German Election: Why Merkel's Tax-Cut Pledge Is a Hard Sell

German voters who love their state benefits are skeptical of pledges to cut taxes that could reduce those services

In the U.S., promising to cut taxes is usually a pretty good way to get elected. In Germany, politicians promising to ease the tax burden more often encounter suspicion bordering on hostility. This quirk of German politics helps explain why Chancellor Angela Merkel could have trouble assembling enough votes in Sept. 27 elections to form a center-right coalition.

Polls indicate that Merkel's Christian Democrats (CDU) will get the most votes on Sept. 27. But it's less likely that the CDU will win enough seats in parliament to form a coalition government with Merkel's favored partner, the pro-business Free Democrats (FDP), who promise to "make work pay again." Merkel may well be forced into another "grand coalition" of Merkel's CDU with the center-left Social Democrats (SPD), led by Frank-Walter Steinmeier. "Merkel remains Germany's most popular politician and her party is likely to win the election by a clear margin. Yet, this is unlikely to be enough," says Grace Annan, analyst at IHS Global Insight, in a note.

Both the CDU and FDP promise to cut taxes by, for example, raising the amount parents can deduct for children. But that pitch finds limited resonance in Germany. Voters seem to prefer the current government, which has been too stalemated to continue economic reforms begun under Merkel's predecessor, Social Democrat Gerhard Schröder. The only party that seems to be benefiting from its stance on taxes is the Left Party, an unruly coalition of dissident Social Democrats, ex-Communists, and various fringe factions. The Left Party promises to raise taxes—for the rich. "It's about time the rich and super-rich paid their share," Sahra Wagenknecht, fiery leader of the Left Party's Communist wing, said in a recent statement.

One reason that the CDU-FDP tax-cut pitch hasn't caught on with voters is that so many people receive government pensions, unemployment benefits, free university tuition, or other public largesse. To these voters, a promise to cut taxes sounds more like a threat to trim benefits.

In addition, voters may doubt—correctly—that the center-right can simultaneously cut taxes and balance the budget so soon after pumping billions into the economy via the country's cash-for-clunkers scheme and other stimulus programs.

"Everybody would like lower taxes," says Martin Lueck, an economist at UBS (UBS) who expects the CDU and FDP to win a slim majority. "With the state throwing money at everything, people simply don't believe what the CDU and FDP are telling them."

Opel Sale Could Hurt Merkel

Merkel's credibility as a fiscal manager may also have suffered from the government's inept handling of the rescue of General Motors' Opel unit. By offering $6.6 billion in government aid, Merkel helped convince GM in September to sell Opel to Canadian-Austrian auto parts maker Magna International (MGA). But Magna has since disclosed that job cuts at Opel may be more severe than expected, while other European countries are enraged that Opel's German factories will probably suffer fewer layoffs than plants in Belgium, Britain, and Spain.

The global economic crisis, which slammed the export-oriented German economy, seems to have only deepened Germans' attachment to a strong social safety net. Hundreds of thousands of workers who might have been axed are still collecting paychecks thanks to "short work" programs, in which the government partly compensates employees for lost wages when companies cut their hours. The program has been widely used by automakers such as Daimler (DAI) in lieu of layoffs. At 8.3% in August, unemployment in Germany is lower than in the U.S., and has risen only modestly from January, when the rate was 7.8%, according to seasonally adjusted figures. But some 5% of the total workforce is on short work and not counted as unemployed, according to UBS.

Merkel's difficulty in rallying support for a center-right platform illustrates a deeper, long-term trend. German voters have shifted back to the left. Ironically, the trend has its roots in pro-market reforms carried out by Schröder, who led a center-left Social Democrat-Green Party government from 1998 to 2005. The tax cuts and other reforms boosted growth and led to a dramatic decline in unemployment, but cutbacks in jobless benefits and other social welfare programs unsettled many ordinary Germans. Many Social Democrats felt the party betrayed its pro-labor roots under Schröder and they defected to the Left Party. As a result, the Left Party has emerged as a strong fifth party and upset the political balance of power. Led by Oskar Lafontaine, a former SPD chairman turned left-wing populist, the Left Party will probably capture some 10% of the nationwide vote, polls indicate. That will make it much more difficult for either of the traditional partnerships—CDU/FDP or SPD/Green—to muster a majority in parliament.

From the point of view of business, the worst-case scenario would be if the three parties on the left win more votes than the CDU and FDP. Then, the SPD and Greens might be tempted to form a government with the Left Party. UBS' Lueck considers that an unlikely scenario this year. The SPD remembers what happened last year in the state of Hesse. The SPD and Greens tried to form a government with the Left in the state, which includes Frankfurt. The highly controversial maneuver split the local SPD, destroyed the political career of the party's state leader, and prolonged CDU rule in the state.

However, Lueck believes a left-wing coalition is probable during the next decade as the Left Party cleans up its image. Chancellor Merkel may worry about the same thing. She seems at pains not to alarm voters with anything that sounds like painful reform. In a plea to voters posted on YouTube, she repeats the tax-cut pledge but also describes the CDU as "the party of the social-market economy"—a term that to Germans means capitalism with a strong social safety net. "We stand for the compatibility of business and employee interests," she says.

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