17 Nov 2023, 14:14

Q&A – What the German top court’s ‘debt brake’ ruling means for climate policy

The recent ruling by Germany's highest court that declared an integral part of the government's funding plan for climate and energy programmes unlawful has been a major blow for the coalition of chancellor Olaf Scholz. However, while the court's decision has thrown the coalition's funding plans through a special "Climate and Transformation Fund" into disarray, it explicitly did not put the urgency of climate action into question – and might even lead to a debate about the usefulness of the country's rigid constitutional 'debt brake' in the climate crisis. This Q&A takes a look at some of the landmark ruling's most important implications. [UPDATES: Scholz, Lindner, Habeck comment on impact budget, climate efforts; CDU/CSU finance experts says budget impact potentially much larger]
Building renovations should go ahead as planned, the government said. Image: Fotolia
Building renovations should go ahead as planned, the government said. Image: Fotolia

What did the court decide on?

The German Constitutional Court (Bundesverfassungsgericht) decided on the role of Germany’s constitutionally enshrined limit on new state debt in emergency situations. Specifically, it looked into the compatibility of a special-purpose fund set up to finance urgent climate and energy transition policy measures with the so-called debt brake. The limit on government borrowing stipulates that new debt must not exceed 0.35 percent of annual economic output, but was temporarily suspended in response to the coronavirus pandemic. By authorising new debt, the previous government under conservative CDU chancellor Angela Merkel — and with current Social Democrat (SPD) chancellor Olaf Scholz as finance minister — thereby aimed to allow itself sufficient financial leeway to finance economic support measures. As the pandemic receded in late 2021, around the time Scholz succeeded Merkel as the new head of government, 60 billion euros in new debt authorisations for the pandemic response remained unused. The new government coalition of Scholz’s SPD, the Green Party and the pro-business FDP then rededicated this authorisation to fill its Climate and Transformation Fund (CTF) and finance urgent climate and energy transition policies outside of the regular budget. It argued that these investments would also help the country to overcome the pandemic-related economic difficulties faster.

After the German parliament greenlighted the rededication in early 2022, shortly before Russia’s war on Ukraine caused a new emergency in form of the energy price crisis, Merkel’s conservative CDU/CSU alliance announced it would litigate against the rededication of authorised debt for the CTF, arguing it violated the debt brake’s principles. Almost two years later, the Constitutional Court ruled that the rededication was, in fact, unconstitutional. The judges argued that the government failed to establish a sound factual connection between pandemic response and climate action measures, mixed long-term policy goals with short term crisis management and failed to plan ahead by using funds from a previous year to finance its current expenditures. Instead of deciding on the validity of climate and energy transition policies, which the Court explicitly backed in a landmark ruling in 2021, the judges thus rather looked at principles of German budget policymaking and the rigour of fiscal discipline – with the CTF serving as an example. The Court asked the government to withdraw the money from the fund but at the same time tasked it with finding alternative funding sources elsewhere.

What does the Climate and Transformation Fund do?

The CTF — set up as the Energy and Climate Fund in 2011 — is only one of several special-purpose funds outside of the regular state budget, which also exists for other areas including defence spending. Its funds can be used to “promote measures that serve to achieve the climate targets” under the country’s climate legislation, especially measures to advance Germany’s transformation to a climate neutral economy. For the years 2024 until 2027, the government has planned total expenditures of 212 billion euros from the fund.

Most of the fund is currently being used for retrofitting buildings to make them more energy-efficient, which together with support for renewable energy remain the biggest expenditures in the years until 2027, according to government plans. In addition, the funds will be used for industry decarbonisation, e-mobility, the hydrogen economy, and semiconductor funding, as well as investments in Germany’s rail system.

The CTF has an annual income from EU and national emissions trading (in 2024, this is projected to amount to about 19 billion euros, rising in the following years due to increasing CO2 prices). In addition, there are higher than expected revenues and lower expenditures in 2023 (9 billion euros) and a substantial reserve, which the government said in its budget planning, will amount to 71 billion euros at the beginning of 2024. That would bring total income of the fund to 99 billion euros, and the government planned expenditures of about 58 billion euros for 2024. However, due to the court ruling, there is now a 60 billion euros hole in planned fund credit authorisations.

