89
V The political economy of tax policy – evidence based on German tax
reform data
The analysis of tax policy is a complex endeavor. This results partly from the complexity of modern tax systems. Additionally, possible interdependencies in between
the political and the economic sphere have to be taken into account.
Figure 42 maps tax policy as the outcome of political decisions within an institutional framework and the interdependencies in between tax policy, citizens and markets.157
TAX
POLITICS
CITIZENS
ELECTIONS
TAX POLICY OUTCOMES
ECONOMIC DEVELOPMENTS
MARKETS
THE POLITICAL ECONOMY OF TAX POLICY
Chambers of
Parliament
(Bundestag/
Bundesrat)
INSTITUTIONAL
FRAMEWORK
TAX POLICY OUTCOMES
Figure 42: Polit-economic interdependencies in tax policy
Tax policy is made by the chambers of parliament. It affects citizens and markets
directly and indirectly. In democratic systems, citizens can react to tax policies by
adjusting their economic decisions but as well by voting in the elections.
157 Early forms of similar illustrations, which tried to cover the interdependencies especially
within models of political business cycles, can be found e.g. in Frey (1975/1978).
90
Economic theory does not offer one general and unified approach for the analysis
of tax policy but many (often competing) approaches which reduce the complexity
by a focus on certain aspects and arguments. Generally, we can distinguish four
fundamentally different groups of approaches – one with an international perspective (tax competition) and three with a focus on domestic developments: Normative
theories, polit-economic theories and theories of economic voting (see Table 4).158
GENERAL APPROACHES TO TAX POLICY - OVERVIEW
Tax competition Normative theories Positive polit-economic theories Economic voting
Increasing factor mobility
intensifies international
competition for capital via
tax policy
Governments follow welfare maximizing goals in
tax policy
Tax policy is made by
self-interested politicians
within an institutional
framework
Tax burden for mobile
capital decreases with
increasing capital mobility
Tax policy is driven
primarily by normative
considerations (financing
of public goods,
stabilization of the
business cycle,,,,)
Tax policy is e.g.
influenced by opportunistic motivation, partisan interests or institutional constellations
Identify the influence of
tax competition on
national tax reforms/tax
policies
Identify the influence of
expenditure developments, deficits, macroeconomic developments
and several other
variables on tax policy
Identify the impact of
polit-economic variables
on tax policy
Voters take economic
conditions and/or economic policy into account
Tax policy influences
electoral results: Tax
burden reductions increase re-election probabilities, tax burden increases reduce reelection probabilities
Identify the influence of
tax policy on the voting
decision
M
ec
ha
ni
sm
Pr
ed
ic
tio
ns
Ai
m
s
of
em
pi
ric
al
te
st
in
g
Table 4: General approaches to the analysis of tax policy
Theories of international tax competition focus on how international forces affect
domestic tax policy outcomes. The unifying characteristic of normative theories is,
that they largely abstract from political and institutional factors and evaluate tax
policy based on normative goals which a benevolent dictator would follow. Politeconomic theories of taxation argue that political and institutional factors are crucial
to explain tax policy. For example, tax policy might be heavily influenced by elec-
158 For a general discussion of normative versus positive approaches see Boadway (2002) and
with respect to the political economy of taxation Hettich/Winer (2003). For a positive (public
choice) perspective on taxation see Brennan/Buchanan (1980) and Buchanan (1963, 1967,
1976, 1993). A discussion of general welfare-economic approaches to tax policy can be found
in Devereux (1996). A normative assessment of tax reforms based on the theory of optimal
taxation can be found in Feldstein (1976), Hettich (1979) or Zodrow (1985).
91
toral motivations. How successful such policies are with respect to electoral results
is analyzed within the fourth approach: the theory of economic voting.
The most important advantage of our data-set on tax policy in Germany from
1964 to 2004159 is that we are able to test hypotheses from these theories based on
new and first-hand data.
In this chapter we review and test hypotheses derived from the four mentioned
groups of approaches. Our treatment covers a broad variety of approaches and aims
at integrating major hypotheses but is of course far from being exhaustive. Our main
goal of the discussion of different theories is to derive hypotheses on tax reforms
which can directly be linked to our data. Therefore, we focus on theories from which
we can derive hypotheses that are testable based on our data. Other theories, which
have no direct implications for the data employed here, are (if at all) only shortly
mentioned.
We start with a discussion of the role of international tax competition on national
tax policy. Then we move on to a domestic perspective. Normative approaches (part
V.1) are followed by polit-economic theories (part V.2). Finally, we discuss the
theory and empirics of economic voting (part V.3).
1 The role of international tax competition for tax reforms
How independent is the German government in tax policy? Is the room for political
maneuvering restricted more and more by international tax competition that dictates
tax policy? Do we have to integrate international developments in our analysis of tax
policy or can we focus on domestic factors?
To discuss these questions, we first review the general theoretical discussion with
respect to the role of international tax competition, then move on to some empirical
findings in the literature, and finally analyze whether there is evidence for an important influence of tax competition in our data-set on tax reforms.
