Berlin poised to fall into lineon stability pact (FT)

After four years of breaching the European budget rules it invented, Germany has returned to the path of fiscal parsimony.

Peer Steinbrück, the fin-ance minister, said yesterday that the German budget deficit would fall to 2.8 per cent of gross domestic product this year, below the 3 per cent limit allowed by the European Union's stability pact.

The minister told parliament he was ready to notify the European Commission that Germany was abiding by the stability pact again. "I see [a debt-to-GDP ratio of] 2.8 per cent as realistic and that is what I will tell Brussels," he said.

Although widely expected, the deficit's return to within the crucial threshold comes a year ahead of the government's original plan, underlining the strength of the recovery that began in Europe's largest economy at the end of last year. The robust rebound has boosted tax receipts and should leave Germany's federal, regional and social security budgets with €15bn ($18bn, £10bn) more in revenues this year than envisaged.

"What we are seeing is the steadily rising profits of companies over the past five years finally spilling over into tax revenues," a government economist told the FT.

He said the government would "definitely" raise its economic growth forecast for this year, currently at 1.6 per cent, above the 2 per cent mark when it upgraded its estimates at the end of next month.

Yet he said several factors would weigh on Germany's performance next year, including high oil and raw material prices, higher interest rates, a 3 percentage point value-added tax rise in January, and rocketing unemployment insurance costs. "We are already seeing signs of vulnerability."

In his speech Mr Steinbrück also warned against "euphoria, complacency and covetousness", adding that the government would stick to its planned VAT increase despite criticism that the measure was both fiscally unnecessary and economically risky.

While the minister has refused to budge on the VAT front, he appeared to have backtracked on his equally controversial plan to reform Germany's burdensome corporate tax system.

People close to Michael Glos, the economics minister and an opponent of Mr Steinbrück's tax blueprint, told the FT that the finance minister had withdrawn his proposal to bar companies from deducting interest payments from taxable profits.

The proposed ban was partly aimed at offsetting the effect of a planned cut in corporate tax rates on the public coffers. While Mr Steinbrück's blueprint envisages a fall in the average nominal tax rate from 39 to 30 per cent, the government wants to keep the ensuing tax relief capped at €5bn per year.

At the same time the ban would have ended a legal form of tax evasion whereby companies draw loans from subsidiaries in low-tax countries and subtract the interest payments from their taxable profits.

The proposal, however, was opposed by business, the economics ministry and Angela Merkel, the chancellor, as a "levy on substance" that could force loss-making companies to pay taxes.
While she denied that the concept was off the table, an official close to Mr Steinbrück said the minister had agreed with senior coalition politicians last week to -consider two alternative -proposals.

These models, developed by the state governments of Bavaria, Hesse and Rhineland-Palatinate, would limit the tax-deductibility of interest payments by stretching it over several years. The models would also apply only above a specific profit level, in effect exempting smaller companies.
Copyright The Financial Times Limited 2006