(Bloomberg) -- The German government is bracing for a crucial court ruling that could strip as much as €75 billion ($82 billion) of tax income from the public coffers and potentially put the battered coalition in jeopardy with just a year to go until elections are scheduled.
The Federal Constitutional Court will hear arguments this month whether the so-called solidarity surcharge introduced to tackle the burden of German reunification is legal. At stake is roughly €66 billion collected since 2020 plus around another €9 billion in interest, according to people familiar with the matter who asked not to be identified discussing confidential information.
If the court rules against the government it would be a devastating blow for Chancellor Olaf Scholz.
The three-party coalition is already struggling with an economy set to contract for the second straight year as industries like cars and chemicals wrestle with disruptive transformations, and Scholz has been unable to find common ground with his vice chancellor, Robert Habeck of the Greens, and the liberal Finance Minister Christian Lindner.
The government is already embroiled in a bitter struggle over next year’s budget with Lindner demanding spending cuts to cover a shortfall of about €8 billion and an adverse ruling could make their differences unbridgeable.
The issue exposes the fundamental contradictions at the heart of the administration — it stems from a case brought by Lindner’s deputy, Florian Toncar, before the Free Democrats entered government in 2021 after Scholz’s surprise election victory.
While striking down the surcharge would be the worst-case scenario for the government, it would suit Lindner and the Free Democrats just fine, according to one senior party official. It would fulfill a longstanding political goal and could offer a boost to the economy, they said.
At the same time, such an outcome would in all likelihood force the government to lift the constitutional borrowing limits — and Lindner, a self-styled fiscal hawk, has made protecting the debt brake one of his highest priorities.
If the judges opt for a more measured approach, they might allow the federal government to keep the money it has already collected but block its use in future. Even that outcome would leave Lindner and his colleagues to find an additional €13 billion for 2025.
“If the federal government loses, I find it hard to imagine that the court will order the total amount to be repaid,” said Henning Tappe, a law professor at Trier University, who considers the tax to be legal. “It’s more likely that the surcharge would be overturned only for the future. But with an amount of around €13 billion euros a year at stake, this would also be a serious problem.”
The surcharge is also part of the government’s medium-term financing plan, so that would need to be redrawn too — with €55 billion less revenue in the four years to 2028.
The Constitutional Court has scheduled a hearing for Nov. 12 and the judgment could take several months. The next federal election is due to be held on Sept. 28 next year.
A finance ministry spokesperson said the government still assumes the levy is constitutional.
Senior officials speaking on the condition of anonymity said they don’t expect the harshest outcome as the judges will consider that such a decision would create instability and that it would be irresponsible to force the government to repay such a large amount.
But they were saying similar things a year ago, just before the same court declared that a €60 billion climate fund was unconstitutional. That decision threw the government into a crisis from which it has never properly recovered.
After weeks of negotiations, Scholz, Lindner and Habeck agreed on cuts to make up the unexpected shortfall, but the compromise led to nationwide protests, hurt support for the coalition and left the relationship between its key players permanently damaged.
The solidarity surcharge was introduced in the 1990s in the aftermath of reunification but criticism of the levy has increased over the years. Critics argue that decades later the former communist bloc in the country’s East no longer needs such special provisions.
Until 2020, almost all taxpayers had to pay extra income tax. From 2021, the government raised the threshold for the additional 5.5% levy so that 90% of contributors were exempt, leaving only the top earners and companies to pay.
Many taxpayers have filed individual suits against the levy, but so far none have prospered.
In a ruling in early 2023, Germany’s top tax court upheld the levy, saying it was still needed because it takes a generation to tackle an historic disruption like the unification. That ruling seemed to indicate that at some point, that phase will be over.
In a legal analysis requested by the Constitutional Court, Germany’s Bar Association wrote that the phase is by now over and the surcharge needs to be struck down. They also said it’s violating the principle of equality as now only 10% of taxpayers are covered.
In the last months, Lindner has repeatedly urged his coalition partners to abolish the controversial levy gradually - instead of waiting for the judges to sort it out. He also, pointedly, didn’t send a representative to defend the surcharge at last year’s top tax court hearing. On Friday, a policy paper by Lindner became public in which he calls for the solidarity tax to be reduced next year and abolished by 2027.
--With assistance from Jeremy Hodges.
©2024 Bloomberg L.P.