Council opinion of 27 February 2007 on the updated stability programme of Germany, 2006-2010
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: Germany, budget estimate, economic forecasting, public finance, stability programme

27.3.2007

EN

Official Journal of the European Union

C 70/5

COUNCIL OPINION

of 27 February 2007

on the updated stability programme of Germany, 2006-2010

(2007/C 70/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

(4)

On 27 February 2007 the Council examined the updated stability programme of Germany, which
covers the period 2006 to 2010.

The macroeconomic scenario underlying the programme envisages that real GDP growth will
temporarily slow down from 2,3 % in 2006 to 1,4 % in 2007, after which it is projected at 1¾ % on
average over the rest of the programme period. Assessed against currently available information (the
latest official estimate of GDP growth in 2006 is a figure of 2,7 %), this scenario appears to be based
on plausible assumptions until 2008 and mildly favourable ones thereafter, compared with Commis-
sion projections for potential growth. The programme's projections for inflation appear to be on the
high side.

For 2006, the programme cites a general government deficit of 2,1 % of GDP (revised down to 1,9 %
by latest government announcement), against a target of 3,3 % of GDP set in the previous update of
the stability programme. The government received unexpectedly high revenues from taxes, which, in
line with the Stability and Growth Pact, were not spent in 2006. The tax burden (i.e. revenues from
taxes and social contributions) is now forecast to increase to around 40 % of GDP in 2006, which is
about 1 % of GDP higher than projected in the previous update. General government expenditure has
been kept under control in 2006. The somewhat tighter budgetary execution derives from lower
monetary transfers, stemming mainly from the unexpected relief that the improving labour market
has provided to the Federal Employment Agency. In addition, interest expenditure and subsidies have
been lower than expected.

The main goal of the medium-term budgetary strategy is to ensure the long-term sustainability of
public finances. To achieve this, the programme proposes to continue budgetary consolidation, while
improving the conditions for growth and employment. After the envisaged correction of the excessive
deficit in 2006, the deficit ratio is projected to decline by ½ percentage point per year (except in
2008) to reach ½ % of GDP in 2010. The improvement in the primary balance follows the same
pattern, with the surplus reaching 2 % of GDP by 2010. While the budget contains corrective
measures on the revenue side, notably the increase in the central VAT rate from 16 % to 19 %, both
revenue and expenditure ratios are set to follow a downward trend in a year-to-year comparison.
Indeed, the expenditure ratio would fall by 2½ percentage points to 43 % of GDP by 2010, which is
planned to be achieved mostly through restraint in social spending. Over the same period, the
revenue-to-GDP ratio is projected to decrease by 1½ percentage points to 42 % of GDP by 2010; an
increase in the tax share (e.g. increase in the central VAT rate in 2007) is broadly offset by a decrease
in the share of social contributions (due to the cut in the unemployment insurance rate in 2007 and
the downward trend of the contributions share), while non-tax revenues decline. Compared with the
previous update, the budgetary targets are higher in each year although no adjustment is planned in
2008.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

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Official Journal of the European Union

27.3.2007

(5)

(6)

(7)

(8)

(9)

the cyclically-adjusted balance net of one-off and other temporary
The structural balance (i.e.
measures), calculated according to the commonly agreed methodology, is planned to improve from a
deficit of around 2 % of GDP in 2006 to ½ % at the end of the programme period, on average by
almost ½ % of GDP per year. As in the previous update of the stability programme, the medium-
term objective (MTO) for the budgetary position presented in the programme is a balanced position
in structural terms, which the programme does not aim to achieve within the programme period. As
the MTO is more demanding than the minimum benchmark (estimated at a deficit of around 1½ %
of GDP), achieving it should fulfil the aim of providing a safety margin against the occurrence of an
excessive deficit. The MTO lies within the range indicated for euro-area and ERM II Member States in
the Stability and Growth Pact and the code of conduct and adequately reflects the debt ratio and
average potential output growth in the long term.

