Gerrit B. Koester, Business taxes – corporate profit and local trade tax in:

Gerrit B. Koester

The political economy of tax reforms, page 65 - 72

An empirical analysis of new German data

1. Edition 2009, ISBN print: 978-3-8329-4131-4, ISBN online: 978-3-8452-1609-6

Series: Neue Studien zur Politischen Ökonomie, vol. 5

Bibliographic information
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. 66 Net profits – as the tax base for corporate taxation – are calculated based on historical costs.99 Local trade tax payments are fully deductible as costs. The corporate tax rate is 25% (independent of distribution or retention) with a 5.5% solidarity surcharge on the tax liability. Dividends distributed to domestic corporate shareholders are tax-exempt, but 5% of the dividend amount are deemed to be a non-deductible expense and are therefore taxed by the corporate profit tax. 2.2.2 Corporate profit tax – reforms A federally unified regulation has applied to corporate taxation since the Erzberg reform of 1920/21 (see part II.2). Since 1950 Germany has had three different systems of corporate taxation (see Figure 29). From 1950 to 1977 corporate profits were taxed independently at the corporate and at the household level. This led to a double taxation of distributed profits and to a heavier taxation of corporate profits in comparison to profits of unincorporated companies (where only income taxes applied). In 1951 tax rates equaled 60% for distributed as well as for retained profits.100 From 1955 on a split rate was applied with 45% for retained and 30% for distributed profits. In 1958 there was a slight increase of the rate for retained profits to 47% and a strong reduction of the rate for distributed profits to 11%.101 In 1977 the system of double taxation was replaced by a so-called “full imputation system” influenced by the idea of a “participant’s tax”.102 This system implemented the idea that double taxation of dividends should be avoided and that corporate profits (including retained earnings) should be taxed according to the personal rate of the stockholder (corporate taxation should be similar to the taxation of partnerships).103 The rates were raised to 36% for distributed and 56% for retained profits. In effect distributed profits were now taxed with the same rates as labor income with the top marginal income tax rate of 56% equaling the corporate tax rate for retained profits.104 In the following years the full imputation system remained in place but the rates were cut substantially. In 1990 a reduction of the rate for retained 99 All expected losses, liabilities and impairments in asset values must be provided in form of write downs or accruals. Unrealized profits, however, may not be included in the tax base until their realization. Inventories are valued at the lower of acquisition cost or cost of production or market value. Costs are allocated on a direct item by item basis if possible. The LIFO (last in first out) method and a moving average or standard cost method are approved for the purpose of simplifying the valuation process and to make the German business sector less vulnerable to inflation. 100 Rates decreased from 65% to 50% in 1948 and increased from 50% to 60% in 1951. 101 Plus a surcharge for Berlin (“Notopfer Berlin”) leading to rates of 15% and 51%. 102 See for details: BGBl I (1976), pp. 2597 ff. 103 For an early proposal of the participant´s tax see Engels/Stuetzel (1968). 104 For profits distributed to incorporated corporations, a setting-off with already paid corporate profit taxes had been possible. Tax exemptions for small companies existed. 67 profits to 50% took place. In 1994 the rates for distributed profits were cut to 30% and a reduction of the rate for retained profits from 50% to 45% was implemented. In 1999 rates for retained profits were cut to 40%. CORPORATE PROFIT TAX RATES - GERMANY 1950-2004 0% 10% 20% 30% 40% 50% 60% 70% 19 50 19 53 19 56 19 59 19 62 19 65 19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01 20 04 Rate for retained profits Rate for distributed profits Introduction of the full imputation system Introduction of the halfincome method Tax rates Figure 29: Corporate profit tax rates 1950-2004 The third system of corporate profit taxation came into effect in 2001 with the introduction of the so-called half-income method in wage and income taxation105 and a strong cut in the corporate profit tax rates to 25% for retained and redistributed profits alike. 106 105 Furthermore the capital gains tax on share disposals of incorporated companies was eliminated from 2002 on to facilitate the sell-off of huge cross-shareholdings between companies. 106 See the discussion of the wage and income tax in the previous part and for details: BGBl I (2000), pp. 1433 ff. 68 2.2.3 Local trade tax – current regulation (2007) The local trade tax is a tax on profits of businesses – unincorporated as well as incorporated. However, income from some independent professions107 and income from agriculture and forestry is exempt from the local trade tax. The tax base of the local trade tax is determined uniformly in Germany by business profits (as defined by the income and corporate profit tax laws), which are adjusted by several additions and reductions.108 Most important is the inclusion of 50% of long-term interest payments in the tax base. Currently the tax exemption level stands at €24,500 and reduced rates apply up to a tax base of €72,500. This leads to far-reaching tax exemption for small companies. The local trade tax payment is deductible from the tax base of the corporate profit tax or – in case of unincorporated companies and distributed