OECD Economic Surveys: Germany 2023

Executive summary

The energy crisis calls for accelerating structural reforms

Russia’s war of aggression against Ukraine disrupted a strong recovery from the COVID-19 pandemic. A spike in energy prices has fuelled inflation and reduced the purchasing power of households. High uncertainty, particularly related to energy security, weighs on investment.

The government has acted swiftly to secure energy supply and support households and firms. The relief measures include strong energy saving incentives and support consumer and investor confidence. However, they could be better targeted to limit fiscal costs. The short-time work scheme has protected jobs, but incentives for training and job-search could be improved.

Table 1. The economy will slowly recover

Growth rates, unless specified	2022	2023	2024
Gross domestic product	1.9	0.3	1.3
Private consumption	4.4	-0.2	1.4
Government consumption	1.2	0.3	0.4
Gross fixed capital formation	0.6	-1.8	1.3
Exports of goods and services	3.0	1.8	3.1
Imports of goods and services	6.1	1.4	2.9
Unemployment rate (% of labour force)	3.0	3.0	2.9
Harmonised index of consumer prices	8.7	6.6	3.0
Harmonised index of core inflation	3.9	5.7	3.4
Financial balance (% of GDP)	-2.7	-2.2	-1.0
Government debt (Maastricht, % of GDP)	66.5	65.8	65.6
Current account balance (% of GDP)	3.7	5.7	6.3

OECD calculations based on the Economic Outlook 112 database.

The economy will slowly recover due to easing supply-chain bottlenecks, a large order backlog and a pickup in export demand. Despite rising interest rates, investment will recover due to high corporate savings and investment needs related to the relocation of supply chains and renewable energy expansion, as well as rising public investment. High inflation will persist due to a lagged pass-through of producer to consumer prices and rising wage pressures, but will gradually moderate during 2023 on the back of monetary and fiscal tightening and falling energy prices. Real wages will grow in 2024, supporting a recovery of private consumption.

Accelerating the green transition will help to strengthen energy security but requires more investment, innovation and business dynamism, which will also support productivity and potential growth. Since the 2000s, Germany has experienced a large outflow of private capital due to weak domestic demand and business dynamism. Reviving investment and innovation and accelerating the green transition require better public governance to lower the administrative burden, particularly for infrastructure planning, and more effective support for research and development (R&D). It also calls for a stronger competition framework and better access to finance to reduce barriers for young and innovative firms.

Rapid population ageing will exacerbate labour shortages, lowering potential growth and raising fiscal pressures (Figure 1). It will also weigh on many manufacturing sectors, which already suffer from high energy prices. Comprehensive structural reforms are needed to maintain fiscal space, raise productivity and sustain living standards despite a declining workforce. Better incentives to work longer should be combined with improved adult education, training programmes and working conditions for the elderly. Raising labour supply of women and low-skilled adults, facilitating skilled migration and improving educational quality for disadvantaged children are key.

Figure 1. Rapid population ageing will exacerbate labour shortages

Working-age (15-64) population, % change, 2020-30

Source: United Nations (2019), World Population Prospects: The 2022 Revision, Online Edition.

Statlink

Modernising the state to support the green and digital transition

A large infrastructure backlog and investment needs for the green and digital transition require raising spending efficiency, better prioritising spending and reducing tax expenditures. Digitalising the public sector is key to reduce the administrative burden, raise the quality of public spending through better policy targeting and evaluation, and improve tax enforcement (Figure 2).

The fiscal framework needs to be updated. Several special funds are used to address the investment backlog, but expenditures under these funds are not included in the core budget, weakening transparency and the credibility of the fiscal framework. Gradually re-including them into the core budget should be combined with more flexibility in the fiscal rules to allow for adequate investment spending, while better incorporating spending reviews in budgeting procedures at all levels of government.

Labour taxes are among the highest across OECD countries, hampering labour supply, particularly of second earners and low-skilled workers. Around 48% of women work part-time, and many are overqualified for their jobs. Shifting the tax burden from labour towards capital income, property, inheritance and consumption taxes and reforming the current joint income taxation rules for couples would help to raise labour supply.

Figure 2. Digitalisation of the public administration is low

OECD Digital Government Index, 2019, score 0 to 1

Source: OECD Survey on Digital Government 1.0.

Statlink

Effective inheritance and gift tax rates are low, particularly for wealthy households, while wealth inequality is high. Reducing tax-allowance thresholds and business asset exemptions, while further extending instalments for tax payments, would raise revenue and reduce inequality.

