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. 73 2.3.2 Value-added tax – history and reforms In 1916123 a sales tax124 of 0.1% was introduced which was expanded in 1918 to a general sales tax with a rate of 0.5%. The rate of this general sales tax was increased several times.125 To abolish incentives for vertical integration (resulting from the cascaded form of the tax), the sales tax was transformed into a value-added tax from 1968 on with a normal rate of 10% and a reduced rate of 5% on sales of specific goods as e.g. certain basic food items, books, newspapers, antiques and specific services.126 Furthermore, the tax base was expanded. Afterwards the most important reforms of the VAT were several rate increases in between 1968 and 2007 (see Figure 32).127 VAT REFORMS -0,2% -0,1% 0,0% 0,1% 0,2% 0,3% 0,4% 0,5% 0,6% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 5 Increases Reductions Rate increase VAT (12%/6%) Abolishment of tax exemptions Introduction VAT (Jan) and rate increase (Jul) to 11%/5.5% Rate increase VAT (13%/6.5%) Rate increase VAT (14%/7%) Rate increase VAT (15%/7%) Rate increase VAT (16%/7%) Tax relief agriculture Reduction of tax on input Tax relief agricultureReduction of tax on input Fiscal Effects/ GDP Own calculations based on: Federal Ministry of Finance (2004)/Tax laws.Reforms by date of implementation. Figure 32: Fiscal effects of tax reforms in VAT 123 During the First World War 1914 – 1918. 124 Named “Warenumsatzstempel”. 125 1920 to 1,5%, 1923 to 2,5%, 1946 to 3% and 1951 to 4%. 126 For legislative details of the transformation of the sales tax into VAT see BGBl I (1967), pp. 545 ff. 127 1968 to 11%/5.5%, 1978 to 12%/6%, 1979 to 13%/6.5%, 1983 to 14%/7%, 1993 to 15%/7%, 1998 to 16%/7% and 2007 to 19%/7%. 74 2.3.3 Fiscal effects of reforms and revenue developments Figure 32 shows the pattern of fiscal effects of VAT reforms. We see that the six rate increases were the most important reforms. The tax rate increases in 1978 and 1983 had the largest fiscal effects. There were only four substantial tax reductions that resulted from a reduction of VAT on input (related to increases of the tax rate) and from tax relieves for agriculture. SALES TAX/VAT RATES AND REVENUES 1950-2007 0% 5% 10% 15% 20% 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 20 07 Normal Rate Reduced Rate 6% 7% 8% 9% 10% 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 -1% 0% 1% 2% 3% 65 68 71 74 77 80 83 86 89 92 95 98 1 4 Cumulated fiscal effects of tax reforms/Final domestic consumption VAT VAT revenues/Final domestic consumption Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office(2007).Reforms by date of implementation. Figure 33: Linking cumulated reform effects and revenue development in VAT We can directly link rate development, cumulated fiscal effects of reforms, and revenue developments in the VAT (see Figure 33). Cumulated fiscal effects of reforms increased slightly with the introduction of the VAT in 1968 and started a strong upward trend with the rate increases from 1978 on. With respect to revenues over final domestic consumption, we saw a strong increase after the introduction of the VAT in 1968 and as well an upward trend in line with the rate increases from 1978 on. Overall the VAT revenues increased from around 6.5% of GDP in 1967 to close to 9% in 2000, reflecting nearly the increase in rates from 10% to 16%. As the ratio of final domestic consumption over GDP was relatively stable in this period, 75 the slightly lower than expected increase of VAT could partly be explained by an increase of the relative size of the shadow economy. 128 2.4 Main excises: mineral oil and tobacco taxes There are a number of excises, but two of them – the mineral oil tax and the tobacco tax – are the most important in revenue terms. In both taxes a federally unified legislation applies. 2.4.1 Current regulation (2007) The mineral oil tax is levied on motor fuel, furnace fuel and natural gas. The tax rates are calculated based on volume sold. Since January 1st, 2003 the rate has equaled €0.6698/l for unleaded fuel, €0,721/l for leaded fuel, and €0.4857/kg for diesel. Heating oil and natural gas for heating purposes are taxed at far lower rates with €0.06135/l for light heating oil, €0.025/kg for heavy heating oil, and €0.550/kwh for natural gas. The tax on tobacco consists of a price-related and a volume-related element with rates depending on the specific product (cigarettes, cigars or tobacco). The current rate for cigarettes is €0.0827 per piece (since September 1st, 2005) and 25.29% of the final sale price, while the rate for cigars and tobacco is lower.129 2.4.2 Mineral oil and tobacco taxes – rates, reforms and revenue development Mineral oil taxes were introduced in 1930. In 1939 diesel was included and since 1960 heating oil as well. Throughout the period analyzed in our data-set tax rates increased (see Figure 34), and the frequency of increases accelerated after reunification in 1990. 128 Schneider (2005) estimates, that the shadow economy in Germany increased from 5.75% of GDP in 1975 to 16.64% of GDP in 2005. 129 The current rate is €0.013 per cigar plus 1% of the final price and for tobacco €19.15 per kg plus 17.02% of the final sale price.