Die Reihe „Neue Studien zur Politischen Ökonomie“ wird herausgegeben von Prof. Dr. Charles B. Blankart Prof. Dr. Reiner Eichenberger Prof. Dr. Lars P. Feld Prof. Dr. Dr. h.c. mult. Bruno S. Frey Prof. Dr. Gebhard Kirchgässner Prof. Dr. Dr. Christian Kirchner Prof. Dr. Dr. h.c. mult. Friedrich Schneider Prof. Dr. Alois Stutzer Prof. Dr. Hannelore Weck-Hannemann Band 5 Gerrit B. Koester 2.Auflage An empirical analysis of new German data The political economy of tax reforms Nomos 1. Auflage 2009 © Nomos Verlagsgesellschaft, Baden-Baden 2009. Printed in Germany. Alle Rechte, auch die des Nachdrucks von Auszügen, der fotomechanischen Wiedergabe und der Übersetzung, vorbehalten. Gedruckt auf alterungsbeständigem Papier. This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically those of translation, reprinting, reuse of illustrations, broadcasting, reproduction by photocopying machine or similar means, and storage in databases. Under § 54 of the German Copyright Law, where copies are made for use other than private use, a fee is payable to »Verwertungsgesellschaft Wort«, Munich. Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http://www.d-nb.de abrufbar. Die Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available in the Internet at http://www.d-nb.de. Zugl.: Berlin, Humboldt-Univ., Diss., 2007 ISBN 978-3-8329-4131-4 5 Acknowledgments First, I need to thank Charles B. Blankart and Christian Kirchner for their willingness to supervise my thesis. My advisor Charles B. Blankart deserves special thanks for unmatched support und academic guidance throughout my work on this dissertation. Furthermore I have profited especially from comments of Sibylle Schmerbach, Ulrich Kamecke and the participants of the Annual Meetings of the European Public Choice Society in Aarhuus (Denmark) in 2003, Durham (UK) in 2005 (here especially of Stanley S. Winer, Lars P. Feld and Friedrich Heinemann) and Turku (Finland) in 2006. I thank Stephanie Kettler for excellent research support and Sascha G. Wolf, Michaela Blankart, Michael C. Burda, Lisa Cwojdzinski, Erik Fasten, Christoph Gorgas, Antje Hildebrandt, Christian Jansen, Sibylle Lehmann, Simon Margraf, Christoph Priesmeier, Birgit Soellner and Sebastian Schwenen for support and comments. 6 Abstracts What determines tax policy? What motivations do governments follow in tax reforms? Do voters react to tax reductions and tax increases? Based on a new data-set of the fiscal effects of tax reforms in Germany from 1964 to 2004 we are able to offer new insights on the pattern of tax reforms and to test economic hypotheses on tax policy. We show that normative approaches are largely unable to contribute to the explanation of tax reforms in Germany. With respect to polit-economic theories we find that divided government matters, but in the opposite direction of the “gridlock-hypothesis”: tax reforms are larger and more frequent in times of divided government. We do not find evidence for partisan politics but for opportunistic behavior of governments. However the governments´ attempts to manipulate re-election probabilities by tax reductions before elections largely fail: our analyses show that voters react strongly to tax burden changes but take the direction of tax reforms within the whole legislative period (and not just in election years) into account. Was bestimmt die Steuerpolitik? Welche Ziele verfolgen die Bundesregierungen bei Steuerreformen? Haben Steuererhöhungen und Steuersenkungen einen Einfluss auf die Wahlergebnisse? Auf der Basis eines neuen Datensatzes zu den fiskalischen Effekten von Steuerreformen im Zeitraum von 1964 bis 2004 zeigen wir Muster der Steuerpolitik auf und testen zentrale ökonomische Hypothesen. Dabei zeigt sich, dass normative ökonomische Ansätze kaum einen Erklärungsbeitrag für die zu beobachtende Steuerpolitik leisten können. Ausgehend von wichtigen polit- ökonomischen Theorien zeigen wir, dass die Mehrheitskonstellationen im Bundesrat einen wichtigen Einfluss auf die Steuerpolitik haben, allerdings genau umgekehrt wie von der Blockade-Hypothese behauptet: Steuerreformen sind gemessen an ihren Fiskaleffekten bei gegenläufigen Mehrheiten in Bundestag und Bundesrat häufiger und umfangreicher. Des Weiteren gibt es keine Hinweise darauf, dass die parteipolitische Zusammensetzung der Bundesregierung einen wichtigen Einfluß auf Steuerreformen hat. Wahltaktische Terminierungen von Steuerreformen spielen aber sehr wohl eine wichtige Rolle. Eine Auswertung des Zusammenhangs von Steuerreformen und Wahlergebnissen zeigt allerdings, dass die Versuche der Bundesregierungen, ihre Wiederwahlwahrscheinlichkeit durch Steuersenkungen kurz vor der Wahl zu erhöhen, wenig erfolgreich sind: Nicht nur die Jahre unmittelbar vor den Wahlterminen, sondern die Steuerpolitik in der gesamten Legislaturperiode hat einen Einfluss auf die Bundestagswahlergebnisse der regierenden Parteien. 