Cutting tax exemptions for real estate and VAT and raising property taxes would reduce distortions, increase fairness and raise revenue. Tax expenditures for income from selling or renting real estate are regressive and lead to a misallocation of capital, contributing to rising housing prices. Many municipalities suffer from volatile revenues, but municipal property tax revenues are low in international comparison, despite soaring real estate prices.

Strengthening tax enforcement is key for levelling the playing field and raising revenue. Large firms and wealthier households make greater use of tax avoidance or evasion strategies to lower their effective tax rates, which puts smaller firms and other taxpayers at a disadvantage. Improving tax enforcement requires stronger incentives for the Laender to scale up their enforcement capacities, better IT infrastructure and cooperation across the Laender, which would allow for more specialisation and targeting of enforcement efforts.

Some progress has been made in the fight against money laundering and corruption. Data quality on asset ownership and cooperation across agencies and levels of government is still weak. Establishing a new federal agency to combat financial crime, with sufficient investigative powers, skilled staff and data access would improve capacities to fight complex financial crimes and money laundering. Providing sufficient staff and IT resources to implement and enforce the new lobby register and include a legislative and a regulatory footprint would help to make lobbying activities more transparent.

The digitalisation of the public administration holds large potential to raise spending efficiency, growth and welfare. The high administrative burden particularly hurts young and innovative firms and weakens business dynamism and innovation. The federal government made online access to public services mandatory from 2023 but failed to introduce mandatory common standards on design and interlinkage of data and IT tools for all levels of government. Establishing a centralised and transparent e-procurement platform and encouraging joint procurement initiatives across municipalities would strongly improve spending efficiency. Digitalising the public sector also requires updating the skills of public employees, which calls for better recruitment procedures, incentive structures and training opportunities.

Reaching net zero while safeguarding competitiveness and social cohesion

Germany released 39% less GHG emissions in 2021 than in 1990 and set an ambitious target of reaching climate neutrality in 2045, which requires tripling the speed of emission reductions. High energy prices and the need to replace Russian energy imports have amplified the determination to act.

Emission pricing can effectively help to reduce emissions, but effective price levels are too low and unpredictable and differ substantially across sectors due to many tax expenditures and subsidies. Price signals should be strengthened by aligning the emission cap in the national trading system with national targets, phasing out fossil fuel subsidies and tax expenditures, and expanding the use of measures that reduce regulatory risks to green investments.

Stronger emission reductions risk hurting energy-intensive industries that are exposed to international trade. Output-based and renewable energy subsidies can support these industries, but they are costly and lead to higher emissions in other countries. The risk to these industries would be better managed by streamlining the planning and approval procedures for renewable energy projects, subsidising green R&D and pushing for international agreements that enforce faster global emission reduction.

The transition to net zero will require reallocation of labour across sectors and firms and risks increasing inequalities. Workers displaced in high-carbon-intensity sectors tend to suffer more lasting and significant decreases in earnings than other workers, because they tend to be older, work in more specific occupations and are geographically concentrated (Figure 3). Expanding the scope of active labour market programmes – focusing on vocational education and training, and mobility subsidies – could reduce adjustment costs for affected employees. Improving adult education opportunities and the offer of partial qualifications combined with recognition of informal prior learning can facilitate the uptake of vocational education, particularly for low-skilled adults. Using revenue from carbon pricing to support households can minimise adverse distributional effects more generally.

Figure 3. Workers displaced by the green transition will need support

Changes in earnings relative to pre-displacement average (in %)

Source: (Barreto, Grundke and Krill, Forthcoming).

Statlink

Gradually phasing out non-targeted subsidies as well as subsidies for mature technologies would improve the cost-effectiveness of mitigation efforts. In the housing sector, untargeted subsidies should be replaced by minimum efficiency standards and energy performance certification for existing buildings, while providing loan support for credit-constrained households. In transport, the focus should shift from subsidising electric cars towards expanding the deployment of charging points, while enhancing competition in the charging points market. Further increasing public investment in rail while accelerating the digitalisation of the control and signalling systems and improving competition would help the shift to a sustainable transport system.

