Fiscal Policy & Crisis: Germany's Budget Policy Between Investment Offensive and Sustainability Risk (2026–2031)

Initial situation & findings

The federal budget 2026, adopted by the Bundestag on 28 November 2025, comprises 524.54 billion euros in the core budget, making it a record figure that is 21.5 billion euros above the previous year. For financing, the core budget provides for net borrowing of 97.97 billion euros; added to this are around 82 billion euros via the special funds for the Bundeswehr and infrastructure, so that total new debt in 2026 reaches more than 180 billion euros – as high as last seen only during the coronavirus pandemic. According to the BMF's target report, the federal government's financing deficit of 98.1 billion euros is 32.8 billion euros above the preliminary 2025 result. At the general government level, the debt level rose to around 2.84 trillion euros by the end of 2025, an increase of 144 billion euros compared with 2024. The debt-to-GDP ratio thus climbed to 63.5 percent of GDP and, according to calculations by the Stability Council, is likely to rise to 66.5 percent in 2026 – well above the Maastricht limit of 60 percent. At the same time, the economy is growing only weakly: in its spring 2026 report, the Council of Economic Experts forecasts GDP growth of only 0.5 percent, after 0.2 percent in 2025. The finding is therefore clear: record spending and record debt coincide with a seventh year of economic weakness, while the federal government's interest expenditure, at around 34.1 billion euros, already ties up about 6.5 percent of the budget.

How it came about: The turning point of the debt brake

The fiscal policy break is marked by the constitutional amendment that the still-incumbent 20th Bundestag adopted on 18 March 2025 by 512 votes to 206 with a two-thirds majority. First, defense spending above 1 percent of GDP – including civil protection, intelligence services, and Ukraine aid – was fully exempted from the debt brake. Second, a credit-financed special fund of 500 billion euros with a twelve-year term was anchored for additional investments in infrastructure and climate neutrality by 2045 (Article 143h of the Basic Law). Third, the states as a whole received a structural borrowing scope of 0.35 percent of GDP. What was politically explosive was that the CDU/CSU under Friedrich Merz had still rejected a loosening during the election campaign, which led to accusations of a broken promise against the FDP. The special fund entered into force retroactively as of 1 January 2025, but only became operationally usable upon publication in the Federal Law Gazette on 2 October 2025. This was preceded by a long phase of rising burdens from coronavirus rescue packages, the energy crisis following the Russian attack in 2022, and the interim rise in interest rates. In total, economists estimated the additional debt resulting from the special fund and the defense exemption at at least 1 trillion euros already at the time of the decision.

Central drivers and mechanisms

Three expenditure blocks are simultaneously driving up debt. First, defence: the defence budget (departmental budget 14) amounts to around €82.69 billion in 2026, supplemented by €25.51 billion from the Bundeswehr special fund; under the NATO definition, the federal government reports €124.7 billion, equivalent to 2.69 percent of GDP, with the target of 3.5 percent to be reached as early as 2029. Second, social spending: the Federal Ministry of Labour and Social Affairs is the largest departmental budget at €197.34 billion and ties up almost 38 percent of the budget, with the federal funds for pension insurance alone amounting to €127.4 billion in 2026. Third, the interest burden, which is stabilising at a historically high level of around €34.1 billion and restricting the scope for future-oriented investment. The central mechanism behind this is demographics: the German Council of Economic Experts warns that demographic change is reducing the potential labour volume and structurally pushing up contribution rates in pension, health and long-term care insurance. Added to this is a weak revenue base, since revenues are growing more slowly than expenditure, which is precisely what explains the high net borrowing. Although tax revenues are expected to exceed the €1,000 billion mark for the first time in 2026, record borrowing is arising even with record revenues. The interplay of these drivers creates a fiscal path dependency from which policymakers can escape only through growth or consolidation.

