investment in infrastructure bonds for ay 2021-14

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Investment in infrastructure bonds for ay 2021-14 nicole arnold universal investments

Investment in infrastructure bonds for ay 2021-14

Aggregate wage growth increased in and , while a deceleration is expected for Gross nominal wages and salaries per employee increased by 2. These developments come after a prolonged period of wage moderation during which wages did not keep up with productivity and external imbalances accumulated see Section 4.

A drop in labour productivity growth, coupled with wage increases, contributed to increasing unit labour costs. As employment levels remained high while production declined in the manufacturing sector and job growth continued in the non-tradable sector, overall productivity growth turned negative in early see also Section 4.

While labour productivity declined by 0. The real effective exchange rate appreciated, due partly to the nominal effective appreciation of the euro. While the risk of poverty or social exclusion continues to decline moderately, rising income inequality raises concerns. In , In addition, in the past five years Germany made significant progress in reaching the SDG 1 People at risk of poverty or social exclusion. Similarly, the disposable income of households continued to grow.

Still, this ratio is in line with the euro area average. The uneven profile of property ownership and steeply rising house prices see Section 4. Regional disparities in Germany have steadily decreased since , especially between the east and west of the country, but the gap between the most and least developed regions of the country remains wide.

Even though they have caught up in the last three decades, the least developed regions remain in the east. GDP per inhabitant of the eastern regions in represented Nevertheless, between and GDP growth per capita exceeded 2. However, other Eastern regions like Mecklenburg-Western Pomerania 1. Regional disparities across Germany also exist with regard to competitiveness, productivity, investment, unemployment rates and demographic developments see Section 4. Source: German Bundesbank, European Commission.

The gradual decline in the current account surplus since temporarily paused in The current account surplus for stood at 7. Compared to , the trade surplus increased by 0. The primary income balance increased by 0. The services balance and the secondary income balance remained unchanged. The transformation of the automotive sector is reflected in the evolution of the trade balance.

Net automotive exports continued to decline and account for much of the decline in the trade surplus since This trend continued in recent quarters as automotive imports increased further while exports declined or stagnated relative to GDP. This reflects both the global slowdown in overall demand for cars and the relocations abroad of a sizeable share of the production of German-branded cars.

Despite weakening growth, the budget surplus remains considerable and the fiscal position favourable, while government debt continues its downward path. Having peaked at 1. It is set to decline gradually in the coming years, as tax revenues are projected to increase less strongly and the implementation of government measures increases overall expenditure European Commission, a see also Section 4.

Overall, Germany performs well in achieving the Sustainable Development Goals. Public finances have kept improving and measures have been taken to increase public investment. Yet, further efforts to address the savings investments imbalance would be welcome. The good fiscal position also created room to intensify investment, and the public investment rate increased from 2. Still, a significant investment backlog remains, with investment gaps persisting in particular at municipal level in education and infrastructure.

Progress towards efficient market structures has been moderate. While the competition law framework was improved, little has been done to open up public procurement and allow more entry into business services and regulated professions, even though complaints abound about a lack of capacity.

Barriers to competition in railways have been reduced only to a limited extent. Improvements in network industries such as telecommunications, energy and transport, have been limited overall, reducing consumer welfare and endangering future competitiveness and sustainability targets. Investment needs in energy transmission and distribution infrastructure are increasing, but there is currently no systematic and comprehensive tracking of investment needs in different types of energy networks and at different levels of government.

The labour market has performed well , but more efforts are needed in view of demographic change. Continuing the trend since , employment and wage levels improved in even as the economy slowed. Labour market incomes have improved through the introduction of the statutory general minimum wage, as well as through efforts to reduce taxes on labour and disincentives to work.

Some progress has been made towards achieving sustained growth in public and private investment and strengthening conditions to support higher w age growth — two CSRs closely related to the euro area recommendations about fostering investment and supporting wage growth see Table 2.

There have be en certain efforts to reduce the labour tax wedge, most notably the abolition of the solidarity surcharge for most taxpayers from Yet taxes on labour remain high, while some of the potential remains underused to raise tax revenue from sources more su pportive of inclusive and sustainable growth, such as environmental and wealth-related taxes. There has been no progress in promoting competition in business services and the regulated professions.

A pending law to reintroduce conditions for practising 12 craft professions even reverses a reform of Limited progress has been recorded in improving the educational outcomes and skill levels of disadvantaged groups. At the request of a Member State the Commission can provide tailor-made expertise through the Structural Reform Support Programme to help design and implement growth-enhancing reforms.

Since , Germany has received such support in the form of three projects. In , the Commission provided the authorities with support to establish a large-cases unit in the German statistical system to ensure adequate coverage in the national statistics of multinational business groups with high economic impact.

Also in , work started on defining the IT infrastructure for this solution and building capacity for its successful implementation. The regulatory framework underpinning the programming of the EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework MFF.

In absolute numbers, Germany is one of the main beneficiaries of EU support. While reducing economic, social and territorial disparities, EU cohesion policy funding also tackles structural challenges in Germany. Through the promotion of research, technology and innovation, but also environment-friendly economic development and SMEs, substantial progress has been made since Furthermore, it has contributed to the creation of over 6, new jobs in enterprises and improved infrastructures for more than 2, researchers.

In addition, EU support has promoted integrated urban development for over 1. The European Social Fund ESF provided EU added value in fostering sustainable and quality employment, combating social exclusion and discrimination and boosting investments in skills and education. Funds disbursed between and , have helped more than 1.

EU rural development policy has contributed to strengthening of rural economies in Germany. Between and , the EAFRD supported more than 5, farmers invest in restructuring and modernisation of their agricultural holdings, thus enhancing the competitiveness of the agricultural sector. The fisheries fund and other EU programmes also contribute to addressing the investment needs. The Alert Mechanism Report concluded that a new in-depth review should be undertaken for Germany to a ssess the persistence or unwinding of the imbalances that affect it.

In February , Germany was identified as having macroeconomic imbalances European Commission, b. The imbalances identified related in particular to excess savings and weak privat e and public investment. This chapter summarises the findings of the analyses in the context of the macroeconomic imbalance procedure MIP in-depth review that are set out in various sections of this report.

While there is a continuing shift towards more domestic demand-driven growth, the overall shares of consumption and investment remain relatively low, given the resilient labour market, favourable financing conditions and infrastructure investment needs. Private investment is lagging behind infrastructure and housing needs. This is reflected in short-term pressures, observed for example through increases in house prices and rents.

Even if the gross investment rate in exceeded the euro area average US and France. This could act as a drag on potential growth. Public investment has picked up, but a still large investment backlog, with depreciation still exceeding new investment at municipal level, will take longer to make up. Meanwhile, the savings rate has been increasing even as interest rates fell to historic lows.

Wage growth continued and disposable incomes expanded, but a large part of these impulses fed to savings rather than consumption, despite the lower return on savings. Precautionary saving for future risks Rodriguez-Palenzuela, is an important savings motive. In addition, inequality of income and wealth contribute to high private savings, as high earners have a particularly high savings rate Brenke and Pfannkuche, Moreover high corporate savings partly reflect the savings of wealthy German households accumulated within firms due to preferential tax treatments for example within the inheritance and gift tax system IMF, Enhancing confidence in the future, and recalibrating the tax system, reducing inequality, could be thus ways to strengthen consumption.

Combining investment policies with structural reform is a potentially powerful tool. Stronger investment in innovation, quality education and skills, very high-speed broadband networks, sustainable transport, electricity infrastructures and affordable housing, could be combined with a set of structural reforms to unleash productive potential. Reducing taxes on labour could increase the labour supply.

Reducing barriers to competition in the construction sector and related professional services could help to alleviate capacity constraints, and raise both short-term growth and long-term potential. This would be of crucial importance especially as population ageing intensifies and immigration may slow down. Growth-enhancing policies could also have positive spillovers for the other EU countries. Following a gradual decline since , the trade balance has widened again in , due to weak demand for imported inputs in manufacturing and cheaper energy imports.

The primary income balance also improved somewhat, while the negative services balance and secondary income balance remained unchanged. The darkest shade of red corresponds to percentile 95 and the darkest shade of green to percentile 5. The percentiles were calculated for each variable based on the full available sample of bilateral exposures among EU countries. The blank spaces represent missing data. Data refer to: Imports — , Imports in value added — , Financial liabilities — , Financial assets — , Liabilities to banks — Q2, Bank Claims — Q2.

The large current account surplus currently reflects savings in the household and public sectors alone, as the non-financial corporate sector no longer has a positive net savings position. This reflects increases in corporate lending and corporate investment and a reduction in corporate savings as a result of rising unit labour costs, compounded lately by the recession in manufacturing.

Wage growth is expected to slow down closer to the euro area average, being less conducive to rebalancing. Given the size of the German economy and its strong trade and financial linkages, there are potentially sizeable spillovers to other EU countries. High trade volumes also reflect the fact that German companies operate and invest in other Member States, resulting in integrated value chains.

Developments in the car industry reveal the complex nature of the resulting linkages across countries: the weak demand for cars in resulted in a production decline in Germany, while German companies actually increased production in other EU countries. This production shift now seems to have bottomed out but it is clear that the ongoing structural change in the car industry will have significant implications also for production facilities across the EU.

Financial linkages are on average smaller than trade linkages, yet for some countries they are very strong. The countries with the strongest financial links, Luxembourg and the Netherlands, saw their linkages strengthen considerably further. More recently, Germany has taken some important policy steps to address its macroeconomic imbalances, but more efforts will be needed in the coming years to fully address them.

There have been policy advances in the area of public investment, though municipal level investment is still lagging behind. There have also been some smaller advances as regards investment in digital infrastructure, reducing disincentives to work and promoting wage growth. However, it remains to be seen if policy action has been decisive enough to produce the desired outcomes. The simulation assumes that no neutralising fiscal measures e.

The output elasticity with respect to the public capital stock is assumed to be 0. Monetary policy is assumed to retain its accommodative stance at the zero lower bound fo r the first 2 years and gradually normalise afterwards. A sustained increase in public investment would have positive domestic and cross-border spillovers. Public investment tends to have a larger output multiplier than public consumption due to the impact on long-term output and wealth.

As illustrated in Table 1, under the stipulated assumptions, increasing the public investment rate in Germany boosts output, employment and price dynamics in both Germany and the rest of the euro area, without exacerbating imbalances. There is also a frontloading of GDP effects. It derives from a real interest rate decline under the zero lower bound and expected positive long-term income effects from capital build-up even under an evenly distributed stimulus.

It would weaken if the duration of stimulus were reduced. The accommodative monetary policy is essential to realising of sizeable positive spillovers in this simulation exercise. Assuming a prolongation of the accommodative stance beyond 2 years could result in even stronger effects on the GDP of the rest of the euro area. This gain is associated with the export demand effects from a stronger depreciation of the euro, and with a strengthening of the real interest rate decline.

Conversely, a monetary contraction would neutralise the spillovers onto the rest of the euro area or make them negative. On the other hand, at typical average debt maturity, debt costs would be affected only slowly by a gradual normalisation of monetary policy. The debt stock increases during the 10 years of stimulus, but together with the assumed low financing costs the impact of the package on the debt-to-GDP is strongly mitigated in the long term by rising tax revenue and growth in nominal GDP.

This simulation complements earlier QUEST simulations designed to model a demand stimulus or structural reforms. The adjustment of the current account surplus has been limited so far, but a gradual decline is set to continue while the surplus level remains elevated.

With the persistent weakness and uncertainty in the external environment, growth is expected to be driven primarily by domestic demand in According to the draft budgetary plan, implementation of measures to increase public investment is set to continue.

Private investment is also expected to remain solid amid strong housing demand and, more importantly, due to the need to adopt new technologies. A comprehensive, long-term investment programme in Germany could reduce the external imbalance and would cons iderably increase GDP.

More progress is needed to reduce the investment backlog and to support the long-term prosperity of the country. An investment programme could contribute to these. Moreover it could largely counterbalance an expected decline in poten tial growth. Since , the government sector achieved headline balance surpluses that have increased over time to peak at 1.

This surplus has declined to 1. The structural balance is also expected to decline over the same period, but to remain in a clear surplus. Several government measures to reduce taxes and increase spending are projected to have an expansionary fiscal stance over the period , according to the Commission autumn forecast European Commission, a.

Public debt is expected to decline further in the coming years. For a debt sustainability analysis and associated fiscal risks see Annex B. Germany has accumulated considerable fiscal space in recent years, which starts being used and could be used further to sustain the upward trend in public investment. Fiscal space is on average present at all levels of government. While the federal government is expected to largely use its headline surplus and return to balanced budgets, the state and local governments, at aggregate levels, still have reserves to boost public investment and overcome the investment backlog especially at m unicipal level.

However, investment barriers in the form of constraints in planning and construction capacities persist. With the measures announced by the government up until , the fiscal space could be reduced to 1. The latter reached 2. Having a long-term vision for investment could facilitate sustainable and inclusive growth and help improve predictability and planning certainty for businesses and local communities.

Trade unions and employer associations have recently agreed on the need for a long-term perspective on public investments in areas such as decarbonisation, digitalisation, transport and education. According to the social partners and their research institutes, the low interest rate environment offers a unique opportunity for a debt-financed investment programme.

Furthermore, capacity constraints could be alleviated by giving incentives to companies from all over the EU to bid for lucrative German contracts. Having a long-term investment plan could create continuous demand for public construction projects. It could give planning certainty to construction companies and municipalities to increase their capacities for managing public investment projects, also by hiring engineers at competitive salaries.

It could also ensure that public investment does not decline in an economic slowdown due to consolidation efforts. Tax revenues in Germany continued to grow, with a major part coming from labour taxation, while taxes more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes, remain underused. In , tax revenues reached This is among the highest in the EU the EU average is At the same time, revenues from indirect taxes are relatively low The same is true for recurrent taxes on immovable property 1.

The share of revenues from taxes on capital stock and on capital income of households is significantly below the EU average. The tax burden on labour, as measured by the tax wedge, is among the highest in the EU In particular, the tax wedge for low-income earners This is largely due to the limited progressivity in social security contributions.

Source: European Commission Tax and benefits indicators database. Certain features of the German tax-benefit system result in disincentives to work in the lower-income segment. This results in strong disincentives for people to increase their working hours the intensive margin , or — for the jobless — to start working This is particularly an issue for people in part-time occupations predominantly women , and goes against consi derations of efficiency and fairness see Section 4.

The increase in the midi-job threshold, above which full social security contributions are paid lowers the tax burden below the threshold, yet effects merit monitoring, as for some groups the mar ginal effective tax rates increase European Commission, b. It could also provide short-term tax revenues, which can be used for compensatory measures to improve the distributional impact of environmental taxes and their acceptance among the population.

Environmental tax revenues in Germany stem primarily from energy-related taxes Tax revenues from transport fuel taxes and taxes on resources are particularly low in Germany compared with other EU countries. Germany has no pollution-related tax revenue Graph 4. As environmental taxes are typically regressive European Commission, , it is important to accompany their increased use with policy measures, including labour tax cuts and cash benefits, that alleviate their impact on vulnerable populations.

Furthermore, as environmental taxes aim to change behaviour, which would, over time, result in the erosion of the associated tax base, an expansion of the tax base and a gradual increase in tax rates could ensure stable revenues. Current price signals across energy carriers and users limit the potential for deploying clean energy technologies and reducing emissions. Taxes and levies i ncluding the levy to finance subsidies for the producers of renewable energies on electricity are currently higher per unit of energy than those on other energy carriers such as petrol and diesel, natural gas and heating oil in Germany Kemfert et al.

This limits the smart integration of electricity into the heating, transport and industry sectors. The situation is unlikely to change significantly over the coming years, despite planned reductions in electricity charges in support of the production of renewable energies.

Exemptions for energy-intensive companies from the renewable surcharge add to the electricity bill of other industrial consumers and households. Furthermore, like many other EU Member States 11 , Germany imposes a lower nominal margi nal tax rate on diesel fuel for private road usage than on unleaded petrol and the ratio of diesel to petrol excises is significantly below the EU average. This is done even though the former has a higher carbon content and greater negative impact on ambie nt air quality This is true for both the tax per litre and the tax per tonne of CO 2 emissions European Commission, One might argue that the German tax system offsets this advantage for diesel fuel at least partially through higher car circul ation taxes on diesel cars.

However, the circulation taxes do not aff ect the extent to which a car is actually used once it is owned and available i. To serve policy objectives of environmental sustainability, it would be preferable to tax transport fuel consistently based on consumpt ion, reflecting the associated externalities in terms of carbon emissions and air pollution. The tax system remains relatively complex, which contributes to comparatively high compliance costs for businesses.

Both statutory rates and effective average tax rates on corporate income are relatively high in Germany European Commission, c. Given that many businesses will not benefit from the abolition of the solidarity surcharge, this situation remains unchanged. Similarly, the debt bias in corporate taxation remains high European Commission, b. Transport taxes include taxes on owners and users of means of transport. Pollution taxes include taxes on emissions, waste management and noise.

Resource taxes include any taxes li nked to the extraction or use of a natural resource. They do not include other levies, e. The go vernment agreed on the abolition of the solidarity surcharge for large parts of the population, and this is expected to help spur job creation and private consumption. The solidarity surcharge an additional 5. The reform is expected to create more than , additional jobs in full time equivalents and generate a substantial fiscal stimulus.

As part of the recently agreed Climate Package, Germany will introduce a CO 2 price with a proposed price path which can help the attainment of its medium-term climate targets, but which might also have a regressive effect. The Climate Package is expected to increase the cost of pollution, lower costs for less-polluting transport modes and give more incentives to promote the use of building insulation and less-polluting types of heating Projektgruppe Gemeinschaftsdiagnose, Evaluations by economic research institutes found that the moderate CO 2 price initially proposed by the government for transport and buildings would not be sufficient to reach the target for reducing emissions not covered by the EU emission trading system DIW, The regressive effect is expected to be partially reduced through a substantial reduction in the renewable electricity surcharge.

In the meantime, most of the corresponding legislation has been adopted by the German Parliament. The law also sets the long-term objective of climate neutrality by The law further apportions the overall emissions reduction targets into sectoral emissio n budgets between key sectors of the economy, in particular, energy, buildings, transport, industry, agriculture and waste management. Compliance with these sectoral annual emission budgets is allocated to the federal ministry responsible for the respectiv e sector.

