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Germany: Schroeder Hopes Tax Cuts Will Rescue Europe's Largest Economy

German Chancellor Gerhard Schroeder is calling for tax cuts to help Germany out of its economic doldrums. But the cuts may put the country at odds with the European Union, if Germany can't control the spending needed to pay for them. The reductions are part of a larger package of controversial reforms, including changes to the labor code, which Schroeder is now promoting. He got an unexpected boost over the weekend when the country's largest trade union called off a strike that a majority of Germans saw as damaging to the economy.

Prague, 1 July 2003 (RFE/RL) -- German Chancellor Gerhard Schroeder is hoping tax cuts can save the German economy.

But Schroeder's proposal, announced yesterday, to start the cuts next year instead of in 2005 poses considerable risks for the country's financial obligations to the European Union. The cuts would cost the German budget as much as 18 billion euros ($20.8 billion), and it's not yet clear how the government would pay for them.

Schroeder told reporters yesterday that the cuts, which would reduce tax rates for the highest wage earners from 48.5 percent to 42 percent, would save the average wage earner 10 percent on his or her tax bill.

"Bringing forward the tax reforms means, for taxpayers, that from next year, they will pay around 10 percent less in income tax than they are paying this year. Ten percent less income tax means 10 percent more spending money. This improves domestic demand and the incentive to work legally rather than illegally [by not paying taxes]," Schroeder said.

The cuts are aimed at reviving Europe's biggest national economy. Germany has been on the verge of recession since the end of the economic boom of the late 1990s.

The thinking behind the cuts is that Germans will spend the extra money on local goods and services, thus giving the economy a boost. U.S. President George W. Bush is also looking to tax cuts to help the struggling American economy.

But tax cuts do not always work. A national tax rebate in the U.S. in 2001 failed to ignite the economy there. German observers say Schroeder's cuts might also fail if citizens choose to put the money in banks or use it to buy goods abroad.

The plan also poses considerable risks to Germany's obligations within the European Union. Germany, along with all other EU members, is obliged to hold its budget deficit to no more than 3 percent of the size of its economy, as measured by gross domestic product.

The limitations were imposed to prevent governments from over-spending and possibly weakening the common currency, the euro, and fueling inflation. While those fears may seem exaggerated these days, as the euro has gained strength and the talk in the bloc is more about the dangers of deflation than inflation, EU officials still take the obligations seriously.

Germany last year failed to meet the EU's budget rules -- known as the "Maastricht criteria" -- and is not expected to meet them this year. Schroeder, however, holds out hope that Germany could fall in line with the EU by 2004.

"With the [economic] measures we have proposed, it is possible to meet the Maastricht budget rules, and we don't have to miss them. But I want to point out that in order to meet those budget rules, certain growth expectations are planned," Schroeder said.

Those expectations -- namely that the economy will grow 0.75 percent this year and 2 percent in 2004 -- may prove unrealistic.

This week, the highly respected DIW economic institute said the German economy will contract, not grow, this year. It added that the economy is unlikely to recover next year either.

The European Union is clearly concerned. EU Monetary Affairs Commissioner Pedro Solbes was in Berlin today for talks on the effects of the tax cuts. After the discussion, he appeared confident that Germany will meet the EU criteria, but added there are what he called "risks and uncertainties." He questioned the 2 percent growth forecast for next year.

The proposed tax cuts come as Schroeder's government also is trying to push through controversial measures to reform the country's labor code. The reforms are intended to make it easier for companies to hire and fire workers, and would scale back benefits to jobless workers.

Germany's jobless rate is well over 10 percent of the workforce, and Schroeder made expanding employment one of his main campaign pledges last year.

The government got an unexpected boost over the weekend when the country's largest trade union, IG Metall, called off a four-week-old strike in the eastern part of the country that had crippled leading automobile manufacturers. Auto exports help drive the German economy.

Some 300,000 industrial workers in Saxony and Berlin were striking to reduce the working week from 38 hours to 35 hours -- the same as in the wealthier western part of the country. Employers refused, saying the extra hours -- for the same base pay -- are a magnet for badly needed investment in the depressed region.

The union called off the strike after opinion polls showed a majority of Germans, including many union members, opposed the strikes as being damaging to the economy. It was the first major defeat for the once all-powerful trade union since 1954.

The unions have been some of the staunchest critics of Schroeder's economic reforms. Some say the end of the strike may signal a shift in sentiment -- as Germans appear increasingly to see their welfare state as unsupportable over the long term.

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    Mark Baker

    Mark Baker is a freelance journalist and travel writer based in Prague. He has written guidebooks and articles for Lonely Planet, Frommer’s, and Fodor’s, and his articles have also appeared in National Geographic Traveler and The Wall Street Journal, among other publications.