Berlin : - A lack of state funding could seriously hamper efforts to cut taxation and balance the budget over the next four years, politicians drawing up Germany's new government coalition warned on Thursday.

The warning came as a three-way team of Chancellor Angela Merkel's Christian Democrats (CDU), their Bavarian Christian Social (CSU) sister party and the pro-business Free Democrats (FDP) met to review progress after three days of coalition talks.

All three party leaders - Merkel, the FDP's Guido Westerwelle, and Horst Seehofer of the CSU - were present at Thursday's review.

The party heads were to examine an overview of the state's budgetary health, prepared by the sub-committee discussing finance issues, which showed that there was little room for new funding allocations.

Taxation is a key area of conflict between the CDU and FDP, who jointly won a parliamentary majority in September's general election.

The FDP is pushing for an overhaul of the tax system, to deliver tax reductions of 35 billion euros (51 billion dollars). Merkel's CDU wants more modest cuts, amounting to
15 billion euros. The CSU also supports greater tax cuts.

An initial achievement was the previous night's decision to absorb Germany's financial oversight body, BaFin, into the German Bundesbank, or central bank.

After eight hours of discussions, Head of the Chancellery Thomas de Maiziere of the CDU and the FDP's financial expert Otto Solms said the move would not threaten the independence of the Bundesbank.

In total, ten sub-committees are hammering out joint government policies for the next four years, to be sealed in a binding CDU-FDP coalition agreement. Decisions over ministry appointments will be made toward the end of the process.

Areas of conflict between the CDU and FDP include healthcare funding, which the FDP would like to restructure, and FDP plans to curb state surveillance measures.

Proposals are also being discussed to extend the life-spans of nuclear energy stations beyond a deadline set for the year 2020.

However, most squabbles come down to decisions over the distribution of dwindling state funds, as the economic crisis has pushed Germany into unprecedented levels of public debt.

Both CDU and FDP campaigned on pledges to cut taxes.

Initial relief could come early 2010, in the form of greater tax exemptions for families, at a cost of 3 billion euros. A proposed 35-euro increase in child benefits would cost an additional 7.5 billion euros.

"This is simply unaffordable," was Thursday's message from the finance sub-committee.(dpa)