German Finance
Minister Hans Eichel still doesn't get it. He told a conference
last week, "The weak economy is pushing the public sector deficit
fairly close to the [3%] limit set in the Maastricht treaty. That
means at the moment we have no room for any additional tax cuts."
OK, Hans, listen up. Here's the deal. Tax rates determine
growth. Growth determines people's incomes and therefore the government's
tax collections. Not the other way around. If the economy is shrinking,
like the German economy is today, tax collections fall because nobody
is making any money. That's why the government budget is in deficit.
To fix the German economy's real problem - The Big Shrink -- you
need to cut tax rates to stimulate growth. That will raise tax collections
and reduce the deficit as a byproduct. You don't need to have room
to cut tax rates. Tax cuts are what make the room, i.e., the revenues,
that allow the government to spend the money so the politicians
can get reelected next September.
Or haven't you been paying attention during these
past twenty-one years.
I know I am taking risk writing this. I can have
a Keynesian Cross burned on my front yard for saying that deficits
don't matter for growth or interest rates. The textbooks still preach
the view that all growth springs from the government budget. But
nobody who has ever run a business or tried to balance a budget
believes the textbooks anymore. It just takes textbooks a long time
to catch up to the real world.
This is important for Germany today because they
are so close to getting it right. The German government shocked
investors a year ago when Chancellor Schroeder announced a rollback
on the capital gains tax on cross-shareholdings. As of January 1,
2002 German corporations that own an interest in other companies
are able to sell that interest at zero capital gains tax. This sets
the stage for a 1980's-style restructuring wave in which German
banks and insurance companies liquidate their holdings in each other
and in German industrial companies and German industrial companies
sell their non-core holdings in vendors, customers, and strategic
allies. The result would be a huge new source of capital for expansion
and would refocus German management teams on improving returns on
capital and increasing shareholder value.
Schroeder's initial announcement restricted the tax
cut to large public companies. He later extended the tax cut to
the mid-sized Mittelstand companies that make up the core of the
German economy. Or, at least to some of them.
But in Germany it is never quite what it seems on
the surface. In Germany, a company is either an AG or a PG. AG's
are owned by the public, PG's are owned persons or families. AG's
are larger, tend to have unions, and their managers tend to support
the SPD (Schroeder's party). PG owners tend to be CDU members, who
will back Mr. Stoiber in the September elections.
Schroeder is a very smart politician. He gave the
capital gains tax cut to large and mid-sized AG's, but not to PG's.
And to buy union support for the cuts he added union members to
the boards of directors of mid-sized PG's. Thus he simultaneously
lowered the cost of capital for a large sector of German industry,
and raised the cost of capital for another large sector of German
industry, making labor markets still more inflexible in the process.
Even still, the tax cuts are big and important. Hostile
takeovers are now possible in Germany. US-style Corporate raiders
are on the scene. Private equity funds are roaming the countryside
looking for deals. Boards are increasingly using stock options to
align the interests of management and shareholders. At a minimum,
this will trigger a wave of intra-European consolidation, as French
and German companies swap subsidiaries for mutual strategic benefit.
At best the pressure from Mr. Stoiber, who will make the economy
the center of his campaign, could force Mr. Schroeder to extend
the tax cuts to PG's this spring. That would improve productivity
and add a percent or so a year to the German growth rate for some
years to come.
But only if the German authorities make up their
mind whether they want to grow or tilt at budget deficits.
This one is important, Hans. Don't blow it.
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