What Merkel, Sarkozy and Bush Have in Common

By Stratfor

French President Nicolas Sarkozy suggested Wednesday that France and Germany should begin converging their fiscal systems. According to Sarkozy, the first step would be to begin examining how to synchronize tax policies. The statement came as German Finance Minister Wolfgang Schaeuble attended the French Cabinet meeting, which followed French Finance Minister Christine Lagarde's participation in a German Cabinet meeting in March.

The proposal - and Cabinet minister exchanges - could be perceived as a positive sign for the EU in that it suggests that the German-French cooperation is alive and well - in fact strengthening - despite the ongoing European economic crisis. France and Germany are the undisputed European leaders. The two countries are the most powerful economically and politically. They have weaved the EU's DNA over six decades of close cooperation and coordination. Were a serious split to develop between Paris and Berlin, the EU would face a serious crisis of leadership.

However, the proposal also brings up some practical questions about its general feasibility as well as about whether Sarkozy and German Chancellor Angela Merkel even have the political capital to see it through.

Coordinating fiscal policy is not simple. Speaking very broadly, France would have to lower taxes and Germany would have to raise them. But what happens if the countries' national accounts are not synchronized, with one running a surplus (and thus being able to lower taxes), and the second running a deficit (thus potentially necessitating tax hikes)? Any substantive coordination would have to wait for both countries to lower their deficits to more manageable levels, which may take three to four years. Furthermore, would the taxes be synchronized permanently? And if so, would that mean that any change would require the other country to mirror the policy in lockstep? This brings up all sorts of issues, from whether the two countries will have to coordinate spending on programs such as social welfare, defense and education, to whether they would have veto power over each other's changes in spending. For France, the change would most likely have the added effect of forcing Paris to converge to Berlin's tax rates, since it is difficult to see how Germany would acquiesce to adopting a more French tax policy.

The bottom line is that taxation is the ultimate practical act of sovereignty; it allows the political entity to raise funds with which to persevere and thus defend its territory. There is a reason why regions dabbling in secession - from Quebec to Catalonia - almost exclusively pick taxation to contest against the government. They are simply following the golden rule that he who has the gold makes the rules.

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Which is why the issue of political capital is an important one. Were Paris and Berlin serious about the effort, a considerable amount of attention would have to be spent on it. This is difficult at a time when Europe is still dealing with a simmering sovereign debt crisis with a potential banking crisis around the corner. This is especially true if Friday's bank stress tests don't reassure investors of the soundness of the Continent's banking system.

But it is even more difficult at a time when both Sarkozy and Merkel are facing political problems at home. Merkel's leadership - starting with her handling of the Greek bailout to her policy on taxes - is being questioned by the public, while her coalition partner - the Free Democratic Party (FDP) - has lost so much support that if elections were held today it would not even enter the Bundestag, or upper chamber. Key members of Merkel's Christian Democratic Union (CDU) are retiring, one lost an important state election leaving Merkel with no majority in the Bundesrat and her personal popularity, normally solid even in light of her party's unpopularity, is at an all-time low. The latest news out of Berlin is that members of Merkel's Cabinet were staging mini-revolts over plans to slash ministry budgets, which represents an unusual level of internal discord for a German government, especially one as supposedly concordant on policy questions as the FDP-CDU coalition.

Sarkozy is meanwhile trying to implement unpopular budget cuts and extremely unpopular changes to the retirement age, while a key ally - and labor minister in charge of the said reforms - is facing severe corruption charges. The scandal is not the first to emerge this year for Sarkozy. If he faced off today against the president of the International Monetary Fund, Dominique Strauss-Kahn (who may run in 2012 on the Socialist Party ticket), he would be trounced in the first round. We therefore also see the latest proposal as an attempt to distract from scandals and get the French press talking about tax convergence with Germany and not about political scandals.

Lack of popularity for Sarkozy and Merkel is a serious problem for both leaders. It can lead to the breaking of the political transmission mechanism by which policy ideas are transformed into laws, particularly when members of the leaders' own party begin deserting them. This happened to U.S. President George W. Bush during his last two years in power, leaving him ineffective and nearly irrelevant. Both Sarkozy and Merkel are approaching Bush's approval ratings, which at the end of his reign stood at 22 percent. The level of intra-party unpopularity that goes with such low approval causes political allies to begin distancing themselves to preserve their own careers, which would render Sarkozy and Merkel potentially ineffective with two and three and a half years, respectively, left in power. Neither has reached Bush's toxic unpopularity levels, but the threat is there.

This is far more troubling for Europe than the fiscal convergence proposal is hopeful because it would impact the Franco-German leadership amid the economic crisis. As the two leaders become embroiled in domestic politics, they will turn their focus inward and away from Europe.

In fact, the very reason they are in trouble with their electorates in the first place is that they focused so much of their attention on Europe during the crisis. The French populace is unhappy that Sarkozy is toeing Berlin's line on austerity measures and retirement age reform. The German populace is unhappy that Merkel has rescued Greece and is reneging on tax decreases. This is a poor sign for European unity and a potential harbinger of how eventual replacements for Merkel and Sarkozy would behave. If Merkel and Sarkozy are deemed to have failed for not paying enough attention to national needs and policies, the pendulum of politics could swing the other way and give Europe French and German leaders who will.

A Stratfor Intelligence Report.
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