Oct. 24 (Bloomberg) -- Chancellor Angela Merkel presented a second-term government that points Germany toward tax cuts and a reprieve for nuclear energy, capping coalition talks that put the finance ministry under her party’s control.

Merkel’s Christian Democrats and the pro-business Free Democrats agreed on a four-year policy program and a reshaped Cabinet, shifting Wolfgang Schaeuble, 67, to finance minister from the law-enforcement post of interior minister. Economy Minister Karl-Theodor zu Guttenberg will move to defense.

“We’re going for growth,” Merkel, whose Christian Democratic Union won Sept. 27 elections, said in Berlin today. “We’re easing the burden on citizens.” She pledged “every effort” to avoid tax increases as German debt reaches a record.

Reconciling campaign pledges of tax cuts with the deficit is the key challenge facing Merkel, 55, at the helm of Europe’s largest economy. The three-party policy pact seeks a 24 billion- euro ($36 billion) tax cut aimed at low and mid-level earners, starting with relief for families with children on Jan. 1.

In a concession to the Free Democrats, the draft coalition contract calls for slashing the number of income-tax brackets as early as 2011, with details to be worked out. “Tax relief will create a sustainable basis for health finances,” according to the draft presented at a news conference today.

Schaeuble, implicated a decade ago in a party financing scandal surrounding former Chancellor Helmut Kohl, inherits a deficit swollen by spending to counter Germany’s deepest recession since World War II. He takes over from Peer Steinbrueck, whose Social Democrats dropped out of Merkel’s government after losing 11 percentage points in the election.

‘Budget Consolidation’

Room for tax cuts is “unusually small,” Schaeuble told the Bild am Sonntag newspaper in May. While Schaeuble has been wheelchair-bound since a deranged gunman shot him in 1990, he’s fought back to occupy a series of senior appointments.

Withholding the finance post from the Free Democrats, who campaigned for deeper tax cuts than Merkel, may mean that “budget consolidation will be more important than tax reductions in the future,” Citigroup Global Markets analysts wrote in an Oct. 23 note.

Schaeuble was chosen “because the challenges in this legislative period will be extraordinary” and he has “breadth of experience,” Merkel said. Keeping finances in Christian Democratic hands ensures “sensible budget policy,” she said.

Free Democratic Party head Guido Westerwelle, 47, an openly gay lawyer, is the new foreign minister and deputy chancellor. While he hasn’t worked on international affairs, he led his party to its best result in national elections.

Nuclear Power

The coalition will work for the removal of remaining U.S. nuclear weapons from Germany, he said at today’s news conference with Merkel and Horst Seehofer, who heads the Christian Social Union, the CDU’s Bavarian sister party.

Merkel’s coalition plan calls for extending the operating time of German nuclear plants with the government claiming most of the windfall profits, overturning a law passed under former Chancellor Gerhard Schroeder that shuts them down by about 2021. Details are to be negotiated with energy companies.

Nuclear-power stations run by Dusseldorf-based E.ON AG, RWE AG of Essen, Vattenfall AB, which is based in Stockholm, and Karlsruhe-based EnBW Energie Baden-Wuerttemberg AG generated 23 percent of Germany’s electricity last year.

The government will seek talks with solar-energy industry on possible “adjustments” to avoid “excessive subsidies,” according to the coalition draft. That may squeeze profits for German companies such as Solarworld AG and Q-Cells SE.

Debt Fund

An FDP convention will vote on the platform tomorrow, followed a day later by the two Christian Democratic parties. Parliament’s 611-member lower house convenes Oct. 27 and may formally re-elect Merkel as chancellor the next day.

Negotiations on tax cuts and how to plug shortfalls at public jobless and health insurers were among the last points resolved. Leaders retreated this week from setting up a special debt fund in 2009 to prop up social-security programs after business lobbies and economists called the plan an accounting trick.

German bonds may come under pressure once the government’s detailed spending plans become clear, Peter Schaffrik, co-head of interest rate strategy at Commerzbank AG, said by phone yesterday. “Chances are that they’re going to fund more in a shorter timeframe and that would clearly be negative.”

“The crucial thing is whether they come up with a credible medium-term plan on how to rein in debt,” he said. “Just saying that promoting growth will bring in higher tax receipts isn’t credible.”

Bond Sales

Government plans call for German bond sales of 329 billion euros this year, an all-time high even after a downward revision in September. Compared with German bonds, France’s sovereign credit is 11 percent more risky and the U.K.’s more than twice as risky, credit-default swaps show.

Signs of economic recovery may help create scope for tax cuts. Germany’s gross domestic product will grow about 1.2 percent next year, resuming a path of export-led expansion after shrinking 5 percent in 2009, the government said Oct. 16. Net new borrowing is forecast to almost double next year to 86.1 billion euros from a record 47.6 billion euros this year, the government budget shows.

“The overall consolidation of euro area public finances is at risk” if Germany fails to lead the way on deficit reduction, the Citigroup analysts said.

To contact the reporter on this story: Tony Czuczka in Berlin at aczuczka@bloomberg.net

Last Updated: October 24, 2009 07:50 EDT