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One year into the Merz government, Germany’s CDU/CSU–SPD coalition faces mounting pressure to deliver visible reforms amid fiscal constraints, high energy costs and weak polling. While a government collapse remains unlikely, the coming months will be decisive for tax, pension, healthcare and energy reforms. For investors and businesses, Germany remains attractive, but opportunities are increasingly concentrated in politically prioritised sectors such as defence, energy, infrastructure and digital.
One year after taking office, the German government - once called “Doomed to succeed” - faces a markedly more difficult domestic and international environment than anticipated. Economic conditions have worsened, political fragmentation has intensified, and current polling suggests that the coalition would no longer command a majority if elections were held today. The federal government has fallen to historic lows in approval ratings, with only around 15% of Germans currently satisfied with its performance. At the same time, the AfD has established itself as the strongest party in several national polls (currently polling at around 27% nationwide), underlining the continued erosion of support for the political centre. Despite a set of relief measures for industry and citizens, the government has so far failed to turn this around.
There is now a largely shared recognition in the coalition government that incremental adjustments will not be sufficient. The need for far-reaching reforms is no longer disputed in principle, but agreement on their scope and direction remains limited. With key reform files, including healthcare and pensions, now moving from expert commissions to concrete proposals, the pressure to decide is rising.
Against this backdrop, the coming months will be decisive. The government faces a narrowing window in which it must move from acknowledgement to action. Reforms intended to take effect from 1 January 2027 will require decisions soon. The coalition is under pressure to deliver before the political window narrows further ahead of autumn state elections in eastern Germany, where the AfD is polling at around 40%. The key question is whether the government can muster the political strength to launch the structurally necessary reforms and make Germany’s economic model fit for the future. In this blog, we look at the reform agenda ahead.
The coalition has committed to lowering the income tax for low and middle earners, with effect on 1 January 2027. This puts the government under considerable time pressure: to meet that deadline, the cabinet would likely need to agree on a draft before the parliamentary summer recess.
However, the substance of the proposed tax relief - and how it should be financed - remains politically contested. The SPD is pushing for higher taxes on top earners, while the CDU/CSU favours subsidy cuts and warns that tax increases could weaken the competitiveness of self-employed workers and family-owned businesses. A possible compromise could follow the approach recently outlined by two CDU MPs. They have proposed raising the basic tax allowance and moving the threshold for the 42% top income tax rate upwards from around €70,000 today to €85,000 in taxable income.
At the same time, the proposal seeks to raise the so-called “rich tax” from 45% to 47.5%, while lowering the income threshold from currently €277,826 to €210,000. To finance the package, proponents point in particular to a reduction in state subsidies, whose volume has increased from €5.5bn in 2016 to €59.5bn in 2026. However, it is questionable where meaningful cuts could realistically be made, not least because the government recently extended several major subsidy schemes, including in the heating sector. The fiscal cost of the reform, therefore, remains the major constraint.
Both CDU/CSU and SPD agree that the statutory pension system needs to be stabilized but have different visions of how this should be done in practice. These differences became visible only recently, when Chancellor Friedrich Merz described the statutory pension as a form of “basic provision”, suggesting that capital market exposure should play a stronger role in the future. These remarks triggered strong criticism within the SPD.
The government-appointed pension commission is due to present proposals for a future-proof pension system by the end of June. Its task is to show how living standards in old age can be secured, particularly for low and middle incomes, while also ensuring sustainable financing and limiting the burden on contributors. Occupational pensions and subsidised private provision are expected to play a central role in this debate.
Compared to other policy areas, defence currently appears to be the least contentious. Russia’s war against Ukraine and the compounding geopolitical pressures (including growing distance from the US and the conflict with Iran) have created broad agreement within the coalition on the need to structurally strengthen the Bundeswehr.
The reform of the debt brake for defence spending and the infrastructure special fund agreed before the government was formed have created important financial foundations for building a more capable, deployable and technologically advanced Bundeswehr. Furthermore, in December, the Bundestag adopted the new military service model, which initially relies on mandatory registration and voluntary service.
