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Leafing through a brown leather scrapbook, Sven Romeike traces the history of his family-owned business back three generations. There's a photo of his grandfather in billowing white overalls when the painting company was founded in 1932. There are his father and uncle when they took over the business in the prosperous 1970s. But what's missing are pictures and pleasant memories from the last couple of years during Sven's management, when the business collapsed and forced him to file for liquidation. "It's been very painful, very sad. It was terrible to have to dismiss my workers," Romeike says. "My career has been a big disappointment."

Yet Romeike's troubles are not entirely of his own making. They stem from a thicket of high taxes, stifling bureaucracy and labor-market rigidity that has dogged Germany in recent years. Romeike faced price competition from craftsmen from the former East Germany, as well as unemployed painters willing to work in the "black economy" without paying taxes. Burdened with a staff of highly paid painters, the 37-year-old Romeike says he was underbid for just about every job. "A company like ours can't adjust to the market situation because we can't dismiss people," he says. "They have been working here for 20 to 30 years and they can't be laid off because laws are too strict or severance pay too high." The result: his 20 employees all lost their jobs without compensation when Romeike filed for liquidation in February last year.

Romeike's plight has become a familiar part of the economic landscape in Germany, as bankruptcies reach historic proportions. According to Creditreform, a company that tracks bad debts, the number of insolvencies in Germany in the first six months of the year was 18,800, an increase of more than 25% over the year before. While high-profile company failures like construction firm Philipp Holzmann and cell-phone service MobilCom draw the headlines — and the government bailouts — it's small companies like Romeike's that have borne the brunt of the economic downturn. "Small- and medium-sized companies are dying out because the political framework is so bad," says Mario Ohoven, president of the Federal Association of Middle-Sized Companies. "Germany has the second-highest taxes in Europe. The more tax a company pays, the less it earns, and the less capital it has in times of crisis."

Higher costs mean it's more difficult for German firms to compete with foreign companies. According to Ohoven, a qualified printer earns €21 an hour in Germany, €14.87 in Britain and just €4 an hour in the Czech Republic. And Germany has the highest non-wage costs — such as pension and health-insurance contributions — in all of Europe, reaching 43.5% of salaries, Ohoven says.

Dirk Andres, a prominent bankruptcy lawyer, says his case load has swelled to 440 bankruptcies in the first nine months of this year, compared to 360 cases in all of last year. Family companies are often overwhelmed by emotion in the face of insolvency, which requires the appointment of an outside administrator while the company restructures. "They cry in court or are in a state of shock," Andres says. The main cause of bankruptcies, according to Andres, is that small companies can no longer pay their mounting tax bills. When German companies bill clients, they must pay the government 16% value-added tax up front. When clients are late in paying, the outstanding taxes can sink a struggling firm.

The biggest problem for small German companies like Romeike's is a wage system known as the tariff. Wage rates for each occupation are negotiated on a national basis by employers' associations and trade unions. There is one rate for all of western Germany and generally lower pay for the states of the former East Germany. So rather than paying what he could afford to stay competitive, Romeike was forced to pay his staff according to West German tariff levels of €12.50 an hour, because his company has its office in West Berlin. He says he had to charge customers €30 an hour just to break even. Just over the boundary in neighboring (and formerly communist) Brandenburg, painting companies charge less because they have lower labor costs. What's more, a steady stream of qualified but illegal workers from Poland, Hungary and the Czech Republic is willing to work for wages as low as €3 an hour. "Those who pay honestly go down the drain in the end," Romeike says.

Michael Pietsch, one of Romeike's former painters, lost his job in March 2001. "I was shocked because it was an old, established company," Pietsch says. "I blame the state for letting all these workers from Poland, Spain and Portugal work here." Andreas Borchardt worked at Romeike for 11 years before being laid off. Now he runs his own company with two employees. "You have to pay health insurance, trade associations and taxes. And they all want your money, no matter where you get it from," he says.

Filing for liquidation is just the final legal step before closing a company down, so these days Romeike's firm is barely surviving. In the 1990s, he borrowed €175,000 from his personal savings to keep the company afloat. He now works by himself trying to earn his money back. Although he apprenticed as a painter at the company, he mainly worked as a supervisor. Now he has returned to painting. As a creditor to the company, he does not have to pay taxes on the money he earns. So he works 65-hour weeks as a subcontractor with no vacations, charging well below the tariff to ensure a steady stream of jobs. He has been forced to sell property to pay off the banks. To help make ends meet, his wife has gone to work as a cashier in a discount food store.

Romeike says he has nothing but regret that he followed his father into the company, just as his father followed his grandfather. "If I started working in a large company I would be earning far more money now and have far fewer worries," he says. For his next job he says he will probably avoid the painting business because of the precarious state of the economy. What he's really good at, he says, is managing crisis. Given the state Germany's in, that skill is likely to come in handy.

• CHARLES P. WALLACE / Berlin
• German state policies toss smaller firms into bankruptcy