Tax talk gives German voters the jitters

BERLIN - Paul Kirchhof has a lot to answer for. Until the university professor and longtime proponent of flat taxes arrived as a member of the Christian Democratic Union's economics team, the centre-right party had an unstoppable lead in the polls for Sunday's elections in Germany.

And now? A ballot that seemed like a sure thing for the CDU is set to go down to the wire. At the very least, Kirchhof's proposals have dashed CDU hopes of ruling with a majority.

That may also end up costing billions for the global investors who piled into Germany on the near-certainty that a new CDU-led government would bring about the pro-business, free-market change the country needs to revive its flagging economy.

"At the moment, the German electorate has a chance to change a lot about how the economy works," said Thorsten Polleit, chief economist for Germany at Barclays Capital in Frankfurt. "Kirchhof has interesting ideas, but people don't seem to want it."

The lesson: There is nothing wrong with having radical economic policies. In fact, Germany probably needs them. There is, however, no point in bothering the electorate with them.

The lead the CDU established during the past few months has been steadily whittled away. A poll in mid-June showed the CDU with 49 per cent of the vote and 6 per cent for its allies, the Free Democrats. Chancellor Gerhard Schroeder's Social Democratic Party was at 26 per cent. Schroeder appeared to be heading not so much for a defeat as a humiliation. But another poll this month put the SPD at 35 per cent, with the CDU at 42 per cent. The Free Democrats were on 6 per cent. The Greens, who have been in government with the SPD, were on 7 per cent.

The CDU, led by Angela Merkel, is still the likely victor. Yet it may fall short of the majority it needs to govern with the Free Democrats.

Kirchhof has pushed for a radical simplification of the German income-tax system, including a possible flat rate of 25 per cent and Schroeder and his party have skilfully exploited that as a huge tax break for the rich.

Meanwhile, Merkel has been slow to distance herself and her party from the idea, even though the CDU's official platform only offers modest cuts in the top rate of tax - to 39 per cent from 42 per cent.

Money has poured into Germany since the elections were called. Last week, the benchmark DAX index broke through the 5000 barrier, a level last seen in 2002. The bet was that market-friendly measures would be pushed through by a triumphant CDU-led government.

Investors may now be dealing with a different government from the one they bet on.

Without a majority, Merkel should still be chancellor, although she may be forced into a grand coalition with the SPD. Her power would be much less than anyone had anticipated.

The bigger lesson is that opposition parties rarely win power by promising radical measures. Voters want change, but only a bit.

- BLOOMBERG