1.1 Capital mobility, international tax competition and tax policy
The theory of tax competition has been on the agenda of public economics at least
since the seminal contribution of Tiebout (1956) who analyzed the mechanisms of
“voting with the feet” on the municipal level. The literature on international tax
competition has been boosted especially by increases in capital mobility and a global
integration of capital markets which made the competition for capital global. Capital
mobility increased especially strongly in the 1990s. World foreign direct investment
inflows for example increased fivefold and world foreign portfolio investment inflows nearly sevenfold from 1990 to 1999 (see Koester (2006a), p. 7). Many propo-
159 See parts III and IV for a description and analysis of the data.
92
nents of an important role of tax competition see the watershed for a dominance of
international factors in tax policy already in the 1986 US tax reform act which implemented strong rate cuts in corporate taxation.160
The main argument for a strong effect of an increase in capital mobility on tax
policy is straightforward: As capital is invested based on net-returns and governments are interested in attracting capital investments, governments compete for the
mobile capital via tax reductions. Because business investments are particularly
mobile, tax reductions take place especially in corporate taxation. The under-betting
of uncoordinated governments leads to a “race to the bottom” in capital taxation (see
e.g. Sinn 1987/1997). In the end capital is taxed only very slightly or not at all, while
the less mobile factors of production – labor and real estate – are not able to avoid
taxation.161 As a consequence of this kind of international tax competition, governments would lose their sovereignty especially in corporate profit taxation.162
The literature on international tax competition is of course not restricted to this
general argument but has become extremely broad. For example, the general argument for a “race to the bottom” is contested by integrating the expenditure side: If
capital profits from infrastructure financed by tax revenues, a positive tax on capital
might be welfare-enhancing even under complete capital mobility.163 Partly based on
this line of argument, a huge branch of literature has evolved discussing the question
whether international tax competition is welfare-enhancing or welfare-reducing164
and if international tax harmonization is therefore preferable to tax competition.165
To make things even more complex, polit-economic approaches argue that we do
not only have to discuss advantages and disadvantages of tax competition from a
welfare-economic point of view but have as well to take self-interested governments
into account.166 In the empirical literature a large number of studies is searching for
160 See e.g. Sinn (2003), chpt. 1.
161 For a more detailed discussion see MacDougall (1960).
162 Tanzi (1995) discusses especially the effects of increasing capital mobility on national sovereignty in tax policy.
163 See Sinn (2003), chpt. 2. The influence of publicly provided infrastructure and public goods
on tax competition is discussed as well in Oates/Schwab (1988), Wellisch (1995) and Buettner (2003).
164 An overview of normative models of tax competition is given in Wilson (1999). A very
comprehensive treatment can be found in Haufler (2001).
165 The effects of tax harmonization are discussed very controversially in the literature. While
Sinn (2003) expects overprovision of public goods in case of expenditure competition, other
models like King/McAfee/Welling (1993) come to the conclusion that an optimal level of
public good provision can be reached even under expenditure competition. The economics of
tax competition versus tax harmonization in an European context are discussed in more detail
especially in Oates (2001), Cnossen (2003), Sinn (1990, 2002 and 2003) and Zodrow (2003).
166 See for a discussion of the Leviathan model and tax competition Edwards/Keen (1995) and
for the effect of tax competition on redistributive taxation by self-interested governments
Gottschalk/Peters (2003). A polit-economic analysis of tax competition based on the medianvoter model can be found in Fuest/Huber (2001).
93
evidence of the influence of international tax competition on taxation.167 Even a
superficial review of this literature is far beyond our scope.
We are mainly curious, whether tax competition is directly reflected in tax policy
decisions covered in our data-set and has to be included as an explanatory factor in
our analysis. Therefore, we restrict ourselves to the question whether the strong
increases of capital mobility have changed the pattern of tax policy by pushing the
tax burden in corporate taxation down. If this would be the case, we should see a
change in the pattern of tax policy (especially with respect to the taxation of capital)
before and after the strong increase in capital mobility after 1986.
We focus here on the influence of tax competition on corporate profit taxation
within the corporate profit and the local trade tax. To analyze the influence of tax
competition on German tax policy, we first shortly review the development of tax
rates and tax burdens in business taxes in Germany and then move on to a discussion
of the influence of tax competition on business tax reforms in our data-set.
1.2 The influence of tax competition on tax policy – evidence from tax rates and tax
burdens
Figure 43 shows the development of the federal corporate profit tax rate from 1980
to 2006 in Germany, the US, the OECD20168 and the EU15.169 After the strong cut in
corporate tax rates in the 1986 tax reform act in the US, corporate tax rates in the
EU15 showed a continuing downward trend and stood in 2006 on average 15 percentage points lower than in 1980. In Germany the reduction was even stronger as
the very high rate of 56% in 1980 came down to a corporate tax rate of 25%170 in
2006.171
167 See for example Feld (2000), Haufler (2001), Stewart/Webb (2006), Auerbach (2006) and
Devereux et al. (2002).
168 The EU15 plus Australia, Canada, Japan, Norway and the USA.
169 For reasons of international comparison we have excluded the local trade tax rate (set individually by the municipalities) which increases the tax burden on corporate profits. Furthermore, the changes in the corporate profit tax rate were by far stronger and more important
than the changes in the local trade tax rate.
170 Excluding the solidarity surcharge.
171 However, this should not be mistaken as an indicator for a comparatively low taxation of
business profits in Germany. Together with the local trade tax, the effective tax burden on
corporate profits was with 38.6% in 2006 still very high in international comparison.
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References
Zusammenfassung
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.