56 Our analyses by kind of tax revealed that tax burden reductions were strongly dominated by wage and income taxes, while consumption taxes played an important role in tax burden increases. Taking increases and reductions together we found the highest tax reform intensity in wage and income taxes, followed by wealth taxes, mineral oil taxes, corporate profit taxes, VAT and the local trade tax. 2 Reform patterns in the most important taxes So far we have analyzed the overall patterns of reforms based on our new data-set. Now we move on to the analysis of reform patterns within different kinds of taxes. What were the most important reforms (with respect to their fiscal effect) in the main taxes? How did the patterns of fiscal effects of reforms look like for different taxes? How were revenue developments and fiscal effects of reforms linked? 76 We start with the income and wage tax and then move to business taxes, followed by a treatment of VAT and major excises. Finally, we review the most important developments in property taxes. With respect to each tax we shortly review the current regulation and the most important tax reforms in the period analyzed. Then we examine how these reforms are reflected in our data-set of fiscal effects of tax reforms and discuss the pattern of reforms separately for the main German taxes. Finally, we link the reform patterns in the main taxes to revenue developments. An excursus on the macroeconomic development in Germany – as a background for the discussion of revenue developments – closes this part. 76 Overviews of the development of the German tax systems can be found in Boss (1987) (focusing on the 1950s), Offerhaus (1997) (covering 1961-1983), Kruer-Buchholz (1982) (focusing on the time before 1975), Muscheid (1986) (covering 1950-1982), Engels (1989) (focusing on the 80s), Johann (2006) (covering 1983 to 1998) and Leibfritz et al. (1998). An international comparative assessment of tax reforms (excluding Germany) can be found in Sandford (1993). An extensive discussion of the development of the US-American tax system in the 60s, which uses a structure similar to the one applied here is Pechman (1971). A discussion of tax reforms in the US based on their fiscal effects can be found in Schick (1991). 57 2.1 Wage and income tax 2.1.1 Current Regulation (2007) TAX BASE All resident individuals in Germany77 are subject to income tax on the their worldwide income from the following seven sources: agriculture and forestry, trade or business enterprises, professional services, employment (wages and salaries), capital investments (interest and dividends), rents and royalties and certain other sources of income designated in the income tax act (e.g. pension payments, speculative gains or alimonies). While the first six kinds of income can be linked to Fuisting´s source theory of taxable income (stating that only regularly income should be taxed), the seventh category expands the definition of taxable income towards the Schanz/Haig/Simons (SHS) income definition which defines taxable income as consumption plus changes in wealth. This makes the German income tax definition a mixture of the “SHS theory” and the “source theory”.78 Profits that do not fall into the seven income sources are tax free.79 As Germany has a synthetic income tax, the net income of each of the seven income sources is calculated separately (income after deduction of expenses) and then added together. The most important exemption are corporate profits distributed to individuals, which are subject to the so called half-income method since 2001. For distributed corporate profits the corporate tax (with a normal rate of 25%) has the form of a final withholding tax, but only 50% of the dividends are included as income in the income tax calculation.80 Deductible expenses are especially expenditure to acquire, secure and maintain revenue,81 certain annuities and church taxes, but interest payments on consumer loans are not deductible. Special tax allowances (as e.g. for insurance contributions or extraordinary expenses) are then deducted from the total income to arrive at the taxable income. TAX RATES The German tax schedule is based on a formula of arithmetic progression and therefore contains no brackets. Income up to €7,664 per year is tax-exempt. For annual income from €7,664 on, marginal tax rates rise in steady, steep and linear progression from 15% to close to 24% at €12,740 and then in steady linear progression to the top marginal income tax rate of 42% for all taxable income above €52,152. Since 2007 a marginal rate of 45% applies to income above €250,000. Income tax law is 77 Individuals who do not have their residence or customary place of domicile in Germany are subject to tax liability only on income from domestic sources. 78 For a detailed discussion see Blankart (2006), pp. 270 ff. 79 As e.g. lottery winnings, sale of privately owned capital assets except for the capital gains derived from transactions realized within a defined time frame. The taxation of capital income (including capital gains) will be changed from 2009 on. 80 Special regulations apply for low-income households. 81 “Operational expenses” and costs incurred on earning income. 58 strictly based on the nominal-value principle and does not provide for indexation (with the effect that the average tax rate on real income increases constantly with inflation). 