Extensive Financial Obligations and Significant Shortfalls - Klingbeil's Second Financial Plan
In a significant move, the German government has unveiled its 2026 budget, marking a shift towards high-debt, high-growth strategies to stimulate the economy and modernise key sectors. The proposed budget, totalling 520.5 billion euros, represents an increase of 3.5% compared to the current year.
The proposed strategies involve relaxations of the "debt brake" rules, enabling record borrowing of around €174 billion in 2026. This borrowing will be used to fund various initiatives, including a €500 billion infrastructure fund, defense spending exemptions, and increased borrowing flexibility for federal states (Länder).
The infrastructure fund, operating outside the debt brake, will finance major investments in transportation, healthcare, energy, and digitalisation. The aim is to modernise and expand Germany’s infrastructure to stimulate long-term productivity and economic growth. Defense expenditures above 1% of GDP are exempt from the debt brake, allowing substantial increases in military spending without hitting fiscal constraints. This reflects a move to enhance Germany's defense capabilities amid growing security concerns.
Furthermore, federal states can now borrow up to 0.35% of GDP annually, increasing fiscal space at regional levels to support additional investments and projects. The draft budget foresees total spending of €520.5 billion and borrowing of approximately €174.3 billion, marking a record high in state borrowing as Germany reverses years of fiscal restraint to promote growth and modernisation.
While not explicitly detailed in the budget summary, investments in energy infrastructure are likely to include climate protection projects as part of the broader infrastructure and energy funding, supporting Germany's climate goals alongside economic stimulus.
The government aims to use this expanded fiscal space to stimulate growth through capital-intensive projects that modernise the economy and infrastructure. However, the success of this strategy depends heavily on how productively the funds are used—productive investments could moderately raise debt levels but enhance growth, while misallocated spending could worsen fiscal risks.
Significantly, Finance Minister Lars Klingbeil has warned that significant austerity measures may be necessary starting in 2027, indicating that this expansionary approach is potentially temporary and contingent on economic outcomes.
In response to the threat posed by the Russian attack on Ukraine, the Bundeswehr's defense capability is to be significantly strengthened. Reforms are planned, including speeding up planning procedures. The federal government is also counting on the economy picking up and bringing in more tax revenues.
The so-called NATO quota states that 3.5% of the gross domestic product should be spent on defense in the year 2029. A special fund worth 500 billion euros for infrastructure and climate protection has been agreed upon by the Bundestag and Bundesrat, with 100 billion euros allocated to the states. However, this money will only partially help plug the budget holes.
The funds from the 100-billion-euro special fund for the Bundeswehr are expected to be fully utilized by 2028. The federal government plans to take on new debts totalling 89.9 billion euros in the core budget for 2026, with additional debts of 84.4 billion euros from two special funds - one for infrastructure and climate protection, the other for the Bundeswehr.
A reform of the social security systems is expected to play an important role in the consolidation of the budget. The coalition agreement also states that income tax for small and medium incomes should be reduced towards the middle of the legislative period. Investments for 2026 are planned to be 126.7 billion euros, allocated for projects such as bridge renovation, railway network, digitisation, education, research, development, and affordable housing.
However, there are concerns about whether the federal government can fund the projects announced in the coalition agreement. The German government is facing a third consecutive year without economic growth, putting pressure on revenues. There is a budget gap of 34.3 billion euros in the year 2027, a "need for action" of 63.8 billion euros in the year 2028, and a gap of 74 billion euros in the year 2029.
Dietmar Bartsch, a member of the Left party, warns that if reckless armament plans persist, the core meltdown of the social state threatens. Financial leeway would have to be created, for example, for a reduction in electricity tax for all companies and private households. The defense spending debt brake has been loosened to allow for significant spending on the Bundeswehr beyond 2028.
In summary, Germany's 2026 budget reflects a bold pivot towards higher deficit spending focused on infrastructure, defense, and (to a more implicit extent) climate protection initiatives, supported by enlarged borrowing capacity and new fiscal flexibilities aimed at boosting economic growth and modernising key sectors. However, the success of this strategy hinges on the productivity of the investments and the economic outcomes.
The German government's 2026 budget, worth €520.5 billion, includes record borrowing of around €174 billion, a significant increase from previous years. This borrowed money will be allocated towards various initiatives, such as infrastructure development, defense spending, and climate protection projects, with the aim of modernizing and stimulating long-term productivity and economic growth. Additionally, the budget relaxation allows for increased borrowing flexibility for federal states (Länder) and exemptions from the debt brake for defense expenditures above 1% of GDP.
