08 March 2013

Legal transposition of the Fiscal Compact in Germany: Postponed, but not cancelled

Transposition of the treaty into German law requires the consent of the two chambers of parliament, the Bundestag and the Bundesrat. Recently, the Bundesrat rejected the draft put forward by the Bundestag for the second time.

In the past two years, a number of surveillance and sanctioning components apart from the Stability and Growth Pact have been instituted in the EU to enable budgetary monitoring and fiscal policy coordination. These include not only the European Semester, the so-called Euro Plus Pact and the "Economic two-pack" consisting of two EU regulations, but above all the Treaty on Stability, Coordination and Governance, referred to as the Fiscal Compact.

The objective of the fiscal policy component of the reforms is partly to establish more automatic triggering mechanisms and tougher sanctions in the Stability and Growth Pact (in short: corrective arm) and partly to anchor the commitment to comply with fiscal rules at the national level (preventive arm). The treaty was signed by 25 EU Member States (without the United Kingdom and Czech Republic) in March 2012 and came into force on January 1, 2013. From 2014, the stipulations of the fiscal pact on the new debt rule have to be implemented at the national level. In this context, Germany – which has already introduced a constitutionally anchored fiscal rule in the shape of a debt brake – will need to amend some of its existing arrangements.

Given its federal structure and the constitutionally guaranteed autonomy of the constituent Länder and municipalities, however, implementation will be anything but simple. Since ultimately all levels of government will need to reach a consensus, the legislative process will also require a positive voting outcome in the Bundesrat. The transposition of the Fiscal Compact into German law will not be cancelled altogether by the Bundesrat's recent rejection of the legislation. It will only be postponed. The Federation has already committed to Germany's external partners that it will accept liability for the stipulations of the pact until 2020.

The medium-term budget target of a structural deficit not exceeding 0.5 per cent of GDP as stipulated by the pact is already addressed by Germany's existing debt brake – this also applies to the required correction mechanism which, at least at the federal level, is largely reflected in the control account and the related deficit adjustment path. However, the deficit concepts differ from one another. Moreover, there is currently no guarantee that the budget target will be met every single year as well as by the government as a whole (i.e. including municipalities and social security), since the German debt brake only covers the Federation and the Länder. Last but not least, there is also incongruity in the timeframe, since the German debt brake applies to the Federation from 2016 but not to the Länder until 2020.

In the process of obtaining the Bundesrat's general consent to the fiscal treaty, the Federation and the Länder reached an agreement in June 2012 on key parameters for its implementation in Germany. This foresees several legal amendments that will also require the approval of the Bundestag and the Bundesrat. These apply – as is so often the case in federal reality in Germany – not only to the heart of the transposition process, i.e. the limiting of deficits and the specification of the division of responsibilities between the Federation and the Länder, but also ultimately to the financial demands of the Länder on the Federation.

As regards limiting the deficit, it has to be noted that at present only the corrective arm of the Stability and Growth Pact is regulated in relations between the Federation and the Länder. There is no arrangement (as yet) for the preventive arm. The Länder want an explicit agreement that they shall only help to comply with the fiscal pact in the framework of applicable constitutional regulations and shall not be required to enter any new or additional commitments. Under the current framework they believe that the latter could happen also after the year 2020. The Bundestag draft legislation did provide for the inclusion of this aspect in the corrective arm, though – a key reason for the Bundesrat to reject it. By contrast, there is no dispute between the Federation and the Länder over the enhancement of the Stability Council in its control and governance function for the three levels of government. It is to be supplemented by an independent advisory council to monitor compliance with the 0.5 per cent deficit limit.

Likely even more important, however, are the financial (equalisation) demands of the Länder. One of these is the call for joint Federation and Länder bonds – "Germany bonds" – with which the Länder want to reduce their interest expenditures. At present, though, there is no agreement on the horizon, since the Federation does not want to accept full liability for Länder bond issuance. Rather, the Federation envisages a type of Federation-Länder jumbo issue with pro rata liability. Another demand focuses on a package of direct financial transfers from the Federation to the Länder. This package currently amounts to some €2.9 bn p.a. It was originally hammered out during the second federalism reform 2009. These transfers are meant to compensate the Länder for expenditures on tasks they were required to shoulder and fund largely on their own following the federalism reform. The total amount has to be reviewed regularly, with the next revision due by year-end. In the current negotiations, the Länder are pressing to have the funding package set for a longer term and are also demanding an increase in the total. The negotiations will probably drag on for a while, but ultimately the Fiscal Compact ought to be implemented in Germany within the deadline.

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