profits – personal income tax as well as from its own tax base. This reduces the effective tax burden of the local trade tax substantially. Additionally, owners of unincorporated businesses and business partnerships can reduce their personal income tax payments by around half the local trade tax payment.109 This leads in effect (together with the possible deduction of the tax payment from the tax base of the income tax) to an exemption of owners of non-incorporated businesses from the local trade tax. The federal base rate for the local trade tax on profits is 5%. The municipalities, which receive large parts of their tax revenue from the local trade tax, are allowed to levy a municipal multiplier on the basic tax rate (within certain limits). There is considerable variation between communities the average of this multiple being 389% in 2005. A few local authorities decided to abstain from their right to determine a tax rate or charged a rate considerably less than the average. Therefore, the legislator introduced a minimum local trade tax rate of around 9% in 2004. In 2006 the general average effective tax rate for retained profits (corporate profit and local trade tax) of incorporated companies equaled 38.6%. 2.2.4 Local trade tax – reforms From 1936 on the local trade tax consisted of three different taxes: a tax on profits and permanent interest payments called “trade revenue tax” (“Gewerbeertragssteuer”), a “trade capital tax” on the book value of assets (“Gewerbekapitalsteuer”) and a “payroll tax” on wages and salaries (“Lohnsummensteuer”).110 The tax base of the trade revenue tax included not only profits but as well long-term interest payments, and the trade capital tax included equity as well as long-term 107 As e.g. lawyers or doctors. 108 Defined in § 8 GewStG and § 9 GewStG. 109 See Footnote 93. 110 See for details Hansmeyer (1981), pp. 617 ff. or Zitzelsberger (1990). 69 debt. In the period covered by our data-set especially six important tax reforms took place. The basic tax rates – on which the municipalities apply their individual multiplier – were defined till 1977 by a progressive tax schedule for the trade revenue tax and a proportional rate of 2% for the trade capital and the payroll tax. The first important reform was that the progressive tax schedule for the trade revenue tax was replaced by a common base rate of 5% in 1977. Second the payroll tax, which was not levied in all states111, was abandoned in January 1980.112 The third important reform was that the amount of permanent debt included in the tax base of the trade capital tax and the amount of interest payments included in the tax base of the trade revenue tax were reduced from 100% to 50% in 1984.113 In 1993 the fourth important reform reduced the tax rates of the trade revenue tax for business partnerships for all revenues lower than €72,500.114 The fifth reform was that the local trade capital tax was not introduced in Eastern Germany115 and was completely abandoned from January 1st, 1998 on.116 Finally, the sixth important reform allowed business partnerships and other non-incorporated companies to subtract around half the local trade tax payments from their income taxes after 2001.117 2.2.5 Reforms based on the new data-set Figure 30 shows the fiscal effects of the reforms in corporate profit and in local trade taxes. With respect to the corporate profit tax we see that the number of reforms with important fiscal effects was very limited. In 1968 some tax exemptions for the banking sector were abolished. The change towards the full imputation system and the accompanying rate changes did only lead to very small reductions of tax revenues. The most important fiscal effects followed from the corporate profit tax rate cut to 50% in 1990, to 45% in 1995, to 40% in 1999, and finally to 25% in 2001. An important tax revenue increase resulted from a temporary 1.5 percentage point surcharge on the corporate profit tax in 2002 which was levied to finance reconstruction after the grand Oder-flodding in Eastern Germany in 2002. 111 Not in Bavaria, the Saarland and Baden-Wurttemberg. 112 For details see BGBl I (1979), pp. 1849 ff. 113 A reduction to 60% had already taken place in 1983. See BGBl I (1982), pp. 1532 ff. 114 See for details BGBl I (1992), pp. 297 ff. 115 See BGBl I (1991), pp. 1322 ff. 116 See for details BGBl I (1997), pp. 2590 ff. 117 However, this had only fiscal effects on income tax revenues and is therefore not reflected in the fiscal effects of reforms in the local trade tax. 70 -0,5% -0,4% -0,3% -0,2% -0,1% 0,0% 0,1% 0,2% 0,3% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 INCR/GDP RED/GDP BUSINESS TAX REFORMS, 1964-2004 CORPORATE PROFIT TAX -0,2% -0,1% 0,0% 0,1% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 INCR/GDP RED/GDP LOCAL TRADE TAX Increase of tax exemption level Abolishment payroll tax Reduction of included long-term interest Abolishment of trade capital tax Reduction of tax rates for small businesses Tax rate cut to 25% Tax rate cut to 45% Tax rate cut to 50% Reduction of tax exemptions in banking Tax rate cut to 40% Fi sc al e ffe ct s ta x re fo rm s/ G D P Fi sc al e ffe ct s ta x re fo rm s/ G D P Temporary rate increase to 26.5% Own calculations based on: Federal Ministry of Finance (2004)/Tax laws.Reforms by date of implementation. Figure 30: Tax reform in business taxes by fiscal effects With respect to the local trade tax, our data-set includes only the changes on the federal level and not the changes of the municipal multipliers which decide on the concrete tax rate. Here we observe as well especially reductions of the tax burden, and the strongest fiscal effects took place already in the early 1980s. The most important reforms (with respect to fiscal effects) were the abolishment of the payroll tax (1980), the reduction of the interest on permanent debt included in the trade revenue tax (1984), the reduction of the tax rates for small businesses (1993), and the abolishment of the trade capital tax in 1998. 