Ongoing and planned measures

The Infrastructure and Climate Neutrality special fund (SVIK) is divided into €300 billion for the federal government, €100 billion for the states and municipalities and €100 billion for the Climate and Transformation Fund (KTF). However, the disbursement of funds is getting off to a sluggish start: €37.2 billion were to be spent on infrastructure projects in 2025, but according to the Finance Ministry the actual figure was only €24 billion, while the federal government's investments overall rose to €87 billion and are set to climb to over €120 billion in 2026. In defence, a jump in the pure defence budget from €82.7 billion (2026) via €93.3 billion (2027) to €136.5 billion (2028) and around €152 billion (2029) is planned, corresponding to a tripling compared with 2023. On the labour market, with the active pension (Aktivrente) introduced in January 2026 and the abolition of the prior-employment ban, the federal government is banking on stronger employment incentives for older people. A newly appointed pension provision commission is to present reform options for the sustainable financing of pensions by the end of the second quarter of 2026. To relieve the energy-intensive economy, the federal government is lowering costs in 2026 by around €30 billion through a reduction in the electricity tax, the abolition of the gas storage levy and grid fee subsidies, and is introducing an industrial electricity price for 2026–2028. To provide counter-financing, savings measures are envisaged in basic income support, personnel, funding programmes and development aid, although their fiscal magnitude remains limited so far.

Economic impact: costs, benefits, fiscal sustainability

The potential benefit of the investment offensive is considerable: model calculations by the DIW put the additional GDP impulse of the special fund at up to 0.8 percentage points per year, provided the funds actually flow and the projects are implemented efficiently. This is precisely where the core reservation of the German Council of Economic Experts lies: additionality and investment orientation are low in the current financial planning, because substantial funds replace regular budget expenditure and the disbursement is often not precisely targeted. According to the Council, institutional safeguards to ensure additionality are so far lacking for the €100 billion to the states and the €100 billion in the KTF. Consequently, the Council expects only a modest growth effect and anticipates that the debt ratio will rise above 85 percent of GDP by 2035. Critics also point out that in 2025 at least 86 percent of the funds were used for projects already planned rather than new ones – an accusation the Finance Ministry disputes. Fiscally alarming is a funding gap of around €172 billion for the years 2027 to 2029, which the government intends to close through stronger growth. The scientific advisory board of the Stability Council already warned of an excessive deficit in 2026 and cautioned against limiting the rise in the debt ratio; investments in defence and infrastructure were justified, but not the plugging of budget holes. The economic balance thus depends entirely on the quality of implementation and expenditure discipline.

International classification and competitiveness

In terms of debt comparison, Germany, with a ratio of around 62 to 63.5 percent, is still in a more favorable position than the USA at roughly 124 percent of GDP, but worse than model countries such as Estonia with 24.6 percent. Nevertheless, the German Council of Economic Experts observes that Germany is losing its role as the fiscal stability anchor in Europe, while states like Ireland, Luxembourg and the Baltic countries continue to comply with the Maastricht criteria. In terms of defense spending, Germany in 2026, at 2.69 percent of GDP, lags behind frontrunners such as Lithuania (5.33 percent), Estonia (5.1 percent) and Poland (4.68 percent), as well as behind the USA (3.17 percent). More serious in competitive terms is the erosion of export strength: goods exports have declined for the third year in a row, and China is increasingly becoming a direct competitor of German industry, with its export prices in August 2025 around 17.3 percent below the 2022 level, while euro-area export prices rose by 14.4 percent. In addition, higher US tariffs and the appreciation of the euro since the beginning of 2025 are weighing on sales prospects. Energy prices in the European gas market remain significantly above the US level, which structurally disadvantages energy-intensive sectors in international competition. In the Council's reading, the weakness of Germany as a business location is thus not merely cyclical but structural – one reason why Germany benefits less from global growth than in earlier decades.

Distributional and second-round effects

The strongest second-round effect emanates from social security contributions: the total social security contribution rate stands at 42.3 percent in 2026 and, according to Council simulations under unchanged legislation, rises to 45.4 percent in 2030 and 49.7 percent in 2040. Higher contribution rates reduce households' disposable income and increase companies' labor costs, which slows employment growth and overall economic performance. The Council estimates that the rising contribution rate will dampen GDP by 0.5 to 0.9 percent by 2035 compared with a constant rate. In the pension insurance system, the sustainability reserve already falls in 2026 from 41.5 to a good 32.4 billion euros, corresponding to around 1.04 months of expenditure, shrinking the buffer for contribution stability; the Federal Employment Agency will require a federal loan of an expected 4.0 billion euros in 2026. In intergenerational terms, with a population of around 83.5 million people, a notional per capita debt of over 32,000 euros is attributable. The as yet undrawn special funds of over 1.2 trillion euros will further increase this burden in the coming years, together with the interest accruing on them. At the same time, the special funds shift expenditure out of the regular budget into shadow budgets, which reduces the transparency of public finances – a legal but economically questionable practice. The distributional effect thus falls primarily on future contributors and taxpayers.

