The Ukraine war has supercharged energy costs around the world, sending inflation soaring in virtually every major economy.
But a specific convergence of crises this summer means Germany might be on the cusp of an even more dramatic economic downturn than other places.
On Wednesday, Germany’s Federal Minister of Finance Christian Lindner unveiled a proposal for a series of comprehensive tax breaks that would be worth over €10 billion (around $10.2 billion) by the end of this year in a bid to bring down cost of living expenses for average Germans, the AP reported.
But the plan was controversial within Germany’s ruling three-party coalition, pushing Lindner to quickly justify it by detailing just how bad the economic situation is becoming in Germany, arguing how policies that once seemed radical might be necessary.
“The economic perspective of our country has become fragile,” Lindner told reporters in Berlin on Wednesday after announcing the tax adjustments. “The economy is deteriorating.”
Germany’s tax structure
Lindner’s tax break proposal was detailed on Wednesday by German outlet DW.
The government would not be directly cutting taxes, but rather raising income thresholds which determine taxation rates. The Finance Ministry will raise the tax-free allowance (the income level at which Germans start paying taxes) by €600 by 2024. The ministry is also planning on raising child benefit payments slightly, and will raise the bar for income that triggers the country’s highest taxation rate from €58,597 (around $60,500) to €63,515 ($65,600) by the end of next year.
Not everyone in Germany’s three-party ruling coalition agreed with Lindner—who is chairman of Germany’s economically liberal Free Democratic Party. Members of the other coalition parties—the Greens and Social Democrats—said that the changes were “regressive” and would disproportionately benefit the wealthy over low-income earners. And new structure will lead to a decrease in tax revenue of over $18 billion by 2024, when the full changes take effect.
But Lindner described the proposed changes as necessary to help Germans handle soaring energy costs.
Fragile economy
Germany’s annual inflation rate is currently 7.5%, exacerbated by rising energy and electricity costs since the Russian invasion of Ukraine in February.
Gas prices in Europe have surged, in part the result of Russia cutting supply along the Nord Stream 1 pipeline as well as from high temperatures and dry conditions affecting energy production in key European energy suppliers such as Norway and France.
Germany has arguably been the hardest hit by the rise in gas prices owing to a long-standing reliance on cheap Russian gas. Before Russia began its war in Ukraine, 55% of all gas consumed in Germany originated from Russia.
But if energy prices in Germany are bad now, they could be poised to get even worse. Consumers have yet to feel the full brunt of higher costs because utilities normally lock in prices for the year. If the supply crunch continues, energy bills could start rising as early as next year when winter electricity demand picks up, Uniper, a German utility company, told Bloomberg last month.
That’s what Lindner is concerned about: Uniper has already warned that Germans are set to face an “enormous wave” of rising energy costs in 2023.
To prepare for the inevitable crunch, German officials have been scrambling to build up their gas reserves from alternative suppliers like Qatar and Senegal, and have even begun recommending energy rationing measures to German businesses and individuals.
Lindner’s fears about Germany’s “deteriorating” economy echo increasingly pessimistic sentiments from the nation’s banks about the country’s economic outlook in recent weeks. The country’s latest GDP numbers—released at the end of July—showed that growth had stagnated for the second quarter in a row, leading most German banks to revise their forecasts, with many believing a recession to be likely before the end of 2022.
Last month, economists at Deutsche Bank, Germany’s largest, wrote that the country was inevitably “moving towards a recession” as a result of rising fuel costs and the growing possibility that gas supplies will continue to shrink into next year. The bank also predicted that German inflation has yet to peak, meaning more cost of living hikes for Germans for the foreseeable future.