The risks to the budgetary projections in the programme appear broadly balanced for 2007, but
budgetary outcomes thereafter could be worse than projected. In particular, the risk remains that the
envisaged decline in the social expenditure ratio would not be achieved without additional measures
that are not specified in the programme. Indeed, the update itself states that further reforms are
needed on the labour market and in the social security systems. In addition, a certain risk stems from
the planned company tax reform in 2008. Thus, it might prove necessary to compensate possible
shortfalls in company tax revenues through additional expenditure restraint. Abstracting from that
reform, the revenue projections seem prudent. Nevertheless, overall, negative risks to the budgetary
adjustment remain, in particular from the implementation of the adjustment path in the outer years.

In view of this risk assessment, the budgetary stance in the programme is consistent with a correction
of the excessive deficit by 2006, one year ahead of the deadline set by the Council. In addition, it
seems to provide a sufficient safety margin against breaching the 3 % of GDP deficit threshold with
normal macroeconomic fluctuations as from 2007, although subject to some risks for 2008. In the
years following the correction of the excessive deficit, the pace of the adjustment towards the MTO
implied by the programme should be strengthened, especially in 2008, to be in line with the Stability
and Growth Pact, which specifies that, for euro-area and ERM II Member States, the annual improve-
ment in the structural balance should be 0,5 % of GDP as a benchmark and that the adjustment
should be higher in ‘good’ economic times and could be lower in ‘bad’ economic times. In particular,
no improvement in the structural balance is planned for 2008, at a time when economic ‘good times’
are expected to prevail. Meeting the required structural adjustment path would actually allow the
MTO to be reached by the programme horizon.

Government gross debt is estimated to have levelled off at 67,9 % of GDP in 2006, above the 60 %
of GDP Treaty reference value. The programme projects the debt ratio to decline by 3½ percentage
points over the programme period. The evolution of the debt ratio may turn out to be less favourable
than projected in the programme given the risks to the deficit targets and uncertainty about the debt-
reducing stock-flow adjustments assumed in the programme. In view of this risk assessment, the debt
ratio may not be sufficiently diminishing towards the reference value over the programme period.

The long-term budgetary impact of ageing in Germany is close to the EU average, though with
pension expenditure showing a somewhat smaller increase than in many other countries, as a result
of the pension reforms already enacted. A draft law has been adopted to raise the statutory retirement
age in steps to 67 years, from 2012 onwards. Although exemptions to the higher age limit are being
granted, the move will enhance the long-term sustainability of public finances. In addition, developing
further private pension arrangements would contribute positively to retirement incomes. The initial
budgetary position constitutes a risk to sustainable public finances even before the long-term
budgetary impact of ageing populations is considered. Moreover, the current level of gross debt is
above the Treaty reference value. Overall, Germany appears to be at medium risk with regard to the
sustainability of public finances.

(10)

The stability programme does not contain a qualitative assessment of the overall
impact of the
October 2006 implementation report of the National Reform Programme within the medium-term
fiscal strategy. In addition, it provides no systematic information on the direct budgetary costs or
savings of the main reforms envisaged in the National Reform Programme and its budgetary projec-
tions do not explicitly take into account the public finance implications of the actions outlined in the

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C 70/7

the company tax reform 2008 and the health care reform are put

National Reform Programme. The measures in the area of public finances that are mentioned in the
stability programme seem consistent with those foreseen in the national reform programme. In par-
ticular,
forward in both
programmes. Moreover, both programmes envisage, as the second stage of the reform of the federal
system, a review of the fiscal relations between levels of government in order to strengthen the
accountability of each level. In addition, the stability programme recognises in this context the neces-
sity to develop an institutional framework that would ensure budgetary discipline at all levels of
government and foresee measures to pre-empt emerging budgetary crises.

(11)

The envisaged measures in the area of public finances are broadly consistent with the broad economic
policy guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme has some gaps in the required and optional data. (1)

Overall, the Council deems the updated programme consistent with a correction of the excessive deficit as
of 2006, one year before the deadline set by the Council, and some progress towards the medium term
objective will be made in the subsequent years. However, there are risks linked to the achievement of the
budgetary targets.

