Q&A – What the German top court’s ‘debt brake’ ruling means for climate policy

1) What did the court decide on?

The German Constitutional Court (Bundesverfassungsgericht) decided on the role of Germany’s constitutionally enshrined limit on new state debt in emergency situations. Specifically, it looked into the compatibility of a special-purpose Climate and Transformation Fund (CTF), which was set up to finance urgent climate and energy transition policy measures, with the country's so-called debt brake. This limit on government borrowing, constitutionally enshrined in 2009, stipulates that new debt must not exceed 0.35 percent of annual economic output. The debt brake was temporarily suspended in response to the coronavirus pandemic, allowing the previous government under conservative CDU chancellor Angela Merkel — and with current Social Democrat (SPD) chancellor Olaf Scholz as finance minister — sufficient financial leeway to finance economic support measures during the global health crisis. As the pandemic receded in late 2021, the time Scholz succeeded Merkel as the new head of government, 60 billion euros in new debt authorisations for the pandemic response remained unused.

The new government coalition of Scholz’s SPD, the Green Party and the pro-business FDP then rededicated this additional debt authorisation to fill the CTF and finance urgent climate and energy transition policies outside of the regular budget. The coalition argued that these investments would also help the country to overcome the pandemic-related economic difficulties faster. Shortly before Russia’s war on Ukraine caused a new emergency in form of the energy price crisis in early 2022, the German parliament greenlighted the rededication. The conservative CDU/CSU alliance immediately announced it would litigate against the rededication of authorised debt for the CTF, arguing this violated the debt brake’s principles. Almost two years later, the Constitutional Court ruled that the rededication was, in fact, unconstitutional.

The judges argued that the government failed to establish a sound factual connection between pandemic response and climate action measures, mixed long-term policy goals with short term crisis management and failed to plan ahead by using funds from a previous year to finance its current expenditures.Instead of deciding on the validity of climate and energy transition policies, which the court explicitly backed in a landmark ruling in 2021, the judges thus rather looked at principles of German budget policymaking and the rigour of fiscal discipline – with the CTF serving as an example. The court asked the government to withdraw the money from the fund but at the same time tasked it with finding alternative funding sources for climate action elsewhere.

2 ) What does the Climate and Transformation Fund do?

The CTF — set up as the Energy and Climate Fund in 2011 — is only one of several special-purpose funds outside of the regular state budget, which also exists for other areas such as defence spending. Its funds can be used to “promote measures that serve to achieve the climate targets” under the country’s climate legislation, especially measures to advance Germany’s transformation to a climate neutral economy. Government plans made the energy-efficient retrofitting of buildings and the support of renewable energy expansion the fund's biggest expenditures until 2027. Additional funds were earmarked for industry decarbonisation, e-mobility, the hydrogen economy, and semiconductor funding, as well as investments in Germany’s rail system.

For the years 2024 until 2027, the government had planned total expenditures of 212 billion euros from the fund. To provide a sense of proportion: all of the federal government’s expenses in Germany in 2022 amounted to roughly 480 billion euros. The CTF has an annual income from EU and national emissions trading (in 2024, this was projected to amount to about 19 billion euros, rising in the following years due to increasing CO2 prices). In addition, there were higher revenues and lower expenditures than expected in 2023 plus a substantial reserve in the fund. In its budget planning, the government said this will amount to 71 billion euros at the beginning of 2024. This brings the total income of the fund to 99 billion euros, while the government planned expenditures amounted to about 58 billion euros in 2024. However, due to the court ruling, there is now a hole of 60 billion euros in planned credit authorisations.

Following an initial agreement on budget reshuffling in December 2023, the fund will be endowed with about 12 billion euros less in 2024 and 45 billion euros less until 2027. Chancellor Olaf Scholz said the agreement meant that Germany will stick to its key target of delivering a climate neutral transformation of the economy but added that “we will have to use significantly less money to meet our goals.”

3) Will the verdict stifle Germany’s climate efforts?

The judges’ decision has dealt a major blow to the financial planning of the government coalition and meant that the court does not follow the interpretation that climate change is an unforeseen crisis that requires an emergency response. It has presented the government coalition with considerable additional baggage to carry into the EU election year and will cause it to lead an uphill battle regarding climate action throughout 2024. However, the ruling does not undermine Germany’s general commitment to implementing ambitious emissions reduction policies and put the country on track towards climate neutrality by 2045, a target year resulting from the Constitutional Court’s landmark 2021 ruling. At the same time, the ruling led to considerable upheaval within the government coalition, leading economy minister Robert Habeck cancelled a planned trip to the UN climate conference COP28, as negotiations about a viable solution demanded his presence in Berlin.

Addressing parliament at the end of November, Scholz insisted his government would continue to pursue its green transition plans even in the face of a budget crisis. “We must now invest heavily in modernising Germany” to put the country "at the forefront of innovation and prosperity in a climate-neutral world,” he argued. Economy minister Habeck and finance minister Christian Lindner likewise stressed that the ruling would not throw climate policy over a cliff and that hat all agreed and legally binding projects will be kept.

