Is Germany’s Debt Brake Undermining its Climate Transformation?

Written by Nikita Pia Jensen (Ambassador to Germany) and edited by Alessia Calarese

Abstract

This piece analyses the interaction between Germany’s fiscal policy – particularly the debt brake – and the struggle to meet its climate transformation goals. Originating as a response to the 2008 global financial crisis, the debt brake has been integral to Germany’s economic stability. However, the impact of the COVID-19 pandemic and energy price surges after Russia’s invasion of Ukraine have exposed significant vulnerabilities within the policy framework. As Germany navigates a slowing economy, high energy prices, and rising military costs, its inflexible fiscal stance increasingly prohibits it from investing sufficient money to meet its climate goals and makes it an unreliable partner on the global stage. Furthermore, a recent court ruling deemed a 60 billion allocation to the Climate and Transformation fund incompatible with the debt brake and resulted in significant cuts to the climate sector. Therefore, the analysis underscores the necessity of policy reform to avoid paralysis in addressing emerging issues.

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Introduction

In response to the global financial crisis, Germany implemented a fiscal policy in 2009 known as the “debt brake” to ensure economic recovery and curb excessive government spending. Over the coming years, Germany celebrated the success of this fiscal framework, attributing the country’s economic resilience and stability to the debt brake.

However, despite its remarkable success in steadying the economy after 2009, Germany has been hit by the global decline in production caused by the COVID-19 pandemic and the soaring energy prices after Russia’s invasion of Ukraine. As the nation’s heavy reliance on Russian oil and gas rendered it more vulnerable than its European counterparts, Germany found itself in a recession in 2023. This prompted the current government to struggle with managing government expenditures while avoiding new debts. This reached its peak in November when the Federal Constitutional Court ruled that an allocation of 60 billion euros from a COVID-19 emergency fund to the Climate and Transformation Fund (“Klima- und Transformationsfonds”) was unconstitutional and hence required the government to repay the money (Bundesverfassungsgericht, 2023). In an attempt to mitigate cuts in social welfare spending, severe budget reductions were enforced in the climate sector for 2024 and beyond. This decision, contrasting Germany’s commitment to achieving carbon neutrality by 2045 and its recent pledge of 100 million euros to the Loss and Damage fund at COP28, raises questions about how Germany plans to fulfil its commitments. By delving into the debt brake framework and analysing its implications for Germany’s climate transformation goal, this piece argues that the country urgently needs to reform its current fiscal policy if it aims to stick to its climate goals.

Germany’s debt brake framework

The debt brake was incorporated into the German constitution in 2009 in response to the global financial crisis. It mandates that the federal government restrict its deficits to 0.35% of GDP, while simultaneously prohibiting state governments from incurring any deficits at all (Hein and Truger, 2014). An exception to this rule arises in the event of a state of emergency, during which the debt brake can be temporarily suspended (Rietzler and Truger, 2019). Additionally, various supplementary funds exist, designated as “Sondervermögen”, which operate outside the general spending limit (Iser et al, 2023). Notable examples are the Climate and Transformation Fund, introduced to help Germany achieve its net-zero emissions goal by 2045 (Knopf and Illenseer, 2023), and the additional military budget of 100 billion passed in 2022 to support Ukraine and modernise the German military.

Since the debt brakes implementation, German finance ministers have rigorously adhered to it, commonly referring to it as the “black zero” or “schwarze Null”, and Germany’s fiscal policy has subsequently gained recognition for its stability and rationality (Knopf and Illenseer, 2023). Indeed, the success of Germany’s economy in the 2010s has often been attributed to the debt brake, with it even being suggested as a potential blueprint for other Eurozone countries (Rietzler and Truger, 2019). However, some experts have cautioned that the German economic upswing was influenced by various macroeconomic factors, such as low-interest rates, and should not be entirely ascribable to the debt brake (Rietzler and Truger, 2019). Critics also argue that while this fiscal model may be effective during prosperous times, it could severely constrain the country during economic downturns (Hein and Truger, 2014).

This assertion was put to the test in 2020 when the COVID-19 pandemic prompted the German government to declare a state of emergency so that they could use stimulus packages to support the economy and the population (Bundesverfassungsgericht, 2023). The state of emergency persisted through 2021 and was renewed in 2022 following Russia’s invasion of Ukraine, which resulted in soaring oil and gas prices (Pakroff, 2023). Germany, particularly vulnerable to these fluctuations, again provided government aid to industry and private households (Bundesregierung, 2023).

While the emergency clause in the debt brake framework has allowed Germany to navigate the pandemic and the fallout from the Russian invasion with relative stability compared to other countries, its economy still took a hit. With persistent high inflation, and its industrial power continuing to decline, Germany is projected to be the only G7 country to enter a recession in 2023 (European Commission, 2023).  This is a significant problem for the country, which, hindered by high bureaucratic hurdles and overly strict regulations, has been struggling to become attractive to investors and foreign businesses for years (Gröschl, 2023).

The Debt Brake and Climate Transformation 

The Climate Transformation Fund was created to handle the significant financial responsibilities linked to climate change. As a result, most initiatives addressing climate issues have to be funded by using its resources (European Commission, 2023). To address this immense financial burden on the fund, the governing coalition transferred residual money from the COVID-19 emergency fund to the Climate Transformation Fund. This practice was ruled unlawful by the Federal Constitutional Court since the money from the supplementary budgets is specifically tied to the fund it was initially designated for (Bundesverfassungsgericht, 2023). Therefore, the government is now forced to repay the 60 billion it incorrectly transferred. However, this proved to be no simple task since the money had already been utilised and was pre-allocated for the 2024 budget.