Will the verdict stifle Germany’s climate efforts?

The judges’ decision has dealt a major blow to the financial planning of the government coalition and meant that the court does not follow the interpretation that climate change is an unforeseen crisis that requires an emergency response. However, it does not doubt Germany’s general commitment to implementing ambitious emissions reduction policies and put the country on track towards climate neutrality by 2045, a target year resulting from the Constitutional Court’s landmark 2021 ruling. Chancellor Scholz, finance minister Christian Lindner and economy minister Robert Habeck all immediately promised that the ruling will not throw climate policy over a cliff and that existing commitments will be funded as promised. However, the verdict forced the government to halt almost all new commitments that were supposed to be financed through the CTF.

Chancellor Scholz said it would still be “guaranteed” that Germany reaches a “record investment quota” this year. Speaking at a trade congress in Berlin one day after the judges announced their decision, the chancellor added that investments in infrastructure and other areas continued to be “of enormous importance for the functioning of our economy.”

Measures related to energy efficiency and renewable power in buildings, which were among the most difficult compromises the coalition decided on this year, are exempt from the suspension, according to finance minister Lindner. However, the 60 billion euros from the CTF had already been a fixture in the government’s climate and transformation policy planning, and must be coughed up by other sources - unless the government changes plans. To provide a sense of proportion: all of the federal government’s expenses in Germany in 2022 amounted to roughly 480 billion euros.

In a speech in parliament following on the ruling, Lindner ruled out tax increases in response to the loss of planned funding. “We don’t have an income problem,” the treasurer said, arguing that Germany instead “for years has struggled to decide on its priorities.” While it would be too early to draw any lasting conclusions from the verdict, it was clear that “we will have to make more effective policies with less money than in the previous years.” The FDP politician pointed that the decision could also affect the budgets of the 16 state governments, some of which are led by the conservative alliance.

Economy minister Habeck in an article by manager magazine warned that the loss of funding meant that supporting the industry in its transformation towards carbon neutrality had become much more difficult due to the decision. Special carbon contracts for difference with steelmakers, for example, could no longer be implemented as planned. “This will be a tough challenge for this industry,” Habeck said. He insisted that “we must find the money somewhere else” to avoid industries from relocating outside of Germany.

What’s the impact on decarbonisation and support measures

The exact impact on individual decarbonisation and support measures is difficult to gauge at this point. While the government has promised that all ongoing projects and programmes are covered for the near future and that some key measures will also be provided with fresh capital in 2024, the blocking of other measures potentially could lead to uncertainty and disruption in affected policy areas.

Researchers from the Mercator Research Institute on Global Commons and Climate Change (MCC) in an analysis from September 2023, found that the government would be about 27.6 billion euros short in 2024 if the money from CTF is not available, depending on how much unused funds will still be available from 2023. “This would probably lead to an underfunding of planned measures,” said MCC author and climate change expert council member Brigitte Knopf.

However, the institute also said that while the range of measures that were supposed to be funded through CTF had continuously been expanded since its inception, the fund increasingly was used to also cover expenses “that have only little or nothing to do with climate action.” Moreover, some important measures have not even been included in the government’s funding plans yet. Support payments for citizens struggling to adapt to rising carbon prices that the government promised under the label “climate money” so far did not figure in the fund’s structuring until 2027. The MCC found that the fund would be facing a financing gap in 2026/2027. The researchers therefore concluded that the government lacked a strategy for long-term transformation funding beyond the CTF already before the ruling.

How can Germany ensure that funding will be secured in the future?

While existing commitments in the CTF can, for the most part, likely be funded through its remaining funds, the government will have to find other ways to secure financial means for making new commitments and safeguard a reliable funding structure for the coming years.

Essentially, it has three options. First, it can reduce its financial commitments regarding climate and transformation and in other policy areas to ensure the most urgent measures that were supposed to be financed through the CTF can still proceed. This could also include a cut of ongoing subsidies that are harmful to the climate, which would fulfil two purposes at once. Second, it could seek to increase its income by raising taxes, levies and surcharges. The SPD recently called for a special levy for rich citizens and a property levy. Both options are very delicate politically and bear the risk of sparking a bitter row between government coalition parties - and it is unlikely that either measure will help the government to quickly find 60 billion euros. Moreover, voters of the Greens and the SPD are unlikely to accept cuts to climate or social policy funding, while the FDP traditionally seeks to shield its supporters from rising taxes – especially during a recession.