However, the economy ministry in a background document conceded that “generally speaking, the constitutional court’s ruling presented us with great challenges.” The ruling could only be adhered to by introducing cuts “that will be felt by citizens,” the ministry said. Habeck stressed that this would be necessary to achieve the best possible solution overall. “It’s the only way for us to keep a range of support schemes and to make sure that Germany has a chance to remain competitive globally,” his ministry stated. The court ruling would hit the country’s industry in transition harder than it is going to be an issue for climate protection, said economy minister Habeck. “The core substance of the German economy is being challenged by the ruling,” he argued. He argued that “half of the world” was subsidising industry transformation, making it extremely competitive.

The missing funds had led to an expected loss in 2024 GDP growth of about 0.5 percentage points and the ruling’s negative impact could also persist to a lesser extent in the two following years, the econom minister said after a meeting with energy ministers from the 16 German states. Finance minister Lindner also said the court ruling made “far-reaching changes” necessary for the budget until 2027, but ruled out tax increases in response to the loss of planned funding. "We don’t have an income problem," the treasurer said, arguing that Germany instead "for years has struggled to decide on its priorities."

Researchers from the Mercator Research Institute on Global Commons and Climate Change (MCC) in an analysis from September 2023, found that the government lacked a strategy for long-term transformation funding beyond the CTF already before the ruling.

4) What’s the impact on decarbonisation and support measures?

The ruling in November was followed by a period of uncertainty as to which cuts will be made and where exactly. This became evident in the changes made to the proposed cuts to diesel fuel and vehicle tax support for the farming industry, which resultein major protests by farmers the led the government to partially backtrack or delay its austerity plans.

A draft by the finance ministry for parliament’s budget committee provided by Table.Media showed substantial cuts to important climate action programmes. Apart from the already agreed cuts to electric vehicle support and building efficiency schemes, these included programmes for natural climate protection and adaptation.The government now aims to have its amended budget adopted by early February.

However, the economy ministry inisted the government could continue to work towards the renewal of the industry and the wider economy, and create jobs and improve productivity with the CTF's the new funding structure. At a time of economic hardships, it was important to provide planning security fast, the ministry argued. “We know that investments create growth.” The money lacking in the CTF will be raised through savings and by reshuffling funds within the scheme as well as through using alternative financing sources for projects, such as modernising Germany’s railway infrastructure, the ministry explained.   

Programmes and schemes that would not be affected substantially by the ruling included:

• The elimination of the renewables levy, which was used to fund the expansion through a surcharge customers paid with their power bills. The state now directly funds the support for renewables through the CTF to ease the power price burden on households and companies
• Funding the replacement of fossil fuel-based heating systems with renewable energy-based alternatives and adapt support payments to income to achieve greater social justice
• Reduced power taxes for companies, power price compensation to manufacturers and the climate contracts for difference scheme for industry.
• Programmes for establishing semiconductor production and a hydrogen industry in Germany, including those agreed under the EU’s IPCEI scheme for joint European industry projects
• Railway company Deutsche Bahn will receive 13 billion euros to invest until 2027 through an increase of the state-owned business’s own capital and not from the CTF

However, about 30 billion euros are projected to be saved through “consolidation” measures that are supposed to focus the CTF on “core projects.” Greater cost efficiency meant that “some things we would have liked to do we can do no more” and "Many programmes will have to be stopped," Habeck’s ministry said.

Germany’s Federal Office for Economic Affairs and Export Control (BAFA), which administers many of the government’s energy and climate projects, in early December released a list of the activities that would be paused as a direct result of the court ruling, for example building energy efficiency consultancy, citizen cooperative support for onshore wind power and professional heat pump expansion training programmes. Beyond these, the agreed cuts include:

• End of a planned expansion of support programmes in the construction sector. While this might lead to a delay in the heating sector’s transition but would not let it grind to a halt or make it socially unjust, the ministry argued. Support for decarbonised heating infrastructure will fall by 40 million euros to 10 million euros in 2024. However, the costs for these measures are expected to only start mounting considerably by 2025. A “large part” of the available funds will therefore be shifted to the following years
• Electricity and gas price brakes introduced during the energy crisis were not extend beyond the end of 2023
• The "environment bonus" that co-funds purchases of new electric vehicles, which was discontinued as well at the end of 2023
• Natural climate protection funds will be cut from 5 to 3.5 billion euros until 2027
• Energy efficiency counselling support will be cut 20 million euros to 240 million euros
• International cooperation projects for energy, raw materials and technology shrinks 20 million euros to 30 million euros
• The funds for CO2 avoidance and usage in basic materials industries remain unchanged at 10 million euros in 2024 but are going to be cut “moderately” in the following years
• The research and innovation programme for climate action in agriculture is cut by one third to 20 million euros. Subsidies for energy efficiency investments in agriculture shrink by 20 million to 10 million euros
• Tax breaks for diesel fuel in the agricultural sector will be phased out gradually, starting with a 40-percent drop in 2024

5) How can Germany ensure that funding will be secured in the future?