In case of failure, the lead ministry must present an emergency adjustment programme of measures to reach future targets. As part of the federal climate protection programme, a CO 2 pricing system will be introduced in the transport and heating sectors - the so-called national emission trading scheme nETS. The German Parliament agreed to raise the level of environmental ambition and the volume of compensatory measures.

The maximum amount of emissions decided in will be set to decrease annually in line with German climate targets. An evaluation of the law is foreseen for to determine whether a price corridor for the following years after is reasonable or necessary. Several initiatives listed in the Climate Package aim to partly compensate final consumers and economic agents for increased energy prices.

First, a large part of the income generated by the nETS is planned to be used to reduce electricity charges and levies In particular, the surcharge on renewable electricity for households and small businesses will be gradually decreased. This extra fiscal benefit of 5 eurocents per km will be increased to 8 eurocents per km in to However, a large part of the additional revenue will go to the federal budget to finance additional climate and energy measures.

In addition, the Climate Package includes a long list of sectoral policies aimed at reducing sectoral emissions. For example, in the buildings sector , Germany plans to increase tax support for refitting heating systems. At the same time, after it will not be allowed to fit a new oil heating system as long as an alternative exists.

In the transport sector , electro-mobility will be supported across the board. The goal is to have 1 million electric vehicle EV charging points available across Germany by The creation of EV charging infrastructure at commonly used private properties will be supported. Public transport investment, creation of new cycling routes, modernisation of ports and inland waterways, support to rail transport Deutsche Bahn , digitalisation and development of new motor fuels e.

From , the motor vehicle tax for newly registered vehicles will be related to their CO 2 emissions per km. The transformation of German industry will be supported by, among other things, investment programmes, higher minimum standards in eco-labelling and the national decarbonisation program, which targets in particular high-emitting sectors.

Battery cell production will be supported. With regard to energy , Germany will phase out coal in power stations by The Climate Package has been welcomed as a step into the right direction but criticised for its distributional impact, showing that low-income households would be more affected than those with high incomes. The study also analysed the distributional impact of the programme and revealed that despite compensatory measures such as the reduction in the surcharge on renewable electricity or the increase in the commuting allowance, low-income households would be more impacted than high-income households.

Although this study assessed a government proposal with a considerably lower level of ambition, concerns about the distributional effects remain. This is mainly due to the further increased Pe ndlerpauschale which benefits richer households proportionally more than those on lower incomes. An assessment made by the Berlin climate research institute MCC and the Potsdam Institute for Climate Impact Research PIK came to a similar conclusion that t he climate protection programme initially proposed by the federal government is unlikely to be sufficient to achieve the climate targets.

Policymakers were advised to make four specific adjustments: i raise the level of ambition for the carbon price ; ii improve the social balance; iii integrate the programme more closely with EU-level action; and iv introduce an effective monitoring process MCC and PIK, However, the net effect might still be regressive as the long-distance commuter tax rebate, which benefits high-income earners, will increase significantly.

The success of the Climate Package will also depend on a multitude of additional measures. The package includes numerous measures beyond CO 2 pricing see Box 4. In addition, the intended beneficial effect will be dampened by the continuation of environmentally problematic fossil fuel subsidies. The government aimed at a revenue-neutral reform that would comply with the ruling.

Furthermore, the administration of the reform is intended to remain relatively simple, with limited distributional ramifications. In principle the amounts of immovable property tax due will continue to be based on property values, although regional governments may opt out and apply a different valuation method.

The draft legislation envisages a fundamentally unchanged valuation method. First, the immovable property will be valued for tax purposes Then, this value will be multiplied by a uniform factor basic federal rate: Steuermesszahl and another multiplier Hebesatz. This box presents hypothetical CO 2 tax scenarios in transport and heating and discusses their distributional effects.

Environmental taxation, including CO 2 pricing, can help internalise externalities from environmental d egradation, incentivise more efficient use of resources and contribute to sustainability goals see Section 4. Transport and heating were also targeted by the recently adopted carbon pricing policy as part of the Climate Package. While the aim of t his box is not to assess the exact policies included in that package for the assessment, see Box 4.

Studies show t hat such taxes are typically regressive, as those on low incomes spend a higher proportion of their income on environmental taxes Hassett et al. While the average household in the lowest income decile emits on average about 7 tonnes of CO 2 per year, the average household in the fifth income decile emits almost twi ce that amount. In the top income decile, the carbon emissions are almost three times higher than in the lowest decile. However, this increase in CO 2 emissions is disproportionate to income, as the average net equivalent income of the top income decile is almost six times that of the bottom decile IX German Council of Economic Experts, a.

These findings justify redistributive measures to counteract the regressive distributional effects of environmental taxes. While this assumption is plausible in the short term, the tax is intended to have steering effects that will ultimately lead to behavioural change and a reduction in CO 2 emissions, and hence in tax revenues.

The additional revenue in the first scenario is spent entirely on compensatory measures in a budget-neutral way. The results confirm that the impact of a CO 2 tax is regressive, but also indicate that well-designed compensatory mechanisms can lead to an overall progressive effect. Without compensatory measures, the regressive effect is stronger the higher the CO 2 price. As a result, adjusted disposable income decreases in the range of 0. The introduction of a cash benefit renders the reform progressive, leading to a gain in adjusted disposable income for households until the third decile in the case of a lump-sum benefit and until the fifth decile in the case of a targeted benefit see Graph 1.

Inequality and the at-risk-of-poverty rate are reduced where compensatory measures are in place. Inequality, as measured by the Gini coefficient, increases in the scenarios without compensatory measures as the price of CO 2 rises. It decreases in the case of the targeted cash benefit and stays roughly the same if a lump-sum compensation is in place. The at-risk-of-poverty rate evolves in a similar way see Graph 1. While the basic federal rate will be the same across all of Germany, the multiplier — and therefore the amount of tax ultimately due — will be determined by local authorities.

For example, Bavaria has already stated its intention to use land values instead of property values to determine the relevant tax base. The reform did not aim to raise additional tax revenues from property owners, and thus missed the opportunity to shape the tax system in a way that is more conducive to inclusive growth. Recurrent taxes on immovable property are generally considered a relatively efficient tax, given the immobility of the tax base European Commission, In addition, taking account of the relatively low rate of home ownership in Germany and its unequal distribution, recurrent property taxes may also contribute to a fairer distribution of the tax burde n.

However, even after the reform, tax revenue from immovable property is expected to remain relatively low as the government envisaged a revenue-neutral reform. Furthermore, the reform did not restrict the possibility for the owner to include the taxes du e in the utilities to be paid by the tenant. This makes the tenant the de facto entity on whom the tax is imposed. Wealth-related taxes account for a small part of revenues. Also, since Germany no longer applies its wealth tax legislation as it discriminated against non-real-estate wealth.

Thus, while revenu es from wealth-related taxes in Germany have declined over the years, the accumulation of wealth has increased substantially, wealth concentration is very high in international comparision Bach and Thiemann, ; Bach et al.

Inefficiencies in healthcare persist. At the same time, avoidable deaths from preventable and treatable causes are close to the EU average and higher than in many other western European countries. The German healthcare system continues to be very hospital-centric. Hospital bed density in 8 beds per 1, people was higher than the EU average 5.

Also the average hospital stay, at 8. The quality of healthcare suffers from a highly fragmented system, with many services provided in small and often inadequately equipped hospitals. A stronger focus on prevention and care integration could bring efficiency gains. Inefficiencies in the healthcare system also arise from the legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of the solidarity-based statutory health insurance scheme. It also allows doctors to charge patients with private health insurance more than those covered by the statutory scheme, which incentivises overprovision of health services.

The retirement of the baby boomer generation is affecting Germany more than other EU c ountries, putting considerable pressure on public finances. By , the country is expected to be facing one of the largest increases in spending on public pensions in the EU up by 1. The long-term fiscal sustainability risk has increased from low to medium, reflecting a softening of the initial budgetary position, which however remains favourable.

This yields an increase in the S2 level by 0. Demographic developments also have implications for the adequacy and fairness of pensions. Since , pension increases are linked to the pension sustainability factor, which measures the change in the number of contributors relative to the number of pensioners.

While in this led to an additional pension increase of 0. At the same time, net pension replacement rates are already relatively low, especially for low-wage earners Furthermore, life expectancy varies between socio-demographic groups and is lower for low-income earners than for high-income earners, as also reported in the Federal Government Report on Poverty and Wealth BMAS, As a result, the annualised compound return of expected pensions compared to their earlier contributions is currently higher for high-income earners than for low-income earners Haan et al.

The principle of intra-generational fairness could be further strengthened in the Grundrente by basing the contribution years on full-time equivalents. This would avoid treating those that worked part-time in relatively well-paid jobs the same as those that have worked their entire life full time in badly paid jobs.

Structural deficits are no longer allowed. Germany continues to conduct spending reviews to increase the efficiency and effectiveness of government spending. Since , the country has held yearly cycles of spending reviews targeting specific policy areas and ministries. While a comprehensive view may be missing, the policy impact could still be analysed for specific climate and environment policy-related actions.

Banking sector. The banking industry needs to adapt to the challenging times ahead. Banks will have to accelerate consolidation and reorient their business strategy in the foreseeable future of ultra-low interest rates While further cost-cutting is necessary, the financial sector needs to invest more in IT infrastructure to modernise day-to-day business.

The disruption initiated by fintech and bigtech may squeeze revenues, while consumer pre ferences and the regulatory environment may also change The sector as a whole needs to adapt to a rapidly changing environment and develop a strategic vision in order to remain viable. The past years of economic growth have helped banks to keep non-performing loan ratios low, while the low interest rate environment contributed to lower funding costs. However, profitability has been dented by the decline in lending interest rates combined with an over-reliance on intermediation income, over-capacity stemming from splintered bank networks, compliance cost, an old IT infrastructure that needs costly overhauls.

Still, banks have managed to remain profitable on aggregate by realising hidden reserves, increasing the maturity transformation, increasing credit flows and taking on higher risks during the past years. Relying on these factors appears more difficult in the future.

Profitability dif fers widely between banking types. By contrast, savings banks and cooperatives are currently more profita ble than big commercial banks and Landesbanken. For the banking system as a whole, the return on assets in was 0. Low profitability calls for an overhaul of cost structure. High costs were a major driver of low profitability. Consolidation progresses still have a long way to go. Mergers across pillars remain difficult, also because their legal set-up differs.

Given the much lower discount rate, pension liabilities increased commensurately. In , the stock of mortgages increased by 4. Outstanding bank credit to the private non-financial sector increased to EUR 1,1 trillion at the end of September Growth accelerated to 5. Outstanding credit increased by 3. For the EU and euro area data includes domestic banking groups and stand-alone banks, foreign non-EU controlled subsidiaries and foreign non-EU controlled branches.

German banks still depend predominantly on intermediation income. It accounts for three quarters of their total income, while in several other euro area jurisdictions non-interest income constitutes about half of aggregate revenue.

Over , loan stock increased by 4. Savings banks and cooperatives had an average margin of 1. Banks pass on negative interest rates to larger corporate customers, but only very timidly to large household depositors. Risk-adjusted capital ratios are still somewhat above the European average.

With 1. Table 4. The stress scenario implies a severe downturn causing the CET1 ratio to fall to Hence, smaller banks would, on average, remain above regulatory minima, which does obviously not preclude individual institutions from falling below that threshold. The share of hard-to-value Level 2 and Level 3 assets has been falling in the last decade. Assets held for trading are classified in three levels depending on the progressing complexity of valuing the asset.

Accounting rules IFRS 13 oblige banks to report gross positions, which might be partly hedged against each other, and are therefore of limited explanatory power compared to net positions. Gross level 2 and level 3 assets amount to In France, these figures are Their share in Germany has been falling slightly over the past decade. Given their complexity, these assets are rather concentrated in the bigger banks. For 31 of the banks tested the impact on Common Tier 1 capital levels would be less than 20bp, 10 banks would see their CET1 ratio fall bp, and only 7 banks would face a capital impact ranging from 73 to 40bp.

Housing market. House prices rose by half this decade, catching up after years of stagnation. Most of the available residential real estate price indicators point to an overvaluation in the bigger cities. Following a period of mainly nominal increases since , real house price growth has accelerated in recent years, slightly outpacing the growth in household income. Today house prices considerably exceed their long-term average, compared to both rents and incomes, suggesting increasing risks of a housing bubble.

House price increases in urban areas reflect a shortage of housing supply relative to demand. The federal government has introduced a number of measures aimed at alleviating this shortage. See also Section 4.

New mortgage attribution is still accelerating, outweighing redemptions quite significantly. In September the mortgage stock was 5. Rising housing prices have led to a higher number of mortgages. Over , average annuities increased by 5. The loan to value at origination increased by basis points bp to Riskier loans also led to higher interest rates. Over , interest rates increased from 1. Yet over , mortgage rates fell faster in Germany, and in September they stood 17bp below the euro area average of 1.

In Germany, most homebuyers choose fixed interest rates insulating them from interest rate changes. The home ownership rate is the lowest in the EU, yet a quarter of the German population has a mortgage, which is close to the EU average. The macro-prudential tools are only partially appropriate.

Adding debt-based limits to the toolkit would enhance its effectiveness as currently only loan-to-value and maturity limits could be activated. In its warning, the European Systemic Risk Board identifies loosening lending standards, accelerating mortgage growth and urban overvaluation as systemic risk sources ESRB Even though Germany will introduce a 0. Capital markets. Venture capital funds amount to 4.

There is a strong concentration of venture capital in two major hubs across all stages of financing. This concentration is related to the relatively str ong innovation performance by both regions. Regarding the sectoral distribution of venture capital investments, ICT and manufacturing stand out Flachenecker et al. Public financing programmes have improved access to early-stage finance. Unlike other public programmes aimed at promoting venture capital investments, the INVEST programme allows private investors to choose which businesses to invest in.

Tighter links between entrepreneurs and investors through investment in incubators, accelerators and business angel networks have improved the entrepreneurial culture and made Germany more attractive to local and international investors. However, access to early-stage and growth finance is still a major impediment for high-growth businesses EFI, ; Flachenecker et al. Recent initiatives focus on providing finance to high-tech and innovative sectors. Issuing private placements of debt promissory notes, Schuldscheine is considerably less costly than issuing a bond.

Promissory notes do not need to be marked to market and therefore banks prefer holding them over classic bonds which are subject to valuation changes. Sectoral saving-investment balances. The high current account surplus is reflected in household and public savings, while corporate deleveraging has halted. Until recently, all sectors of the economy contributed to the current account surplus.

This now only holds for households and the general government. Since , non-financial corporations have turned into net borrowers: the net lending of corporations declined from 1. This reflects a consistent increase in corporate investment since in response to high capacity utilisation.

Households have benefited from an increase in gove rnment transfers and the resilient labour market. The share of labour income has been recovering further, reflecting the continuation of employment growth and resilient wages.

Only a part of the disposable income increase found its way into consumption and investment: the household savings rate increased further to By contrast, general government savings increased in the years to as a share of GDP, reflecting strengthening tax revenues. This has driven the fiscal surplus up, creating room for more public investment and other long-term growth-enhancing expenditure.

The public sector net lending position peaked at 1. Further reductions are expected in the future, to a broadly balanced balance by Source: German Bundesbank European Commission. The current account surplus and the net international investment position remain considerably above what fundamentals suggest. Yet, a large part of the surplus 3. An increasing net international investment position continued to contribute to a sizeable positive income balance 1.

The remarkably strong labour market masks labour hoarding and diverging trends between services and manufacturing. The unemployment rate stabilised at around 3. While manufacturing and related business services have contributed about half of the employment growth in recent years, since the second quarter of job creation in these sectors slowed noticeably and it even came to a halt in Graph 4. Still, dismissals were limited as many manufacturing companies hoarded labour, reducing hours worked by winding down working time account balances Arbeitszeitkonten and using short-time work arrangements Kurzarbeit.

The number of workers participating in cyclical short-term work arrangements increased markedly from its lowest level of about 10, to about 84, in November remaining nonetheless far below the peak of 1. This suggests considerable further room for labour hoarding against a cyclical shortage of demand. Kurzarbeit however is not a general remedy for structural transformation needs, which in the car sector are already leading to dismissals. Even as job creation in manufacturing and related services halted, hiring continued in construction and the large majority of services, notably public services, healthcare and education.

Overall wage growth has been resilient so far but i s expected to slow this year towards the euro area average. Even as the labour market started to show signs of stress, with employment growth decelerating and productivity declining 28 , growth in nominal compensation per employee accelerated, from 2. Wage increases in services contributed considerably to overall wage growth, while wages in manufacturing slowed along with the declining production.

Despite relatively strong wage growth Graph 4. In general, wage growth may decelerate as employers see their bargaining power increasing due to a softer labour market and also react to low productivity growth and squeezed profit margins. Effective collective bargaining may be a tool f or finding the right balance between wage increases and maintaining employment.

In this respect the situation is roughly unchanged, as the proportion of workers covered by collective bargaining agreements stagnated in Kohaut, at a relatively lo w level compared to the past. The European Pillar of Social Rights is a compass for a renewed process of upward convergence towards better working and living conditions in the European Union. It sets out 20 essential principles and rights in the areas of equal opportunities and access to the labour market, fair working conditions and social protection and inclusion.

The Social Scoreboard supporting the European Pillar of Social Rights points to relatively few employment and social challenges in Germany. This is accompanied by a wide gender pay gap , reflecting differences in the number of hours worked and in the sectoral composition of employment across genders. Germany has one of the highest proportions of women working for low w ages. Early school leavers account for In Berlin, 9.

The tertiary education attainment rate among year-olds also differs significantly by 30pps between regions. The proportion of people who are long-term unemployed has decreased in recent years. On the back of a strong labour market performance, long-term unemployment stood at 3. Further improvements can be expected, due partly to government measures like the Teilhabechancengesetz. Following past increases in negotiated wages, minimum wage updates appear to have lagged behind general wage developments.

These increases, given legal force by the federal government, were based on developments in negotiated wages in for the increase and the first half of for the increase. Linking minimum-wage increases to past developments in negotiated wages appears to have resulted in a gradual erosion of the relative level of the minimum wage since According to European Commission calculations, the ratio to the median is expected to stay unchanged in , but the ratio to the average wage is expected to further decrease.

