Benefit check: why Germany is confronted with a welfare state fiasco (FT)

It is early afternoon when Helge Hofmeister reaches the Parkhotel Rödermarkt and heads for the cavernous bar.

A bulky man with a gun bulging through his untucked summer shirt, he has a date with "Pregnant Natasha", a Russian prostitute. But Mr Hofmeister is neither lonely businessman nor pimp. He is a civil servant going about his lawful business.

Pregnant or not, selling one's body is legal in Germany. But claiming unemployment benefits at the same time is not. And that, according to the file tucked under his arm, is what Natasha has been doing for months.

Mr Hofmeister, a former policeman, and his colleague, Helena Fürst, head of the new welfare-benefit fraud investigation unit in Offenbach, a quiet suburb of Frankfurt, have since November been fighting a battle they cannot win: to fix one of the most urgent economic, financial and political challenges facing Angela Merkel's grand coalitiongovernment.

A labour law nicknamed Hartz IV and hailed at its inception as the most radical structural reform in Europe since the era of Margaret Thatcher has become a case study in unintended consequences that casts a harsh light on the flaws in the way Germany makes policy. It has not only failed to dent unemployment but has also sent welfare costs spiralling, jeopardising the government's efforts to bring public finances under control and putting Ms Merkel's unwieldy left-right coalition under severe strain.

When an expert commission appointed by Gerhard Schröder, Ms Merkel's predecessor as chancellor, unveiled its blueprint for an ambitious labour market reform four years ago, Peter Hartz, a Volkswagen executive and chairman of the working group that drew it up, claimed the measures would halve unemployment.

Instead, in the 18 months since Hartz IV, the central plank of the reform, was introduced the number of recipients has rocketed from an initial estimate of 2.6m to just under 4m. In its first year, the benefit cost the state €25bn ($31bn, £17bn), or €10bn more than planned. And although the government took that into account when drafting this year's budget, overruns of up to €4bn are expected this year and next. Without drastic cuts, the 2007 federal budget is heading straight for a breach of the constitution, which bans borrowings from exceeding investments.

How could this happen? Clues can be found in Offenbach, the first German municipality to take action when fears of a massive increase in welfare-benefit fraud began to surface. "Hartz IV is an open invitation to rob the state," says Ms Fürst, a hard-bitten chain-smoker whose persistence once earned her the epithet "Hartz-Nazi" from an irate victim. Hartz IV merged two types of benefits - a generous wage-indexed payment for jobseekers who had worked in the past and a more basic form of income support for those who had never held a job - into one, flat-rate benefit that would apply to everyone who had been jobless for more than a year. The goal was to support the needy while "coercing" those capable of work back into the labour market.

But although Hartz IV meant a benefit cut for a minority, recipients of the old basic benefit, known as social assistance, found themselves better off overnight. "The fact that the new system is more generous than the old one went completely unnoticed," says Ralf Brauksiepe, a Christian Democrat member of parliament and labour market expert.

While the new flat-rate benefit may appear low at €345 a month, recipients can claim rent, heating and even furnishing costs from the state, which also foots pension and health insurance bills. Subsidies for interest payments on mortgages and for dependent children are also on offer. The cost to the public coffers of rent and heating subsidies alone trebled between 2004 and 2005 to €12.5bn.

While under the old system, no one with more than €2,000 in assets was eligible for social assistance, the threshold under Hartz IV was raised to €26,000 and every adult member of a recipient household is entitled to a car.

Many such provisions were not in the original draft but were added during the tense negotiations between the CDU-controlled upper house of parliament and the Social Democrat-led government that shaped the final bill in late 2004. "It was a classic case of German over-engineering," says a member of the original Hartz commission. "Once they had the draft, politicians began adding this or that sweetener and lost sight of the broader edifice. No wonder no one knew how high the eventual bill would be."

