By Andrea Thomas 

Germany's new finance minister ruled out a shift in fiscal policy that would help Europe's largest economy reduce its yawning trade surplus with the rest of the world, closing a possible avenue to resolve the unfolding trade conflict with the U.S.

Speaking on his flight back from a meeting of Group of 20 finance ministers and central bankers in Argentina, Olaf Scholz told The Wall Street Journal that even though public coffers were full, the government wouldn't consider large income and corporate tax cuts that could spur domestic demand and reduce the economy's dependence on exports.

"As German finance minister and as a Social Democrat, I want solid public finances and a good framework for business," Mr. Scholz said in his first interview with a non-German publication since taking office last week.

Together with China, Germany has become a favorite punching bag for the U.S. administration because of its large trade surplus, which President Donald Trump sees as evidence of the kind of unfair trade practices that for decades have put U.S. exporters at a disadvantage.

Germany would be among the hardest hit in Europe by the steel and aluminum tariffs that the U.S. is set to start levying this week. And Mr. Trump has repeatedly threatened to slap German cars with punitive import tariffs of up to 25% -- 10 times their current level.

But impatience with Germany's export-oriented economic model goes back further than Mr. Trump's election. For years, successive U.S. governments, the International Monetary Fund, the European Commission, and other international organizations have urged Berlin to loosen its fiscal policy to stimulate demand, boost imports, and reduce its trade surplus -- currently the world's second-largest behind China's.

Berlin, in turn, has argued that such recommendations would have little impact on a surplus that reflects the competitiveness of its manufacturing sector and the exchange rate of a currency -- the euro -- over which it has no influence.

The appointment of Mr. Scholz, the first Social Democrat to occupy the finance ministry since 2009, had raised hopes in Brussels and neighboring European countries about a change of tone in Berlin. But the minister, who is also deputy to Chancellor Angela Merkel, made it clear Berlin's fiscal policy would largely continue as in the past four years.

Even though Germany has among the highest combination of income and payroll taxes in the world, a modest tax relief worth EUR10 billion ($12.2 billion) a year starting in 2021 would be the only such tax cut before the next general election in 2021, he said.

"It's clear to me that our next big task will be to develop a fairer, more balanced tax system," Mr. Scholz said. But this reform, which would include further relief for lower incomes and possibly tax rises for the rich "will be a task for the next parliament."

Corporate tax cuts, he added, "are currently not on the agenda."

The rejection of tax cuts goes against recommendations by the government's own Council of Economic Advisers, who said this week Germany's average income-tax rate had reached its highest level in a generation and was set to rise further this year just as the country's overall budget surplus continues to widen from 1.1% to 1.4% of GDP.

Mr. Scholz welcomed the fact that Washington and the European Commission, lead trade negotiator for the entire bloc, were in talks over seeking an exemption from Mr. Trump's steel and aluminum tariffs and warned a full-blown trade war would "lead to a situation where no one benefits."

But he offered no measure that would help reduce Germany's vast trade surplus with the U.S.

Reiterating a longstanding German position, he said the surplus reflected the strength of Germany's myriad export-oriented small and midsize manufacturers, known collectively as the Mittelstand, suggesting others should copy this model.

"Nobody ever criticized us for having a highly performing and competitive economy," Mr. Scholz said. "Like everyone else, we wish others all around the world would manage to establish such growing and highly productive economies."

The new Merkel government has also shut down a possible avenue raised by Washington that could secure Europe exemption from the metal import tariffs: a sharp increase in military spending. Berlin plans a steady but modest increase in its defense budget over the next four years that will leave the country far below the North Atlantic Treaty Organization target of 2% of gross domestic product.

Returning to the question of tariffs, Mr. Scholz turned the table on Washington, recalling that Mr. Trump had suspended talks on the Transatlantic Trade and Investment Partnership with Europe, which would have included substantial and mutual tariff cuts.

"Not too long ago, [the U.S. and Europe] were having a debate about free trade, and it wasn't the Europeans who put an end to these talks," Mr. Scholz said. "We were also talking about tariffs. Perhaps that conversation could be a foundation for today's talks."

Write to Andrea Thomas at andrea.thomas@wsj.com

(END) Dow Jones Newswires

March 21, 2018 09:47 ET (13:47 GMT)

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