November 11, 2005

German parties seal ‘grand coalition’ deal

By Noah Barkin and James Mackenzie

BERLIN (Reuters) - Germany's main parties sealed an
agreement on Friday to create a government of traditional
rivals under the leadership of conservative Angela Merkel,
breaking eight weeks of deadlock after an inconclusive general

"I'm convinced that the coalition creates a genuine
opportunity for Germany," said Merkel, who will become the
country's first woman chancellor and first from the former
communist East if, as expected, the new parliament formally
elects her on November 22.

She will head a potentially unwieldy bipartisan government
that includes her Christian Democrats (CDU), their Bavarian
sister party the Christian Social Union (CSU) and the Social
Democrats of outgoing Chancellor Gerhard Schroeder.

But the new government -- only the second "grand coalition"
in post-war history -- will be able to operate without
crippling opposition from the Bundesrat upper house of
parliament, which has blocked reform efforts by previous

In almost a month of relatively harmonious talks, the
conservatives and the SPD have bridged differences that
bitterly divided them during the campaign.

At the heart of the deal is an agreement to bring Germany's
ballooning budget deficit back within European Union borrowing
limits by 2007 -- a colossal challenge requiring upwards of 35
billion euros in savings or extra revenues.

A good chunk of that sum will come from higher taxes. The
parties agreed on Friday to a controversial 3 percentage point
hike in value added tax (VAT) in 2007, an idea championed by
the conservatives during the election campaign.

In return for agreeing to the VAT hike, the SPD secured
conservative agreement for a so-called "rich tax," which will
take the rate for Germans earning 250,000 euros or more up to
45 percent from 42 percent previously.

Economists and leaders of German industry worry the tax
rises could hit already weak consumption and prevent the
parties from achieving their number one stated priority --
cutting unemployment.

"Never before has a new government hit the public with so
many burdens," said Gerd Langguth, a political scientist at
Bonn University and biographer of Merkel.


Schroeder, who has led Germany for the past seven years,
called for early elections in May as unemployment soared to
post-war highs and the electorate grew disillusioned with his
reform plans.

He was expected to be trounced by Merkel, whose plans to
shake up the German labor market and cut bureaucracy have
earned her the nickname "Maggie Merkel" after reform-minded
former British Prime Minister Margaret Thatcher.

But a roaring performance from Schroeder on the campaign
trail helped his SPD narrow a double-digit poll gap in the last
weeks and score almost as well as Merkel's conservatives in the
September 18 election. Unable to form a government with her
preferred partners, Merkel was forced into talks with the SPD.

The agreement between the longtime rival parties yielded
compromises on both sides and that showed in a sober
business-like news conference with Merkel and other party

"Coalitions are marriages of convenience. One shouldn't
make too much of it," said outgoing SPD chief Franz
Muentefering, who is to become labor minister and vice
chancellor under Merkel.

"But I am optimistic," he said. "The personal relationships
which are not unimportant in coalitions like this are solid and
I think we can make politics together."

The CDU was unable to convince the SPD to reverse
Schroeder's policy of phasing out nuclear power stations.

But they did win concessions from the SPD in labor market
policy. Part of the VAT hike will go toward cutting non-wage
labor costs -- a measure the conservatives say is crucial for
encouraging German firms to hire.

Both parties must hope the measures do not hit the German
economy, which is already showing one of the weakest growth
rates in the 25-nation European Union.

"It looks like consumers are going to be hit hardest by
these moves," said Rainer Guntermann, of the bank Dresdner
Kleinwort Wasserstein. "The election promises we heard about
sparing private households have not really been fulfilled."

A survey on Friday for ZDF television showed 63 percent of
Germans were against the VAT hike.

However, given the dire state of German public finances,
some commentators have welcomed signs of a concerted attack on
the deficit.

In foreign policy, the parties have vowed to improve
relations with the United States which were strained by
Schroeder's staunch opposition to the Washington-led war in
Iraq. The CDU and CSU, which oppose Turkey joining the EU, have
agreed not to try to prevent membership negotiations that
started in October from continuing. But they have vowed to
ensure EU criteria imposed on Ankara are strictly adhered to.