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 0 30 00 57 00 84 00 11 10 0 13 80 0 16 50 0 19 20 0 21 90 0 24 60 0 27 30 0 30 00 0 32 70 0 35 40 0 38 10 0 40 80 0 43 50 0 46 20 0 48 90 0 51 60 0 54 30 0 57 00 0 59 70 0 62 40 0 65 10 0 67 80 0 2005 Marginal 2005 Average TAXABLE INCOME (€) TAX RATE INCOME TAX SCHEDULES (2005) Data source: Federal Ministry of Finance (2006). Figure 24: Wage and income tax tariff 2005/2007 PARTICULARITIES: Especially four particularities are important. First, a 5.5% solidarity surcharge on the tax liability is levied – used to finance the ongoing support of Eastern Germany after reunification in 1990.82 Second, members of the catholic and protestant churches pay an extra 8 to 9% surcharge on their income tax liability (church tax) which itself qualifies as an itemized deduction from the income tax base. Third, married couples may elect to be assessed either jointly or separately. In the case of joint assessment, the net income accruing to each spouse is aggregated and the couple is treated as a single taxpayer. Income tax is then determined by a joint income-splitting-system, with the tax being computed according to the general tax schedule on one-half of the joint income and the result being doubled. Finally, child benefits are paid in form of a tax credit and amount to €154 per month for the first three and €179 for the fourth and subsequent children. In the wage and income tax assessment, a child allowance 82 Wages and salaries below a certain threshold are free of the surcharge. 59 of €5,808 per child replaces the tax credit if it leads to higher relief (which is only the case for tax payers with high taxable incomes). 2.1.2 Tax reforms Wage and income taxation in Germany is highly complex and in a state of constant change. In our data-set we find alone more than 800 different regulations that had an effect on wage and income taxes. In our discussion of tax reforms we start with the most important reforms of the tax tariff. Then we move on to the reform pattern in our data-set to evaluate the importance of tariff reforms and identify other important reforms with large fiscal effects.83 Tariff reforms We observe 20 different income tax tariffs in Germany from 1950 to 2007.84 14 of these fell into the period analyzed in our data-set (1965-2003)85. The relevant tariffs for our analysis can be summarized into two groups: 1965 to 1988 (see Figure 25) and 1990 to 2004 (see Figure 26). 83 For a discussion of the reforms in the wage and income tax in Germany since 1950 see Bareis (1999), Dziadkowski (2005) and Zimmerer (1996). 84 1951, 1953, 1957, 1958, 1965, 1975, 1978, 1979, 1981, 1986, 1988, 1990, 1996, 1998, 1999, 2000, 2001, 2004, 2005, 2007. 85 If we restrict our data-set to the years which are completely covered. 60 INCOME TAX SCHEDULES, GERMANY, 1958-1988 0% 10% 20% 30% 40% 50% 60% 60 0 66 00 12 60 0 18 60 0 24 60 0 30 60 0 36 60 0 42 60 0 48 60 0 54 60 0 60 60 0 66 60 0 72 60 0 78 60 0 84 60 0 90 60 0 96 60 0 10 26 00 10 86 00 11 46 00 12 06 00 12 66 00 13 26 00 13 86 00 14 46 00 15 06 00 1958 1965 1975 1978 1979 1981 1986 1988 TAXABLE INCOME (DM) MARGINAL TAX RATE Data source: Federal Ministry of Finance (2006). Figure 25: Development of wage and income tax tariffs 1958-1988 Figure 25 shows the wage and income tax schedules (marginal tax rates) from 1958 to 1988. All tariffs in this period were characterized by a relatively low exemption level, a steep progression of marginal tax rates in the middle income range and a constant marginal top rate of in between 53% and 56%. The top rate was applied from an income of around €61,400 (roughly DM120,000) on. From 1958 on there was a general trend to increase the exemption level and to moderate the tax rate progression for lower and middle incomes. In 1990 the so-called linear-progressive tariff was introduced (see Figure 26). The most important change was the transformation of the tariff structure in the middleincome range. The introduction of linear progression reduced marginal tax rates for middle incomes and especially strongly for incomes around €30,700 (around DM60,000). From 1990 to 2005 the general trend to increase the tax exemption level continued – partly pushed by a ruling of the constitutional court (see part V.3.1). Furthermore, there was a continuous reduction of the highest and the lowest marginal tax rates. The top marginal rate was cut from 53% in 1990 to 42% in 2005 and the lowest marginal rate from 19% in 1990 to 15% in 2005.86 86 For a more detailed discussion see Corneo (2005). 61 INCOME TAX SCHEDULES, GERMANY, 1990-2004 0% 10% 20% 30% 40% 50% 60% 60 0 66 00 12 60 0 18 60 0 24 60 0 30 60 0 36 60 0 42 60 0 48 60 0 54 60 0 60 60 0 66 60 0 72 60 0 78 60 0 84 60 0 90 60 0 96 60 0 10 26 00 10 86 00 11 46 00 12 06 00 12 66 00 13 26 00 13 86 00 14 46 00 15 06 00 1990 1996 1998 1999 2000 2001 2002 2004 TAXABLE INCOME (DM) MARGINAL TAX RATE Data source: Federal Ministry of Finance (2006). Figure 26: Development of wage and income tax tariffs 1990-2004 2.1.3 The pattern of tax reforms in the wage and income tax Figure 27 shows the fiscal effects (increases, reductions and net effects over GDP) of reforms in the wage and income tax for the period from 1965 to 2004 (based on the date when they became effective). We exclude temporary measures which took place especially in the early 1970s.87 We see that fiscal effects of tariff changes dominated the tax reform pattern. The first important reduction took place with the tariff reform of 1965 followed by a period of relatively little reform activity. In 1975 a series of major reforms started with tariff changes in 197588, 1978, 1979 and 1981. All these reforms reduced the tax burden substantially by rate cuts. Tax burden increases by base broadening measures played nearly no role in these reforms. A large tax reform in three steps 87 We exclude the tax reforms aimed at stabilizing the business cycle especially from 1967 to 1975 (as e.g. temporary surcharges on wage and income and corporate taxes). For further details see excursus on temporary measures in part III.3. 