Whither Merkel?

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

Two drivers at the wheel is rarely a good thing, as the news about Germany is reminding us this month.

The country’s new grand coalition between Social Democrats and Christian Democrats looks fine behind the dashboard. And the new chancellor, Angela Merkel, boasts poll approval ratings in the 70% range, a level that Karl Rove can only dream of.

But the philosophical differences between her conservatives and the left-leaning SPD are already causing concerns about the German economy. Without intending to do so, this pair may end up jerking the German car right off the road.

Consider the work of the coalition already. Chancellor Merkel was in the U.S. this week, giving a carefully worded speech about the importance of entrepreneurship to the American Council on Germany. She also suggested it was time that the average German got better acquainted with the concept of individual shareholding and capital generally.

At home, many of the measures her young coalition is undertaking are anti-entrepreneurial. The first is an increase in the value-added tax to 19% from 16%. The Social Democrats like this change, set to take effect in January 2007, because it brings in so much money. Each percentage point increase is expected to bring in 8 billion ($10.2 billion) to 9 billion euros, making the VAT change alone the largest single tax increase in the history of the Federal Republic, which already is heavily taxed.

“This year, Germany might finally get 2% growth after hovering near zero all those years,” says Wilfried Prewo, head of the Hannover Chamber of Commerce. “And everyone thinks that number is great. But some of that growth may be because Germans are rushing out to buy flat-screen TVs before the tax increase. This is borrowed growth from next year.”

Finance Minister Peer Steinbrueck apparently agrees; he recently said that the new VAT would cost German growth. In London, JP Morgan’s David Mackie is relatively optimistic about Germany, but more for reasons of global growth than because of German fiscal policy, which he views as problematic. “There’s a common view amongst Europeans that fiscal tightening is a good thing for growth,” he said. “But it’s not always clear that’s true.”

Next comes the income tax itself. Finance Minister Steinbrueck is leading the government in a “get the rich plan” to increase the statutory top marginal rate to 45% from 42%. That isn’t counting the famous “solidarity surcharge” of roughly 2 1/2 percentage points for higher earners.

That surcharge was originally supposed to go away after the country absorbed the cost of reunification. But German leaders treat the special levy as if it were permanent. These are hardly good signals for entrepreneurs.

Third comes a proposal of a new capital-gains tax on individual investors. Historically, individuals in Germany have not been subject to such tax on investments held over the long term. That rule applied to real estate investments, along with equities or bonds.

Former Chancellor Gerhard Schroeder, a Social Democrat and Merkel’s predecessor, fiddled with this in a nasty way by narrowing the definition of long term. Thanks to Gerhard you have to hold a stock for a year, instead of six months, to fall into the tax-free category; rental properties must be held for 10 years instead of two.

But Steinbrueck et al. are now talking about doing away with the long-term exemption altogether in 2008. That means that capital gains for regular shareholders would be treated at Germany’s income tax rates – that is, in that same prohibitive 40% range. This would discourage, not encourage, German acquaintance with share ownership and investment.

The reason you haven’t heard more about all this is threefold.

The coalition is so new that everyone wants to be friendly. There is also that general continental faith that cutting budgets is the path to growth. But most important is the fact that Merkel and the Social Democrats are also promising a number of significant tax cuts for business.

The general idea is to reduce rates on both corporations and small business to 25% or 30% from the current levels, which are often 38% or higher when you include the infamous local trade tax, or Gewerbesteuer.

Still, the details of these latter cuts have not been agreed upon, whereas the tax increase for the rich and the egregious VAT change have been. This worries economists in Germany, and rightly so, for it leaves the entire burden of forcing through the good changes on Merkel.

Merkel grew up in socialist East Germany. This, as observers have hopefully noted, means she has an instinctual understanding of the importance of freedom.

But she is no Maggie Thatcher, for she trained as a particle physicist. She is more planner than a shopkeeper. That means she enjoys engineering budgets with her Social Democratic partners – perhaps too much. The business cuts may come, but they are likely to be less than expected.

Alone behind the wheel, Merkel might make that economy race as it once did. But Merkel together with the Social Democrats means all bets are off. And Germany watchers have to ask: Whither this vehicle?

Ms. Shlaes is a columnist for Bloomberg News.

The New York Sun

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