How the debt brake could be reformed

The SPD and the Greens want to reform the debt brake enshrined in the Basic Law. Economic research institutes also recommend “cautious adjustments”. Which proposals are being discussed?

From Finance Minister Christian Lindner’s point of view, the matter is clear: for the FDP politician, there is nothing to change about the debt brake. After all, it is in the Basic Law.

“It is a constitutional requirement,” Lindner recently said in the ARD morning magazine. “You can’t turn constitutional commandments off and on like a light switch.”

Slight deviations are possible

In 2009, the Bundestag and Bundesrat anchored the debt brake in the Basic Law. In view of the global financial crisis at the time, new, strict rules should be introduced for government borrowing in order to ensure a long-term, sustainable financial policy.

The federal states are therefore not allowed to take on any more debt; the federal government has a limit of 0.35 percent of gross domestic product (GDP). Slight upward and downward deviations due to the economic situation are possible – the so-called economic component.

Critics of the debt brake complain that the rules are too strict. And within the traffic light coalition, politicians from the SPD and the Greens are repeatedly calling for the debt brake to be reformed so that the state can take out additional loans – be it for climate protection or for schools and daycare centers.

Some institutions from the International Monetary Fund (IMF) to the Bundesbank have recently also addressed the question of the extent to which the debt brake could and should be reformed. A number of reform proposals are being discussed.

Raise the deficit limit

The International Monetary Fund and the Council of Experts for the Assessment of Overall Economic Development, the so-called economic experts, suggest allowing more scope for new debt. Instead of 0.35 percent, the federal government could take out up to 1 percent of GDP in new loans annually. The argument goes that this would allow the state’s total debt to be kept within limits in the long term.

The chairwoman of the Wirtschaftsweise, Monika Schnitzer, sees it as positive “if you want to make future-oriented investments that the next generation will also benefit from.” This is something worth going into debt for.

Critics complain that the so-called economists around Schnitzer generally want to expand the scope for credit. The state could also take on debt to plug gaps in the social budget. That is not sustainable.

Special rules for investments only

The Scientific Advisory Board at the Federal Ministry of Economics recommends that certain investments be exempt from the debt brake – for example in order to invest money in climate protection. The proposal is reminiscent of the so-called “Golden Rule”, which applied before the introduction of the debt brake. At that time, the state was allowed to borrow as much as it invested in money.

However, this led to finance ministers declaring more and more expenditure as investment when they were in financial difficulties. Because the definition of the term “investment” is quite flexible. Many education politicians would see the repair of a school building as an investment, but economists would not. The Scientific Advisory Board therefore recommends that an independent institution must check when exactly an expenditure is to be considered an investment.

Transition rules after suspending the debt brake

In the years 2020 to 2023, the debt brake was suspended in order to initially respond to the emergency of the pandemic and later to the consequences of the Russian war in Ukraine and the associated energy crisis. This was permitted under the debt brake rules for “extraordinary emergency situations”. However, this also stipulates that the strict requirements will come into effect again immediately after the emergency has ended.

In their spring report, the leading economic research institutes therefore took up the proposal to establish transitional rules after an emergency. “The idea is that macroeconomic shocks will have an impact for several years,” says Stefan Kooths, director at the Kiel Institute for the World Economy (IfW). It therefore makes sense to gradually return to the 0.35 percent target after a shock.

However, the institutes also emphasize that although moderate modifications to the debt brake seem sensible, “the welfare and woe of Germany as a business location does not depend on it.” Overall, the debt brake has stabilized public finances – better than the “Golden Rule” in the period before the debt brake, according to Oliver Holtemöller from the Leibniz Institute for Economic Research Halle (IWH).

Economy stronger take into account

The debt brake provides for a so-called economic component. In bad times, the state is allowed to borrow a little more than 0.35 percent of GDP, and a little less in good times. However, this only amounts to a few billion euros per year.

The Bundesbank has developed a proposal that would generally expand this framework somewhat – especially depending on tax revenue. However, financial scientist Thiess Büttner points out that this does not create any new leeway in the long term: “Everything that you would get as additional leeway in a bad economic situation would have to be paid for by having less leeway in good times economic situation. In this respect, it is not entirely clear what will be gained from this.”

However, the federal government has some leeway if it wants to approach the calculation of the economic component. A change to the Basic Law would not be necessary for this.

The traffic light had already agreed in the coalition agreement to review the economic component without fundamentally changing the debt brake. Finance Minister Lindner once again expressed his openness to this in December. However, the calculation basis for the economic component has not yet been changed.

For the other reform proposals, however, a change to the Basic Law would be needed – and thus a two-thirds majority in the Bundestag and Bundesrat. However, this is very unlikely until the next federal election. Because the Union is currently not available for this – and neither is the FDP.