Following weeks of negotiations, the German parliament managed to find a solution, retroactively declaring 2023 an emergency year and thereby suspending the debt brake once again (Packroff, 2023). Significant budget cuts were then implemented to repay the 60 billion and return to normality in 2024. Chancellor Olaf Scholz of the Social Democrats was steadfast in minimising cuts to social welfare spending, resulting in many of the reductions affecting the Climate Transformation Fund (ZEIT Online, 2023). Its 2024 budget was cut by 12.7 billion, with plans for an additional 45 billion euros in cuts until 2027 (ZEIT Online, 2023). This means that initiatives such as the expansion of solar power and subsidies for electric vehicles will be severely winnowed in the following years (ZEIT Online, 2023). Furthermore, the uncertainty after the court’s decision disgruntled many investors and businesses alike, as they remained in doubt about whether they would receive the already promised subsidies (Armbrüster, 2023). This highlights the shift from Germany’s previously praised rational fiscal policy to something now seen as unpredictable. At a time when the economy depends on attracting investments and encouraging businesses to return, such a change in signals could have serious consequences.

As part of the efforts to bolster government revenue in the upcoming years, the CO2 tax is set to rise from 35 to 45 euros per ton of emitted CO2 in 2024 (Tagesschau, 2023b). While deemed a necessary measure to combat the climate crisis and achieve the 2030 climate goals, this increase is adding strain on a population already grappling with high energy prices, as well as making Germany even less attractive for businesses. When the coalition, comprising the Social Democrats, the Green Party, and the Free Democrats, assumed power in 2021, they pledged to introduce subsidies for the population to alleviate the burdens of the climate transformation on individuals (“Klimageld”) (Tagesschau, 2023b). However, concrete plans for the disbursement of these funds are yet to be published and are now even more unlikely to occur in the near future considering the loss of the 60 billion in funds. With the surge in energy prices on top of a persistent rise in the cost of living due to inflation, a substantial portion of the population is growing frustrated with the calls for a cleaner industry (Spiegel, 2023). Even the ones who support the net-zero emissions goal are suffering under the costs and are becoming increasingly disillusioned (Spiegel, 2023).

In light of the court’s ruling and the government’s steadfast commitment to adhere to the debt brake, prospects for substantial relief for the population seem dim and support for the current government is dwindling fast (Deutsche Welle, 2023). Furthermore, given that the Climate Transformation Fund’s spendings already outstrip its revenue, there is mounting scepticism regarding its capacity to facilitate the green transition in a manner that aligns with the ambitious 2030 climate goals (Knopf and Illenseer, 2023). 

Underlining the tight financial constraints of the debt brake is the government’s announcement that in the event of escalating costs for the war in Ukraine or increased support requirements for the post-flood reconstruction in Ahrtal, declaring a state of emergency will be inevitable (Tagesschau, 2023a). Given the overall escalating global tensions which are threatening the world’s stability, the German government’s unwavering commitment to the debt brake appears increasingly disconnected from the current reality.

Moreover, Germany’s fiscal policy constraints extend beyond its domestic concerns and are influencing global climate goals. During COP28, Germany took an early and proactive step by promising financial support for the Loss and Damage fund (United Nations Türkiye, 2023). The German delegation committed to contributing 100 million euros, mirroring the reported commitment from Saudi Arabia (United Nations Türkiye, 2023). However, critics rightly argue that these pledges, though commendable, constitute only a small fraction of the necessary support for countries most adversely affected by climate change (World Economic Forum, 2023). The costs of tackling the climate crisis are only going to rise in the coming years, raising the question of how Germany wants to finance its external liabilities, if it even struggles to fund its internal goals in a constitutional manner. For a country emphasising its commitment to climate transformation, the reliance on supplementary budgets to pay for it presents an unfavourable image of its overarching priorities and the sustainability of its financial model for the years to come.

Conclusion

As the analysis above shows, the German debt brake is in dire need of reform. Once considered to be the reason for Germany’s successful consolidation after the 2008 global financial crisis, the events experienced since 2020 revealed that such an austere fiscal policy is inadequate and fails to consider broader economic factors. A worsening international security situation, ongoing economic challenges, and the increasing urgency of climate change require the country to spend money way beyond the limits of the debt brake. In this new reality, supplemental funds like the Climate and Transformation fund prove insufficient in attaining the goals for which they have been created.

For Germany to maintain its role as both a staunch supporter of Ukraine and a model for carbon-neutral economic transformation, it must have the flexibility to spend and invest more freely. These past three years have proven the inadequacy of the emergency budget as a long-term solution, as the bureaucratic obstacles inherent in implementing it are ill-suited for a world where decisions must be made promptly. Germany is no stranger to critique when it comes to the slowness of its bureaucracy. However, if even one of the most vital governmental functions, the fiscal budget, is embedded in this slowness, a fitting response to global emergencies becomes almost impossible. Climate change will inevitably increase the occurrence of disasters governments need to respond fast to. Germany needs to learn from the last weeks of chaos and overthink its obsession with the “black zero”. Otherwise, it will eventually become paralysed by its own constitution.

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