Germany's constitutional court ruled on Wednesday that the government's re-allocation of 60 billion euros ($65 billion) of unused debt from the pandemic era to a climate fund was illegal, dealing a blow to Chancellor Olaf Scholz's coalition.
This is a key decision as it sets a precedent for fiscal responses in future crises in Europe's biggest economy, while it could also trigger tensions in the coalition in a key week for budget negotiations.
The budget maneuver agreed in December 2021 by the center-left Social Democrats (SPD), pro-spending Greens and fiscally cautious Free Democrats (FDP) in their coalition deal, allowed the parties to make the most of a temporary, pandemic-related suspension of borrowing limits in the constitution.
This was done with the Second Supplementary Budget Act 2021, which retroactively amended the Budget Act for 2021. The constitutional court ruled that this act was incompatible with Germany's Basic Law and so was void.
In addition, the government changed the accounting principal by which borrowing counted against the budget deficit in the year the borrowing was actually done. Therefore, the 60 billion euros transfer counted only as a deficit in 2021, but not in the years 2023 and 2024 when most of the spending was supposed to occur.
This enabled Germany's finance minister Christian Lindner to return to the debt brake rule this year. The rule restricts the German public deficit to 0.35% of GDP but was suspended due to the pandemic from 2020 to 2022.
"The court ruling has far-reaching consequences for fiscal policy in Germany," said Clemens Fuest, President of the Ifo economic institute.
"There are significant constraints for federal budgets in coming years in terms of spending on government support for decarbonization," he said.
The federal court based its ruling on three points.
Firstly, the debt ceiling can only be exceeded if there is an emergency, which was the case with the coronavirus crisis but the transfer of the funds to the climate fund did not satisfy those conditions, the court said in its ruling.
"The legislator failed to sufficiently demonstrate the necessary factual connection between the emergency and the crisis management measures taken in response," said the court.
Secondly, dating the credit authorization to the 2021 financial year but planning the measures for which the money was needed for the coming financial years was unconstitutional, it said.
Thirdly, adopting the law after the end of the 2021 fiscal year violated a principle set out in the Basic Law that the budget must be determined in advance, it said.
The ruling piles pressure on budget deliberations.
Germany's 2024 budget and financial plans through 2027 are to be finalized on Friday, as Europe's biggest economic power curbs spending that surged in response to COVID-19 and the Ukraine war.
The ruling against the government means it needs to find money for the climate fund elsewhere, challenging in the current tight budget environment and amid discord in the coalition.