88 The tariff reform in 1975 included an abolishment of the possibility to reduce taxable income in the wage and income tax by wealth tax payments. This had effectively reduced the wealth tax payments for households with high incomes by around 50% before 1975. 62 from 1986 to 1990 was the first to include substantial base broadening (in the last step in 1990), although the overall effect of the reform was a strong tax relief. -2,0% -1,5% -1,0% -0,5% 0,0% 0,5% 1,0% 1,5% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 INCREASES REDUCTIONS WAGE AND INCOME TAX REFORMS Tarif 1965 Tarif 1975 Tarif 1978 Tarif 1979 Tarif 1981 Tarif 1986 Tarif 1988 Tarif 1990 Tarif 1996 (including new regulation child subsidies) Tax reduction for pension provisions Tarif 2001 and imputation of local trade tax Tarif 1999 Tarif 2000 Solidarity surcharge Increase of threshold for interest income Several tax subsidy cuts Withholding tax on interest New regulation of child subsidies Increase of solidarity surcharge Cut of tax subsidies and base broadening in income taxes Fiscal effects of reforms /GDP Half-income method Own calculations based on: Federal Ministry of Finance (2004)/Tax laws.Reforms by date of implementation. Adjusted for temporary measures. Figure 27: Reform pattern in the wage and income tax by fiscal effects of reforms The next tariff reform took place in 1996, closely followed by new tariffs in 1998, 1999, 2000, 2001 and 2004. After 1996 we observed tax burden reductions of a similar size as from the mid-1970s to 1990, but here tax burden reductions – mostly driven by cuts in rates – were accompanied by strong tax burden increases which resulted partly from base broadening measures. Besides the tariff changes, reforms with important fiscal effects were relatively limited. Our data-set shows high fiscal effects (see Figure 27) especially for the six following changes: The first was a reform of the taxation of interest. Interest income had always been taxable in Germany within the wage and income tax, but taxation was largely evaded. To enforce taxation of interest income within the wage and income tax, an interest withholding tax of 25% at the source was introduced in 199389 for all inter- 89 To reduce tax evasion, a 10% withholding tax on interest income had already been introduced in January 1989 (together with a doubling of the tax-exempted interest income) but was abolished again already in June 1989 after massive outflows of capital took place. 63 est income above DM6,000 (€3,068). In the annual income tax assessment the withholding tax paid at the source could be offset against the total income tax liability.90 The tax rate of the withholding tax was increased to 30% in 1998.91 In 2004 the exemption level for tax-free interest income was reduced to €1,421. Second, the introduction of a solidarity surcharge of 3.75% on wage and income tax payments led to important fiscal effects in 1991. The surcharge was abolished in 1993 but re-introduced in 1995 with a higher rate of 7.5%. From 1995 on the surcharge was reduced to 5.5%. Third, the reform of the child support system and an increase in the child subsidy in 1996 led to strong tax burden increases and reductions at the same time. A fourth important reform was the introduction of the so-called half-income method for the taxation of dividends in 2001.92 A fifth important change was that business partnerships, independent professionals, and non-incorporated companies have been allowed to subtract around half the local trade tax payments from their income taxes since 2001 leading to a substantial reduction of income tax revenues.93 Finally, the introduction of tax reductions for old-age provisions in 200294 led to a strong reduction of the tax burden in wage and income taxes. 2.1.4 Linking fiscal effects of reforms and revenue developments The wage and income tax is – in revenue terms – the most important tax in Germany. The share of the wage and income tax in total tax revenues increased from 22% in 1950 to 45% in 2001 and fell back only slightly to 40% in 2004 (see Figure 28). 90 Including interest income. 91 With a slight increase in tax-exempted income to DM6,100/€3,119. 92 Under the half-income method the corporate tax (with a normal rate of 25%) on distributed corporate profits has the form of a final withholding tax. To limit double taxation, only 50% of the distributed corporate profits are included as income in the income tax calculation. For details see BGBl I (2000), pp. 1433 ff. 93 The tax code foresees that 1.8 times the federal tax measure for the local trade tax – which is normally 5% of the tax base (lower rates apply for small companies) – can be subtracted from the personal income tax payment. As the average municipal multipliers equaled 387% in 2003 (leading to a nominal tax rate of 21.5% and an effective rate of 17.7% (taking the deductibility of the local trade tax from its own base into account)), this equals roughly 50% of the local trade tax liability. See for a discussion: Blankart (2006), pp. 270 ff. 94 Including the “Riester-Rente”. 