Berlin – The German government is facing increasing pressure from influential economic research institutes and advocacy groups to re-evaluate its fiscal strategy, with critics arguing that recently expanded borrowing capacities are not being adequately utilized for crucial long-term investments. A discussion paper, seen by Handelsblatt, from the employer-affiliated Institute of the German Economy (IW), the Climate Economy Foundation (Stiftung Klimawirtschaft), and Fiscal Future, contends that the administration is failing to leverage new debt allowances for essential investments, particularly in future technologies and national defense. The organizations are calling for higher investment levels and a fundamental reform of the "Schuldenbremse" (debt brake), Germany’s constitutional fiscal rule, which currently restricts borrowing for defense.
The critique comes at a politically sensitive juncture as the governing coalition grapples with the drafting of the 2027 federal budget. For months, economic research institutions and the Federal Court of Auditors have sharply criticized the government, accusing it of misusing new borrowing opportunities to fulfill electoral promises and plug budget deficits. This latest intervention highlights a growing concern that Germany’s fiscal framework is hindering its ability to address pressing challenges, from climate transition to geopolitical security.
The Looming Fiscal Crossroads: A Call for Strategic Investment
"For the loans taken out to be worthwhile, it is crucial that public funds also stimulate private investment and new growth, so that the interest payments can be covered," stated Sabine Nallinger, Executive Director of the Climate Economy Foundation. "Currently, we are witnessing the opposite, which is why the government should step in and steer more investment towards future technologies." This sentiment underscores a core argument: that debt should be an instrument for growth-generating investments, not simply a mechanism to maintain current spending or fulfill short-term political objectives.
The German debt brake, enshrined in the Basic Law, generally limits structural federal debt to 0.35% of GDP. However, since 2020, exceptional circumstances, including the COVID-19 pandemic and the energy crisis, have led to temporary suspensions and the creation of special funds, effectively expanding the government’s borrowing powers. The reform of the debt brake in early 2023 introduced specific provisions allowing for unlimited borrowing for defense expenditures and established a €50 billion special fund for infrastructure modernization. The underlying promise was that these new debt instruments would finance additional investments.
However, the IW, Fiscal Future, and the Climate Economy Foundation assert in their paper that the increase in federal debt has so far been met with only marginal growth in investments and overall economic expansion. A significant portion of the new borrowing, they argue, is being allocated to defense spending. Furthermore, some funds from the infrastructure special fund are reportedly replacing expenditures that were already planned, rather than representing genuinely new initiatives. In the Climate and Transformation Fund, the government is increasingly utilizing resources for relief measures instead of the intended investments in climate action and economic transformation.
This misallocation, according to the paper, is detrimental to long-term growth prospects. The institutes warn that this trend could lead to a future scarcity of funds needed to service rapidly increasing interest payments. "The long-term growth perspective remains weak, and fiscal leeway is narrowing because the interest burden is growing faster than the economy," the paper states. Projections indicate that federal interest payments could nearly double to over €80 billion annually by 2030 compared to current levels, further constricting the room for essential investments.
A Tightening Fiscal Squeeze and Political Stalemate
The pressure on the federal government intensifies as an expert commission’s report on reforming the debt brake is anticipated. The commission’s deliberations have been prolonged due to a lack of consensus. Representatives appointed by the conservative CDU/CSU opposition advocate for a swift return to financing defense spending from regular revenue. In contrast, the Social Democratic Party (SPD), a junior partner in the ruling coalition, favors a more gradual phasing out of the defense expenditure exception.
Adding to the complexity, the SPD is pushing for new exceptions to the debt rule specifically for investments, a proposal strongly opposed by the CDU/CSU. This divergence reflects a broader political debate about the role of fiscal discipline versus the necessity of public investment in a changing global landscape. Meanwhile, the ruling coalition faces growing pressure to reach a reform agreement, with the CDU/CSU bloc expressing increasing concern over the mounting national debt.
"Politics has significant opportunities to catch up on the shortcomings in infrastructure, transformation, and defense," commented IW researcher Tobias Hentze. "Now, it must deliver and act responsibly. Otherwise, the increase in debt will come at a high cost."
