Angela Merkel’s “read my lips” moment

May 31, 2010

    Angela Merkel has already abandoned plans to pursue billions of euros in tax cuts next year — the central policy pledge of her 2009 election campaign and main plank of her 7-month-old coalition agreement with the Free Democrats.

    But now her uneasy government looks ready to go one step further and raise value-added tax on certain products which benefit from a reduced rate to help it consolidate the budget.

    This is what Merkel had to say about such a move in an interview with N24 television in June 2009, in the midst of the election campaign: “There is absolutely no need to worry about that, it won’t happen. In the midst of an economic crisis it is absurd to even discuss these questions.”

    She told top-selling daily Bild that same week: “With me, there will be no increase in the next legislative period, neither of the full, nor of the reduced rate of value-added tax.”

    If her government does decide to raise VAT rates — it will meet this weekend to try to forge a consensus on fiscal plans — Merkel can and will claim that underlying economic conditions have changed since she uttered those seemingly definitive words nearly a year ago.

    The Greek crisis has spooked leaders across the euro zone, and many are scrambling to consolidate their budgets to avoid suffering the same fate as Athens, which was forced to go cap in hand to the EU and IMF.

    But Merkel’s about-face is different and more serious, especially for a leader who came into office in 2005 vowing to put an end to the “false promises” of previous German governments.

    For one, Germany’s own economic outlook has not changed much since Merkel argued forcefully for tax cuts last year and repeatedly dismissed her political opponents for suggesting Berlin lacked the money to pay for them.

    Last October, when she began her second term, the government was forecasting a budget deficit at 3.7 perent of GDP for 2009 and GDP growth of 1.2 percent for 2010.

    In the end, the 2009 deficit came in better than anticipated — at 3.3 percent of GDP — and the government has since revised up its growth estimate for this year to 1.4 percent.

    The excuse that some members of Merkel’s government are using for Berlin’s policy U-turn — that debt-brake legislation enshrined in the constitution has forced their hand — also doesn’t fly.

    The debt-brake rule was in place even before Merkel was actively advocating tax relief.

    The real reasons for the shift are twofold. First, Merkel has realised belatedly that there is very little public support for tax cuts.

    Pushing tax relief was good politics last year when an election was looming and Merkel was searching around for policy ideas that would differentiate her party from the centre-left SPD. But that is no longer the case.

    Second, officials in Merkel’s Chancellery have concluded that Germany must set an example for the fiscal laggards in the euro zone.

    It would be more difficult for Berlin to lecture its partners on budget responsibility and push through the radical tightening of EU fiscal rules that Merkel wants if it were not blazing the trail with spending cuts and tax hikes of its own.

    But the new course carries big risks for the chancellor and Germany’s partners.

    President George Bush the elder saw his political career curtailed after breaking his “read my lips” promise to U.S. voters on taxes.

    Likewise, Merkel could see her image as an honest, straight-talker irreversibly damaged by a blatant about-face on taxes. Relations with her coalition partner the Free Democrats (FDP), who remain advocates of tax relief, would probably deteriorate further.

    And speculation would increase that her government might not last the full four years. A nascent rapprochement between the FDP, SPD and Greens in the large western state of North Rhine-Westphalia carries major risks for Merkel at the federal level.

    More serious are the implications of Germany’s newfound fiscal stance on the euro zone itself. Spending cuts and tax rises will further hit private consumption, which already subtracted half a percentage point from German GDP in the first quarter of 2010.

    That will make it more difficult for German consumers to help struggling countries across Europe recover. Ultimately, that could deepen the woes of the euro zone economy at a time when it is scrambling to restore its credibility. That too could come back to haunt Merkel.

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