Can Germany afford a 5% NATO defense spending target?

Tax hikes and soaring debt might be Germany’s new reality, as NATO allies are set to soon face a higher defense spending target.

The country in 2024 spent around 2% of its gross domestic product (GDP) on defense, coming in at over 90 billion euros ($104 billion), according to a NATO estimate. While that expenditure is in line with the existing NATO target, it falls short of the 5% spending goal members of the military alliance have now reportedly agreed on.

Under the new rules, members would be expected to allocate 3.5% of GDP to classic defense spending and 1.5% to broader related matters such as infrastructure and cyber security.

The U.S.-led push for more defense spending has been highly contested, with some NATO members saying they would struggle to assign more funds to such expenditures, while others have been supportive. While Germany has said that it backed the proposal by U.S. President Donald Trump’s, questions linger over whether a 5% target is truly feasible for Europe’s largest economy.

Jumping from a 2% GDP expenditure to 5% would see Germany spend additional tens of billions of euros on defense each year, with Chancellor Friedrich Merz saying earlier this year that 1% of the country’s GDP would represent around 45 billion euros.

These additional expenses will likely have to be financed by loans, Hubertus Bardt, managing director of economic institute IW Koeln, told CNBC.

“Despite this, such an increase will lead to notable distribution conflicts in the country’s annual budget,” he said, according to a CNBC translation. He added that, on top of loans, the Berlin administration would likely also have to hold discussions about implementing funding cuts elsewhere — along with tax increases.

Emilie Hoeslinger, a researcher at the ifo institute, meanwhile pointed to Germany’s recent fiscal U-turn. Berlin’s new rules mean that defense expenditures above a certain threshold are exempt from Germany’s so-called debt brake, which limits how much debt the government can take on and dictates the size of the federal government’s structural budget deficit. Germany also approved a 500 billion euro special infrastructure fund.

“Financing defense expenditures through additional debt gives the government more leeway in the short term,” she said according to a CNBC translation. “But the increased need for debt will lead to higher interest costs in the medium-term, which will weigh on the federal budget,” she said.

Bardt echoed these concerns.

“A complete financing through loans is almost impossible long-term,” he said.

Another potential issue that experts have flagged in discussions around higher defense spending are the European Union’s fiscal rules, which could get in the way of the bloc’s members taking on more debt.

The rules can, however, be temporarily suspended under exceptional circumstances, and some countries including Germany have requested such a reprieve on defense and security grounds.