Key Demands for a Sustainable Fiscal Future
In their joint paper, the organizations outline seven specific proposals aimed at sustainably strengthening Germany’s investment capacity:
- Prioritize Productive Investments: All new borrowing, whether through direct debt or special funds, should be demonstrably channeled into investments that foster long-term economic growth and societal well-being. This includes modernizing infrastructure, advancing the green transition, and enhancing research and development.
- Reform the Debt Brake for Investment: The constitutional debt brake should be reformed to create a clearer and more stable framework for productive public investments. This could involve establishing a dedicated "investment pillar" that allows for greater borrowing for specific, well-defined projects with high economic and social returns, distinct from cyclical or current spending.
- Phased Reduction of Defense Expenditure Exception: While acknowledging the increased security needs, the broad exception for defense spending should be gradually phased out. This transition should be accompanied by a clear plan for how these expenditures will be sustainably financed in the future, potentially through revenue enhancements or reprioritization of existing budgets.
- Strengthen the Revenue Side: To create fiscal space for investments without excessive reliance on new debt, the government should explore measures to bolster federal revenues. This could involve reviewing tax expenditures, addressing tax avoidance and evasion, and potentially considering modest adjustments to tax rates where economically justified.
- Improve Budgetary Transparency and Efficiency: The government must enhance transparency in its spending and borrowing practices. A rigorous evaluation of all public expenditures is needed to identify inefficiencies and ensure that funds are allocated to their most impactful uses.
- Long-Term Investment Planning: A comprehensive, long-term investment strategy is required, spanning multiple legislative periods. This strategy should identify key priority areas and provide a stable funding outlook to encourage private sector participation and ensure the successful execution of major projects.
- Foster Public-Private Partnerships: Where appropriate, the government should actively promote and facilitate public-private partnerships (PPPs) to leverage private capital and expertise for infrastructure and other development projects, thereby sharing risks and accelerating implementation.
Carl Muehlbach, Managing Director of Fiscal Future, emphasized the intergenerational aspect of fiscal policy: "Young people depend on future-proof public finances. For this, the financing of investments must be stabilized. Furthermore, the carve-out for defense must be reduced and replaced by a strengthening of the revenue side."
The Climate Economy Foundation positions itself as a business-led initiative advocating for ambitious climate action, comprised of CEOs, managing directors, and family business owners in Germany. Fiscal Future is a non-governmental organization composed of young individuals advocating for sustainable financial policies, which had previously deemed the former debt brake too restrictive. The Institute of the German Economy (IW) is a research institute funded by employers, often providing economic analysis from a pro-business perspective. The collective voice of these diverse organizations signifies a broad consensus on the need for fiscal reform that prioritizes long-term economic health and strategic investment.
Background and Context
The debate surrounding Germany’s debt brake has been ongoing for years, intensifying with the country’s commitment to ambitious climate targets and the escalating geopolitical security challenges, notably Russia’s invasion of Ukraine. The creation of special funds, such as the €100 billion Bundeswehr fund and the Climate and Transformation Fund, reflects an attempt to circumvent the constitutional limitations on borrowing for specific purposes. However, the effectiveness and transparency of these mechanisms have come under scrutiny.
The reform of the debt brake in 2023 was a complex political compromise. While it allowed for increased borrowing for defense and climate initiatives, it also aimed to reintroduce fiscal discipline. The current debate centers on whether the government is adhering to the spirit of these reforms, particularly concerning the utilization of borrowed funds for genuinely new and growth-enhancing investments.
The Federal Court of Auditors has repeatedly warned about the increasing complexity and opacity of the federal budget, including the proliferation of special funds. Critics argue that these off-budget vehicles can obscure the true extent of public debt and make it more difficult to hold the government accountable for its fiscal decisions.
The upcoming report from the expert commission on debt brake reform is expected to provide further recommendations, but the political divisions, particularly between the CDU/CSU and the SPD, suggest that reaching a consensus on fundamental changes will be a challenging endeavor. The economic implications of prolonged fiscal uncertainty and underinvestment are significant, potentially impacting Germany’s competitiveness, its ability to meet its climate goals, and its capacity to respond to future crises. The call from IW, Stiftung Klimawirtschaft, and Fiscal Future is a clear signal that the time for decisive action and a strategic reorientation of Germany’s fiscal policy is now.