2.2.6 Linking fiscal effects of reforms and revenue developments The importance of business taxes (corporate and local trade taxes) in revenue terms increased strongly after the Second World War until the early 1960s (see Figure 31). From then on the revenue share of business taxes (over all tax revenues) showed a downward trend. While revenues of the local trade tax were decreasing slowly and at relatively constant pace, the corporate profit tax revenues were far more volatile. Corporate profit tax revenues decreased strongly till the early 1970s then increased again from 1977 till 1987 and decreased again till 1996. After a strong increase till 71 2000, corporate profit tax revenues were nearly zero in 2001, before they rose strongly again (albeit to a low level). Cumulated fiscal effects of reforms (see the lower part of Figure 31) showed a continuous downward trend in the local trade tax. With respect to the corporate profit tax, we observed important effects based on tax reductions only after 1990. However, the effects strongly accelerated from 1999 on. The link between tax reforms and revenue developments in business taxes seems to be far less direct than for example in wage and income taxes. This results partly from the fact that our data-set does not cover rate changes in the local trade tax which directly affect revenues. BUSINESS TAXES - GERMANY 1950-2004 0% 5% 10% 15% 20% 25% 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 BUSINESS TAX REVENUES CORPORATE PROFIT TAX REVENUES LOCAL TRADE TAX REVENUES -4% -2% 0% 2% 67 70 73 76 79 82 85 88 91 94 97 0 3 Cumulated fiscal effects of tax reforms/Total tax revenues Corporate tax Local trade tax Revenues/Total Tax Revenues Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office (2007).Reforms by date of implementation. Figure 31: Linking cumulated reform effects and revenue developments in business taxes Although we are not attempting to explain the revenue development in detail here,118 we can nonetheless point out the important reforms which are reflected in our data on the fiscal effects of tax reforms. The important corporate tax rate cuts throughout 118 As it depends especially with respect to corporate and local trade taxes on many factors. 72 the 1990s went along with the strong reduction in corporate tax revenues which even collapsed to zero in 2001.119 With respect to the local trade tax, we cannot see important reforms directly reflected in tax revenue developments, but the continuing overall downward trend of revenues (as a share of total tax revenues) throughout the period analyzed generally goes along with the continuing reductions of the tax base via tax reforms. 2.3 Value-added tax 2.3.1 Value-added tax – current regulation (2007) The German value-added tax (VAT) is a tax on the net value-added at every stage of production with a deduction for prepaid VAT on purchases. Here VAT is first levied on all sales, and then pre-tax VAT payments on previous steps in the value-creating process are subtracted to derive the final tax liability. In practice, suppliers of goods and services must add VAT to the net prices of their sales and pay VAT to the tax offices with an entitlement to credit for VAT paid on their input. Currently, the normal VAT rate equals 19% (since 2007) and a reduced rate of 7% applies to special goods like food items, books, newspapers and local public transportation. The most significant exemptions from the VAT are the banking and insurance businesses120, sales of land and buildings, services of hospitals and medical doctors, and most cultural institutions. Special tax rates and flat-rate input tax deductions apply to farming and forestry businesses. The EU has started various attempts to harmonize national VAT systems of member states.121 So far EU regulation is mainly restricted to a minimum tax rate of 15% and several regulations for reduced rates.122 119 Due to the former imputation system for companies that had been subject to the corporate profit tax, the change of the tax regime at the end of 2000 resulted in large corporate profit tax reserves which could be released from 2001 onwards. This led directly to a collapse of corporate tax revenues and to a modification in the corporation tax reform act restricting the possibilities to release corporate profit tax reserves. For details on the consequences of the reform on revenue development see Menck (2001). 120 In the insurance business the insurance tax, which has the same rates as the VAT, applies. 121 In Germany – as in all other EU states – the destination principle is implemented, where all goods and services are taxed with the VAT rates valid in the country where the good is finally sold to the customer. Exports are therefore VAT exempt and imports are taxed by the VAT of the importing country. With respect to private customers, the origin principle applies (with the exemption of automobiles and mail-order trade). For an economic discussion of the general principles see Sinn (1990). 122 See EU (2002), pp. 51 ff.

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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 zeigt das Werk Muster der Steuerpolitik auf und testet 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 zeigt der Autor, 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.