THE DEBT BRAKE AFTER THE FEDERAL CONSTITUTIONAL COURT JUDGEMENT: INCREASE FLEXIBILITY – MAINTAIN STABILITY

Executive Summary

Following the ruling of the Federal Constitutional Court on the Second Supplementary Budget Act 2021, the debt brake must be interpreted much more narrowly than previously practised by the Federal Government. In particular, no credit authorisations can be transferred to special funds for use in subsequent years if the emergency exception clause has been applied. After the emergency situation, therefore, either consolidation must take place immediately or an emergency situation must be re-established in subsequent years.

The aim of the debt brake is to ensure the sustainability of German public finances. In its current form, however, the debt brake is more rigid than it would be necessary to maintain (debt) sustainability in Germany. In light of the Federal Constitutional Court's clarification on the interpretation of the debt brake and the resulting stronger restrictions for fiscal policy following an emergency, a reform of the debt brake should be considered.

A pragmatic reform could increase the flexibility of fiscal policy by adapting three elements of the debt brake without jeopardising stability. First, a transitional phase should be introduced in the years immediately after the application of the debt brake's exception clause. During this phase, the permissible structural deficit could be above the regular limit, but would have to be steadily reduced. Second, the limit for the annual structural deficit should be staggered depending on the level of the debt ratio. The limit could be designed in such a way that higher structural deficits are permitted if the debt ratio is below a certain threshold and the previous deficit limit applies if the debt ratio is above [this threshold]. Thirdly, cyclical adjustments should be less susceptible to revisions through methodological improvements in the estimation of potential output.

Potential courses of action

• Introduce a transition phase for the years immediately following the application of the debt brake’s exception clause.
• Increase the structural deficit limit of the debt brake when debt ratios are low.
• Make cyclical adjustments less susceptible to revisions.