PRESS RELEASE

Federal Budget: Fiscal Measures on Historic Scale Required

• Federal spending is projected to rise in the coming years, driven primarily by defence expenditure and interest obligations. This will widen the federal funding gap and drive up the debt-to-GDP ratio.
• Funding defence expenditures through continuous borrowing is unsustainable. The share of debt-financed defence expenditures should therefore be gradually reduced.
• Consolidating the federal budget demands a comprehensive package of fiscal measures: targeted subsidy cuts, reforms of the social insurance system, and a more efficient tax framework. Even combined, these measures will not fully close the funding gap.

Fiscal pressures on the German federal budget continue to worsen in the coming years, with the long-term funding gap hinging largely on the extent to which defence spending continues to be debt-financed. According to projections by the German Council of Economic Experts (GCEE), the funding gap could reach between 2.7 and 4.8 per cent of gross domestic product (GDP) by 2040, depending on the pace at which debt financing is reduced. “Closing these funding gaps will require a comprehensive policy package: targeted subsidy cuts, reforms of the social insurance system, and a more efficient design of the tax system. Yet, this will not be sufficient,” said Monika Schnitzer, chair of the GCEE.

Phasing out debt-financed defence spending

Federal spending has surged since the early 2020s, driven by crisis-related expenditures, expansions in the social security funds, and higher subsidies. Over the coming years, rising defence expenditures and interest obligations will place an additional strain on the federal budget. If defence spending continues to be debt-financed, Germany's debt-to-GDP ratio could reach as much as 98 per cent by 2040. The actual trajectory will depend primarily on whether – and how quickly – this debt financing is scaled back. “Germany must enhance its defence capabilities. However, financing defence expenditure permanently through additional debt is not sustainable. The gradual phasing out of borrowing should therefore be enshrined in the Basic Law,” explains Monika Schnitzer.

To reduce net borrowing, the threshold exempting defence expenditure from the debt brake should be raised. The GCEE proposes raising this threshold – currently set at 1 per cent of GDP – by 0.25 percentage points annually starting in 2031. This path would leave a federal consolidation requirement of 4.6 per cent of GDP in 2040. A gradual phaseout would spread the impact of necessary consolidation on the overall economy over a longer period. The decision on the reduction path should be taken before the end of this legislative term.

Consolidation requires a comprehensive package of measures

A decision on the consolidation strategy should likewise be taken during this legislative term. The GCEE discusses a range of measures that would ease fiscal pressure on the federal budget by up to 2.2 per cent of GDP. Key measures include phasing out inefficient and environmentally harmful subsidies, fully implementing the Pension Commission’s recommenddations – notably abolishing early retirement with full benefits for long-term contributors (“pension at 63”) – and the withdrawal of the “Mothers’ Pension III.” Yet even if all these measures were implemented, a residual funding gap of at least 2.4 per cent of GDP would remain, if debt-financing of defence expenditure is reduced along the path favoured by the GCEE.

Over the medium term, tax increases may become necessary, as higher economic growth alone cannot realistically close the funding gap. Such measures, however, should serve only as a last resort once other options have been exhausted. To ensure fiscal consolidation does not undermine vital capital investment in roads, rail, and waterways, the GCEE proposes to establish a dedicated transport infrastructure fund.