Merkel Gambles All on Tax Shake-Up

By Roger Boyes

At the heart of its 124-page program - essentially a four-year binding contract between Merkel's Christian Democrats and the Free Democrats of Guido Westerwelle - is the promise to slash taxes and thus stimulate growth. The tax burden is supposed to be cut by E24 billion ($39bn) over the next 18 months. Lower taxes, runs the logic, revive consumer spending and boost investment.

"We're going for growth," says the Chancellor. Economic recovery will then pave the way for public spending cuts from 2011. Will it work? Economists are already saying that the tax cuts are too piecemeal: lower value-added tax for hoteliers, rebates for Germans with children, concessions on company and inheritance tax.

From 2011, the income tax system will be overhauled. Fewer loopholes, but a more simple three, possibly four-stage tax rate.

But if the economy fails to make a strong recovery, all bets are off. And the rest of the government program looks modest. Army conscription to be cut from nine to six months? Hardly earth-shaking. A small increase in childcare allowance, to show that a centre-right, progressively conservative government has a heart. But also higher medical insurance contributions from workers to make up for shortfalls in the health budget. A compulsory German test for immigrants. Lighter control of the internet. And, for the time being, policies that will make financial conservatives turn prematurely grey.

Next year, federal subsidies will plug a E16bn deficit in the unemployment insurance scheme.

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In short: if the tax gamble doesn't work, Merkel's legacy will be at risk. There are no big initiatives being plotted for the Copenhagen summit; little scope for grandstanding abroad as she did at the outset of her first stint in office, in coalition with the Social Democrats.

Her vulnerability becomes obvious as soon as one studies her bantamweight cabinet line-up.

Karl-theodor zu Guttenberg, the former economics minister and shooting star, has been sidelined and sent to defence where, he will spend a lot of time in helicopters.

Health reform has been given to a 36-year-old tyro, Philipp Rosler. He has an interesting and media-friendly biography - he was a South Vietnamese war orphan - but not enough clout to deal with the powerful pharmaceuticals lobby.

Merkel is forced to take ministers put forward by her coalition partners, even if they are untried. Even so, it is plain that her main priority is to rule out a future revolt. She wants a Kanzlerdemokratie (chancellor democracy) in which she is seen to be the chief source of national recovery. There are only four women in a cabinet of 14 and she is the only east German. Angela Merkel wants to be a stand-out.

The strongman is the wheelchair-bound new Finance Minister, Wolfgang Schauble. He is 67, so this is probably his last job in a long political career: he helped to negotiate the terms of German reunification, was shot and paralysed in 1990, was regarded for a while as the national heir to Helmut Kohl, stumbled over a party funding affair and then re-emerged as Merkel's interior minister. He has stayed loyal to her. Until last week he was tipped to be Germany's candidate for the job of European foreign minister. Now his job is to save Merkel's bacon.

The first problem, for both Schauble and the new Economics Minister, the Free Democrat Rainer Bruderle, will be how to handle a rapid rise in unemployment. More than a million Germans are on short-term employment; these are expensively subsidised jobs. High unemployment would have boosted the chances of left-wing parties during the election campaign so many employers decided to maintain their workforces through the autumn. With the arrival of a business-friendly government, they no longer need to hold back.

In theory, life should have been more difficult for Merkel in harness with the Social Democrats. But they have been pussycats over the past four years and paid the electoral price for their passivity. The Social Democrats were a spent force and had nowhere to go, no credible alternative. The alliance with the Free Democrats and the increasingly insecure Bavarian Christian Social Union will be far more difficult.

Expectations are higher, the room for manoeuvre much tighter. It could be a bumpy ride for Angela Merkel.

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