Beyond savings and consolidation measures, the government coalition also agreed on finding new revenue sources for the CTF. A key measure is its decision to increase the national CO2 price in the transport and heating sector to 45 euros per tonne instead of 40 euros, the coalition returns to the trajectory already agreed under the previous government. This became necessary to fund measures like the abandoned renewables levy, which meant that 85 percent of the carbon price’s earnings are returned to customers, the economy ministry argued. In total, about half of the CTF’s remaining funds would go into relief measures for households and companies. Moreover, it agreed a tax for aviation fuel for domestic flights, an increase of flight ticket prices and and a tax on plastics.

The government also signalled it will declare another emergency situation caused by Russia’s ongoing war on Ukraine to allow for more debt than is constitutionally permissible in non-emergency times. This is meant to retroactively ensure the constitutional legality of the billions of euros in planned support to citizens and companies to keep energy prices in check this year. Economic and legal experts consulted by parliament ahead of a public hearing on the budget decision on 5 December largely backed the approach that would put the budget on a new footing by taking on nearly 45 billion euros in fresh debt through the government’s economic stabilization fund.

However, the government will have to find other ways to secure financial means for making new commitments and safeguard a reliable funding structure also for the coming years. Apart from finding fresh sources of revenue and cutting expenditures, especially support payments that are harmful to the climate, a third option is addressing the purpose and limits of the debt brake itself. The decision has already triggered a debate whether the rule is still fit for purpose, with leading members of Scholz's SPD in January doubling down on efforts to initiate a reform. Critics have questioned the sensibleness of the country’s limit on new government borrowing, arguing it was based on the assumption of having reliable access to cheap natural gas from Russia, that China is a buyer and supplier of German products and not a competitor, that the alliance with the U.S. was unshakeable and that there would be no more wars in Europe.

A removal of the debt brake is unlikely, as this would require the consent of the conservative CDU/CSU camp for a two-third majority in parliament. However, calls for the declaration of another emergency and suspension of the debt brake or enhancing the role of special-purpose funds may rise again. This second option has been backed by several economists commenting on the ruling, who share the view that the debt ceiling is a useful tool to prevent government profligacy but must not undermine future-oriented investments needed to sustain the economy’s long-term stability.

6) What impact could the ruling have on Scholz’s government coalition?

The ruling has been a major setback for the government coalition – in particular for SPD chancellor Scholz himself and for FDP finance minister Lindner, who oversaw the transfer of pandemic response funds into the CTF. Lindner’s ministry (BMF) is responsible for ensuring the budget’s constitutionality, which gives only the treasurer the power to veto cabinet decisions. Lindner consented despite warnings that the move could backfire. However, he could be sure of Scholz’s support, since the chancellor initially came up with the idea of repurposing funds in his previous role as finance minister under Merkel.

Both the chancellor and his treasurer see their reputation damaged by the ruling, while Green economy minister Robert Habeck now might struggle to secure funding for decarbonisation and support mechanisms that his ministry had planned. The decision is likely to also reverberate in the transport ministry, where FDP minister Volker Wissing planned to use billions in state money to support the expansion of electric vehicle charging infrastructure and modernise Germany's rail system.

At the same time, the court’s decision has been a major success for the litigants from the conservative CDU/CSU alliance, the largest opposition faction in parliament. For the second time, the conservatives under leader Friedrich Merz managed to throw a spanner in the government’s works through a constitutional ruling. Earlier this year, the court already forced Scholz’s government to postpone a planned law on heating sector decarbonisation, after the CDU/CSU alliance litigated the proposed regulation. However, because of its successful intervention, the opposition party might ultimately find itself caught up in a new debate about the debt brake’s role. Merz already entered into an open dispute with the head of city state Berlin, CDU mayor Kai Wegner, who said that while the a cap new government lending was a good concept in principle, its current interpretation made it a “future brake.”

Irrespective of that, it is unlikely that the court ruling will cause a fast rupture of the government coalition or even lead to a breakdown and new elections. The coalition parties all have little to gain now from cancelling their partnership and move into campaigning again, as they continue to poll well below their 2021 election result and stand to gain little from a new vote at the moment. With the far-right AfD recently making substantial gains in state elections and the conservatives leading in national polls, the SPD, the Greens and the FDP instead might try to use the defeat at the constitutional court as a platform for a fresh start and jointly strengthen their image as reliable government parties. However, as the ruling means that many of the climate policy questions the three parties painstakingly negotiated throughout the past months, often in public display of considerable disagreement, reopening debate will not be an easy feat.