Shortages of skilled labour are acting as a drag on growth. Despite slowing economic activity, labour shortages remain considerable. At the same time, the vacancy rate the number of vacant jobs as a proportion of all jobs is close to its historical highs at 3. Demographic ageing and technological transformation are making securing a skilled workforce also a structural challenge. Without additional measures, potential growth in Germany is expected to decline from 1.

Upskilling and reskilling of the labour force can help relieve labour shortages. While Germany has one of the highest employment rates in the EU, the employment rate for the low-qualified is relatively low at Atypical employment and low pay are particularly widespread in this group. Current price signals across energy carriers and users limit the potential for clean energy technology deployment and emissions reduction.

As environmental taxes are typically regressive, their increased use needs to be coupled with policy measures mitigating the impact on the vulnerable pop ulation groups. The lack of appropriate transmission and distribution grid infrastructure is causing fin ancial losses and market distortions in Germany and other EU countries due to congestion and limited flexibility of the electric system.

The need for investment in additional transmission capacity is growing. Taxes and levies limit the smart integration of electricity in the heating, transport and industry sectors. The installation of wind turbines show a declining trend. The transport sector has done particularly badly at cutting emissions of both greenhouse gases and local air pollutants, which has meant that Germany has fallen behind in meeting its target under the Effort Sharing Decision setting national emission targets for EU countries b etween and The transformation of the transport sector can be facilitated by stronger investment in clean public transport and infrastructure, including in alternative fuels such as hydrogen and e-fuels.

In addition, appropriate incentive structu res are needed for clean, safe and better-performing mobility solutions, which would encourage technological competition and spur innovation. The housing cost overburden rate is one of the highe st in the EU. House prices rose by half over the last decade, suggesting overvaluation in the bigger cities and an increasing risk of a housing bubble.

Policy measures mitigate rental price increases, but do not keep pace with the demand for affordable hou sing. Other key structural issues analysed in this report, which point to particular challenges for Germany's economy, are the following:. Capitalisation ratios are satisfactory, but German banks face challenges related to their cost structure.

Consolidation efforts are needed, as a fragmented market structure weighs on profits. The disruption initiated by fintech a nd bigtech may further squeeze revenues. There is also a need to strengthen macro-prudential tools. Demographic change is expected to chal lenge the sustainability and the adequacy of pensions. Furthermore, the large gap in life expectancy across socio-economic groups, combined with the relatively low pension net replacement rates for low-income earners compared to other countries,raises the issue of intra-generational fairness..

Healthcare efficiency can be improved by consolidating the hospital sector, focusing more strongly on prevention and care integration, providing the same price signal for the same treatment, and better use of eHealth. Germany is spending less of its resources on education than it did in the past and also at a rate below the EU average, even though the country is particularly affect ed by automation and immigration.

Inequalities in educational attainment persist, with socio-economic and migrant backgrounds still exerting a strong influence. Teacher shortages threaten the provision of quality education. It is designed to ensure that the transition towards EU climate neutrality is fair by helping the most affected regions in Germany to address the social and economic consequences. Key priorities for support by the Just Transition Fund, set up as part of the Just Transition Mechanism, are identified in Annex D, building on the analysis of the transition challenges outlined in this report.

The economic expansion slowed sharply in Growth has been uneven and fragile since , following the pattern of export growth and held back by the pronounced weakness of manufacturing activity. After a rebound to 0. Overall investment increased robustly early in the year by 1. For the year as a whole GDP increased by just 0.

Source: European commission. The domestic side of the economy remained resilient and employment reached a new record high. Despite the weakness in activity and deteriorating business sentiment, the labour market remained strong. Job growth continued in the services sector. Layoffs in industry remained contained, as companies try to avoid losing skilled workers and to stay fit for an upswing.

Wages continued to grow. This helped consumption growth stay relatively steady at 0. Public consumption supported growth. The buoyant growth in construction continued. There was a mixed picture in services, with public and consumer services showing resilience, while business-related services, including transport, remaining weak. Consumption should continue benefitting from stable employment and ongoing wage increases.

Even if constrained by capacity, construction activity is expected to continue expanding. Equipment investment should strengthen as export activity normalises as expected in a few quarters. The ten-year expansion is set to continue. These prospects are subject to downside risks. Risks for exports and investment relate to global growth and trade uncertainty, sectoral structural issues e.

Planning and implementation capacity in the public sector could constrain the further expansion of public investment. Recent strong wage growth has boosted the saving rate and this trend could be reinforced if consumer confidence deteriorates. Manufacturing weakness is weighing on economic growth. Export growth slowed considerably and the production side of the economy weakened further in In Q4 manufacturing continued to decline for the sixth consecutive quarter since early The car-manufacturing sector is undergoing a structural transformation and production is depressed while equipment manufacturers are adversely affected by the impact of trade conflicts and weakening global trade on investment demand.

Car production in Germany has shrunk considerably, while German carmakers produced more abroad. Through its complex value chain, it has a significant impact on the overall dynamics of manufacturing Graph 1. The industry is experiencing a significant decline in domestic production.

The production of 5. At the same time, German companies increased their production abroad by 3. The decline in new car registrations in Germany and the EU in general has been driven largely by falling demand for diesel cars. Demand for diesel cars has declined while the share of alternative-fuelled cars is increasing slowly. Following the diesel scandal and reinforced plans for reducing emissions through stricter regulations, the demand for cars with traditional internal combustion engines, and diesels in particular, is falling.

Several Member States and cities have adopted ambitious plans to reduce air pollution, including by restricting diesel entry into city zones. Some countries plan to ban sales of new petrol and diesel cars in a decade or two. In Germany the number of new registrations of diesel cars stabilised in after a drop since the diesel scandal Graph 1. Demand is switching above all to hybrid cars, of which plug-in hybrids are a small part , rather than purely electric driven models.

Source: European Commission. Inflation should remain moderate. Consumer price inflation has been running below wage growth, which is supportive of purchasing power. Not taking into account volatile energy and unprocessed food prices, it hovered around 1. Inflationary pressure is expected to remain contained and inflation not to change significantly, reflecting the moderate level of domestic demand projected.

Public investment has continued increasing against the backdrop of a significant investment backlog, and is likely to increase further with the budget. This raised the public investment rate from 2. In and , total government net investment turned positive for the first time since 0. In , this development was driven by municipal investment, where, however, net investment remains negative and needs to catch up with depreciation.

Data for January-September suggest that, investment growth intensified at the level of municipalities. Private investment remains solid despite slowing economic growth. Only non-residential construction investment growth remained subdued. In , real investment continued increasing somewhat more slowly 2. Non-residential investment picked up speed, while equipment investment growth weakened.

The fastest growing components in recent years have been housing see Section 4. Equipment and non-residential construction have seen their shares of investment change little. The aggregate net investment rate remains relatively low by historical and international standard. The gross investment rate increased to It has also been above the level in the rest of the euro area since It has remained subdued since the turn of the century after an initial post-unification surge. Currently it ranges around the average for the rest of the EU15 the 15 countries which were Member States before the enlargement of the EU but significantly below the levels for peers like the US or France.

Investment in transport infrastructure in recent years has stayed constant below 0. The unemployment rate continued to decline, stabilising at a post-reunification low of around 3. Still, employment growth has been slowing, and companies in the manufacturing sector increasingly rely on short-time-work arrangements to avoid dismissals see Section 4. While labour shortages are still apparent in some sectors, Germany does not fully use the labour market potential of some groups and female part-time work remains among the highest in Europe.

Source: Destatis, European Commission. Aggregate wage growth increased in and , while a deceleration is expected for Gross nominal wages and salaries per employee increased by 2. These developments come after a prolonged period of wage moderation during which wages did not keep up with productivity and external imbalances accumulated see Section 4.

A drop in labour productivity growth, coupled with wage increases, contributed to increasing unit labour costs. As employment levels remained high while production declined in the manufacturing sector and job growth continued in the non-tradable sector, overall productivity growth turned negative in early see also Section 4. While labour productivity declined by 0. The real effective exchange rate appreciated, due partly to the nominal effective appreciation of the euro.

While the risk of poverty or social exclusion continues to decline moderately, rising income inequality raises concerns. In , In addition, in the past five years Germany made significant progress in reaching the SDG 1 People at risk of poverty or social exclusion. Similarly, the disposable income of households continued to grow. Still, this ratio is in line with the euro area average.

The uneven profile of property ownership and steeply rising house prices see Section 4. Regional disparities in Germany have steadily decreased since , especially between the east and west of the country, but the gap between the most and least developed regions of the country remains wide. Even though they have caught up in the last three decades, the least developed regions remain in the east. GDP per inhabitant of the eastern regions in represented Nevertheless, between and GDP growth per capita exceeded 2.

However, other Eastern regions like Mecklenburg-Western Pomerania 1. Regional disparities across Germany also exist with regard to competitiveness, productivity, investment, unemployment rates and demographic developments see Section 4. Source: German Bundesbank, European Commission. The gradual decline in the current account surplus since temporarily paused in The current account surplus for stood at 7.

Compared to , the trade surplus increased by 0. The primary income balance increased by 0. The services balance and the secondary income balance remained unchanged. The transformation of the automotive sector is reflected in the evolution of the trade balance. Net automotive exports continued to decline and account for much of the decline in the trade surplus since This trend continued in recent quarters as automotive imports increased further while exports declined or stagnated relative to GDP.

This reflects both the global slowdown in overall demand for cars and the relocations abroad of a sizeable share of the production of German-branded cars. Despite weakening growth, the budget surplus remains considerable and the fiscal position favourable, while government debt continues its downward path. Having peaked at 1. It is set to decline gradually in the coming years, as tax revenues are projected to increase less strongly and the implementation of government measures increases overall expenditure European Commission, a see also Section 4.

Overall, Germany performs well in achieving the Sustainable Development Goals. Public finances have kept improving and measures have been taken to increase public investment. Yet, further efforts to address the savings investments imbalance would be welcome. The good fiscal position also created room to intensify investment, and the public investment rate increased from 2.

Still, a significant investment backlog remains, with investment gaps persisting in particular at municipal level in education and infrastructure. Progress towards efficient market structures has been moderate. While the competition law framework was improved, little has been done to open up public procurement and allow more entry into business services and regulated professions, even though complaints abound about a lack of capacity. Barriers to competition in railways have been reduced only to a limited extent.

Improvements in network industries such as telecommunications, energy and transport, have been limited overall, reducing consumer welfare and endangering future competitiveness and sustainability targets. Investment needs in energy transmission and distribution infrastructure are increasing, but there is currently no systematic and comprehensive tracking of investment needs in different types of energy networks and at different levels of government.

The labour market has performed well , but more efforts are needed in view of demographic change. Continuing the trend since , employment and wage levels improved in even as the economy slowed. Labour market incomes have improved through the introduction of the statutory general minimum wage, as well as through efforts to reduce taxes on labour and disincentives to work.

Some progress has been made towards achieving sustained growth in public and private investment and strengthening conditions to support higher w age growth — two CSRs closely related to the euro area recommendations about fostering investment and supporting wage growth see Table 2.

There have be en certain efforts to reduce the labour tax wedge, most notably the abolition of the solidarity surcharge for most taxpayers from Yet taxes on labour remain high, while some of the potential remains underused to raise tax revenue from sources more su pportive of inclusive and sustainable growth, such as environmental and wealth-related taxes.

There has been no progress in promoting competition in business services and the regulated professions. A pending law to reintroduce conditions for practising 12 craft professions even reverses a reform of Limited progress has been recorded in improving the educational outcomes and skill levels of disadvantaged groups.

At the request of a Member State the Commission can provide tailor-made expertise through the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since , Germany has received such support in the form of three projects. In , the Commission provided the authorities with support to establish a large-cases unit in the German statistical system to ensure adequate coverage in the national statistics of multinational business groups with high economic impact.

Also in , work started on defining the IT infrastructure for this solution and building capacity for its successful implementation. The regulatory framework underpinning the programming of the EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework MFF.

In absolute numbers, Germany is one of the main beneficiaries of EU support. While reducing economic, social and territorial disparities, EU cohesion policy funding also tackles structural challenges in Germany. Through the promotion of research, technology and innovation, but also environment-friendly economic development and SMEs, substantial progress has been made since Furthermore, it has contributed to the creation of over 6, new jobs in enterprises and improved infrastructures for more than 2, researchers.

In addition, EU support has promoted integrated urban development for over 1. The European Social Fund ESF provided EU added value in fostering sustainable and quality employment, combating social exclusion and discrimination and boosting investments in skills and education.

Funds disbursed between and , have helped more than 1. EU rural development policy has contributed to strengthening of rural economies in Germany. Between and , the EAFRD supported more than 5, farmers invest in restructuring and modernisation of their agricultural holdings, thus enhancing the competitiveness of the agricultural sector. The fisheries fund and other EU programmes also contribute to addressing the investment needs. The Alert Mechanism Report concluded that a new in-depth review should be undertaken for Germany to a ssess the persistence or unwinding of the imbalances that affect it.

In February , Germany was identified as having macroeconomic imbalances European Commission, b. The imbalances identified related in particular to excess savings and weak privat e and public investment. This chapter summarises the findings of the analyses in the context of the macroeconomic imbalance procedure MIP in-depth review that are set out in various sections of this report.

While there is a continuing shift towards more domestic demand-driven growth, the overall shares of consumption and investment remain relatively low, given the resilient labour market, favourable financing conditions and infrastructure investment needs. Private investment is lagging behind infrastructure and housing needs. This is reflected in short-term pressures, observed for example through increases in house prices and rents.

Even if the gross investment rate in exceeded the euro area average US and France. This could act as a drag on potential growth. Public investment has picked up, but a still large investment backlog, with depreciation still exceeding new investment at municipal level, will take longer to make up. Meanwhile, the savings rate has been increasing even as interest rates fell to historic lows. Wage growth continued and disposable incomes expanded, but a large part of these impulses fed to savings rather than consumption, despite the lower return on savings.

Precautionary saving for future risks Rodriguez-Palenzuela, is an important savings motive. In addition, inequality of income and wealth contribute to high private savings, as high earners have a particularly high savings rate Brenke and Pfannkuche, Moreover high corporate savings partly reflect the savings of wealthy German households accumulated within firms due to preferential tax treatments for example within the inheritance and gift tax system IMF, Enhancing confidence in the future, and recalibrating the tax system, reducing inequality, could be thus ways to strengthen consumption.

Combining investment policies with structural reform is a potentially powerful tool. Stronger investment in innovation, quality education and skills, very high-speed broadband networks, sustainable transport, electricity infrastructures and affordable housing, could be combined with a set of structural reforms to unleash productive potential.

Reducing taxes on labour could increase the labour supply. Reducing barriers to competition in the construction sector and related professional services could help to alleviate capacity constraints, and raise both short-term growth and long-term potential. This would be of crucial importance especially as population ageing intensifies and immigration may slow down.

Growth-enhancing policies could also have positive spillovers for the other EU countries. Following a gradual decline since , the trade balance has widened again in , due to weak demand for imported inputs in manufacturing and cheaper energy imports. The primary income balance also improved somewhat, while the negative services balance and secondary income balance remained unchanged.

The darkest shade of red corresponds to percentile 95 and the darkest shade of green to percentile 5. The percentiles were calculated for each variable based on the full available sample of bilateral exposures among EU countries. The blank spaces represent missing data. Data refer to: Imports — , Imports in value added — , Financial liabilities — , Financial assets — , Liabilities to banks — Q2, Bank Claims — Q2.

The large current account surplus currently reflects savings in the household and public sectors alone, as the non-financial corporate sector no longer has a positive net savings position. This reflects increases in corporate lending and corporate investment and a reduction in corporate savings as a result of rising unit labour costs, compounded lately by the recession in manufacturing. Wage growth is expected to slow down closer to the euro area average, being less conducive to rebalancing.

Given the size of the German economy and its strong trade and financial linkages, there are potentially sizeable spillovers to other EU countries. High trade volumes also reflect the fact that German companies operate and invest in other Member States, resulting in integrated value chains. Developments in the car industry reveal the complex nature of the resulting linkages across countries: the weak demand for cars in resulted in a production decline in Germany, while German companies actually increased production in other EU countries.

This production shift now seems to have bottomed out but it is clear that the ongoing structural change in the car industry will have significant implications also for production facilities across the EU. Financial linkages are on average smaller than trade linkages, yet for some countries they are very strong.

The countries with the strongest financial links, Luxembourg and the Netherlands, saw their linkages strengthen considerably further. More recently, Germany has taken some important policy steps to address its macroeconomic imbalances, but more efforts will be needed in the coming years to fully address them.

There have been policy advances in the area of public investment, though municipal level investment is still lagging behind. There have also been some smaller advances as regards investment in digital infrastructure, reducing disincentives to work and promoting wage growth. However, it remains to be seen if policy action has been decisive enough to produce the desired outcomes.

The simulation assumes that no neutralising fiscal measures e. The output elasticity with respect to the public capital stock is assumed to be 0. Monetary policy is assumed to retain its accommodative stance at the zero lower bound fo r the first 2 years and gradually normalise afterwards. A sustained increase in public investment would have positive domestic and cross-border spillovers.

Public investment tends to have a larger output multiplier than public consumption due to the impact on long-term output and wealth. As illustrated in Table 1, under the stipulated assumptions, increasing the public investment rate in Germany boosts output, employment and price dynamics in both Germany and the rest of the euro area, without exacerbating imbalances. There is also a frontloading of GDP effects. It derives from a real interest rate decline under the zero lower bound and expected positive long-term income effects from capital build-up even under an evenly distributed stimulus.

It would weaken if the duration of stimulus were reduced. The accommodative monetary policy is essential to realising of sizeable positive spillovers in this simulation exercise. Assuming a prolongation of the accommodative stance beyond 2 years could result in even stronger effects on the GDP of the rest of the euro area.

This gain is associated with the export demand effects from a stronger depreciation of the euro, and with a strengthening of the real interest rate decline. Conversely, a monetary contraction would neutralise the spillovers onto the rest of the euro area or make them negative. On the other hand, at typical average debt maturity, debt costs would be affected only slowly by a gradual normalisation of monetary policy.

The debt stock increases during the 10 years of stimulus, but together with the assumed low financing costs the impact of the package on the debt-to-GDP is strongly mitigated in the long term by rising tax revenue and growth in nominal GDP.

This simulation complements earlier QUEST simulations designed to model a demand stimulus or structural reforms. The adjustment of the current account surplus has been limited so far, but a gradual decline is set to continue while the surplus level remains elevated. With the persistent weakness and uncertainty in the external environment, growth is expected to be driven primarily by domestic demand in According to the draft budgetary plan, implementation of measures to increase public investment is set to continue.