Key fiscal indicators for Germany: actual and projection (in billion euros or percent)

Scenarios

Options for action

1. Legally secure the additionality and precision of the special fundThe GCEE calls for clear rules on transparency, additionality, and prioritization according to macroeconomic impact, including for the 100 billion euros each allocated to the states and the CTF. Otherwise, much of the growth impulse of up to 0.8 percentage points dissipates because funds merely replace regular spending. Effect: a higher capital stock and stronger production potential instead of pure borrowing.
2. Structural reform of the social security systemsWithout reform, the total social security contribution rises to 49.7 percent by 2040 and dampens GDP by 0.5 to 0.9 percent. A longer working life, higher labor force participation, and efficiency gains in statutory health insurance and long-term care can slow the increase. Effect: lower non-wage labor costs, higher employment, and relieved federal subsidies beyond the 127.4 billion euros for pensions.
3. Consolidation of the core budget and expenditure prioritizationThe financing gap of 172 billion euros for 2027–2029 requires concrete savings concepts rather than mere hopes for growth. With tax revenues exceeding 1,000 billion euros for the first time alongside record debt, spending discipline is imperative. Effect: stabilization of the debt-to-GDP ratio and recovery of fiscal room to maneuver against future interest burdens.
4. Lower energy costs permanentlySince European gas prices remain significantly above the US level, energy remains a decisive location disadvantage for energy-intensive industry. Competitiveness can be strengthened through grid expansion, supply expansion, and efficient relief—already around 30 billion euros in 2026. Effect: lower production costs and a slowdown in the migration of industrial value creation.
5. Expand the labor volume and skilled labor baseDemographic aging reduces the labor potential; instruments such as the active pension and a digital work-and-stay agency address this. Higher labor force participation and immigration simultaneously support the contribution base of social security. Effect: higher production potential and relief for the pay-as-you-go systems.

Key risks

• Interest rate increase and risk premiumsRising capital market interest rates would further increase the already high interest burden of 34.1 billion euros and additionally narrow the room for investment.
• Slow or diverted SVIK outflowIn 2025, only 24 billion euros flowed instead of 37.2 billion; if funds replace regular spending, the hoped-for growth effect is lost while debt is fully accumulated.
• Demographically driven social security contributionsThe rise in the total contribution to up to 49.7 percent by 2040 burdens labor costs and purchasing power and permanently dampens growth.
• Energy price shock from the Iran warPersistently high oil and gas prices worsen the terms of trade, reduce consumption and investment, and pushed the GCEE forecast for 2026 down to 0.5 percent.
• Erosion of competitiveness relative to ChinaChinese export prices in 2025 were around 17.3 percent below the 2022 level, while German goods exports declined for the third consecutive year.
• Uncovered financing gap 2027–2029If the hoped-for growth and savings effects fail to materialize, further net borrowing and a rise in the debt-to-GDP ratio above 85 percent by 2035 loom.

Outlook

The next five years hinge on a single question: Will the debt-financed investment and defense offensive be translated into productivity and growth quickly enough to bear the simultaneously rising interest and social spending burden? The baseline data call for caution—a debt-to-GDP ratio on its way from 66.5 percent (2026) toward 80 percent (2029), a total social security contribution of 42.3 percent with a clear upward trend, and growth of only 0.5 percent leave little buffer. If high additionality of the special fund plus structural social and supply-side reforms succeed, Germany can modernize its capital stock and stabilize competitiveness. If implementation fails or the energy price shock becomes entrenched, the transition from a managed weakness into a structural sustainability crisis looms. Decisive factors will be spending discipline in the core budget, the efficiency of fund disbursement, and the willingness to undertake unpopular social reforms. The report therefore assesses the 5-year outlook as slightly negative, with high sensitivity to political implementation.