Germany’s top court puts ‘debt brake’ on Olaf Scholz’s coalition

Germany’s parliament was set to finally approve a painfully negotiated budget on Thursday but, less than 24 hours before, the country’s top court threw a financial — and political — hand grenade into the process.

In a move that will heap pressure on the already fractious coalition government of Olaf Scholz, judges at the constitutional court in Karlsruhe ordered that €60bn of funding for clean energy and industrial projects be cancelled.

“The government will pay close attention to this ruling by the Federal Constitutional Court,” said Scholz at a hastily convened press conference in the chancellery on Wednesday.

The chancellor insisted a Bundestag vote on the government’s budget would go ahead as planned.

But, if approved, the vote will lock in regular government spending plans for next year and give the coalition almost no room to plug the financial hole opened by the court ruling. The judgment almost exclusively hits projects championed by Scholz’s Green party coalition partner, many of which have been funded “off balance sheet”.

Worker at Siemens Energy’s new Gigafactory in Berlin
Siemens Energy’s new gigafactory in Berlin, which will be used in the production of ‘green’ hydrogen. The government had earmarked €60bn of funding for industrial and clean energy projects that included hydrogen  © Hannibal Hanschke/EPA-EFE/Shutterstock

For the conservative opposition Christian Democrats (CDU), who took the case against the government to the constitutional court, the ruling is a major political victory and the triumphant reassertion of stringent fiscal orthodoxy in Berlin.

Karlsruhe ruled that the government’s transfer of €60bn-worth of unused emergency funds from the coronavirus pandemic to a special green fund violated Germany’s constitutionally enshrined “debt brake”, which places hard limits on government spending.

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“This decision undermines the federal government’s entire financial and budget planning,” said CDU leader Friedrich Merz. “They have been shown clear boundaries . . . this is the end of all shadow budgeting.”

Markus Söder, state prime minister of Bavaria and leader of the CDU’s sister party, the CSU, was less circumspect. “Any legitimacy to continue governing is over. A government cannot go on like this,” he said.

The constitutional court has forced the government to immediately suspend dispersals from its Climate and Transformation Fund (KTF), the cornerstone of the coalition’s plans to decarbonise, digitise and revitalise its sluggish economy. The fund had planned to dole out more than €177bn in subsidies over the next three years.

Unless replacement funds can be found, the KTF, which had been allocated the disputed €60bn, will have to radically curb its ambitions.

Economy minister Robert Habeck holds a graphic at a press conference
Economy minister Robert Habeck’s policy agenda is in tatters © Fabrizio Bensch/Reuters

“That would substantially dampen economic growth,” said Sebastian Dullien, an economist at the Hans Böckler Foundation, a think-tank. Politically, he said, the impact could be more immediate.

Indeed, the judgment drives a wedge into the ruling coalition’s most sensitive faultline — between the fiscally conservative finance minister Christian Lindner, leader of the liberal FDP party, and Green vice-chancellor and economy minister Robert Habeck, whose policy agenda is now in tatters.

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“The money was a key element to square the wishes of the coalition partners,” Dullien said. “The key projects of the Green party are now in jeopardy . . . it’s hard to see how the Greens can stay in coalition if no alternative financing for decarbonisation projects can be found.”

Mark Hallerberg, a professor in public management and political economy at the Hertie School in Berlin, said the climate fund had been one of the few reasons the Greens “could live with Lindner’s rhetoric”. But now that Lindner’s insistence to observe the debt brake had been upheld in court, “one side has to lose”.

“There are no easy ways out of this given the opinions of the parties’ membership,” Hallerberg added. “Both sides don’t want to give anymore. And one or both may prefer an end to the coalition instead.”

Striking a conciliatory tone, Lindner accepted on Wednesday that he had initially supported the decision to hand the €60bn to the KTF.

However, that was when the coalition was formed under Scholz in 2021. Two years on, Lindner has little wriggle room.

After two disastrous regional election results last month, the FDP’s leadership have found themselves under pressure to show more ideological mettle to appease disenchanted core voters, with the debt brake a core issue for the party members.

The impasse is likely to start an intense debate in Germany about the constitutional constraints imposed on public spending. Under the brake rules, the government is limited to running a deficit equivalent to just 0.35 per cent of GDP annually.

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Germany is the weakest performing major advanced economy in the world with an intensifying need to invest heavily in areas such as digitisation and the shift to renewable energy.

Europe’s largest economy shrank 0.1 per cent in the third quarter from the previous quarter and the European Commission forecast this week it would contract 0.3 per cent this year.

Carsten Brzeski, an economist at Dutch bank ING, said: “The question remains whether the debt brake makes economic sense when the country struggles with structural stagnation and a long list of serious challenges and transitions, of which many need fiscal support.”

Friedrich Heinemann, an economist at the Leibniz Centre for European Economic Research, said the ruling could lead to subsequent challenges against other off-budget funds raised to circumvent the debt brake. These include the government’s €200bn economic stabilisation fund, and several smaller ones set up by regional states, such as Saarland, North Rhine-Westphalia and Berlin.

“This will kick-off an intense debate,” he said.

The rule is unlikely to change, however, as it would require a two-thirds majority in both houses of parliament.

A likelier way forward may be for the government to invoke another state of emergency — this time in relation to the war in Ukraine — and legally authorise exemptions to the debt brake, as it did during the pandemic. That too could be open to legal challenge, however, given the war has been raging since the beginning of 2022.

“Economists have warned for a long time that the debt brake is too strict,” Dullien said. “Now, Germany might feel the consequences of the grave mistake of writing these rules into the constitution.”