Private investment is also expected to remain solid amid strong housing demand and, more importantly, due to the need to adopt new technologies. A comprehensive, long-term investment programme in Germany could reduce the external imbalance and would cons iderably increase GDP.

More progress is needed to reduce the investment backlog and to support the long-term prosperity of the country. An investment programme could contribute to these. Moreover it could largely counterbalance an expected decline in poten tial growth. Since , the government sector achieved headline balance surpluses that have increased over time to peak at 1. This surplus has declined to 1. The structural balance is also expected to decline over the same period, but to remain in a clear surplus.

Several government measures to reduce taxes and increase spending are projected to have an expansionary fiscal stance over the period , according to the Commission autumn forecast European Commission, a. Public debt is expected to decline further in the coming years. For a debt sustainability analysis and associated fiscal risks see Annex B. Germany has accumulated considerable fiscal space in recent years, which starts being used and could be used further to sustain the upward trend in public investment.

Fiscal space is on average present at all levels of government. While the federal government is expected to largely use its headline surplus and return to balanced budgets, the state and local governments, at aggregate levels, still have reserves to boost public investment and overcome the investment backlog especially at m unicipal level.

However, investment barriers in the form of constraints in planning and construction capacities persist. With the measures announced by the government up until , the fiscal space could be reduced to 1. The latter reached 2. Having a long-term vision for investment could facilitate sustainable and inclusive growth and help improve predictability and planning certainty for businesses and local communities.

Trade unions and employer associations have recently agreed on the need for a long-term perspective on public investments in areas such as decarbonisation, digitalisation, transport and education. According to the social partners and their research institutes, the low interest rate environment offers a unique opportunity for a debt-financed investment programme.

Furthermore, capacity constraints could be alleviated by giving incentives to companies from all over the EU to bid for lucrative German contracts. Having a long-term investment plan could create continuous demand for public construction projects.

It could give planning certainty to construction companies and municipalities to increase their capacities for managing public investment projects, also by hiring engineers at competitive salaries. It could also ensure that public investment does not decline in an economic slowdown due to consolidation efforts.

Tax revenues in Germany continued to grow, with a major part coming from labour taxation, while taxes more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes, remain underused. In , tax revenues reached This is among the highest in the EU the EU average is At the same time, revenues from indirect taxes are relatively low The same is true for recurrent taxes on immovable property 1.

The share of revenues from taxes on capital stock and on capital income of households is significantly below the EU average. The tax burden on labour, as measured by the tax wedge, is among the highest in the EU In particular, the tax wedge for low-income earners This is largely due to the limited progressivity in social security contributions. Source: European Commission Tax and benefits indicators database. Certain features of the German tax-benefit system result in disincentives to work in the lower-income segment.

This results in strong disincentives for people to increase their working hours the intensive margin , or — for the jobless — to start working This is particularly an issue for people in part-time occupations predominantly women , and goes against consi derations of efficiency and fairness see Section 4.

The increase in the midi-job threshold, above which full social security contributions are paid lowers the tax burden below the threshold, yet effects merit monitoring, as for some groups the mar ginal effective tax rates increase European Commission, b. It could also provide short-term tax revenues, which can be used for compensatory measures to improve the distributional impact of environmental taxes and their acceptance among the population.

Environmental tax revenues in Germany stem primarily from energy-related taxes Tax revenues from transport fuel taxes and taxes on resources are particularly low in Germany compared with other EU countries. Germany has no pollution-related tax revenue Graph 4. As environmental taxes are typically regressive European Commission, , it is important to accompany their increased use with policy measures, including labour tax cuts and cash benefits, that alleviate their impact on vulnerable populations.

Furthermore, as environmental taxes aim to change behaviour, which would, over time, result in the erosion of the associated tax base, an expansion of the tax base and a gradual increase in tax rates could ensure stable revenues. Current price signals across energy carriers and users limit the potential for deploying clean energy technologies and reducing emissions.

Taxes and levies i ncluding the levy to finance subsidies for the producers of renewable energies on electricity are currently higher per unit of energy than those on other energy carriers such as petrol and diesel, natural gas and heating oil in Germany Kemfert et al. This limits the smart integration of electricity into the heating, transport and industry sectors.

The situation is unlikely to change significantly over the coming years, despite planned reductions in electricity charges in support of the production of renewable energies. Exemptions for energy-intensive companies from the renewable surcharge add to the electricity bill of other industrial consumers and households. Furthermore, like many other EU Member States 11 , Germany imposes a lower nominal margi nal tax rate on diesel fuel for private road usage than on unleaded petrol and the ratio of diesel to petrol excises is significantly below the EU average.

This is done even though the former has a higher carbon content and greater negative impact on ambie nt air quality This is true for both the tax per litre and the tax per tonne of CO 2 emissions European Commission, One might argue that the German tax system offsets this advantage for diesel fuel at least partially through higher car circul ation taxes on diesel cars.

However, the circulation taxes do not aff ect the extent to which a car is actually used once it is owned and available i. To serve policy objectives of environmental sustainability, it would be preferable to tax transport fuel consistently based on consumpt ion, reflecting the associated externalities in terms of carbon emissions and air pollution.

The tax system remains relatively complex, which contributes to comparatively high compliance costs for businesses. Both statutory rates and effective average tax rates on corporate income are relatively high in Germany European Commission, c. Given that many businesses will not benefit from the abolition of the solidarity surcharge, this situation remains unchanged.

Similarly, the debt bias in corporate taxation remains high European Commission, b. Transport taxes include taxes on owners and users of means of transport. Pollution taxes include taxes on emissions, waste management and noise. Resource taxes include any taxes li nked to the extraction or use of a natural resource. They do not include other levies, e. The go vernment agreed on the abolition of the solidarity surcharge for large parts of the population, and this is expected to help spur job creation and private consumption.

The solidarity surcharge an additional 5. The reform is expected to create more than , additional jobs in full time equivalents and generate a substantial fiscal stimulus. As part of the recently agreed Climate Package, Germany will introduce a CO 2 price with a proposed price path which can help the attainment of its medium-term climate targets, but which might also have a regressive effect.

The Climate Package is expected to increase the cost of pollution, lower costs for less-polluting transport modes and give more incentives to promote the use of building insulation and less-polluting types of heating Projektgruppe Gemeinschaftsdiagnose, Evaluations by economic research institutes found that the moderate CO 2 price initially proposed by the government for transport and buildings would not be sufficient to reach the target for reducing emissions not covered by the EU emission trading system DIW, The regressive effect is expected to be partially reduced through a substantial reduction in the renewable electricity surcharge.

In the meantime, most of the corresponding legislation has been adopted by the German Parliament. The law also sets the long-term objective of climate neutrality by The law further apportions the overall emissions reduction targets into sectoral emissio n budgets between key sectors of the economy, in particular, energy, buildings, transport, industry, agriculture and waste management.

Compliance with these sectoral annual emission budgets is allocated to the federal ministry responsible for the respectiv e sector. In case of failure, the lead ministry must present an emergency adjustment programme of measures to reach future targets. As part of the federal climate protection programme, a CO 2 pricing system will be introduced in the transport and heating sectors - the so-called national emission trading scheme nETS.

The German Parliament agreed to raise the level of environmental ambition and the volume of compensatory measures. The maximum amount of emissions decided in will be set to decrease annually in line with German climate targets. An evaluation of the law is foreseen for to determine whether a price corridor for the following years after is reasonable or necessary. Several initiatives listed in the Climate Package aim to partly compensate final consumers and economic agents for increased energy prices.

First, a large part of the income generated by the nETS is planned to be used to reduce electricity charges and levies In particular, the surcharge on renewable electricity for households and small businesses will be gradually decreased. This extra fiscal benefit of 5 eurocents per km will be increased to 8 eurocents per km in to However, a large part of the additional revenue will go to the federal budget to finance additional climate and energy measures.

In addition, the Climate Package includes a long list of sectoral policies aimed at reducing sectoral emissions. For example, in the buildings sector , Germany plans to increase tax support for refitting heating systems. At the same time, after it will not be allowed to fit a new oil heating system as long as an alternative exists.

In the transport sector , electro-mobility will be supported across the board. The goal is to have 1 million electric vehicle EV charging points available across Germany by The creation of EV charging infrastructure at commonly used private properties will be supported.

Public transport investment, creation of new cycling routes, modernisation of ports and inland waterways, support to rail transport Deutsche Bahn , digitalisation and development of new motor fuels e. From , the motor vehicle tax for newly registered vehicles will be related to their CO 2 emissions per km. The transformation of German industry will be supported by, among other things, investment programmes, higher minimum standards in eco-labelling and the national decarbonisation program, which targets in particular high-emitting sectors.

Battery cell production will be supported. With regard to energy , Germany will phase out coal in power stations by The Climate Package has been welcomed as a step into the right direction but criticised for its distributional impact, showing that low-income households would be more affected than those with high incomes.

The study also analysed the distributional impact of the programme and revealed that despite compensatory measures such as the reduction in the surcharge on renewable electricity or the increase in the commuting allowance, low-income households would be more impacted than high-income households. Although this study assessed a government proposal with a considerably lower level of ambition, concerns about the distributional effects remain. This is mainly due to the further increased Pe ndlerpauschale which benefits richer households proportionally more than those on lower incomes.

An assessment made by the Berlin climate research institute MCC and the Potsdam Institute for Climate Impact Research PIK came to a similar conclusion that t he climate protection programme initially proposed by the federal government is unlikely to be sufficient to achieve the climate targets. Policymakers were advised to make four specific adjustments: i raise the level of ambition for the carbon price ; ii improve the social balance; iii integrate the programme more closely with EU-level action; and iv introduce an effective monitoring process MCC and PIK, However, the net effect might still be regressive as the long-distance commuter tax rebate, which benefits high-income earners, will increase significantly.

The success of the Climate Package will also depend on a multitude of additional measures. The package includes numerous measures beyond CO 2 pricing see Box 4. In addition, the intended beneficial effect will be dampened by the continuation of environmentally problematic fossil fuel subsidies. The government aimed at a revenue-neutral reform that would comply with the ruling. Furthermore, the administration of the reform is intended to remain relatively simple, with limited distributional ramifications.

In principle the amounts of immovable property tax due will continue to be based on property values, although regional governments may opt out and apply a different valuation method. The draft legislation envisages a fundamentally unchanged valuation method.

First, the immovable property will be valued for tax purposes Then, this value will be multiplied by a uniform factor basic federal rate: Steuermesszahl and another multiplier Hebesatz. This box presents hypothetical CO 2 tax scenarios in transport and heating and discusses their distributional effects.

Environmental taxation, including CO 2 pricing, can help internalise externalities from environmental d egradation, incentivise more efficient use of resources and contribute to sustainability goals see Section 4. Transport and heating were also targeted by the recently adopted carbon pricing policy as part of the Climate Package. While the aim of t his box is not to assess the exact policies included in that package for the assessment, see Box 4. Studies show t hat such taxes are typically regressive, as those on low incomes spend a higher proportion of their income on environmental taxes Hassett et al.

While the average household in the lowest income decile emits on average about 7 tonnes of CO 2 per year, the average household in the fifth income decile emits almost twi ce that amount. In the top income decile, the carbon emissions are almost three times higher than in the lowest decile. However, this increase in CO 2 emissions is disproportionate to income, as the average net equivalent income of the top income decile is almost six times that of the bottom decile IX German Council of Economic Experts, a.

These findings justify redistributive measures to counteract the regressive distributional effects of environmental taxes. While this assumption is plausible in the short term, the tax is intended to have steering effects that will ultimately lead to behavioural change and a reduction in CO 2 emissions, and hence in tax revenues.

The additional revenue in the first scenario is spent entirely on compensatory measures in a budget-neutral way. The results confirm that the impact of a CO 2 tax is regressive, but also indicate that well-designed compensatory mechanisms can lead to an overall progressive effect. Without compensatory measures, the regressive effect is stronger the higher the CO 2 price.

As a result, adjusted disposable income decreases in the range of 0. The introduction of a cash benefit renders the reform progressive, leading to a gain in adjusted disposable income for households until the third decile in the case of a lump-sum benefit and until the fifth decile in the case of a targeted benefit see Graph 1.

Inequality and the at-risk-of-poverty rate are reduced where compensatory measures are in place. Inequality, as measured by the Gini coefficient, increases in the scenarios without compensatory measures as the price of CO 2 rises. It decreases in the case of the targeted cash benefit and stays roughly the same if a lump-sum compensation is in place. The at-risk-of-poverty rate evolves in a similar way see Graph 1. While the basic federal rate will be the same across all of Germany, the multiplier — and therefore the amount of tax ultimately due — will be determined by local authorities.

For example, Bavaria has already stated its intention to use land values instead of property values to determine the relevant tax base. The reform did not aim to raise additional tax revenues from property owners, and thus missed the opportunity to shape the tax system in a way that is more conducive to inclusive growth.

Recurrent taxes on immovable property are generally considered a relatively efficient tax, given the immobility of the tax base European Commission, In addition, taking account of the relatively low rate of home ownership in Germany and its unequal distribution, recurrent property taxes may also contribute to a fairer distribution of the tax burde n. However, even after the reform, tax revenue from immovable property is expected to remain relatively low as the government envisaged a revenue-neutral reform.

Furthermore, the reform did not restrict the possibility for the owner to include the taxes du e in the utilities to be paid by the tenant. This makes the tenant the de facto entity on whom the tax is imposed. Wealth-related taxes account for a small part of revenues. Also, since Germany no longer applies its wealth tax legislation as it discriminated against non-real-estate wealth.

Thus, while revenu es from wealth-related taxes in Germany have declined over the years, the accumulation of wealth has increased substantially, wealth concentration is very high in international comparision Bach and Thiemann, ; Bach et al. Inefficiencies in healthcare persist. At the same time, avoidable deaths from preventable and treatable causes are close to the EU average and higher than in many other western European countries. The German healthcare system continues to be very hospital-centric.

Hospital bed density in 8 beds per 1, people was higher than the EU average 5. Also the average hospital stay, at 8. The quality of healthcare suffers from a highly fragmented system, with many services provided in small and often inadequately equipped hospitals.

A stronger focus on prevention and care integration could bring efficiency gains. Inefficiencies in the healthcare system also arise from the legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of the solidarity-based statutory health insurance scheme. It also allows doctors to charge patients with private health insurance more than those covered by the statutory scheme, which incentivises overprovision of health services.

The retirement of the baby boomer generation is affecting Germany more than other EU c ountries, putting considerable pressure on public finances. By , the country is expected to be facing one of the largest increases in spending on public pensions in the EU up by 1.

The long-term fiscal sustainability risk has increased from low to medium, reflecting a softening of the initial budgetary position, which however remains favourable. This yields an increase in the S2 level by 0. Demographic developments also have implications for the adequacy and fairness of pensions. Since , pension increases are linked to the pension sustainability factor, which measures the change in the number of contributors relative to the number of pensioners.

While in this led to an additional pension increase of 0. At the same time, net pension replacement rates are already relatively low, especially for low-wage earners Furthermore, life expectancy varies between socio-demographic groups and is lower for low-income earners than for high-income earners, as also reported in the Federal Government Report on Poverty and Wealth BMAS, As a result, the annualised compound return of expected pensions compared to their earlier contributions is currently higher for high-income earners than for low-income earners Haan et al.

The principle of intra-generational fairness could be further strengthened in the Grundrente by basing the contribution years on full-time equivalents. This would avoid treating those that worked part-time in relatively well-paid jobs the same as those that have worked their entire life full time in badly paid jobs. Structural deficits are no longer allowed. Germany continues to conduct spending reviews to increase the efficiency and effectiveness of government spending.

Since , the country has held yearly cycles of spending reviews targeting specific policy areas and ministries. While a comprehensive view may be missing, the policy impact could still be analysed for specific climate and environment policy-related actions. Banking sector.

The banking industry needs to adapt to the challenging times ahead. Banks will have to accelerate consolidation and reorient their business strategy in the foreseeable future of ultra-low interest rates While further cost-cutting is necessary, the financial sector needs to invest more in IT infrastructure to modernise day-to-day business. The disruption initiated by fintech and bigtech may squeeze revenues, while consumer pre ferences and the regulatory environment may also change The sector as a whole needs to adapt to a rapidly changing environment and develop a strategic vision in order to remain viable.

The past years of economic growth have helped banks to keep non-performing loan ratios low, while the low interest rate environment contributed to lower funding costs. However, profitability has been dented by the decline in lending interest rates combined with an over-reliance on intermediation income, over-capacity stemming from splintered bank networks, compliance cost, an old IT infrastructure that needs costly overhauls.

Still, banks have managed to remain profitable on aggregate by realising hidden reserves, increasing the maturity transformation, increasing credit flows and taking on higher risks during the past years. Relying on these factors appears more difficult in the future. Profitability dif fers widely between banking types.

By contrast, savings banks and cooperatives are currently more profita ble than big commercial banks and Landesbanken. For the banking system as a whole, the return on assets in was 0. Low profitability calls for an overhaul of cost structure.

High costs were a major driver of low profitability. Consolidation progresses still have a long way to go. Mergers across pillars remain difficult, also because their legal set-up differs. Given the much lower discount rate, pension liabilities increased commensurately. In , the stock of mortgages increased by 4. Outstanding bank credit to the private non-financial sector increased to EUR 1,1 trillion at the end of September Growth accelerated to 5.

Outstanding credit increased by 3. For the EU and euro area data includes domestic banking groups and stand-alone banks, foreign non-EU controlled subsidiaries and foreign non-EU controlled branches. German banks still depend predominantly on intermediation income. It accounts for three quarters of their total income, while in several other euro area jurisdictions non-interest income constitutes about half of aggregate revenue.

Over , loan stock increased by 4. Savings banks and cooperatives had an average margin of 1. Banks pass on negative interest rates to larger corporate customers, but only very timidly to large household depositors. Risk-adjusted capital ratios are still somewhat above the European average. With 1. Table 4. The stress scenario implies a severe downturn causing the CET1 ratio to fall to Hence, smaller banks would, on average, remain above regulatory minima, which does obviously not preclude individual institutions from falling below that threshold.

