Following its military defeat in World War II, Germany was occupied and divided into the Federal Republic of Germany (West Germany) under western influence, and the German Democratic Republic (East Germany) within the communist bloc. On the wake of the democratic reforms in the Soviet Union initiated by President Mikhail Gorbachev in the 1980s, and the collapse of communism in eastern Europe, the German countries were reunited on October 3, 1990. The political system is based on the Basic Law (Grundgesetz, or constitution) of 1949. The country is a democratic federation of 16 states (Länder) with their own governments and local traditions. Each state has an elected legislature and government whose responsibilities include local affairs such as education and keeping a police force. The federal legislative power is vested in a bicameral Federal Assembly or parliament comprising the Bundestag (lower house), with 662 members (328 elected from local constituencies and 334 elected through party lists in each state for a 4-year term), and the Bundesrat (upper house) comprised of 69 members nominated by the 16 states. Each state has between 3 and 6 votes in the Bundesrat, depending on its population, and these are required to vote as a block. The role of the Bundesrat is limited, but it can veto or initiate revision of legislation passed in the Bundestag when it would affect the interests of the states. Parliamentary elections in September of 1998 brought to office the cabinet of Chancellor Gerhard Schröder of the Social Democratic Party of Germany (SPD), and elections were scheduled for 2002. The head of state is the president (a role that is largely ceremonial), elected for a maximum of 2 5-year terms by an electoral college consisting of members of the Bundestag and representatives of the state legislatures. The president in 2001 was Johannes Rau, who took office in 1999, and presidential elections were scheduled for May 2004. The federal executive power is vested in the federal government led by the chancellor (prime minister), elected by the Bundestag on the nomination of the president.
Major political parties represented in parliament in 2001 included the Socialist Party (SPD) and the environmentalist, pacifist Alliance 90/the Greens; the conservative Christian Democratic Union (CDU) and the Christian Social Union (CSU); the Free Democratic Party (FDP); and the Party of Democratic Socialism (PDS). In early 2001 the SPD (supporting social welfare) had 298 seats. The CDU and its Bavarian sister party the CSU (or CDU/CSU) had 245 seats in the Bundestag. CDU/CSU was a major party that kept office for 16 years under Chancellor Helmut Kohl until 1998. It is generally conservative on economic and social policy but was plagued by corruption scandals in the 1990s. The Alliance 90/The Greens (Buendnis 90/Die Gruenen), with 47 seats, was a junior partner in the federal coalition government. The Free Democratic Party (FDP), with a relatively market-oriented, civil libertarian platform, had 43 seats in the Bundestag and was a traditional coalition partner of the CDU/CSU. The Party of Democratic Socialism (PDS), the successor party to the Communist Party of the former East Germany, had 36 seats, maintaining its political base in the poorer eastern states.
The center-left coalition government that took office in 1998 hoped to stimulate economic growth and control the rising government debt. Total German government debt stood at DM1,500 billion, or 61 percent of the GDP in 1998, and federal debt service obligations reached 25 percent of federal revenues. Reducing unemployment and fostering the development of eastern Germany were also high priorities. The government worked to enhance German competitiveness by implementing tax cuts, budget spending restraints, growth incentives, and structural reforms. Pension reforms were aimed at limiting the financial pressure on the public social security system and encouraging citizens to open extra privately funded retirement accounts. Fiscal consolidation and pension reforms were expected to reduce the government debt and to allow further tax reforms, thus cutting corporate income taxes and reducing personal income taxes while broadening the tax base. Tax cuts were designed to provide incentives to growth, by allowing corporations to invest more easily in high technology and by supporting an increase in the export of products through a reduction in the overall tax costs of production.
By 2000 the government had implemented significant tax cuts for low-income taxpayers, a modest tax relief for businesses, and higher energy taxes in return for lower labor costs. In 1999 the corporate tax rate for local companies on profits distributed to stockholders was 30 percent and on undistributed profits it was 45 percent, but under the tax reform this split rate was reduced to a single flat rate of 25 percent applicable also to foreign companies that were once subject to a 42 percent corporate tax on total profits. Additional local taxes still pushed the total rate of taxation for individuals and companies up to around 50 percent. A value-added tax (VAT) applied to all sales and services, at a rate of 16 percent or at a reduced rate of 7 percent. In addition to the VAT, there were numerous excise and other taxes, mainly at the state and municipal levels, including tobacco, gasoline, oil and heating oil, alcohol, stamp duties , and lottery taxes. The government decided to tax energy consumption after 1 April 1999 by a levy on the use of gas, oil and electricity; and after 1 January 2000 further tax increases on energy consumption were implemented.