Sunday, Sep. 11, 2005

Looking for Germany's Mr. Fix-It

By PETER GUMBEL

Until a month ago, Paul Kirchhof was a respected but little-known former judge and law professor in Heidelberg with strong views about the inequities of the German tax code. "We have a system that is riddled with privileges," he told Time in an interview last year, arguing that it was time to strike "a liberating blow" for the economy by replacing the country's complex tax regime with a flat tax rate of 25% on income, after the first 38,000, which would be tax free. Corporations would be treated the same way as individuals. When Angela Merkel appointed Kirchhof to her team last month, many in her Christian Democratic Union (cdu) party were surprised; his views on tax are far more radical than the modest cuts proposed by the cdu. But if Merkel wins Sunday's elections, the 62-year-old former judge just might become the next German Finance Minister, and his ideas could become the new economic orthodoxy.

That prospect is electrifying the final days of the campaign. The Kirchhof model would amount to a massive reduction of the tax burden on individuals and companies, although it would also entail the elimination of more than 400 tax loopholes and government-subsidy programs. Advocates say it would jump-start the economy and make Germany a far more attractive place to set up and operate businesses, thereby creating a substantial number of jobs. Alfred Boss, a public-finance expert at the Kiel Institute for World Economics, who has tried to calculate the effects of Kirchhof's plan, says it "would spur growth and eventually improve the state's financial situation."

But it's far from certain that Kirchhof would be able to carry out his scheme. Some in the cdu say it's too politically tricky to implement; even some in the business community are privately griping about the closing of various loopholes. But the sudden political prominence given to his views suggests that German economic policy could be in for an overhaul if the cdu and its ally, the Free Democratic Party, win a convincing victory.

Alongside Kirchhof's new policies, Merkel is proposing several measures to reduce the cost of labor and allow employers greater flexibility in hiring and firing. Health-insurance premiums would be decoupled from wages, and firms would have the ability to opt out of national wage-setting accords — effectively curbing the power of German labor unions. "If the program as promised is carried out, it would be good for business confidence," says Barbara Böttcher, an economist at Deutsche Bank in Frankfurt, who estimates that a powerful cdu showing could give German growth a short-term boost of as much as 0.5% in 2007, and more in the longer term.

Not all economists are as convinced about the benefits, though. Most problematic is the plan to raise VAT on goods — to 18% from 16%, in order to finance a cut in unemployment-insurance charges — which risks dampening already weak consumer demand. Economists at Frankfurt-based Commerzbank reckon household disposable income would take a sizeable hit — €13 billion, or just under 1% of the annual total. "It's a substantial negative for 2006," says the bank's Eckart Tuchtfeld. But by some estimates, the lighter labor costs that the VAT hike would finance could create as many as 200,000 jobs and thus mitigate any longer-term damage to the economy.

Chancellor Gerhard Schröder and his Social Democratic Party are highly critical of cdu policies, and much of their criticism has been aimed directly at Kirchhof. In a televised debate with Merkel last week, Schröder repeatedly attacked the former judge, referring to him derisively as "the professor from Heidelberg," and ridiculed his tax plans. Still, many believe Germany is ripe for a tough economic cure. One late August poll showed that even though only 38% of Germans approve of Kirchhof's tax scheme, 50% say they prefer him to the current Finance Minister, Hans Eichel.

If Kirchhof is fazed by being at the center of attention, he isn't showing it. During the 12 years he served as tax expert at the Constitutional Court, he realized that he was being called upon "to repair a car that wasn't fixable," he says. The big question now is whether he'll have the opportunity, and the political support, to design a radical new one to replace it.