The share of hard-to-value Level 2 and Level 3 assets has been falling in the last decade. Assets held for trading are classified in three levels depending on the progressing complexity of valuing the asset. Accounting rules IFRS 13 oblige banks to report gross positions, which might be partly hedged against each other, and are therefore of limited explanatory power compared to net positions. Gross level 2 and level 3 assets amount to In France, these figures are Their share in Germany has been falling slightly over the past decade.

Given their complexity, these assets are rather concentrated in the bigger banks.

JULIAN WONG FOREX CONVERTER

Despite the weakness in activity and deteriorating business sentiment, the labour market remained strong. Job growth continued in the services sector. Layoffs in industry remained contained, as companies try to avoid losing skilled workers and to stay fit for an upswing. Wages continued to grow. This helped consumption growth stay relatively steady at 0. Public consumption supported growth. The buoyant growth in construction continued. There was a mixed picture in services, with public and consumer services showing resilience, while business-related services, including transport, remaining weak.

Consumption should continue benefitting from stable employment and ongoing wage increases. Even if constrained by capacity, construction activity is expected to continue expanding. Equipment investment should strengthen as export activity normalises as expected in a few quarters. The ten-year expansion is set to continue. These prospects are subject to downside risks.

Risks for exports and investment relate to global growth and trade uncertainty, sectoral structural issues e. Planning and implementation capacity in the public sector could constrain the further expansion of public investment. Recent strong wage growth has boosted the saving rate and this trend could be reinforced if consumer confidence deteriorates.

Manufacturing weakness is weighing on economic growth. Export growth slowed considerably and the production side of the economy weakened further in In Q4 manufacturing continued to decline for the sixth consecutive quarter since early The car-manufacturing sector is undergoing a structural transformation and production is depressed while equipment manufacturers are adversely affected by the impact of trade conflicts and weakening global trade on investment demand.

Car production in Germany has shrunk considerably, while German carmakers produced more abroad. Through its complex value chain, it has a significant impact on the overall dynamics of manufacturing Graph 1. The industry is experiencing a significant decline in domestic production. The production of 5. At the same time, German companies increased their production abroad by 3.

The decline in new car registrations in Germany and the EU in general has been driven largely by falling demand for diesel cars. Demand for diesel cars has declined while the share of alternative-fuelled cars is increasing slowly. Following the diesel scandal and reinforced plans for reducing emissions through stricter regulations, the demand for cars with traditional internal combustion engines, and diesels in particular, is falling.

Several Member States and cities have adopted ambitious plans to reduce air pollution, including by restricting diesel entry into city zones. Some countries plan to ban sales of new petrol and diesel cars in a decade or two. In Germany the number of new registrations of diesel cars stabilised in after a drop since the diesel scandal Graph 1. Demand is switching above all to hybrid cars, of which plug-in hybrids are a small part , rather than purely electric driven models.

Source: European Commission. Inflation should remain moderate. Consumer price inflation has been running below wage growth, which is supportive of purchasing power. Not taking into account volatile energy and unprocessed food prices, it hovered around 1.

Inflationary pressure is expected to remain contained and inflation not to change significantly, reflecting the moderate level of domestic demand projected. Public investment has continued increasing against the backdrop of a significant investment backlog, and is likely to increase further with the budget. This raised the public investment rate from 2.

In and , total government net investment turned positive for the first time since 0. In , this development was driven by municipal investment, where, however, net investment remains negative and needs to catch up with depreciation. Data for January-September suggest that, investment growth intensified at the level of municipalities. Private investment remains solid despite slowing economic growth. Only non-residential construction investment growth remained subdued. In , real investment continued increasing somewhat more slowly 2.

Non-residential investment picked up speed, while equipment investment growth weakened. The fastest growing components in recent years have been housing see Section 4. Equipment and non-residential construction have seen their shares of investment change little. The aggregate net investment rate remains relatively low by historical and international standard. The gross investment rate increased to It has also been above the level in the rest of the euro area since It has remained subdued since the turn of the century after an initial post-unification surge.

Currently it ranges around the average for the rest of the EU15 the 15 countries which were Member States before the enlargement of the EU but significantly below the levels for peers like the US or France. Investment in transport infrastructure in recent years has stayed constant below 0. The unemployment rate continued to decline, stabilising at a post-reunification low of around 3. Still, employment growth has been slowing, and companies in the manufacturing sector increasingly rely on short-time-work arrangements to avoid dismissals see Section 4.

While labour shortages are still apparent in some sectors, Germany does not fully use the labour market potential of some groups and female part-time work remains among the highest in Europe. Source: Destatis, European Commission. Aggregate wage growth increased in and , while a deceleration is expected for Gross nominal wages and salaries per employee increased by 2. These developments come after a prolonged period of wage moderation during which wages did not keep up with productivity and external imbalances accumulated see Section 4.

A drop in labour productivity growth, coupled with wage increases, contributed to increasing unit labour costs. As employment levels remained high while production declined in the manufacturing sector and job growth continued in the non-tradable sector, overall productivity growth turned negative in early see also Section 4. While labour productivity declined by 0.

The real effective exchange rate appreciated, due partly to the nominal effective appreciation of the euro. While the risk of poverty or social exclusion continues to decline moderately, rising income inequality raises concerns.

In , In addition, in the past five years Germany made significant progress in reaching the SDG 1 People at risk of poverty or social exclusion. Similarly, the disposable income of households continued to grow. Still, this ratio is in line with the euro area average. The uneven profile of property ownership and steeply rising house prices see Section 4.

Regional disparities in Germany have steadily decreased since , especially between the east and west of the country, but the gap between the most and least developed regions of the country remains wide. Even though they have caught up in the last three decades, the least developed regions remain in the east. GDP per inhabitant of the eastern regions in represented Nevertheless, between and GDP growth per capita exceeded 2. However, other Eastern regions like Mecklenburg-Western Pomerania 1.

Regional disparities across Germany also exist with regard to competitiveness, productivity, investment, unemployment rates and demographic developments see Section 4. Source: German Bundesbank, European Commission. The gradual decline in the current account surplus since temporarily paused in The current account surplus for stood at 7. Compared to , the trade surplus increased by 0. The primary income balance increased by 0. The services balance and the secondary income balance remained unchanged.

The transformation of the automotive sector is reflected in the evolution of the trade balance. Net automotive exports continued to decline and account for much of the decline in the trade surplus since This trend continued in recent quarters as automotive imports increased further while exports declined or stagnated relative to GDP. This reflects both the global slowdown in overall demand for cars and the relocations abroad of a sizeable share of the production of German-branded cars.

Despite weakening growth, the budget surplus remains considerable and the fiscal position favourable, while government debt continues its downward path. Having peaked at 1. It is set to decline gradually in the coming years, as tax revenues are projected to increase less strongly and the implementation of government measures increases overall expenditure European Commission, a see also Section 4.

Overall, Germany performs well in achieving the Sustainable Development Goals. Public finances have kept improving and measures have been taken to increase public investment. Yet, further efforts to address the savings investments imbalance would be welcome. The good fiscal position also created room to intensify investment, and the public investment rate increased from 2. Still, a significant investment backlog remains, with investment gaps persisting in particular at municipal level in education and infrastructure.

Progress towards efficient market structures has been moderate. While the competition law framework was improved, little has been done to open up public procurement and allow more entry into business services and regulated professions, even though complaints abound about a lack of capacity. Barriers to competition in railways have been reduced only to a limited extent.

Improvements in network industries such as telecommunications, energy and transport, have been limited overall, reducing consumer welfare and endangering future competitiveness and sustainability targets. Investment needs in energy transmission and distribution infrastructure are increasing, but there is currently no systematic and comprehensive tracking of investment needs in different types of energy networks and at different levels of government.

The labour market has performed well , but more efforts are needed in view of demographic change. Continuing the trend since , employment and wage levels improved in even as the economy slowed. Labour market incomes have improved through the introduction of the statutory general minimum wage, as well as through efforts to reduce taxes on labour and disincentives to work.

Some progress has been made towards achieving sustained growth in public and private investment and strengthening conditions to support higher w age growth — two CSRs closely related to the euro area recommendations about fostering investment and supporting wage growth see Table 2. There have be en certain efforts to reduce the labour tax wedge, most notably the abolition of the solidarity surcharge for most taxpayers from Yet taxes on labour remain high, while some of the potential remains underused to raise tax revenue from sources more su pportive of inclusive and sustainable growth, such as environmental and wealth-related taxes.

There has been no progress in promoting competition in business services and the regulated professions. A pending law to reintroduce conditions for practising 12 craft professions even reverses a reform of Limited progress has been recorded in improving the educational outcomes and skill levels of disadvantaged groups. At the request of a Member State the Commission can provide tailor-made expertise through the Structural Reform Support Programme to help design and implement growth-enhancing reforms.

Since , Germany has received such support in the form of three projects. In , the Commission provided the authorities with support to establish a large-cases unit in the German statistical system to ensure adequate coverage in the national statistics of multinational business groups with high economic impact. Also in , work started on defining the IT infrastructure for this solution and building capacity for its successful implementation.

The regulatory framework underpinning the programming of the EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework MFF. In absolute numbers, Germany is one of the main beneficiaries of EU support. While reducing economic, social and territorial disparities, EU cohesion policy funding also tackles structural challenges in Germany. Through the promotion of research, technology and innovation, but also environment-friendly economic development and SMEs, substantial progress has been made since Furthermore, it has contributed to the creation of over 6, new jobs in enterprises and improved infrastructures for more than 2, researchers.

In addition, EU support has promoted integrated urban development for over 1. The European Social Fund ESF provided EU added value in fostering sustainable and quality employment, combating social exclusion and discrimination and boosting investments in skills and education. Funds disbursed between and , have helped more than 1. EU rural development policy has contributed to strengthening of rural economies in Germany. Between and , the EAFRD supported more than 5, farmers invest in restructuring and modernisation of their agricultural holdings, thus enhancing the competitiveness of the agricultural sector.

The fisheries fund and other EU programmes also contribute to addressing the investment needs. The Alert Mechanism Report concluded that a new in-depth review should be undertaken for Germany to a ssess the persistence or unwinding of the imbalances that affect it. In February , Germany was identified as having macroeconomic imbalances European Commission, b.

The imbalances identified related in particular to excess savings and weak privat e and public investment. This chapter summarises the findings of the analyses in the context of the macroeconomic imbalance procedure MIP in-depth review that are set out in various sections of this report.

While there is a continuing shift towards more domestic demand-driven growth, the overall shares of consumption and investment remain relatively low, given the resilient labour market, favourable financing conditions and infrastructure investment needs. Private investment is lagging behind infrastructure and housing needs. This is reflected in short-term pressures, observed for example through increases in house prices and rents.

Even if the gross investment rate in exceeded the euro area average US and France. This could act as a drag on potential growth. Public investment has picked up, but a still large investment backlog, with depreciation still exceeding new investment at municipal level, will take longer to make up. Meanwhile, the savings rate has been increasing even as interest rates fell to historic lows. Wage growth continued and disposable incomes expanded, but a large part of these impulses fed to savings rather than consumption, despite the lower return on savings.

Precautionary saving for future risks Rodriguez-Palenzuela, is an important savings motive. In addition, inequality of income and wealth contribute to high private savings, as high earners have a particularly high savings rate Brenke and Pfannkuche, Moreover high corporate savings partly reflect the savings of wealthy German households accumulated within firms due to preferential tax treatments for example within the inheritance and gift tax system IMF, Enhancing confidence in the future, and recalibrating the tax system, reducing inequality, could be thus ways to strengthen consumption.

Combining investment policies with structural reform is a potentially powerful tool. Stronger investment in innovation, quality education and skills, very high-speed broadband networks, sustainable transport, electricity infrastructures and affordable housing, could be combined with a set of structural reforms to unleash productive potential.

Reducing taxes on labour could increase the labour supply. Reducing barriers to competition in the construction sector and related professional services could help to alleviate capacity constraints, and raise both short-term growth and long-term potential. This would be of crucial importance especially as population ageing intensifies and immigration may slow down. Growth-enhancing policies could also have positive spillovers for the other EU countries. Following a gradual decline since , the trade balance has widened again in , due to weak demand for imported inputs in manufacturing and cheaper energy imports.

The primary income balance also improved somewhat, while the negative services balance and secondary income balance remained unchanged. The darkest shade of red corresponds to percentile 95 and the darkest shade of green to percentile 5. The percentiles were calculated for each variable based on the full available sample of bilateral exposures among EU countries.

The blank spaces represent missing data. Data refer to: Imports — , Imports in value added — , Financial liabilities — , Financial assets — , Liabilities to banks — Q2, Bank Claims — Q2. The large current account surplus currently reflects savings in the household and public sectors alone, as the non-financial corporate sector no longer has a positive net savings position.

This reflects increases in corporate lending and corporate investment and a reduction in corporate savings as a result of rising unit labour costs, compounded lately by the recession in manufacturing. Wage growth is expected to slow down closer to the euro area average, being less conducive to rebalancing.

Given the size of the German economy and its strong trade and financial linkages, there are potentially sizeable spillovers to other EU countries. High trade volumes also reflect the fact that German companies operate and invest in other Member States, resulting in integrated value chains. Developments in the car industry reveal the complex nature of the resulting linkages across countries: the weak demand for cars in resulted in a production decline in Germany, while German companies actually increased production in other EU countries.

This production shift now seems to have bottomed out but it is clear that the ongoing structural change in the car industry will have significant implications also for production facilities across the EU. Financial linkages are on average smaller than trade linkages, yet for some countries they are very strong. The countries with the strongest financial links, Luxembourg and the Netherlands, saw their linkages strengthen considerably further.

More recently, Germany has taken some important policy steps to address its macroeconomic imbalances, but more efforts will be needed in the coming years to fully address them. There have been policy advances in the area of public investment, though municipal level investment is still lagging behind. There have also been some smaller advances as regards investment in digital infrastructure, reducing disincentives to work and promoting wage growth. However, it remains to be seen if policy action has been decisive enough to produce the desired outcomes.

The simulation assumes that no neutralising fiscal measures e. The output elasticity with respect to the public capital stock is assumed to be 0. Monetary policy is assumed to retain its accommodative stance at the zero lower bound fo r the first 2 years and gradually normalise afterwards. A sustained increase in public investment would have positive domestic and cross-border spillovers.

Public investment tends to have a larger output multiplier than public consumption due to the impact on long-term output and wealth. As illustrated in Table 1, under the stipulated assumptions, increasing the public investment rate in Germany boosts output, employment and price dynamics in both Germany and the rest of the euro area, without exacerbating imbalances.

There is also a frontloading of GDP effects. It derives from a real interest rate decline under the zero lower bound and expected positive long-term income effects from capital build-up even under an evenly distributed stimulus. It would weaken if the duration of stimulus were reduced. The accommodative monetary policy is essential to realising of sizeable positive spillovers in this simulation exercise. Assuming a prolongation of the accommodative stance beyond 2 years could result in even stronger effects on the GDP of the rest of the euro area.

This gain is associated with the export demand effects from a stronger depreciation of the euro, and with a strengthening of the real interest rate decline. Conversely, a monetary contraction would neutralise the spillovers onto the rest of the euro area or make them negative. On the other hand, at typical average debt maturity, debt costs would be affected only slowly by a gradual normalisation of monetary policy.

The debt stock increases during the 10 years of stimulus, but together with the assumed low financing costs the impact of the package on the debt-to-GDP is strongly mitigated in the long term by rising tax revenue and growth in nominal GDP. This simulation complements earlier QUEST simulations designed to model a demand stimulus or structural reforms. The adjustment of the current account surplus has been limited so far, but a gradual decline is set to continue while the surplus level remains elevated.

With the persistent weakness and uncertainty in the external environment, growth is expected to be driven primarily by domestic demand in According to the draft budgetary plan, implementation of measures to increase public investment is set to continue.

Private investment is also expected to remain solid amid strong housing demand and, more importantly, due to the need to adopt new technologies. A comprehensive, long-term investment programme in Germany could reduce the external imbalance and would cons iderably increase GDP.

More progress is needed to reduce the investment backlog and to support the long-term prosperity of the country. An investment programme could contribute to these. Moreover it could largely counterbalance an expected decline in poten tial growth. Since , the government sector achieved headline balance surpluses that have increased over time to peak at 1. This surplus has declined to 1. The structural balance is also expected to decline over the same period, but to remain in a clear surplus.

Several government measures to reduce taxes and increase spending are projected to have an expansionary fiscal stance over the period , according to the Commission autumn forecast European Commission, a. Public debt is expected to decline further in the coming years. For a debt sustainability analysis and associated fiscal risks see Annex B. Germany has accumulated considerable fiscal space in recent years, which starts being used and could be used further to sustain the upward trend in public investment.

Fiscal space is on average present at all levels of government. While the federal government is expected to largely use its headline surplus and return to balanced budgets, the state and local governments, at aggregate levels, still have reserves to boost public investment and overcome the investment backlog especially at m unicipal level.

However, investment barriers in the form of constraints in planning and construction capacities persist. With the measures announced by the government up until , the fiscal space could be reduced to 1. The latter reached 2. Having a long-term vision for investment could facilitate sustainable and inclusive growth and help improve predictability and planning certainty for businesses and local communities. Trade unions and employer associations have recently agreed on the need for a long-term perspective on public investments in areas such as decarbonisation, digitalisation, transport and education.

According to the social partners and their research institutes, the low interest rate environment offers a unique opportunity for a debt-financed investment programme. Furthermore, capacity constraints could be alleviated by giving incentives to companies from all over the EU to bid for lucrative German contracts. Having a long-term investment plan could create continuous demand for public construction projects.

It could give planning certainty to construction companies and municipalities to increase their capacities for managing public investment projects, also by hiring engineers at competitive salaries. It could also ensure that public investment does not decline in an economic slowdown due to consolidation efforts.

Tax revenues in Germany continued to grow, with a major part coming from labour taxation, while taxes more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes, remain underused. In , tax revenues reached This is among the highest in the EU the EU average is At the same time, revenues from indirect taxes are relatively low The same is true for recurrent taxes on immovable property 1.

The share of revenues from taxes on capital stock and on capital income of households is significantly below the EU average. The tax burden on labour, as measured by the tax wedge, is among the highest in the EU In particular, the tax wedge for low-income earners This is largely due to the limited progressivity in social security contributions. Source: European Commission Tax and benefits indicators database. Certain features of the German tax-benefit system result in disincentives to work in the lower-income segment.

