to larger corporate customers, but only very timidly to large household depositors. During 2018, the interest offered on corporate deposits was ‑0.03%, whereas banks remunerated new household deposits with 0.02% on average. Risk-adjusted capital ratios are still somewhat above the European average. Germany’s leverage ratio, which divides capital through unweighted assets, is one of Europe’s lowest. German banks’ CET1 ratio (Common Equity Tier 1 divided through risk-weighted assets) of 15.4% is respectively 40 and 60 basis points above the EU and euro area average. With 1.3%, Germany has been having one of the lowest non-performing loan ratios in the euro area. (Table 4.2.1) Very low default rates over the last decade have influenced banks’ internal risk models, and raise the issue whether credit risk may be underestimated. Indeed, once Basel III is fully implemented, capital requirements might rise significantly for German banks (EBA, 2019). The Bundesbank’s stress test on smaller banks confirms that financial stability ratios are generally satisfactory. Whilst the European Banking Authority conducted a stress test on Europe’s bigger banks in 2018 (EBA, 2018), the Bundesbank ran a test on Germany’s 1,412 smallest banks holding 38% of bank assets in 2019. In EBA’s stress test scenario, the German institutions’ CET1 ratio would fall to 7-34% by end 2020. In the Bundesbank’s baseline scenario, Return on Assets would rise from 0.42% in 2018 to 0.46% in 2023 and banks’ end 2018 CET1 ratio of 16.5% would grow slightly to 16.7%, whereas for 1/3 of the banks, capital ratios would