64 WAGE AND INCOME TAX REVENUES - GERMANY 1950-2004 0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00% 35,00% 40,00% 45,00% 50,00% 19 52 19 55 19 58 19 61 19 64 19 67 19 70 19 73 19 76 19 79 19 82 19 85 19 88 19 91 19 94 19 97 20 00 20 03 WAGE AND INCOME TAX WAGE TAX (CORR) ASSESSED INCOME TAX (CORR) NOT ASSESED INCOME TAXES FROM EARNINGS INTEREST WITHHOLDING -60% -40% -20% 0% 67 70 73 76 79 82 85 88 91 94 97 0 3Cumulated fiscal effects of tax reforms/Total tax revenues Revenues/Total Tax Revenues Own calculations based on: Federal Ministry of Finance (2004)/ Federal Statistical Office(2007).Reforms by date of implementation. Figure 28: Linking cumulated reform effects and revenue development in the wage and income tax95 What do we find if we compare the general revenue developments with the cumulated fiscal effects of tax reforms? In Figure 28 we see that the share of wage and income tax revenues over all tax revenues increased strongly from 1950 to 1975. Strong economic growth (see excursus on the macroeconomic development in part IV.3) pushed revenues up as wage and income tax revenues grow over proportionally with GDP resulting from the progressive tax schedule. In 1965 the tariff reform with important tax burden reductions slowed down this upward trend. Strong increases in nominal GDP – largely driven by inflation – in the early 1970s led again to a strong increase in the revenues of the progressive income and wage taxes until 1975 (partly driven by cold progression). From 1975 on cumulated reform effects 95 Official statistics, which are widely used for economic analyses, are at least partly distorted. The statistics tend to overstate revenues of wage taxes while revenues of the assessed income taxes are understated. Most importantly, tax returns based on annual wage tax assessments are subtracted from assessed income tax revenues and not from wage tax revenues. Additionally, a subsidy for occupied housing and an investment subsidy are subtracted from the assessed income taxes. See for a detailed discussion BDI (2004). In our figure we have corrected the data for these three factors. The most important change compared to the uncorrected data is that the upward trend in the share of wage tax revenues flattens after 1975 while the downward trend in assessed income tax revenues is moderated. 65 (see the lower part of Figure 28) showed a strong and continuing downward trend. These tax burden reductions led to a stabilization of revenues from wage and income tax revenues from 1975 on. The only major exception resulted from the corporate tax reform which increased the incentives to distribute accumulated retained profits and therefore led to a strong increase of not assessed income from earnings in 2001. Based on federal tax statistics the revenues of the wage and income tax can be split in between wage taxes, assessed income taxes, not assessed income taxes from earnings (mostly capital income) and finally (since 1993) revenues from the interest withholding tax. Here we see that the share of the wage tax component of total tax revenues grew especially strongly from 1965 to 1975 while the assessed income tax showed a slight downturn. What caused this development – macroeconomic factors or tax reforms? Our data-set shows that there were no major tax burden increases or reductions in between 1965 and 1975. This points strongly in the direction of a macroeconomic explanation. From the macroeconomic perspective, a first explanation is that the share of income from dependent labor in the economy increased – based on national accounts – strongly from 65% in 1965 to 73% in 1975 while income from entrepreneurship and wealth (which is linked to income tax revenues) showed the opposite development.96 One alternative explanation could be that recipients of wages had fewer possibilities (than recipients of other income) to avoid the effects of high inflation97 on the progressiveness of their taxes. 2.2 Business taxes – corporate profit and local trade tax The corporate profit and the local trade tax are the most important business taxes in Germany. We start our discussion with the corporate profit tax and then move on to the local trade tax. 2.2.1 Corporate profit tax – current regulation (2007) While income of unincorporated companies is subject to the synthetic income tax, corporations, limited partnerships, and other entities of similar standing (such as branches of foreign corporations whose registered domicile or place of management is in Germany) are liable for corporate income taxes on their worldwide income irrespective of its source.98 96 However, this is unlikely to be a sufficient explanation, because a similar development had taken place from 1958 to 1965 with no similar effect on tax revenues. See the excursus on macroeconomic development in part IV.3. 97 Especially from 1970 to 1974. 98 Except where a double tax treaty provides for specific exclusions.