This results in strong disincentives for people to increase their working hours the intensive margin , or — for the jobless — to start working This is particularly an issue for people in part-time occupations predominantly women , and goes against consi derations of efficiency and fairness see Section 4. The increase in the midi-job threshold, above which full social security contributions are paid lowers the tax burden below the threshold, yet effects merit monitoring, as for some groups the mar ginal effective tax rates increase European Commission, b.

It could also provide short-term tax revenues, which can be used for compensatory measures to improve the distributional impact of environmental taxes and their acceptance among the population. Environmental tax revenues in Germany stem primarily from energy-related taxes Tax revenues from transport fuel taxes and taxes on resources are particularly low in Germany compared with other EU countries.

Germany has no pollution-related tax revenue Graph 4. As environmental taxes are typically regressive European Commission, , it is important to accompany their increased use with policy measures, including labour tax cuts and cash benefits, that alleviate their impact on vulnerable populations.

Furthermore, as environmental taxes aim to change behaviour, which would, over time, result in the erosion of the associated tax base, an expansion of the tax base and a gradual increase in tax rates could ensure stable revenues. Current price signals across energy carriers and users limit the potential for deploying clean energy technologies and reducing emissions.

Taxes and levies i ncluding the levy to finance subsidies for the producers of renewable energies on electricity are currently higher per unit of energy than those on other energy carriers such as petrol and diesel, natural gas and heating oil in Germany Kemfert et al. This limits the smart integration of electricity into the heating, transport and industry sectors. The situation is unlikely to change significantly over the coming years, despite planned reductions in electricity charges in support of the production of renewable energies.

Exemptions for energy-intensive companies from the renewable surcharge add to the electricity bill of other industrial consumers and households. Furthermore, like many other EU Member States 11 , Germany imposes a lower nominal margi nal tax rate on diesel fuel for private road usage than on unleaded petrol and the ratio of diesel to petrol excises is significantly below the EU average.

This is done even though the former has a higher carbon content and greater negative impact on ambie nt air quality This is true for both the tax per litre and the tax per tonne of CO 2 emissions European Commission, One might argue that the German tax system offsets this advantage for diesel fuel at least partially through higher car circul ation taxes on diesel cars.

However, the circulation taxes do not aff ect the extent to which a car is actually used once it is owned and available i. To serve policy objectives of environmental sustainability, it would be preferable to tax transport fuel consistently based on consumpt ion, reflecting the associated externalities in terms of carbon emissions and air pollution. The tax system remains relatively complex, which contributes to comparatively high compliance costs for businesses.

Both statutory rates and effective average tax rates on corporate income are relatively high in Germany European Commission, c. Given that many businesses will not benefit from the abolition of the solidarity surcharge, this situation remains unchanged.

Similarly, the debt bias in corporate taxation remains high European Commission, b. Transport taxes include taxes on owners and users of means of transport. Pollution taxes include taxes on emissions, waste management and noise. Resource taxes include any taxes li nked to the extraction or use of a natural resource. They do not include other levies, e. The go vernment agreed on the abolition of the solidarity surcharge for large parts of the population, and this is expected to help spur job creation and private consumption.

The solidarity surcharge an additional 5. The reform is expected to create more than , additional jobs in full time equivalents and generate a substantial fiscal stimulus. As part of the recently agreed Climate Package, Germany will introduce a CO 2 price with a proposed price path which can help the attainment of its medium-term climate targets, but which might also have a regressive effect.

The Climate Package is expected to increase the cost of pollution, lower costs for less-polluting transport modes and give more incentives to promote the use of building insulation and less-polluting types of heating Projektgruppe Gemeinschaftsdiagnose, Evaluations by economic research institutes found that the moderate CO 2 price initially proposed by the government for transport and buildings would not be sufficient to reach the target for reducing emissions not covered by the EU emission trading system DIW, The regressive effect is expected to be partially reduced through a substantial reduction in the renewable electricity surcharge.

In the meantime, most of the corresponding legislation has been adopted by the German Parliament. The law also sets the long-term objective of climate neutrality by The law further apportions the overall emissions reduction targets into sectoral emissio n budgets between key sectors of the economy, in particular, energy, buildings, transport, industry, agriculture and waste management.

Compliance with these sectoral annual emission budgets is allocated to the federal ministry responsible for the respectiv e sector. In case of failure, the lead ministry must present an emergency adjustment programme of measures to reach future targets. As part of the federal climate protection programme, a CO 2 pricing system will be introduced in the transport and heating sectors - the so-called national emission trading scheme nETS.

The German Parliament agreed to raise the level of environmental ambition and the volume of compensatory measures. The maximum amount of emissions decided in will be set to decrease annually in line with German climate targets. An evaluation of the law is foreseen for to determine whether a price corridor for the following years after is reasonable or necessary.

Several initiatives listed in the Climate Package aim to partly compensate final consumers and economic agents for increased energy prices. First, a large part of the income generated by the nETS is planned to be used to reduce electricity charges and levies In particular, the surcharge on renewable electricity for households and small businesses will be gradually decreased. This extra fiscal benefit of 5 eurocents per km will be increased to 8 eurocents per km in to However, a large part of the additional revenue will go to the federal budget to finance additional climate and energy measures.

In addition, the Climate Package includes a long list of sectoral policies aimed at reducing sectoral emissions. For example, in the buildings sector , Germany plans to increase tax support for refitting heating systems. At the same time, after it will not be allowed to fit a new oil heating system as long as an alternative exists.

In the transport sector , electro-mobility will be supported across the board. The goal is to have 1 million electric vehicle EV charging points available across Germany by The creation of EV charging infrastructure at commonly used private properties will be supported. Public transport investment, creation of new cycling routes, modernisation of ports and inland waterways, support to rail transport Deutsche Bahn , digitalisation and development of new motor fuels e.

From , the motor vehicle tax for newly registered vehicles will be related to their CO 2 emissions per km. The transformation of German industry will be supported by, among other things, investment programmes, higher minimum standards in eco-labelling and the national decarbonisation program, which targets in particular high-emitting sectors.

Battery cell production will be supported. With regard to energy , Germany will phase out coal in power stations by The Climate Package has been welcomed as a step into the right direction but criticised for its distributional impact, showing that low-income households would be more affected than those with high incomes. The study also analysed the distributional impact of the programme and revealed that despite compensatory measures such as the reduction in the surcharge on renewable electricity or the increase in the commuting allowance, low-income households would be more impacted than high-income households.

Although this study assessed a government proposal with a considerably lower level of ambition, concerns about the distributional effects remain. This is mainly due to the further increased Pe ndlerpauschale which benefits richer households proportionally more than those on lower incomes. An assessment made by the Berlin climate research institute MCC and the Potsdam Institute for Climate Impact Research PIK came to a similar conclusion that t he climate protection programme initially proposed by the federal government is unlikely to be sufficient to achieve the climate targets.

Policymakers were advised to make four specific adjustments: i raise the level of ambition for the carbon price ; ii improve the social balance; iii integrate the programme more closely with EU-level action; and iv introduce an effective monitoring process MCC and PIK, However, the net effect might still be regressive as the long-distance commuter tax rebate, which benefits high-income earners, will increase significantly.

The success of the Climate Package will also depend on a multitude of additional measures. The package includes numerous measures beyond CO 2 pricing see Box 4. In addition, the intended beneficial effect will be dampened by the continuation of environmentally problematic fossil fuel subsidies.

The government aimed at a revenue-neutral reform that would comply with the ruling. Furthermore, the administration of the reform is intended to remain relatively simple, with limited distributional ramifications. In principle the amounts of immovable property tax due will continue to be based on property values, although regional governments may opt out and apply a different valuation method.

The draft legislation envisages a fundamentally unchanged valuation method. First, the immovable property will be valued for tax purposes Then, this value will be multiplied by a uniform factor basic federal rate: Steuermesszahl and another multiplier Hebesatz. This box presents hypothetical CO 2 tax scenarios in transport and heating and discusses their distributional effects.

Environmental taxation, including CO 2 pricing, can help internalise externalities from environmental d egradation, incentivise more efficient use of resources and contribute to sustainability goals see Section 4. Transport and heating were also targeted by the recently adopted carbon pricing policy as part of the Climate Package. While the aim of t his box is not to assess the exact policies included in that package for the assessment, see Box 4.

Studies show t hat such taxes are typically regressive, as those on low incomes spend a higher proportion of their income on environmental taxes Hassett et al. While the average household in the lowest income decile emits on average about 7 tonnes of CO 2 per year, the average household in the fifth income decile emits almost twi ce that amount.

In the top income decile, the carbon emissions are almost three times higher than in the lowest decile. However, this increase in CO 2 emissions is disproportionate to income, as the average net equivalent income of the top income decile is almost six times that of the bottom decile IX German Council of Economic Experts, a. These findings justify redistributive measures to counteract the regressive distributional effects of environmental taxes.

While this assumption is plausible in the short term, the tax is intended to have steering effects that will ultimately lead to behavioural change and a reduction in CO 2 emissions, and hence in tax revenues. The additional revenue in the first scenario is spent entirely on compensatory measures in a budget-neutral way. The results confirm that the impact of a CO 2 tax is regressive, but also indicate that well-designed compensatory mechanisms can lead to an overall progressive effect.

Without compensatory measures, the regressive effect is stronger the higher the CO 2 price. As a result, adjusted disposable income decreases in the range of 0. The introduction of a cash benefit renders the reform progressive, leading to a gain in adjusted disposable income for households until the third decile in the case of a lump-sum benefit and until the fifth decile in the case of a targeted benefit see Graph 1. Inequality and the at-risk-of-poverty rate are reduced where compensatory measures are in place.

Inequality, as measured by the Gini coefficient, increases in the scenarios without compensatory measures as the price of CO 2 rises. It decreases in the case of the targeted cash benefit and stays roughly the same if a lump-sum compensation is in place. The at-risk-of-poverty rate evolves in a similar way see Graph 1.

While the basic federal rate will be the same across all of Germany, the multiplier — and therefore the amount of tax ultimately due — will be determined by local authorities. For example, Bavaria has already stated its intention to use land values instead of property values to determine the relevant tax base.

The reform did not aim to raise additional tax revenues from property owners, and thus missed the opportunity to shape the tax system in a way that is more conducive to inclusive growth. Recurrent taxes on immovable property are generally considered a relatively efficient tax, given the immobility of the tax base European Commission, In addition, taking account of the relatively low rate of home ownership in Germany and its unequal distribution, recurrent property taxes may also contribute to a fairer distribution of the tax burde n.

However, even after the reform, tax revenue from immovable property is expected to remain relatively low as the government envisaged a revenue-neutral reform. Furthermore, the reform did not restrict the possibility for the owner to include the taxes du e in the utilities to be paid by the tenant.

This makes the tenant the de facto entity on whom the tax is imposed. Wealth-related taxes account for a small part of revenues. Also, since Germany no longer applies its wealth tax legislation as it discriminated against non-real-estate wealth. Thus, while revenu es from wealth-related taxes in Germany have declined over the years, the accumulation of wealth has increased substantially, wealth concentration is very high in international comparision Bach and Thiemann, ; Bach et al.

Inefficiencies in healthcare persist. At the same time, avoidable deaths from preventable and treatable causes are close to the EU average and higher than in many other western European countries. The German healthcare system continues to be very hospital-centric.

Hospital bed density in 8 beds per 1, people was higher than the EU average 5. Also the average hospital stay, at 8. The quality of healthcare suffers from a highly fragmented system, with many services provided in small and often inadequately equipped hospitals.

A stronger focus on prevention and care integration could bring efficiency gains. Inefficiencies in the healthcare system also arise from the legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of the solidarity-based statutory health insurance scheme.

It also allows doctors to charge patients with private health insurance more than those covered by the statutory scheme, which incentivises overprovision of health services. The retirement of the baby boomer generation is affecting Germany more than other EU c ountries, putting considerable pressure on public finances. By , the country is expected to be facing one of the largest increases in spending on public pensions in the EU up by 1. The long-term fiscal sustainability risk has increased from low to medium, reflecting a softening of the initial budgetary position, which however remains favourable.

This yields an increase in the S2 level by 0. Demographic developments also have implications for the adequacy and fairness of pensions. Since , pension increases are linked to the pension sustainability factor, which measures the change in the number of contributors relative to the number of pensioners. While in this led to an additional pension increase of 0. At the same time, net pension replacement rates are already relatively low, especially for low-wage earners Furthermore, life expectancy varies between socio-demographic groups and is lower for low-income earners than for high-income earners, as also reported in the Federal Government Report on Poverty and Wealth BMAS, As a result, the annualised compound return of expected pensions compared to their earlier contributions is currently higher for high-income earners than for low-income earners Haan et al.

The principle of intra-generational fairness could be further strengthened in the Grundrente by basing the contribution years on full-time equivalents. This would avoid treating those that worked part-time in relatively well-paid jobs the same as those that have worked their entire life full time in badly paid jobs.

Structural deficits are no longer allowed. Germany continues to conduct spending reviews to increase the efficiency and effectiveness of government spending. Since , the country has held yearly cycles of spending reviews targeting specific policy areas and ministries. While a comprehensive view may be missing, the policy impact could still be analysed for specific climate and environment policy-related actions.

Banking sector. The banking industry needs to adapt to the challenging times ahead. Banks will have to accelerate consolidation and reorient their business strategy in the foreseeable future of ultra-low interest rates While further cost-cutting is necessary, the financial sector needs to invest more in IT infrastructure to modernise day-to-day business. The disruption initiated by fintech and bigtech may squeeze revenues, while consumer pre ferences and the regulatory environment may also change The sector as a whole needs to adapt to a rapidly changing environment and develop a strategic vision in order to remain viable.

The past years of economic growth have helped banks to keep non-performing loan ratios low, while the low interest rate environment contributed to lower funding costs. However, profitability has been dented by the decline in lending interest rates combined with an over-reliance on intermediation income, over-capacity stemming from splintered bank networks, compliance cost, an old IT infrastructure that needs costly overhauls.

Still, banks have managed to remain profitable on aggregate by realising hidden reserves, increasing the maturity transformation, increasing credit flows and taking on higher risks during the past years. Relying on these factors appears more difficult in the future. Profitability dif fers widely between banking types.

By contrast, savings banks and cooperatives are currently more profita ble than big commercial banks and Landesbanken. For the banking system as a whole, the return on assets in was 0. Low profitability calls for an overhaul of cost structure. High costs were a major driver of low profitability. Consolidation progresses still have a long way to go. Mergers across pillars remain difficult, also because their legal set-up differs.

Given the much lower discount rate, pension liabilities increased commensurately. In , the stock of mortgages increased by 4. Outstanding bank credit to the private non-financial sector increased to EUR 1,1 trillion at the end of September Growth accelerated to 5.

Outstanding credit increased by 3. For the EU and euro area data includes domestic banking groups and stand-alone banks, foreign non-EU controlled subsidiaries and foreign non-EU controlled branches. German banks still depend predominantly on intermediation income.

It accounts for three quarters of their total income, while in several other euro area jurisdictions non-interest income constitutes about half of aggregate revenue. Over , loan stock increased by 4. Savings banks and cooperatives had an average margin of 1. Banks pass on negative interest rates to larger corporate customers, but only very timidly to large household depositors. Risk-adjusted capital ratios are still somewhat above the European average.

With 1. Table 4. The stress scenario implies a severe downturn causing the CET1 ratio to fall to Hence, smaller banks would, on average, remain above regulatory minima, which does obviously not preclude individual institutions from falling below that threshold. The share of hard-to-value Level 2 and Level 3 assets has been falling in the last decade. Assets held for trading are classified in three levels depending on the progressing complexity of valuing the asset.

Accounting rules IFRS 13 oblige banks to report gross positions, which might be partly hedged against each other, and are therefore of limited explanatory power compared to net positions. Gross level 2 and level 3 assets amount to In France, these figures are Their share in Germany has been falling slightly over the past decade. Given their complexity, these assets are rather concentrated in the bigger banks.

For 31 of the banks tested the impact on Common Tier 1 capital levels would be less than 20bp, 10 banks would see their CET1 ratio fall bp, and only 7 banks would face a capital impact ranging from 73 to 40bp. Housing market. House prices rose by half this decade, catching up after years of stagnation. Most of the available residential real estate price indicators point to an overvaluation in the bigger cities. Following a period of mainly nominal increases since , real house price growth has accelerated in recent years, slightly outpacing the growth in household income.

Today house prices considerably exceed their long-term average, compared to both rents and incomes, suggesting increasing risks of a housing bubble. House price increases in urban areas reflect a shortage of housing supply relative to demand. The federal government has introduced a number of measures aimed at alleviating this shortage. See also Section 4. New mortgage attribution is still accelerating, outweighing redemptions quite significantly. In September the mortgage stock was 5. Rising housing prices have led to a higher number of mortgages.

Over , average annuities increased by 5. The loan to value at origination increased by basis points bp to Riskier loans also led to higher interest rates. Over , interest rates increased from 1. Yet over , mortgage rates fell faster in Germany, and in September they stood 17bp below the euro area average of 1. In Germany, most homebuyers choose fixed interest rates insulating them from interest rate changes.

The home ownership rate is the lowest in the EU, yet a quarter of the German population has a mortgage, which is close to the EU average. The macro-prudential tools are only partially appropriate. Adding debt-based limits to the toolkit would enhance its effectiveness as currently only loan-to-value and maturity limits could be activated.

In its warning, the European Systemic Risk Board identifies loosening lending standards, accelerating mortgage growth and urban overvaluation as systemic risk sources ESRB Even though Germany will introduce a 0. Capital markets. Venture capital funds amount to 4. There is a strong concentration of venture capital in two major hubs across all stages of financing. This concentration is related to the relatively str ong innovation performance by both regions. Regarding the sectoral distribution of venture capital investments, ICT and manufacturing stand out Flachenecker et al.

Public financing programmes have improved access to early-stage finance. Unlike other public programmes aimed at promoting venture capital investments, the INVEST programme allows private investors to choose which businesses to invest in. Tighter links between entrepreneurs and investors through investment in incubators, accelerators and business angel networks have improved the entrepreneurial culture and made Germany more attractive to local and international investors.

However, access to early-stage and growth finance is still a major impediment for high-growth businesses EFI, ; Flachenecker et al. While labour productivity declined by 0. The real effective exchange rate appreciated, due partly to the nominal effective appreciation of the euro. While the risk of poverty or social exclusion continues to decline moderately, rising income inequality raises concerns.