7 Table of Content I Introduction 17 II Structure and development of the German tax system 19 1 The German tax system – overview 19 2 Historical roots of the German tax system 21 3 The development of the German tax system since 1950 22 3.1 Development of the revenue structure 23 3.2 Development of the German tax system in international perspective 24 3.3 Important trends in the development of the German tax system 29 4 The relationship of social security contributions and taxation 32 5 Summary 35 III A new data-set of tax reforms in Germany 36 1 Empirical approaches to the analysis of tax policy 36 2 A new data-set on tax reforms in Germany 38 3 Reliability of the data 40 4 Summary 47 IV Tax reforms in Germany 1964-2004 48 1 New insights on tax reforms in Germany from 1964 to 2004 48 1.1 The role of reunification and temporary measures 50 1.2 New regulations by fiscal effects 50 1.3 Timing of reforms 51 1.4 Increases, reductions and reform intensity in the main taxes 52 1.5 Summary of findings 55 2 Reform patterns in the most important taxes 56 2.1 Wage and income tax 57 2.1.1 Current Regulation (2007) 57 2.1.2 Tax reforms 59 2.1.3 The pattern of tax reforms in the wage and income tax 61 2.1.4 Linking fiscal effects of reforms and revenue developments 63 2.2 Business taxes – corporate profit and local trade tax 65 2.2.1 Corporate profit tax – current regulation (2007) 65 8 2.2.2 Corporate profit tax – reforms 66 2.2.3 Local trade tax – current regulation (2007) 68 2.2.4 Local trade tax – reforms 68 2.2.5 Reforms based on the new data-set 69 2.2.6 Linking fiscal effects of reforms and revenue developments 70 2.3 Value-added tax 72 2.3.1 Value-added tax – current regulation (2007) 72 2.3.2 Value-added tax – history and reforms 73 2.3.3 Fiscal effects of reforms and revenue developments 74 2.4 Main excises: mineral oil and tobacco taxes 75 2.4.1 Current regulation (2007) 75 2.4.2 Mineral oil and tobacco taxes – rates, reforms and revenue development 75 2.5 Property taxes 79 2.5.1 Property taxes: current regulation (2007) 79 2.5.1.1 The local real estate tax – current regulation 79 2.5.1.2 The real estate transfer tax – current regulation 79 2.5.1.3 The inheritance and gift tax – current regulation 80 2.5.2 Property taxes: reforms 80 2.5.2.1 Reforms of standard values 80 2.5.2.2 The real estate tax 80 2.5.2.3 The real estate acquisition tax 81 2.5.2.4 The inheritance and gift tax 81 2.5.2.5 The net wealth tax 81 2.5.3 Fiscal effects of reforms and revenue developments 82 2.6 Summary 84 3 Excursus: Macroeconomic development in Germany 1950-2005 85 V The political economy of tax policy – evidence based on German tax reform data 89 1 The role of international tax competition for tax reforms 91 1.1 Capital mobility, international tax competition and tax policy 91 1.2 The influence of tax competition on tax policy – evidence from tax rates and tax burdens 93 1.3 The influence of tax competition on tax policy 96 2 Normative approaches 97 2.1 The financing and the stabilization function 99 2.1.1 The financing function of taxation 99 2.1.1.1 General approach 99 2.1.1.2 Hypotheses 99 2.1.2 The stabilization function of taxation 100 2.1.2.1 General approach 100 9 2.1.2.2 Hypotheses 100 2.1.3 Empirical testing of the financing and the stabilization hypotheses 101 2.1.3.1 Revenues, expenditure and deficits 101 2.1.3.2 Tests based on annual data 102 2.1.3.3 Tests based on legislative periods 104 2.2 Tax reforms as a reaction to cold progression 106 2.2.1 General approach and hypotheses 106 2.2.2 Empirical tests of tax reforms as reaction to cold progression 107 2.3 Tax smoothing 109 2.4 Summary of findings 109 3 Polit-economic theories 110 3.1 Legislative competencies in tax policy and political development 110 3.1.1 The financial constitution – legislative competencies