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German Government Delays Tax Cuts to Boost Flood Aid

To provide aid for the regions hit by the current flood disaster, the government is delaying tax cuts scheduled for next year and freezing its budget -- a move that could threaten major defense projects.

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The government says cleaning this mess will require tightening the public belt and delaying tax cuts

The government late Monday said it will delay by one year the next phase of its tax reform program in a bid to release additional funds to help the regions hit by the current flood disaster.

The tax cuts that were due to have come into effect in 2003 were worth seven billion euros, with the federal government accounting for 3.2 billion euros and the states and municipalities accounting for the remainder. The tax reform package was the centrepiece of Chancellor Gerhard Schröder's economic policy after four years in power.

The Finance Ministry said the Transportation Ministry would make one billion euros in additional investments in eastern Germany, the region hit hardest by the flood disaster so far. Some estimate the overall costs of the flood damage in Germany alone at more than 10 billion euros. The third and final stage of the reform will be implemented in 2005 as planned, cutting taxes by an additional 19.2 billion euros.

A postponement of the next phase of the reform will require approval from the Bundesrat, or upper house of parliament, in which the Social Democrats and Greens, which form Germany’s government coalition, do not have a majority. Following the government’s announcement Monday evening, the opposition Christian Democrats immediately raised objections, saying that the move would further damage the country’s frail economic recovery.

Bert Rürup, one of the government’s five independent economic advisers, said Monday that “the postponement of the tax reform is certainly one option to finance flood aid”. But he said it would be wise to first asses the actual damage before an alternative financing method was considered.

Volker Nitsch, analyst at Bankgesellschaft Berlin, said that “spending on reconstruction in principle has a positive impact on the economy”. But the government had little scope in its budget for such special expenses without the risk of failing to meet the budget deficit targets set out in the EU Stability and Growth Pact. He added that he expected a delay in tax cuts to have little effect on consumer or business confidence.

Finance Minister Hans Eichel also announced a budget freeze to come into effect on Tuesday. Flood-aid related investments and the anti-terror package passed after last year’s Sept. 11 attacks were exempt from the freeze, the minister said. “We will adhere to the Stability and Growth Pact, but it will be tight,” Eichel added.

Handelsblatt has learned that the planned budget changes could put a question mark over the financing of several major defense projects. “We have to consider changes in the Eurofighter project,” SPD budget expert Hans-Georg Wagner said.

Meanwhile, a report by Germany’s central bank issued Monday underscored just how fragile the nascent upturn in Europe's largest economy really is. The Bundesbank said that Germany's economic recovery had yet to develop the kind of strength or dynamism that it would need to enable it to ward off new shocks, whether external or home-made.

In its monthly report, issued ahead of official Federal Statistics Office figures on Thursday, the Bundesbank said GDP in the second quarter of 2002 can be expected to have risen about 0.25% on the previous quarter.

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