According to the federal labour agency, monthly benefits for a married couple with two children can reach €1,600. While welfare experts in parliament blame sluggish growth for the lack of jobs, many economists consider such generous benefits a powerful disincentive to work.
Even low-wage workers qualify, provided their earnings fall below a certain level. Nearly 1m Hartz IV recipients are legally employed and, as Ms Merkel herself admitted in a speech to the BDI industry federation last week, many deliberately work short hours in order to maintain their eligibility.

So dramatic has been the haemorrhage of state money that charitable organisations, including the Red Cross, recently disconcerted some of their own members by publishing a joint letter calling for benefit cuts "to guarantee the sustainability and stability of the welfare system".
While the generous payments make fraud attractive, it was a second flaw in the system that made it possible: the administrative chaos that reigned during the changeover at the agencies administering the scheme.

In a report published on Friday, the Hartz IV ombudsman's office, which oversees the reform, branded the "poorly organised" local agencies responsible for recipients on the ground as "bureaucratic monsters" in need of urgent repair. Again, the report blamed the politicians. Having failed to agree on whether the federal labour agency or municipal welfare offices should have ultimate control of the scheme, they had opted for hybrid solutions that had "blurred responsibilities". One finance ministry official in Berlin suspects that an endemic "bleeding-heart culture" at the federal labour agency and many welfare offices also accounts for some of the profligacy.

Given the combination of attractive benefits, generous means-testing rules and lax controls, Ms Fürst, whose team of two has recovered €300,000 in misappropriated benefits since November, estimates that 20 per cent of all Hartz IV claims are groundless.

She has a fund of horror stories. One manager who earned €3,800 a month was granted Hartz IV for more than a year. Another recipient sold all his furniture on Ebay, then re-equipped his house by claiming a generous subsidy for movers. As she drives through an affluent neighbourhood, she points to a villa surrounded by a vast garden. Its owner, she says, managed to pocket €9,000 in Hartz IV payments masquerading as a jobless tenant while in fact working as a freelance consultant.

Natasha, officially an unemployed doctor, has claimed Hartz IV while maintaining a website where she poses naked, promising to "fulfil all male fantasies with much creativity anddedication".

"Hiding assets is popular," says Mr Hofmeister. The team found recipients with villas in Lebanon, estates in Turkey, yachts, high-end kitchens and plasma screens. One was operating a hotel in Spain.

Whenever fraudsters are caught, they must repay the money and their files are passed to the local prosecutor. Yet, with overloaded courts prioritising more serious offences, in 18 months not a single person has been convicted. And in the absence of fines, abuse is essentially risk-free.

"Fraudsters should have to repay double the money illegally obtained," says Peter Walter, former Frankfurt police chief and the top CDU man on Offenbach's municipal council."That would cover the cost of our investigations and create a deterrent where there is none today."
Fraud, however, only partly explains the escalating costs. The dentist's wife who moves out of her home or the teenager who gets his own flat in order to claim benefits and rent subsidies, are acting perfectly legally. Germans, says Ms Fürst, are treating Hartz IV as a sporting challenge to the ingenious dodger. Mr Walter adds: "I hear complaints about the entitlement mentality and eroding morals, but [this] is the result of what we have done for decades, which is to gradually replace full employment by welfare support."

A "Hartz IV modification" bill, rushed through the lower house of parliament last month, will close the most gaping loopholes and beef up sanctions for the workshy. Yet it will save only €500m this year and €1.2bn in 2007. The CDU's powerful state premiers - whose budgets bear much of the Hartz IV burden - have secured the promise of a more ambitious reform this autumn after threatening to block the "modification" bill.

At the same time, though, some within the grand coalition are crossing party lines and banding together to resist radical change, anxious that if they are party to a crackdown, they could pay the price at the next election.

"The grand coalition should have moved earlier on this," says Leef Dierks, economist at Barclays Capital in Frankfurt. "The longer it waits, the less likely it is [to] muster the courage and the will."
Copyright The Financial Times Limited 2006