In , In addition, in the past five years Germany made significant progress in reaching the SDG 1 People at risk of poverty or social exclusion. Similarly, the disposable income of households continued to grow. Still, this ratio is in line with the euro area average. The uneven profile of property ownership and steeply rising house prices see Section 4. Regional disparities in Germany have steadily decreased since , especially between the east and west of the country, but the gap between the most and least developed regions of the country remains wide.

Even though they have caught up in the last three decades, the least developed regions remain in the east. GDP per inhabitant of the eastern regions in represented Nevertheless, between and GDP growth per capita exceeded 2. However, other Eastern regions like Mecklenburg-Western Pomerania 1.

Regional disparities across Germany also exist with regard to competitiveness, productivity, investment, unemployment rates and demographic developments see Section 4. Source: German Bundesbank, European Commission. The gradual decline in the current account surplus since temporarily paused in The current account surplus for stood at 7.

Compared to , the trade surplus increased by 0. The primary income balance increased by 0. The services balance and the secondary income balance remained unchanged. The transformation of the automotive sector is reflected in the evolution of the trade balance. Net automotive exports continued to decline and account for much of the decline in the trade surplus since This trend continued in recent quarters as automotive imports increased further while exports declined or stagnated relative to GDP.

This reflects both the global slowdown in overall demand for cars and the relocations abroad of a sizeable share of the production of German-branded cars. Despite weakening growth, the budget surplus remains considerable and the fiscal position favourable, while government debt continues its downward path. Having peaked at 1. It is set to decline gradually in the coming years, as tax revenues are projected to increase less strongly and the implementation of government measures increases overall expenditure European Commission, a see also Section 4.

Overall, Germany performs well in achieving the Sustainable Development Goals. Public finances have kept improving and measures have been taken to increase public investment. Yet, further efforts to address the savings investments imbalance would be welcome. The good fiscal position also created room to intensify investment, and the public investment rate increased from 2.

Still, a significant investment backlog remains, with investment gaps persisting in particular at municipal level in education and infrastructure. Progress towards efficient market structures has been moderate. While the competition law framework was improved, little has been done to open up public procurement and allow more entry into business services and regulated professions, even though complaints abound about a lack of capacity.

Barriers to competition in railways have been reduced only to a limited extent. Improvements in network industries such as telecommunications, energy and transport, have been limited overall, reducing consumer welfare and endangering future competitiveness and sustainability targets.

Investment needs in energy transmission and distribution infrastructure are increasing, but there is currently no systematic and comprehensive tracking of investment needs in different types of energy networks and at different levels of government. The labour market has performed well , but more efforts are needed in view of demographic change. Continuing the trend since , employment and wage levels improved in even as the economy slowed.

Labour market incomes have improved through the introduction of the statutory general minimum wage, as well as through efforts to reduce taxes on labour and disincentives to work. Some progress has been made towards achieving sustained growth in public and private investment and strengthening conditions to support higher w age growth — two CSRs closely related to the euro area recommendations about fostering investment and supporting wage growth see Table 2. There have be en certain efforts to reduce the labour tax wedge, most notably the abolition of the solidarity surcharge for most taxpayers from Yet taxes on labour remain high, while some of the potential remains underused to raise tax revenue from sources more su pportive of inclusive and sustainable growth, such as environmental and wealth-related taxes.

There has been no progress in promoting competition in business services and the regulated professions. A pending law to reintroduce conditions for practising 12 craft professions even reverses a reform of Limited progress has been recorded in improving the educational outcomes and skill levels of disadvantaged groups. At the request of a Member State the Commission can provide tailor-made expertise through the Structural Reform Support Programme to help design and implement growth-enhancing reforms.

Since , Germany has received such support in the form of three projects. In , the Commission provided the authorities with support to establish a large-cases unit in the German statistical system to ensure adequate coverage in the national statistics of multinational business groups with high economic impact. Also in , work started on defining the IT infrastructure for this solution and building capacity for its successful implementation. The regulatory framework underpinning the programming of the EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework MFF.

In absolute numbers, Germany is one of the main beneficiaries of EU support. While reducing economic, social and territorial disparities, EU cohesion policy funding also tackles structural challenges in Germany. Through the promotion of research, technology and innovation, but also environment-friendly economic development and SMEs, substantial progress has been made since Furthermore, it has contributed to the creation of over 6, new jobs in enterprises and improved infrastructures for more than 2, researchers.

In addition, EU support has promoted integrated urban development for over 1. The European Social Fund ESF provided EU added value in fostering sustainable and quality employment, combating social exclusion and discrimination and boosting investments in skills and education.

Funds disbursed between and , have helped more than 1. EU rural development policy has contributed to strengthening of rural economies in Germany. Between and , the EAFRD supported more than 5, farmers invest in restructuring and modernisation of their agricultural holdings, thus enhancing the competitiveness of the agricultural sector. The fisheries fund and other EU programmes also contribute to addressing the investment needs.

The Alert Mechanism Report concluded that a new in-depth review should be undertaken for Germany to a ssess the persistence or unwinding of the imbalances that affect it. In February , Germany was identified as having macroeconomic imbalances European Commission, b. The imbalances identified related in particular to excess savings and weak privat e and public investment.

This chapter summarises the findings of the analyses in the context of the macroeconomic imbalance procedure MIP in-depth review that are set out in various sections of this report. While there is a continuing shift towards more domestic demand-driven growth, the overall shares of consumption and investment remain relatively low, given the resilient labour market, favourable financing conditions and infrastructure investment needs.

Private investment is lagging behind infrastructure and housing needs. This is reflected in short-term pressures, observed for example through increases in house prices and rents. Even if the gross investment rate in exceeded the euro area average US and France. This could act as a drag on potential growth.

Public investment has picked up, but a still large investment backlog, with depreciation still exceeding new investment at municipal level, will take longer to make up. Meanwhile, the savings rate has been increasing even as interest rates fell to historic lows.

Wage growth continued and disposable incomes expanded, but a large part of these impulses fed to savings rather than consumption, despite the lower return on savings. Precautionary saving for future risks Rodriguez-Palenzuela, is an important savings motive. In addition, inequality of income and wealth contribute to high private savings, as high earners have a particularly high savings rate Brenke and Pfannkuche, Moreover high corporate savings partly reflect the savings of wealthy German households accumulated within firms due to preferential tax treatments for example within the inheritance and gift tax system IMF, Enhancing confidence in the future, and recalibrating the tax system, reducing inequality, could be thus ways to strengthen consumption.

Combining investment policies with structural reform is a potentially powerful tool. Stronger investment in innovation, quality education and skills, very high-speed broadband networks, sustainable transport, electricity infrastructures and affordable housing, could be combined with a set of structural reforms to unleash productive potential.

Reducing taxes on labour could increase the labour supply. Reducing barriers to competition in the construction sector and related professional services could help to alleviate capacity constraints, and raise both short-term growth and long-term potential. This would be of crucial importance especially as population ageing intensifies and immigration may slow down. Growth-enhancing policies could also have positive spillovers for the other EU countries.

Following a gradual decline since , the trade balance has widened again in , due to weak demand for imported inputs in manufacturing and cheaper energy imports. The primary income balance also improved somewhat, while the negative services balance and secondary income balance remained unchanged. The darkest shade of red corresponds to percentile 95 and the darkest shade of green to percentile 5.

The percentiles were calculated for each variable based on the full available sample of bilateral exposures among EU countries. The blank spaces represent missing data. Data refer to: Imports — , Imports in value added — , Financial liabilities — , Financial assets — , Liabilities to banks — Q2, Bank Claims — Q2. The large current account surplus currently reflects savings in the household and public sectors alone, as the non-financial corporate sector no longer has a positive net savings position.

This reflects increases in corporate lending and corporate investment and a reduction in corporate savings as a result of rising unit labour costs, compounded lately by the recession in manufacturing. Wage growth is expected to slow down closer to the euro area average, being less conducive to rebalancing. Given the size of the German economy and its strong trade and financial linkages, there are potentially sizeable spillovers to other EU countries. High trade volumes also reflect the fact that German companies operate and invest in other Member States, resulting in integrated value chains.

Developments in the car industry reveal the complex nature of the resulting linkages across countries: the weak demand for cars in resulted in a production decline in Germany, while German companies actually increased production in other EU countries. This production shift now seems to have bottomed out but it is clear that the ongoing structural change in the car industry will have significant implications also for production facilities across the EU. Financial linkages are on average smaller than trade linkages, yet for some countries they are very strong.

The countries with the strongest financial links, Luxembourg and the Netherlands, saw their linkages strengthen considerably further. More recently, Germany has taken some important policy steps to address its macroeconomic imbalances, but more efforts will be needed in the coming years to fully address them.

There have been policy advances in the area of public investment, though municipal level investment is still lagging behind. There have also been some smaller advances as regards investment in digital infrastructure, reducing disincentives to work and promoting wage growth.

However, it remains to be seen if policy action has been decisive enough to produce the desired outcomes. The simulation assumes that no neutralising fiscal measures e. The output elasticity with respect to the public capital stock is assumed to be 0. Monetary policy is assumed to retain its accommodative stance at the zero lower bound fo r the first 2 years and gradually normalise afterwards.

A sustained increase in public investment would have positive domestic and cross-border spillovers. Public investment tends to have a larger output multiplier than public consumption due to the impact on long-term output and wealth.

As illustrated in Table 1, under the stipulated assumptions, increasing the public investment rate in Germany boosts output, employment and price dynamics in both Germany and the rest of the euro area, without exacerbating imbalances.

There is also a frontloading of GDP effects. It derives from a real interest rate decline under the zero lower bound and expected positive long-term income effects from capital build-up even under an evenly distributed stimulus. It would weaken if the duration of stimulus were reduced. The accommodative monetary policy is essential to realising of sizeable positive spillovers in this simulation exercise. Assuming a prolongation of the accommodative stance beyond 2 years could result in even stronger effects on the GDP of the rest of the euro area.

This gain is associated with the export demand effects from a stronger depreciation of the euro, and with a strengthening of the real interest rate decline. Conversely, a monetary contraction would neutralise the spillovers onto the rest of the euro area or make them negative. On the other hand, at typical average debt maturity, debt costs would be affected only slowly by a gradual normalisation of monetary policy. The debt stock increases during the 10 years of stimulus, but together with the assumed low financing costs the impact of the package on the debt-to-GDP is strongly mitigated in the long term by rising tax revenue and growth in nominal GDP.

This simulation complements earlier QUEST simulations designed to model a demand stimulus or structural reforms. The adjustment of the current account surplus has been limited so far, but a gradual decline is set to continue while the surplus level remains elevated. With the persistent weakness and uncertainty in the external environment, growth is expected to be driven primarily by domestic demand in According to the draft budgetary plan, implementation of measures to increase public investment is set to continue.

Private investment is also expected to remain solid amid strong housing demand and, more importantly, due to the need to adopt new technologies. A comprehensive, long-term investment programme in Germany could reduce the external imbalance and would cons iderably increase GDP.

More progress is needed to reduce the investment backlog and to support the long-term prosperity of the country. An investment programme could contribute to these. Moreover it could largely counterbalance an expected decline in poten tial growth. Since , the government sector achieved headline balance surpluses that have increased over time to peak at 1. This surplus has declined to 1. The structural balance is also expected to decline over the same period, but to remain in a clear surplus.

Several government measures to reduce taxes and increase spending are projected to have an expansionary fiscal stance over the period , according to the Commission autumn forecast European Commission, a. Public debt is expected to decline further in the coming years. For a debt sustainability analysis and associated fiscal risks see Annex B. Germany has accumulated considerable fiscal space in recent years, which starts being used and could be used further to sustain the upward trend in public investment.

Fiscal space is on average present at all levels of government. While the federal government is expected to largely use its headline surplus and return to balanced budgets, the state and local governments, at aggregate levels, still have reserves to boost public investment and overcome the investment backlog especially at m unicipal level. However, investment barriers in the form of constraints in planning and construction capacities persist. With the measures announced by the government up until , the fiscal space could be reduced to 1.

The latter reached 2. Having a long-term vision for investment could facilitate sustainable and inclusive growth and help improve predictability and planning certainty for businesses and local communities. Trade unions and employer associations have recently agreed on the need for a long-term perspective on public investments in areas such as decarbonisation, digitalisation, transport and education.

According to the social partners and their research institutes, the low interest rate environment offers a unique opportunity for a debt-financed investment programme. Furthermore, capacity constraints could be alleviated by giving incentives to companies from all over the EU to bid for lucrative German contracts.

Having a long-term investment plan could create continuous demand for public construction projects. It could give planning certainty to construction companies and municipalities to increase their capacities for managing public investment projects, also by hiring engineers at competitive salaries. It could also ensure that public investment does not decline in an economic slowdown due to consolidation efforts. Tax revenues in Germany continued to grow, with a major part coming from labour taxation, while taxes more supportive of inclusive and sustainable growth, such as environmental and wealth-related taxes, remain underused.

In , tax revenues reached This is among the highest in the EU the EU average is At the same time, revenues from indirect taxes are relatively low The same is true for recurrent taxes on immovable property 1. The share of revenues from taxes on capital stock and on capital income of households is significantly below the EU average.

The tax burden on labour, as measured by the tax wedge, is among the highest in the EU In particular, the tax wedge for low-income earners This is largely due to the limited progressivity in social security contributions.

Source: European Commission Tax and benefits indicators database. Certain features of the German tax-benefit system result in disincentives to work in the lower-income segment. This results in strong disincentives for people to increase their working hours the intensive margin , or — for the jobless — to start working This is particularly an issue for people in part-time occupations predominantly women , and goes against consi derations of efficiency and fairness see Section 4.

The increase in the midi-job threshold, above which full social security contributions are paid lowers the tax burden below the threshold, yet effects merit monitoring, as for some groups the mar ginal effective tax rates increase European Commission, b. It could also provide short-term tax revenues, which can be used for compensatory measures to improve the distributional impact of environmental taxes and their acceptance among the population.

Environmental tax revenues in Germany stem primarily from energy-related taxes Tax revenues from transport fuel taxes and taxes on resources are particularly low in Germany compared with other EU countries. Germany has no pollution-related tax revenue Graph 4. As environmental taxes are typically regressive European Commission, , it is important to accompany their increased use with policy measures, including labour tax cuts and cash benefits, that alleviate their impact on vulnerable populations.

Furthermore, as environmental taxes aim to change behaviour, which would, over time, result in the erosion of the associated tax base, an expansion of the tax base and a gradual increase in tax rates could ensure stable revenues. Current price signals across energy carriers and users limit the potential for deploying clean energy technologies and reducing emissions.

Taxes and levies i ncluding the levy to finance subsidies for the producers of renewable energies on electricity are currently higher per unit of energy than those on other energy carriers such as petrol and diesel, natural gas and heating oil in Germany Kemfert et al. This limits the smart integration of electricity into the heating, transport and industry sectors.

The situation is unlikely to change significantly over the coming years, despite planned reductions in electricity charges in support of the production of renewable energies. Exemptions for energy-intensive companies from the renewable surcharge add to the electricity bill of other industrial consumers and households.

Furthermore, like many other EU Member States 11 , Germany imposes a lower nominal margi nal tax rate on diesel fuel for private road usage than on unleaded petrol and the ratio of diesel to petrol excises is significantly below the EU average. This is done even though the former has a higher carbon content and greater negative impact on ambie nt air quality This is true for both the tax per litre and the tax per tonne of CO 2 emissions European Commission, One might argue that the German tax system offsets this advantage for diesel fuel at least partially through higher car circul ation taxes on diesel cars.

However, the circulation taxes do not aff ect the extent to which a car is actually used once it is owned and available i. To serve policy objectives of environmental sustainability, it would be preferable to tax transport fuel consistently based on consumpt ion, reflecting the associated externalities in terms of carbon emissions and air pollution.

The tax system remains relatively complex, which contributes to comparatively high compliance costs for businesses. Both statutory rates and effective average tax rates on corporate income are relatively high in Germany European Commission, c. Given that many businesses will not benefit from the abolition of the solidarity surcharge, this situation remains unchanged. Similarly, the debt bias in corporate taxation remains high European Commission, b.

Transport taxes include taxes on owners and users of means of transport. Pollution taxes include taxes on emissions, waste management and noise. Resource taxes include any taxes li nked to the extraction or use of a natural resource. They do not include other levies, e. The go vernment agreed on the abolition of the solidarity surcharge for large parts of the population, and this is expected to help spur job creation and private consumption. The solidarity surcharge an additional 5.

The reform is expected to create more than , additional jobs in full time equivalents and generate a substantial fiscal stimulus. As part of the recently agreed Climate Package, Germany will introduce a CO 2 price with a proposed price path which can help the attainment of its medium-term climate targets, but which might also have a regressive effect. The Climate Package is expected to increase the cost of pollution, lower costs for less-polluting transport modes and give more incentives to promote the use of building insulation and less-polluting types of heating Projektgruppe Gemeinschaftsdiagnose, Evaluations by economic research institutes found that the moderate CO 2 price initially proposed by the government for transport and buildings would not be sufficient to reach the target for reducing emissions not covered by the EU emission trading system DIW, The regressive effect is expected to be partially reduced through a substantial reduction in the renewable electricity surcharge.

In the meantime, most of the corresponding legislation has been adopted by the German Parliament. The law also sets the long-term objective of climate neutrality by The law further apportions the overall emissions reduction targets into sectoral emissio n budgets between key sectors of the economy, in particular, energy, buildings, transport, industry, agriculture and waste management.

Compliance with these sectoral annual emission budgets is allocated to the federal ministry responsible for the respectiv e sector. In case of failure, the lead ministry must present an emergency adjustment programme of measures to reach future targets. As part of the federal climate protection programme, a CO 2 pricing system will be introduced in the transport and heating sectors - the so-called national emission trading scheme nETS.

The German Parliament agreed to raise the level of environmental ambition and the volume of compensatory measures. The maximum amount of emissions decided in will be set to decrease annually in line with German climate targets. An evaluation of the law is foreseen for to determine whether a price corridor for the following years after is reasonable or necessary. Several initiatives listed in the Climate Package aim to partly compensate final consumers and economic agents for increased energy prices.

First, a large part of the income generated by the nETS is planned to be used to reduce electricity charges and levies In particular, the surcharge on renewable electricity for households and small businesses will be gradually decreased. This extra fiscal benefit of 5 eurocents per km will be increased to 8 eurocents per km in to However, a large part of the additional revenue will go to the federal budget to finance additional climate and energy measures.