in tax policy 110 3.1.1.1 Historical development of the German financial constitution before 1950 110 3.1.1.2 Development of the financial constitution since 1950 112 3.1.1.2.1 Tax revenue assignment 112 3.1.1.2.2 Legislative Competencies in tax policy 114 3.1.1.2.3 The current tax policy process 116 3.1.1.2.4 Implications for our study of the political economy of taxation 118 3.1.2 Political development 119 3.1.3 The role of the constitutional court 121 3.1.4 The role of the EU 122 3.1.5 Summary 123 3.2 Polit-economic approaches to tax policy – overview 124 3.3 Status quo bias and inertia in tax policy 126 3.3.1 General approach and related literature 126 3.3.2 Hypotheses 127 3.3.3 Empirical analysis 128 3.4 Fiscal illusion by timing of tax reforms 129 3.4.1 General approach 129 3.4.2 Hypotheses 129 3.4.3 Empirical analysis 130 3.5 Opportunistic behavior 131 3.5.1 General approach and related literature 131 3.5.2 Hypotheses 131 3.5.3 Empirical analysis 132 3.5.4 Summary of results 136 3.6 The partisan politics approach 136 3.6.1 General approach and related literature 136 3.6.2 Hypotheses on partisan interests and tax reforms in Germany 138 10 3.6.3 Empirical analysis 140 3.6.4 Summary of results 143 3.7 The role of divided government: partisan governments in a bicameral legislature 144 3.7.1 General approach and related literature 144 3.7.2 Hypotheses 145 3.7.3 Empirical analysis 145 3.7.4 Summary of results 150 3.8 Combined testing of different approaches 151 3.9 Summary 153 4 Economic voting: The influence of tax policy on elections 154 4.1 Economic voting and tax policy – general approach and related literature 154 4.1.1 Economic voting and tax policy 155 4.1.2 Economic voting and tax reforms – hypotheses 156 4.2 The influence of tax reforms on elections – empirical analysis 156 4.2.1 The independent variable – changes in the vote 157 4.2.2 Empirical analysis of the influence of tax policy on voting 159 4.3 Summary 165 VI Summary and conclusion 166 VII Bibliography 169 11 List of figures Figure 1: Tax revenues and tax mix – Germany 2006 19 Figure 2: Development of the tax/GDP ratio and the tax mix 1913-1950 21 Figure 3: Tax structure development 1950-2006 23 Figure 4: Development of the tax and social security over GDP ratio (OECD 1965-2003) 25 Figure 5: Development of the tax revenues over GDP ratio in the OECD 1965-2003 26 Figure 6: Development of the total income tax revenues over GDP ratio in the OECD 1965-2003 27 Figure 7: Development of the consumption tax revenues over GDP ratio 1965-2003 28 Figure 8: Development of the property tax revenues over GDP ratio 1965-2003 29 Figure 9: Importance of tax revenues for public revenues 30 Figure 10: Development of the number of taxes 31 Figure 11: Development of the tax mix concentration 32 Figure 12: Development of social security revenues and contribution rates 33 Figure 13: Number of tax reforms, new regulations, increases and reductions 39 Figure 14: Fiscal effects of tax reforms (adopted/implemented) 40 Figure 15: GDP elasticity of tax revenues and fiscal effects of tax reforms 42 Figure 16: GDP elasticity of tax revenues and fiscal effects of tax reforms (adjusted for temporary measures) 44 Figure 17: Reforms and new regulations 1964-2004 48 Figure 18: Fiscal effects of tax reforms 1964-2004 49 Figure 19: Tax reforms by size (Histogram) 51 Figure 20: Timing of new regulations 52 Figure 21: Importance of main taxes for tax reductions and tax increases 53 Figure 22: Importance of reductions and increases in main taxes 54 Figure 23: Tax reforms intensity in main taxes 55 Figure 24: Wage and income tax tariff 2005/2007 58 Figure 25: Development of wage and income tax tariffs 1958-1988 60 Figure 26: Development of wage and income tax tariffs 1990-2004 61 Figure 27: Reform pattern in the wage and income tax by fiscal effects of reforms 62 Figure 28: Linking cumulated reform effects and revenue development in the wage and income tax 64 Figure 29: Corporate profit tax rates 1950-2004 67 Figure 30: Tax reform in business taxes by fiscal effects 70 Figure 31: Linking cumulated reform effects and revenue developments in business taxes 71 Figure 32: Fiscal effects of tax reforms in VAT 73 12 Figure 33: Linking cumulated reform effects and revenue development in VAT 74 Figure 34: Tax reforms in mineral oil and tobacco taxes 76 Figure 35: