The German government is moving forward with a major fiscal package that aims to implement structural changes to the country’s debt rules and significantly expand public spending.
The agreement, reached between the CDU/CSU and SPD, proposes a multi-year financial framework that would allow increased investment in defense and infrastructure.
The proposed changes require constitutional amendments and have sparked debate within the political landscape, particularly concerning the role of the Green party in securing parliamentary approval.
One of the most consequential aspects of the package is the reform of the debt brake, a constitutional rule that limits structural deficits.
Under the new plan, defense expenditures above 1% of GDP would be permanently excluded from these constraints, potentially unlocking an estimated €400 billion (9.3% of GDP) over the next decade.
This move aligns with Germany’s broader efforts to bolster its defense capabilities amid shifting geopolitical dynamics.
However, concerns have been raised that the reform could create spending flexibility that extends beyond defense, a key point of contention for the Greens.
The party has proposed raising the exclusion threshold to 1.5% of GDP and broadening the definition of defense expenditures to include cyber and energy security.
Alongside defense spending, the fiscal package outlines a €500 billion (11.6% of GDP) special fund for government investment, spread over ten years.
This fund is intended to finance infrastructure projects, with €100 billion reserved for expenditures at the state level.
The plan marks a departure from Germany’s traditionally restrictive fiscal stance, with an emphasis on modernizing transport networks, supporting decarbonization efforts, and addressing housing shortages.
However, questions remain over the package’s additionality, with critics arguing that some of the investment may replace existing budgetary allocations rather than providing new funding.
The Greens have pushed for stricter guarantees to ensure that the package leads to tangible increases in public investment rather than budgetary reshuffling.
The parliamentary process for approving the fiscal package is complex, requiring a two-thirds majority in both the Bundestag and the Bundesrat.
With the current coalition lacking a sufficient majority in the new Bundestag, the strategy is to rely on the outgoing parliament’s composition to secure passage before the newly elected members take office.
In the Bundesrat, which comprises the governments at the state level, states governed solely by CDU/CSU, SPD, or Greens do not have a two-thirds majority.
Hence, states where the FDP or the Free Voters are part of the government would have to be won over to agree to the reform.
The government has set a deadline of March 24 for the approval process, given that the new Bundestag is set to convene the following day.
Beyond domestic considerations, the package interacts with broader European fiscal rules. Germany remains bound by the European Union’s deficit constraints, which limit the general government deficit to 3% of GDP.
However, the European Commission’s ReArm Europe proposal could provide additional fiscal flexibility, potentially allowing defense spending to be exempted from EU rules.
If approved, this exemption could offer Germany further leeway in meeting its military investment commitments without breaching European deficit targets.
Economic implications of the package include potential growth stimulus, particularly through higher public investment. German defense spending amounted to 2.1% of GDP in 2024.
If one assumes an additional 0.5% of GDP in defense expenditures (to 2.6% of GDP) in 2026 and conservatively a fiscal multiplier of 0.5 for defense spending, this would provide a growth boost of 0.3 percentage points next year.
German government investment expenditures were 2.8% of GDP in 2023, lagging the Eurozone (3.3% of GDP) and in particular France (4.3% of GDP). The new fund would open up the possibility to ramp this up by €50 billion per year (1.2% of GDP), more than closing the gap to the Eurozone.
Assuming an increase in spending by 0.5% of GDP (to reach the Eurozone average) and a higher fiscal multiplier of around 1 for government investment, this would imply a growth boost of 0.5 percentage points in 2026, so that the overall growth uplift next year could amount to 80 basis points.
While the spending increases in both areas may be higher in coming years, the ramp-up in spending is expected to take some time.
The proposed fund matches the estimates by the German Industry Association BDI of Germany’s additional investment needs, which include the areas of education, transport, decarbonization, housing, and measures to strengthen the economy’s resilience.
Insofar as the investment spending financed from the special fund would not just be additional but could replace some of the spending that is currently done in the federal budget, it would free up additional resources in the federal budget that could be used for other purposes.
German debt-to-GDP stood at 62.9% in 2023, broadly the same level as in 2007. Mechanically adding the combined 21% of GDP in debt resulting from additional €400 billion in defense spending and €500 billion in infrastructure over the next ten years would lift debt-to-GDP to around 84%.
However, this does not take into account a positive impact on GDP growth, which would dampen the debt-to-GDP increase. Also to note is that the borrowing will take place when the money is spent, over time.
