Dec. 15 (Bloomberg) -- German Chancellor Gerhard Schroeder, bowing to opposition demands, agreed to slash his proposed tax cuts for next year in half to 7.8 billion euros ($9.5 billion), clouding the outlook for growth in Europe's biggest economy. ``This is a tragic, tragic compromise that nobody but a fool will sell as a victory,'' said Eva Vorbauer, who helps manage the equivalent of about $12 billion at HSBC Trinkaus Capital Management in Dusseldorf. ``Taxpayers just won't understand this, nor will foreign investors. What a wasted opportunity to give the economy a lift.'' Schroeder, who had sought to push through 15.6 billion euros of tax cuts, said in Berlin he'll seek to reduce taxes by another 7.8 billion euros in 2005. The opposition Christian Democratic Union threatened to veto his plans in the upper house of parliament, arguing they would put further strain on a budget deficit that already violates European Union rules.
The compromise, reached at 3:30 a.m. after talks between Schroeder and opposition leaders, raises concern that Germany's recovery from a recession in the first half may fade. Schroeder was counting on the proposed tax cuts to spur economic growth to 2 percent next year after three years of stagnation. His plan had helped lift consumer confidence for eight months. Schroeder, whose government won re-election in September with the narrowest margin since World War II, announced his plans to bring forward income tax cuts in March as the slumping economy caused his popularity with voters to sink. He had threatened to resign if the tax cuts failed to pass. The compromise will be submitted to both houses of parliament on Friday.
Household Spending
``It's not as much as I wanted,'' Schroeder told a press briefing in Berlin. ``But it will still help the economy.'' Shares in German retailers fell, even as the benchmark DAX 30 rose close to its highest since August 2002. Metro Group, the country's biggest retailer, dropped 1.7 percent to 35.89 euros at 12:37 p.m. in Frankfurt. KarstadtQuelle stock fell 5 percent to 21.09 euros and shares in Douglas Holding AG, Germany's biggest cosmetics retailer, slipped 3.3 percent to 22.60 euros. Companies such as KarstadtQuelle AG, Germany's biggest department-store chain, and TUI AG, Europe's largest travel company, had backed Schroeder's plans. They and 11 other companies ran full-page advertisements in German newspapers over the weekend, urging opposition parties to support the tax cuts. Retailers and tourism companies were counting on the reductions to revive consumer spending, the largest part of the economy. Spending by households fell 0.6 percent in the third quarter from the second, leaving Germany's recovery from recession reliant on an increase in export demand.
Forecast Halved
Germany's HDE retail group, representing 100,000 companies, cut its sales growth forecast next year to 0.5 percent from 1 percent following today's tax decision. ``Germany hasn't boosted retail sales since 1992 -- half a percent growth next year is a drop in the ocean,'' said Hubertus Pellengahr, the group's spokesman, in an interview. A married taxpayer earning about $50,000 a year would have gained $1,000 in extra income if opposition parties had backed all of Schroeder's cuts. ``I guess this means we can forget going on a decent holiday next year,'' said Andrea Borchardt, a 33-year-old architect who works in Berlin. ``My partner and I had really hoped for a tangible tax gift -- I doubt we'll really gain anything.''
Subsidy Cuts
The tax cuts agreed to with the opposition will be financed by reductions in subsidies to homebuilders and commuters, by sales of government-owned assets and by a smaller tax writedown for corporate equipment. A quarter of the 7.8 billion-euro plan will be financed by debt. The highest and lowest income tax rates will be reduced less than Schroeder proposed. The top rate of tax will fall to 45 percent from 48.5 percent. The lowest rate will fall to 16 percent, a percentage point higher than originally planned. ``Maybe short-term you can see it as positive that at least we have a reform,'' said Carsten Klude, head of strategy at M.M. Warburg & Co. in Hamburg, which manages $18 billion. ``But it won't have much of an economic impact -- people were expecting a lot more.'' Schroeder was supported in his bid for bigger cuts by lawmakers from his ruling Social Democrats and from the Greens, his junior coalition partners, after threatening to resign. The chancellor intensified talks with opposition parties this month in a bid to get tax cuts on the books by Jan. 1.
Widening Deficit
Opposition parties rejected Schroeder's plan to raise new borrowing to finance the cuts. Germany, the architect of the European Union's rule limiting budget deficits to 3 percent of gross domestic production, expects to breach that limit for a third year in 2004. The EU's decision to allow France and Germany to break the rule last month undermined efforts to shape a common constitution, which collapsed at a Brussels summit this weekend. Germany, the biggest of the 12 economies sharing the euro, will hold up the rest of the region should growth fail to accelerate, said Philippe de Buck, secretary general of Unice, the European employers' federation. ``Germany is, in a certain sense, the weak part of the European Union at this moment,'' de Buck said in a televised interview with Bloomberg News in Brussels. The decision to halve the tax cuts ``is of course not a good signal for us.''
Welfare Reductions
Schroeder agreed to opposition demands to ease further than planned rules on firing workers at small companies and withhold welfare for unemployed people who turn down job offers. The agreement shows Schroeder can count on the opposition for ``minimal support only,'' said Hans-Juergen Hoffmann, managing director of Psephos GmbH, a market research company in Berlin. ``That's devastating for Schroeder's plans to cut welfare, pension and healthcare spending.'' Germany will help meet the costs of the tax cuts by selling assets worth 5.3 billion euros, of which an estimated 2.65 billion euros will compensate states for loss in tax revenue following implementation of the cuts.
The government will also cut commuter tax breaks by 400 million euros and reduce housebuilders' subsidies by 98 million euros. Tax writedowns on new equipment will also be reduced by 240 million euros. The agreement raises next year's borrowing requirement by about 1.8 billion euros, which may help Schroeder keep his total net borrowing requirement close to the 29.3 billion euros planned in the budget. Today's compromise ``sets a positive signal'' for the German economy, Edmund Stoiber, leader of the opposition Christian Social Union party, said in a statement. ``It meets our aim to lower taxes but limits credit to less than 25 percent of the cost of the package.'' //www.bloomberg.com