Under-fire German ruling coalition unveils reform package to boost economy

By Andreas Rinke and Miranda Murray

BERLIN, July 2 (Reuters) – German Chancellor Friedrich Merz’s coalition unveiled a package of reforms on Thursday, including tax relief for lower-income families and far-reaching pension reforms in a bid to revive growth and competitiveness in Europe’s largest economy. 

The measures won some praise from economists that the government was delivering concrete changes after months of wrangling between Merz’s conservatives and their more left-wing junior coalition partner, the Social Democrats. 

They aim to make life easier for companies, with promises to cut red tape, allow employers more scope to hire workers on short-term contracts and make it harder for them to call in sick.

While winning praise from some employers, the measures were also variously criticised as unfair or unworkable, or not going far enough. 

Trailing in opinion polls behind the far-right Alternative for Germany party, Merz’s government has stressed the urgency of the reforms amid ferocious foreign competition and a rapidly shifting global order where Germany risks being left behind.

“We want to get Germany back on track,” Merz told reporters.

The measures include €10 billion ($11 billion) in annual tax relief for lower-income earners, building more affordable housing and an action plan against benefit fraud. The government aims to cut staffing by 8% in federal ministries through digitisation.

The tax relief will be mainly funded by raising the top rate of tax to 47% from 45% for the highest earners with an annual income of €280,000 or more. 

“The reform train has no brakes… this is a substantial package designed to strengthen Germany as a business location in the long run and put public finances on a sustainable footing,” said Carsten Brzeski, global head of macro at ING.

“One is tempted to shout, ‘Finally!’ It took a year, but the ‘summer of reform’ has arrived,” he said. 

Employers’ Association President Rainer Dulger welcomed the package as a “long-overdue change of course.”

Christiane Benner, chair of Germany’s largest union, IG Metall, welcomed tax relief for employees but criticised more fixed-term employment contracts as an “attack on workers’ rights.”

WORK AND PENSION CHANGES

The German economy has been struggling since the COVID pandemic to regain momentum, with increased competition from China as well as higher energy prices – caused first by the Ukraine war and now exacerbated by the Iran conflict – challenging its export-driven economic model.

In a fracturing domestic political landscape, Merz’s conservatives now trail the far-right AfD, which could win a state election for the first time in the eastern state of Saxony-Anhalt in September.

The government in April halved its growth forecast for 2026 to 0.5% and has also cut its growth prediction for 2027 to 0.9%, down from a previous estimate of 1.3%. It also raised its inflation projections, as soaring energy prices take their toll.

“The government has demonstrated its ability to agree on key structural reforms and implement them by the end of the year,” said Marion Muehlberger from Deutsche Bank Research, calling it one of the most significant reform packages in decades.

“This is likely to boost sentiment and reinforces our forecast of accelerating economic growth in the second half of the year.” 

Standing alongside Merz, Finance Minister Lars Klingbeil said the government was taking a tougher course against China and would protect companies from unfair competition.

The reform package document did not mention China by name but aimed to strengthen European Union anti-dumping and anti-subsidy measures. 

China’s vast market has provided a huge source of growth for German companies in the past, but Berlin now sees China as a global geopolitical rival and a major challenge for Germany’s once dominant industries, such as cars. 

On pensions, a commission appointed by Merz last month has suggested a Swedish-style pension fund and a gradual increase in the retirement age to help stabilise the country’s pension system as the population ages. The government on Thursday said parliament would pass the pension reform by the end of the year.

But the reform has sparked criticism from unions who oppose raising the retirement age for those with physically demanding jobs, while employers said mandatory pension contributions by employers would make hiring more expensive.  

“The reform package’s greatest weakness is the absence of measures to consolidate government spending,” Ifo institute President Clemens Fuest told Reuters. “Tax relief is not feasible in the medium term unless the growth of government spending is curbed.”

Merz this year annoyed Germans, who work some of the shortest hours in the European Union, by saying that habits such as four-day working weeks or taking overly long sick leave were harming the country’s competitiveness. 

Markus Blumenthal-Beier, the head of the German Association of General Practitioners, told the RND media group the proposed sick note changes were “absolutely catastrophic” that would clog up the health system.  

($1 = 0.8777 euros)

(Reporting by Andreas Rinke, Miranda Murray, Friederike Heine, Rene Wagner and Matthias Williams; writing by Matthias Williams; editing by Thomas Seythal and Jon Boyle)