This leaves a third option: Debating the purpose and limits of the debt brake itself. While the court generally backed the instrument that was put into the constitution in 2009, the decision is also likely to trigger a debate whether it is fit for purpose, given the ongoing string of major challenges the government must cope with. While the debt brake helped consolidate the German budget and enable a powerful fiscal response both during the pandemic and the energy crisis, it also puts limits to how lawmakers can respond to exceptional events – which they can circumvent by establishing special-purpose funds. Before the ruling, the Green Party and parts of the SPD already sought to launch a debate on the credit cap, given the continuously higher demand for state intervention in the energy transition and other major developments. While a removal of the debt brake is unlikely, as this would require the consent of the conservative CDU/CSU camp for a two-third majority in parliament, calls for the declaration of another emergency and suspension of the debt brake or enhancing the role of special-purpose funds may rise again. This second option has been backed by several economists commenting on the ruling, who share the view that the debt ceiling is a useful tool to prevent government profligacy but must not undermine future-oriented investments needed to sustain the economy’s long-term stability.

What impact could the ruling have on Scholz’s government coalition?

The ruling has been a major setback for Olaf Scholz and his cabinet – in particular for FDP finance minister Christian Lindner, who oversaw the transfer of pandemic response funds into the CTF. Lindner’s ministry (BMF) is responsible for ensuring the budget’s constitutionality, which gives only the treasurer the power to veto cabinet decisions. Lindner consented despite warnings that the move could backfire. However, he could be sure of Scholz’s support, since the chancellor initially came up with the idea of repurposing funds in his previous role as finance minister under Merkel.

Both the chancellor and his treasurer see their reputation damaged by the ruling, while Green economy minister Robert Habeck now might struggle to secure funding for decarbonisation and support mechanisms that his ministry had planned. The decision is likely to also reverberate in the transport ministry, where FDP minister Volker Wissing planned to use billions in state money to support the expansion of electric vehicle charging infrastructure and modernise Germany's rail system.

At the same time, the court’s decision has been a major success for the litigants from the conservative CDU/CSU alliance, the largest opposition faction in parliament. For the second time, the conservatives under leader Friedrich Merz managed to throw a spanner in the government’s works through a constitutional ruling. Earlier this year, the court already forced Scholz’s government to postpone a planned law on heating sector decarbonisation, after the CDU/CSU alliance litigated the proposed regulation. However, because of its successful intervention, the opposition party might ultimately find itself caught up in a new debate about the debt brake’s role.

Irrespective of that, it is unlikely that the court ruling will cause a fast rupture of the government coalition or even lead to a breakdown and new elections. The coalition parties all have little to gain now from cancelling their partnership and move into campaigning again, as they continue to poll well below their 2021 election result and stand to gain little from a new vote at the moment. With the far-right AfD recently making substantial gains in state elections and the conservatives leading in national polls, the SPD, the Greens and the FDP instead might try to use the defeat at the constitutional court as a platform for a fresh start and jointly strengthen their image as reliable government parties. However, as the ruling means that many of the climate policy questions the three parties painstakingly negotiated throughout the past months, often in public display of considerable disagreement, reopening debate will not be an easy feat.

In the budget negotiations in parliament on the day after the ruling, members of the CDU/CSU alliance declined to take part in the talks with government parties, arguing the court’s decision meant that “no serious budget talks can be held” in this context. In a letter to other conservative MPs, the CDU/CSU’s financial policy experts argued the government intended to “once again adopt an unconstitutional budget,” news station n-tv reported. The opposition party representatives said the ruling had to be examined closely before negotiations can continue. Mathias Middelberg, who sits on the parliament’s budget commission for the CDU, said the ruling could mean that other financial arrangements by the government are also at risk of being booked irregularly. In particular, this could be the case for the 200-billion euro financial ‘defence shield’ the government drew up in response to Russia’s war on Ukraine, he added. The judges’ decision had initiated a cascade of “enormous problems,” Middelberg said in an article by public broadcaster ARD.

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