In addition, the Climate Package includes a long list of sectoral policies aimed at reducing sectoral emissions. For example, in the buildings sector , Germany plans to increase tax support for refitting heating systems. At the same time, after it will not be allowed to fit a new oil heating system as long as an alternative exists. In the transport sector , electro-mobility will be supported across the board.

The goal is to have 1 million electric vehicle EV charging points available across Germany by The creation of EV charging infrastructure at commonly used private properties will be supported. Public transport investment, creation of new cycling routes, modernisation of ports and inland waterways, support to rail transport Deutsche Bahn , digitalisation and development of new motor fuels e. From , the motor vehicle tax for newly registered vehicles will be related to their CO 2 emissions per km.

The transformation of German industry will be supported by, among other things, investment programmes, higher minimum standards in eco-labelling and the national decarbonisation program, which targets in particular high-emitting sectors.

Battery cell production will be supported. With regard to energy , Germany will phase out coal in power stations by The Climate Package has been welcomed as a step into the right direction but criticised for its distributional impact, showing that low-income households would be more affected than those with high incomes. The study also analysed the distributional impact of the programme and revealed that despite compensatory measures such as the reduction in the surcharge on renewable electricity or the increase in the commuting allowance, low-income households would be more impacted than high-income households.

Although this study assessed a government proposal with a considerably lower level of ambition, concerns about the distributional effects remain. This is mainly due to the further increased Pe ndlerpauschale which benefits richer households proportionally more than those on lower incomes. An assessment made by the Berlin climate research institute MCC and the Potsdam Institute for Climate Impact Research PIK came to a similar conclusion that t he climate protection programme initially proposed by the federal government is unlikely to be sufficient to achieve the climate targets.

Policymakers were advised to make four specific adjustments: i raise the level of ambition for the carbon price ; ii improve the social balance; iii integrate the programme more closely with EU-level action; and iv introduce an effective monitoring process MCC and PIK, However, the net effect might still be regressive as the long-distance commuter tax rebate, which benefits high-income earners, will increase significantly.

The success of the Climate Package will also depend on a multitude of additional measures. The package includes numerous measures beyond CO 2 pricing see Box 4. In addition, the intended beneficial effect will be dampened by the continuation of environmentally problematic fossil fuel subsidies. The government aimed at a revenue-neutral reform that would comply with the ruling. Furthermore, the administration of the reform is intended to remain relatively simple, with limited distributional ramifications.

In principle the amounts of immovable property tax due will continue to be based on property values, although regional governments may opt out and apply a different valuation method. The draft legislation envisages a fundamentally unchanged valuation method.

First, the immovable property will be valued for tax purposes Then, this value will be multiplied by a uniform factor basic federal rate: Steuermesszahl and another multiplier Hebesatz. This box presents hypothetical CO 2 tax scenarios in transport and heating and discusses their distributional effects.

Environmental taxation, including CO 2 pricing, can help internalise externalities from environmental d egradation, incentivise more efficient use of resources and contribute to sustainability goals see Section 4.

Transport and heating were also targeted by the recently adopted carbon pricing policy as part of the Climate Package. While the aim of t his box is not to assess the exact policies included in that package for the assessment, see Box 4. Studies show t hat such taxes are typically regressive, as those on low incomes spend a higher proportion of their income on environmental taxes Hassett et al. While the average household in the lowest income decile emits on average about 7 tonnes of CO 2 per year, the average household in the fifth income decile emits almost twi ce that amount.

In the top income decile, the carbon emissions are almost three times higher than in the lowest decile. However, this increase in CO 2 emissions is disproportionate to income, as the average net equivalent income of the top income decile is almost six times that of the bottom decile IX German Council of Economic Experts, a.

These findings justify redistributive measures to counteract the regressive distributional effects of environmental taxes. While this assumption is plausible in the short term, the tax is intended to have steering effects that will ultimately lead to behavioural change and a reduction in CO 2 emissions, and hence in tax revenues. The additional revenue in the first scenario is spent entirely on compensatory measures in a budget-neutral way.

The results confirm that the impact of a CO 2 tax is regressive, but also indicate that well-designed compensatory mechanisms can lead to an overall progressive effect. Without compensatory measures, the regressive effect is stronger the higher the CO 2 price. As a result, adjusted disposable income decreases in the range of 0. The introduction of a cash benefit renders the reform progressive, leading to a gain in adjusted disposable income for households until the third decile in the case of a lump-sum benefit and until the fifth decile in the case of a targeted benefit see Graph 1.

Inequality and the at-risk-of-poverty rate are reduced where compensatory measures are in place. Inequality, as measured by the Gini coefficient, increases in the scenarios without compensatory measures as the price of CO 2 rises. It decreases in the case of the targeted cash benefit and stays roughly the same if a lump-sum compensation is in place. The at-risk-of-poverty rate evolves in a similar way see Graph 1. While the basic federal rate will be the same across all of Germany, the multiplier — and therefore the amount of tax ultimately due — will be determined by local authorities.

For example, Bavaria has already stated its intention to use land values instead of property values to determine the relevant tax base. The reform did not aim to raise additional tax revenues from property owners, and thus missed the opportunity to shape the tax system in a way that is more conducive to inclusive growth. Recurrent taxes on immovable property are generally considered a relatively efficient tax, given the immobility of the tax base European Commission, In addition, taking account of the relatively low rate of home ownership in Germany and its unequal distribution, recurrent property taxes may also contribute to a fairer distribution of the tax burde n.

However, even after the reform, tax revenue from immovable property is expected to remain relatively low as the government envisaged a revenue-neutral reform. Furthermore, the reform did not restrict the possibility for the owner to include the taxes du e in the utilities to be paid by the tenant. This makes the tenant the de facto entity on whom the tax is imposed.

Wealth-related taxes account for a small part of revenues. Also, since Germany no longer applies its wealth tax legislation as it discriminated against non-real-estate wealth. Thus, while revenu es from wealth-related taxes in Germany have declined over the years, the accumulation of wealth has increased substantially, wealth concentration is very high in international comparision Bach and Thiemann, ; Bach et al. Inefficiencies in healthcare persist. At the same time, avoidable deaths from preventable and treatable causes are close to the EU average and higher than in many other western European countries.

The German healthcare system continues to be very hospital-centric. Hospital bed density in 8 beds per 1, people was higher than the EU average 5. Also the average hospital stay, at 8. The quality of healthcare suffers from a highly fragmented system, with many services provided in small and often inadequately equipped hospitals. A stronger focus on prevention and care integration could bring efficiency gains.

Inefficiencies in the healthcare system also arise from the legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of the solidarity-based statutory health insurance scheme. It also allows doctors to charge patients with private health insurance more than those covered by the statutory scheme, which incentivises overprovision of health services.

The retirement of the baby boomer generation is affecting Germany more than other EU c ountries, putting considerable pressure on public finances. By , the country is expected to be facing one of the largest increases in spending on public pensions in the EU up by 1. The long-term fiscal sustainability risk has increased from low to medium, reflecting a softening of the initial budgetary position, which however remains favourable.

This yields an increase in the S2 level by 0. Demographic developments also have implications for the adequacy and fairness of pensions. Since , pension increases are linked to the pension sustainability factor, which measures the change in the number of contributors relative to the number of pensioners.

While in this led to an additional pension increase of 0. At the same time, net pension replacement rates are already relatively low, especially for low-wage earners Furthermore, life expectancy varies between socio-demographic groups and is lower for low-income earners than for high-income earners, as also reported in the Federal Government Report on Poverty and Wealth BMAS, As a result, the annualised compound return of expected pensions compared to their earlier contributions is currently higher for high-income earners than for low-income earners Haan et al.

The principle of intra-generational fairness could be further strengthened in the Grundrente by basing the contribution years on full-time equivalents. This would avoid treating those that worked part-time in relatively well-paid jobs the same as those that have worked their entire life full time in badly paid jobs. Structural deficits are no longer allowed. Germany continues to conduct spending reviews to increase the efficiency and effectiveness of government spending.

Since , the country has held yearly cycles of spending reviews targeting specific policy areas and ministries. While a comprehensive view may be missing, the policy impact could still be analysed for specific climate and environment policy-related actions. Banking sector. The banking industry needs to adapt to the challenging times ahead. Banks will have to accelerate consolidation and reorient their business strategy in the foreseeable future of ultra-low interest rates While further cost-cutting is necessary, the financial sector needs to invest more in IT infrastructure to modernise day-to-day business.

The disruption initiated by fintech and bigtech may squeeze revenues, while consumer pre ferences and the regulatory environment may also change The sector as a whole needs to adapt to a rapidly changing environment and develop a strategic vision in order to remain viable. The past years of economic growth have helped banks to keep non-performing loan ratios low, while the low interest rate environment contributed to lower funding costs.

However, profitability has been dented by the decline in lending interest rates combined with an over-reliance on intermediation income, over-capacity stemming from splintered bank networks, compliance cost, an old IT infrastructure that needs costly overhauls. Still, banks have managed to remain profitable on aggregate by realising hidden reserves, increasing the maturity transformation, increasing credit flows and taking on higher risks during the past years. Relying on these factors appears more difficult in the future.

Profitability dif fers widely between banking types. By contrast, savings banks and cooperatives are currently more profita ble than big commercial banks and Landesbanken. For the banking system as a whole, the return on assets in was 0. Low profitability calls for an overhaul of cost structure.

High costs were a major driver of low profitability. Consolidation progresses still have a long way to go. Mergers across pillars remain difficult, also because their legal set-up differs. Given the much lower discount rate, pension liabilities increased commensurately. In , the stock of mortgages increased by 4. Outstanding bank credit to the private non-financial sector increased to EUR 1,1 trillion at the end of September Growth accelerated to 5. Outstanding credit increased by 3.

For the EU and euro area data includes domestic banking groups and stand-alone banks, foreign non-EU controlled subsidiaries and foreign non-EU controlled branches. German banks still depend predominantly on intermediation income. It accounts for three quarters of their total income, while in several other euro area jurisdictions non-interest income constitutes about half of aggregate revenue.

Over , loan stock increased by 4. Savings banks and cooperatives had an average margin of 1. Banks pass on negative interest rates to larger corporate customers, but only very timidly to large household depositors. Risk-adjusted capital ratios are still somewhat above the European average. With 1. Table 4. The stress scenario implies a severe downturn causing the CET1 ratio to fall to Hence, smaller banks would, on average, remain above regulatory minima, which does obviously not preclude individual institutions from falling below that threshold.

The share of hard-to-value Level 2 and Level 3 assets has been falling in the last decade. Assets held for trading are classified in three levels depending on the progressing complexity of valuing the asset. Accounting rules IFRS 13 oblige banks to report gross positions, which might be partly hedged against each other, and are therefore of limited explanatory power compared to net positions. Gross level 2 and level 3 assets amount to In France, these figures are Their share in Germany has been falling slightly over the past decade.

Given their complexity, these assets are rather concentrated in the bigger banks. For 31 of the banks tested the impact on Common Tier 1 capital levels would be less than 20bp, 10 banks would see their CET1 ratio fall bp, and only 7 banks would face a capital impact ranging from 73 to 40bp.

Housing market. House prices rose by half this decade, catching up after years of stagnation. Most of the available residential real estate price indicators point to an overvaluation in the bigger cities. Following a period of mainly nominal increases since , real house price growth has accelerated in recent years, slightly outpacing the growth in household income.

Today house prices considerably exceed their long-term average, compared to both rents and incomes, suggesting increasing risks of a housing bubble. House price increases in urban areas reflect a shortage of housing supply relative to demand. The federal government has introduced a number of measures aimed at alleviating this shortage.

See also Section 4. New mortgage attribution is still accelerating, outweighing redemptions quite significantly. In September the mortgage stock was 5. Rising housing prices have led to a higher number of mortgages. Over , average annuities increased by 5. The loan to value at origination increased by basis points bp to Riskier loans also led to higher interest rates.

Over , interest rates increased from 1. Yet over , mortgage rates fell faster in Germany, and in September they stood 17bp below the euro area average of 1. In Germany, most homebuyers choose fixed interest rates insulating them from interest rate changes. The home ownership rate is the lowest in the EU, yet a quarter of the German population has a mortgage, which is close to the EU average.

The macro-prudential tools are only partially appropriate. Adding debt-based limits to the toolkit would enhance its effectiveness as currently only loan-to-value and maturity limits could be activated. In its warning, the European Systemic Risk Board identifies loosening lending standards, accelerating mortgage growth and urban overvaluation as systemic risk sources ESRB Even though Germany will introduce a 0.

Capital markets. Venture capital funds amount to 4. There is a strong concentration of venture capital in two major hubs across all stages of financing. This concentration is related to the relatively str ong innovation performance by both regions. Regarding the sectoral distribution of venture capital investments, ICT and manufacturing stand out Flachenecker et al.

Public financing programmes have improved access to early-stage finance. Unlike other public programmes aimed at promoting venture capital investments, the INVEST programme allows private investors to choose which businesses to invest in. Tighter links between entrepreneurs and investors through investment in incubators, accelerators and business angel networks have improved the entrepreneurial culture and made Germany more attractive to local and international investors.

However, access to early-stage and growth finance is still a major impediment for high-growth businesses EFI, ; Flachenecker et al. Recent initiatives focus on providing finance to high-tech and innovative sectors. Issuing private placements of debt promissory notes, Schuldscheine is considerably less costly than issuing a bond.

Promissory notes do not need to be marked to market and therefore banks prefer holding them over classic bonds which are subject to valuation changes. Sectoral saving-investment balances. The high current account surplus is reflected in household and public savings, while corporate deleveraging has halted.

Until recently, all sectors of the economy contributed to the current account surplus. This now only holds for households and the general government. Since , non-financial corporations have turned into net borrowers: the net lending of corporations declined from 1. This reflects a consistent increase in corporate investment since in response to high capacity utilisation. Households have benefited from an increase in gove rnment transfers and the resilient labour market.

The share of labour income has been recovering further, reflecting the continuation of employment growth and resilient wages. Only a part of the disposable income increase found its way into consumption and investment: the household savings rate increased further to By contrast, general government savings increased in the years to as a share of GDP, reflecting strengthening tax revenues.

This has driven the fiscal surplus up, creating room for more public investment and other long-term growth-enhancing expenditure. The public sector net lending position peaked at 1. Further reductions are expected in the future, to a broadly balanced balance by Source: German Bundesbank European Commission. The current account surplus and the net international investment position remain considerably above what fundamentals suggest.

Yet, a large part of the surplus 3. An increasing net international investment position continued to contribute to a sizeable positive income balance 1. The remarkably strong labour market masks labour hoarding and diverging trends between services and manufacturing. The unemployment rate stabilised at around 3.

While manufacturing and related business services have contributed about half of the employment growth in recent years, since the second quarter of job creation in these sectors slowed noticeably and it even came to a halt in Graph 4. Still, dismissals were limited as many manufacturing companies hoarded labour, reducing hours worked by winding down working time account balances Arbeitszeitkonten and using short-time work arrangements Kurzarbeit. The number of workers participating in cyclical short-term work arrangements increased markedly from its lowest level of about 10, to about 84, in November remaining nonetheless far below the peak of 1.

This suggests considerable further room for labour hoarding against a cyclical shortage of demand. Kurzarbeit however is not a general remedy for structural transformation needs, which in the car sector are already leading to dismissals. Even as job creation in manufacturing and related services halted, hiring continued in construction and the large majority of services, notably public services, healthcare and education.

Overall wage growth has been resilient so far but i s expected to slow this year towards the euro area average. Even as the labour market started to show signs of stress, with employment growth decelerating and productivity declining 28 , growth in nominal compensation per employee accelerated, from 2.

Wage increases in services contributed considerably to overall wage growth, while wages in manufacturing slowed along with the declining production. Despite relatively strong wage growth Graph 4. In general, wage growth may decelerate as employers see their bargaining power increasing due to a softer labour market and also react to low productivity growth and squeezed profit margins.

Effective collective bargaining may be a tool f or finding the right balance between wage increases and maintaining employment. In this respect the situation is roughly unchanged, as the proportion of workers covered by collective bargaining agreements stagnated in Kohaut, at a relatively lo w level compared to the past.

The European Pillar of Social Rights is a compass for a renewed process of upward convergence towards better working and living conditions in the European Union. It sets out 20 essential principles and rights in the areas of equal opportunities and access to the labour market, fair working conditions and social protection and inclusion. The Social Scoreboard supporting the European Pillar of Social Rights points to relatively few employment and social challenges in Germany.

This is accompanied by a wide gender pay gap , reflecting differences in the number of hours worked and in the sectoral composition of employment across genders. Germany has one of the highest proportions of women working for low w ages. Early school leavers account for In Berlin, 9. The tertiary education attainment rate among year-olds also differs significantly by 30pps between regions. The proportion of people who are long-term unemployed has decreased in recent years.

On the back of a strong labour market performance, long-term unemployment stood at 3. Further improvements can be expected, due partly to government measures like the Teilhabechancengesetz. Following past increases in negotiated wages, minimum wage updates appear to have lagged behind general wage developments.

These increases, given legal force by the federal government, were based on developments in negotiated wages in for the increase and the first half of for the increase. Linking minimum-wage increases to past developments in negotiated wages appears to have resulted in a gradual erosion of the relative level of the minimum wage since According to European Commission calculations, the ratio to the median is expected to stay unchanged in , but the ratio to the average wage is expected to further decrease.

Shortages of skilled labour are acting as a drag on growth. Despite slowing economic activity, labour shortages remain considerable. At the same time, the vacancy rate the number of vacant jobs as a proportion of all jobs is close to its historical highs at 3. Demographic ageing and technological transformation are making securing a skilled workforce also a structural challenge.

Without additional measures, potential growth in Germany is expected to decline from 1. Upskilling and reskilling of the labour force can help relieve labour shortages. While Germany has one of the highest employment rates in the EU, the employment rate for the low-qualified is relatively low at Atypical employment and low pay are particularly widespread in this group.

Participation in adult learning, at 8. On average, 4. Strengthening the upskilling of low-skilled workers would also be beneficial given that Germany is estimated to have only 3. In Germany started some promising reforms to improve upskilling and reskilling, yet there is potential to do more.

It is, inter alia, expected to improve transparency and accessibility, better recognise informal skills and guide the low-skilled to formal qualifications, including through partial qualifications.

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