German Economics Institute Warns Against Tax Cuts

by Ulrika Lomas, Tax-News.com, Brussels

14 October 2009

Convinced that the German economy has not yet fully stabilized, the Deutsche Institut für Wirtschaftsforschung (DIW), the largest economics research institute in the country, has urged the newly elected Coalition parties to begin the process of budgetary consolidation, rather than relentlessly bickering over plans to cut taxes.

Although the institute has recently forecast growth of around 1.3% for 2010, it has, nevertheless, warned that the economy is still not on a robust and stabile growth path. According to the DIW, there is currently no financial leeway for the government to implement its desired tax cut plans at the present time.

Given the current shortfall in tax revenue, a result of both the economic downturn and government initiated stimulus programs, coupled with an increase in recent government spending, the DIW has reported a gap of between 2% and 3% of GDP, corresponding to an annual budget deficit of around EUR50bn to EUR75bn.

DIW President Klaus Zimmermann has emphasized that the new government must now turn its attention to increasing long-term growth, by investing in research and training, and by improving regulation of the financial markets. These “self-financing” measures will improve growth more effectively than by implementing reductions in tax, which simply cannot be funded, he added.

Zimmermann is convinced that the government must increase revenue and curb spending. In order to increase tax revenue, a rise in VAT is unavoidable, he stressed.

The German economics research institute has also advocated abolishing the reduced tax rate currently levied on diesel, which, it believes, would serve to generate in the region of EUR6bn. The DIW is also firmly in favor of introducing a car toll in Germany – a measure already being debated by the Coalition parties.

Zimmermann announced back in June that an increase in VAT was the best means of reducing the crippling state debt. At the time, he put forward the idea of announcing a 6% rise in VAT, to 25%, from 2011. This would have a profound effect, he stated, given that VAT has a wide tax base, and affects imports, and would, given that a premature announcement would also significantly boost consumption, thus kick-start the economy. Acknowledging that a rise in VAT would adversely affect low-income earners, Zimmermann also suggested that social security contributions could be reduced as a counter measure.

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