Fiscal effects of tax reforms in mineral oil and tobacco taxes 77 Figure 36: Linking cumulated reform effects and revenue development in main excises 78 Figure 37: Fiscal effects of tax reforms in property taxes 82 Figure 38: Linking cumulated reform effects and revenue developments in property taxes 83 Figure 39: Reform patterns in income, business, consumption and property taxes 85 Figure 40: Economic growth and inflation – Germany 1950-2004 86 Figure 41: Unemployment rate (national definition) and shares in national income 87 Figure 42: Polit-economic interdependencies in tax policy 89 Figure 43: Corporate tax rates – international development 1980-2006 94 Figure 44: Effective tax rates in Germany based on national accounts data 95 Figure 45: Tax competition and business tax reforms 96 Figure 46: Revenues, expenditures and deficits in Germany 1950-2004 101 Figure 47: Expenditure growth and tax reforms (based on legislative periods) 104 Figure 48: Fiscal deficits and tax reforms (based on legislative periods) 105 Figure 49: Real GDP growth and tax reforms (based on legislative periods) 106 Figure 50: Inflation and net fiscal effects of wage and income tax reforms 107 Figure 51: Inflation and fiscal effects of tax reductions in wage and income taxes 108 Figure 52: Changes in tax revenue assignment 1950-2006 113 Figure 53: Legislative processes in tax policy 114 Figure 54: Importance of mandatory co-decision in tax legislation 116 Figure 55: Revenue assignment and legislative competencies (2004) 117 Figure 56: Political development in Germany 1950-2006 119 Figure 57: Cumulated fiscal effects of tax reforms 128 Figure 58: Fiscal illusion and timing of tax reforms 130 Figure 59: Tax reforms and the electoral cycle 132 Figure 60: Wage and income and VAT reforms and the electoral cycle 134 Figure 61: Mineral oil and tobacco tax reforms in the electoral cycle 135 Figure 62: Clienteles of the two main German political parties 138 Figure 63: Progressiveness of VAT and wage and income taxes 139 Figure 64: Fiscal effects of tax reforms by partisan constellation 141 Figure 65: Fiscal effects of reforms by partisan constellation (adjusted for reunification effects) 142 Figure 66: Tax reforms and tax revenue developments under divided and undivided government 146 Figure 67: Influence of divided government on tax reforms 147 Figure 68: Influence of divided government on tax reforms in consumption taxes 148 Figure 69: Influence of divided government on tax reforms in mineral oil and tobacco taxes 149 13 Figure 70: Vote share changes and vote shares of federal governments 1965-2004 158 Figure 71: Effects of real GDP growth on votes changes (legislative periods) 159 Figure 72: Effects of tax reforms on vote share changes 1965-2004 163 Figure 73: Effects of GDP growth and tax reforms in election years and legislative periods on vote changes 164 List of tables Table 1: Tax rates and tax bases of main taxes (2007) 20 Table 2: Data for empirical analyses of tax policy 36 Table 3: Testing the reliability of the expected fiscal effects of tax reforms 46 Table 4: General approaches to the analysis of tax policy 90 Table 5: Normative hypotheses on tax reforms 98 Table 6: Testing the financing and the stabilization hypotheses 103 Table 7: Importance of bicameral legislation in main German taxes 118 Table 8: Polit-economic approaches to the study of tax reform 124 Table 9: Descriptive statistics of tax reforms by political constellation 126 Table 10: Testing positive hypotheses of tax reforms in Germany 1965-2003 152 Table 11: Effects of GDP growth and fiscal effects of tax reforms on vote share changes (election years) 161 Table 12: Effects of GDP growth and fiscal effects of tax reforms on vote share changes (legislative periods) 162 15 Abbreviations ADJ Adjusted AVG average BGBL Bundesgesetzblatt bn billion BVerfGe Federal Constitutional Court (Bundesverfassungsgericht) c.p. ceteris paribus chpt. chapter e.g. exempli gratia ed./eds. editor/editors EKStG Wage and income tax law (Einkommensteuergesetz) Exp. Expenditure f./ff. following GDP Gross Domestic Product GewstG Local trade tax law (Gewerbesteuergesetz) GR Growth rate i.e. id est Infl. Inflation LP Legislative period m million OECD Organization for Economic Cooperation and Development p.a. per annum pp. pages RGBL Reichsgesetzblatt VAT Value-added tax