In view of the above assessment, the Council invites Germany to:

(i) Benefiting from economic ‘good times’, strengthen the structural adjustment in 2008 including by using
any extra revenues for deficit reduction, continue the fiscal consolidation towards the medium-term
objective thereafter, by maintaining tight control over expenditures, while ensuring that the announced
reform of the corporate tax system does not jeopardise the fiscal consolidation;

(ii) In view of the level of debt and the projected increase in age-related spending,

improve long-term
sustainability of public finances by achieving the MTO and by implementing reforms, particularly in the
health care system;

(iii) Improve the budgetary framework so as to strengthen fiscal discipline at all

levels of government,

notably by implementing the plans for the second stage of the reform of the federal system.

Comparison of key macroeconomic and budgetary projections

2005

2006

2007

2008

2009

2010

1 ¾

1 ¾

1 ¾

2,0

—

1 ¾

1 ¾

—

1,2

—

—

—

—

0,0

—

—

—

—

—

—

0,0

—

—

Real GDP
(% change)

HICP inflation
(%)

SP Nov 2006

COM Nov 2006

SP Feb 2006

SP Nov 2006

COM Nov 2006

SP Feb 2006

0,9

0,9

0,9

—

1,9

—

2,3

2,4

1 ½

—

1,8

—

1,4

1,4

1

—

2,2

—

Output gap
(% of potential GDP)

SP Nov 2006 (1)

– 1,2

– 0,3

– 0,3

– 0,2

COM Nov 2006 (5)

– 1,3

– 0,2

– 0,4

0,1

SP Feb 2006 (1)

– 0,9

– 0,7

– 1,1

– 0,7

– 0,4

General government
balance
(% of GDP)

SP Nov 2006

– 3,2

– 2,1

– 1 ½

– 1 ½

– 1

– ½

COM Nov 2006

– 3,2

– 2,3

– 1,6

– 1,2

—

SP Feb 2006

– 3,3

– 3,3

– 2 ½

– 2

– 1 ½

—

—

(1) In particular, data on HICP inflation, total social transfers and the stock-flow adjustment are not provided in the
programme, as well as compensation of employees and the break-down of tax revenues, which were provided separately to
the Commission.

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Official Journal of the European Union

27.3.2007

2005

2006

2007

2008

2009

2010

Primary balance
(% of GDP)

SP Nov 2006

COM Nov 2006

– 0,5

– 0,5

½

0,4

SP Feb 2006

– 0,5

– ½

1

1,1

½

1

1,5

1 ¼

1 ½

—

1 ½

2

—

—

Cyclically-adjusted
balance
(% of GDP)

Structural balance (2)
(% of GDP)

SP Nov 2006 (1)

– 2,6

– 2,0

– 1,5

– 1,5

– 1,0

– 0,6

COM Nov 2006

– 2,6

– 2,2

– 1,4

– 1,2

—

SP Feb 2006 (1)

– 2,9

– 2,9

– 1,8

– 1,5

– 1,1

—

—

SP Nov 2006 (3)

– 2,7

– 2,0

– 1,5

– 1,5

– 1,0

– 0,6

COM Nov 2006 (4)

– 2,7

– 2,2

– 1,4

– 1,2

—

Government gross debt
(% of GDP)

SP Feb 2006

SP Nov 2006

COM Nov 2006

– 3,0

– 2,9

– 1,8

– 1,5

– 1,1

67,9

67,9

67,9

67,8

67,7

67,3

67

66 ½

65 ½

64 ½

SP Feb 2006

67 ½

69

68 ½

68

—

—

—

67

—

—

Notes:
(1) Commission services calculations on the basis of the information in the programme.
(2) Cyclically-adjusted balance (as in the previous rows) excluding one-off and other temporary measures.
(3) One-off and other temporary measures taken from the programme (deficit-increasing 0.1% of GDP in 2005).
(4) One-off and other temporary measures taken from the Commission services' autumn 2005 forecast (deficit-increasing 0.1% of GDP in

2005).

(5) Based on estimated potential growth of 1.2%, 1.3%, 1.4% and 1.4% respectively in the period 2005-2008.

Source:
Stability programme (SP); Commission services' autumn 2006 economic forecasts (COM); Commission services' calculations