 

Main findings	Key recommendations
Updating the fiscal framework, raising spending efficiency and reforming the tax system
Core inflation and wages are rising. Fiscal policy will add to inflationary pressures if energy prices and corresponding subsidies remain high.	Avoid an expansionary fiscal stance to contain inflationary pressures, while standing ready to support vulnerable households.
A rising number of extra-budgetary funds at federal and Laender level reduces transparency and weakens the credibility of the national debt brake. Investment needs are high.	Gradually include extra-budgetary funds in the core budget, while introducing more flexibility in the fiscal rules to allow for adequate investment spending.
An increasing share of spending at lower levels of government is financed by the federal level with limited accountability and incentives for spending efficiency.	Foster a culture of impact evaluation by developing the necessary data sharing infrastructure, strengthening spending reviews in budgeting procedures and encouraging peer learning across levels of government.
Mandatory common standards on design and interlinkage of data and IT tools are missing across levels of government, hindering the digitalisation of public services.	Set mandatory common IT standards and encourage the harmonization of administrative procedures and joint software development across levels of government.
Joint income taxation rules for couples in combination with the Mini-Job regulation lead to steep labour tax schedules for second-earners, reducing labour supply incentives, particularly for women.	Raise labour supply incentives for second and low-wage earners by reforming the joint taxation rules for couples, while reducing the income threshold at which social security contributions progressively increase
High inflation increases real effective income tax rates, particularly for low- and middle-income earners, and lowers labour supply incentives.	Lower personal income taxes by raising tax-free allowances and decreasing tax rates.
Generous exemptions to gift and inheritance taxes reduce effective tax rates, in particular for wealthier households. Wealth inequality is high.	Reduce allowance thresholds for gift and inheritance taxes and exemptions for business assets, while extending instalments for tax payments.
Generous tax expenditures for income from selling or renting real estate distort capital allocation, contribute to rising housing prices and increase inequality. VAT exemptions are costly and regressive.	Improve tax collection and reduce distortions by abolishing tax expenditures for income from selling or renting real estate and VAT exemptions.
Improving tax enforcement and the fight against money laundering and corruption
Tax collection and enforcement is under the responsibility of the Laender, including for taxes shared between Laender and the federal level, which creates incentives to underinvest in tax enforcement.	Set binding guidelines on tax enforcement capacities and performance for the Laender, using Laender-specific tax gap estimates, and regularly publish guidelines and performance outcomes.
Capacity constraints and weak cooperation and data exchange between law and tax enforcement authorities of the Laender complicate the fight against money laundering and tax crimes.	Implement plans to establish a Federal Financial Police and improve cooperation and data analysis across levels of government as well as the enforcement of reporting requirements.
The new transparency register for lobbying activities excludes certain lobby organisations and lower levels of the administration, where many lobbying activities take place to influence draft bills.	Provide sufficient staff and IT resources to implement and enforce the new lobby register, increase its coverage, including contacts with lower administration levels, and introduce a legislative and regulatory footprint.
Reaching net zero cost-effectively
Germany prices 90% of its GHG emissions, explicitly or implicitly, but levels are too low and differ substantially across sectors.	Set an emissions cap for all sectors not covered by the EU ETS, which is in line with the national targets, until the European trading system for road transport and heating starts operating.
Many fossil fuel subsidies and tax expenditures weaken price signals and can jeopardise climate goals	Gradually phase out fossil fuel subsidies and tax expenditures, replacing them with abatement subsidies or direct transfers to households if needed.
The quality of the rail services deteriorated in the pre-pandemic years. Investment in rail is lower than in leading countries.	Increase public investment in rail, subject to cost-benefit analysis, and accelerate the digitalisation of the control and signaling systems.
The limited supply of publicly available charging stations is slowing electric vehicles' uptake.	Expand the deployment of charging capacity, while enhancing competition in and access to the market by targeting support at small players, standardizing pricing, and setting performance requirements.
Landlords have limited incentives to invest in energy-saving measures as tenants pay for energy costs. The efficiency standards in existing buildings have not been raised since 2009.	Increase minimum efficiency standards and apply energy performance certification to all existing buildings.
Carbon pricing makes solar and wind technologies price competitive. Renewable energy subsidies can help to reduce electricity prices, but they are costly and can lead to higher emissions in other EU countries.	Gradually shift support from renewable energy subsidies towards more targeted subsidies for green R&D and the deployment of near-zero emission industrial technologies to reduce future abatement costs.
Protecting social cohesion and addressing skilled labour shortages
The effective age of labour market exit is still significantly below the legal retirement age. Strong incentives for early retirement exist and many older workers have difficulties updating their skills.	Reduce incentives for early retirement, while cooperating with employers to improve adult learning opportunities and working conditions for older workers.
Educational outcomes for children from disadvantaged background are weak. Access to childcare and early-childhood education is limited due to informal and decentralised application procedures which act as a barrier for disadvantaged households.	Further expand access to early-childhood education by centralising application procedures within municipalities. Raise the quality of basic education by using performance evaluations to better target support to children with weaker learning outcomes.