German Bundesrat upper house of parliament backed on Friday an increase in value-added tax (VAT), clearing the way for the country's biggest post-war tax rise from the beginning of next year.

The three percentage points hike in VAT to 19 per cent from next January is one of the government's flagship policies and aims to ease the strain on Germany's public finances. Economists say it could choke off a recovery in Europe's largest economy.

"In my view, we have no alternative," Finance Minister Peer Steinbrueck said of the measure in a speech to the Bundesrat.

Revenue from the VAT rise will be used to cut social security contributions and consolidate the budget so Germany can comply with European Union deficit rules that it has breached every year since 2002.

The Bundesrat voted the measure through after Chancellor Angela Merkel's chief of staff met German state leaders late on Thursday to allay their concerns about an accompanying measure that would cut federal subsidies for local transport networks.

State leaders had threatened to delay adoption of the bill by sending it to a mediation committee to work on the subsidy cuts, but dropped their opposition after the government agreed at Thursday's talks to ease the size of the subsidy reductions.

The Bundesrat's approval of the measure relieves some pressure on Merkel's ruling coalition of conservatives (CDU/CSU) and Social Democrats (SPD), which has laboured under doubts that it is strong enough to push through controversial reforms.

The VAT increase, reform of the health insurance system and changes to the corporate tax regime are seen as the major tests.

President Horst Koehler must now sign the VAT bill for it to take effect as law a step that is seen as a formality.

Growth threat

Originally a conservative party campaign pledge, the VAT plan was adopted by the grand coalition with minor changes despite pre-election condemnation from the Social Democrats.

Steinbrueck, a Social Democrat, has said tax increases could have negative effects on growth and domestic demand but he nonetheless pushed ahead with the plan to help address Germany's strained public finances.

Andreas Pinkwart, finance expert for the opposition liberal Free Democrats (FDP) attacked the VAT hike, saying it would hit consumer spending, reduce corporate profits and restrict growth.

"Fewer jobs, higher welfare costs and tax revenue shortfalls will be the result of this," he told the Bundesrat, adding that the measure would fuel inflation, influence wage talks and drive up interest rates.

"The European Central Bank will follow up the interest rate increases there have been with additional ones," he said.

This in turn, he said, would make it harder for Germany to reduce its existing debt burden of some 1.5 trillion euros (US$1,899 billion).

Some analysts have favoured scaling back the extent of the VAT rise to ease pressure on the economy. In a sign Germany's economic recovery may be peaking, a report on Tuesday showed investor morale fell more sharply than expected in June.

Source: China Daily