For businesses in defence, infrastructure, digitalisation and industrial production, Germany is likely to remain one of Europe’s most important growth markets for the foreseeable future. Berlin is increasingly willing to link industrial policy to security and sovereignty objectives. The recently adopted military strategy underlines the sustained demand not only for traditional defence capabilities, but also for enabling infrastructure, logistics, digital backbone systems, resilient communications, data infrastructure, dual-use technologies and broader industrial capacity.
High energy prices remain a central pressure point for both industry and households, and are increasingly shaping the government’s economic agenda. The Ministry for Economy and Energy under Katharina Reiche is pursuing a recalibration of energy policy that is explicitly designed to respond to mounting structural constraints. Grid expansion continues to lag behind the pace of new generation and demand, while competition for limited connection capacity is creating bottlenecks for new projects. In response, the government is advancing a series of legislative initiatives, including a comprehensive grid package to better align generation and network expansion, the introduction of a capacity market to incentivise investment in dispatchable power generation, and a broader reform of renewable energy policy that is still awaiting cabinet approval.
Taken together, these measures aim to improve system stability, reduce costs and address capacity gaps, including through a stronger focus on grid-oriented deployment of renewables and the role of flexible gas-fired capacity. However, this approach remains politically contested within the coalition. The SPD are likely to challenge elements that are seen as slowing renewable expansion, increasing reliance on gas and fossil fuels or placing additional burdens on consumers. Criticism has also intensified in light of geopolitical risks and concerns about energy security, as well as the perceived proximity to industrial and energy sector interests.
At the same time, the government has moved ahead with a concrete relief instrument for industry. The introduction of an industrial electricity price for the period 2026 to 2028 has now been approved by the European Commission under state aid rules. The measure targets energy-intensive sectors with a price level of around 5 ct/kWh for eligible electricity costs and is intended to stabilise production, safeguard employment and support the transition to climate-neutral industry. While this provides short-term relief and greater planning certainty for key industries, it also raises familiar questions about fiscal cost, market distortions and the balance between targeted support and broader structural reform.
Rising expenditure, demographic pressure, and a projected deficit in statutory health insurance have made the need for action increasingly urgent. While the coalition had initially deferred structural reform to an expert commission, Health Minister Nina Warken has now translated a substantial share of its recommendations into legislation. The draft, approved by the cabinet on 29 April, aims to generate savings of around €16.3 billion in 2027, thereby closing a projected deficit of approximately €15.3 billion. It now moves to the Bundestag, where it is likely to become an early test of the government’s reform capacity. The package combines increased contributions for higher earners, restrictions on family co-insurance, increased co-payments and targeted spending cuts, alongside new revenue measures such as a levy on sugary drink. Conflict lines are already emerging over the social distribution of burdens and the role of benefit cuts versus additional revenues. The parliamentary process will therefore not only determine the final shape of the reform, but also signal how far the coalition is willing and able to sustain contentious reforms under growing economic and political pressure.
The German government enters its second year with limited time to translate political commitments into actionable legislation. While a collapse of the coalition remains unlikely, internal disagreements and tight fiscal headroom will constrain the scale and speed of reforms, particularly on tax relief and welfare restructuring. For businesses and investors, this points to a bifurcated outlook. Targeted public spending and regulatory support are likely to be concentrated in defence procurement, grid expansion, industrial policy, and digital infrastructure, where funding frameworks and policy direction are already taking shape. In contrast, most other sectors should plan for continued exposure to high energy costs, incremental rather than structural tax changes, and a more complex regulatory environment. Investment decisions will therefore need to take into account the policy agenda of the government.
The Flint Global Germany team advises companies and investors across Germany and Europe on political, regulatory and competition issues, combining in-country expertise with a global perspective to help clients anticipate and navigate complex decision-making environments.
Das Flint Global Germany Team berät Unternehmen und Investoren in Deutschland und Europa zu politischen und regulatorischen Herausforderungen. Unser Beratungsansatz verbindet fundierte lokale Expertise mit einer internationalen Perspektive. Wir unterstützen unsere Mandanten dabei, komplexe regulatorische Entwicklungen und politische Entscheidungsprozesse frühzeitig zu erkennen, einzuordnen und in klare Handlungsschritte zu übersetzen.
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