97
extraordinary role of the tax rate cut to 25% in 2001, which was promoted by the
government as an answer to international tax competition, can be seen as an indicator for an important role of tax competition as well.
On the other hand, reforms in the local trade tax were stronger in the 1970s than
in the 1980s and the 1990s. Here average annual fiscal effects of tax reductions were
1.8 times higher in the period from 1965 to 1986(especially driven by the abolishment of the payroll tax) compared to the period from 1987 to 2004.175 Therefore, the
reform pattern in the local trade tax does not support the hypothesis of a “race to the
bottom”.
What are the implications for the analysis to follow? First, we conclude from our
findings that we need to integrate tax competition as explanatory variable for the
corporate profit but not for the local trade tax. If we take into account that the fiscal
effects of corporate tax reforms from 1964 to 2004 account only for less than 4% of
the total fiscal effects of all tax reforms covered in our data-set, we see that international tax competition had only a very limited influence on our data-set as a whole.
Therefore, we are able to largely abstract from tax competition in our general analyses of tax reforms but control for a possible influence on a case by case basis.
2 Normative approaches
While we are generally focusing on polit-economic analyses, we do not completely
exclude main normative approaches which all largely abstract from political and
institutional variables in tax policy. It is especially important for us to analyze,
whether normative approaches can contribute to our understanding of tax reforms
and are thereby limiting the importance of positive theories.176
We start with the “financing function” of taxation which argues that tax policy is
driven by expenditure decisions and the financial needs of the state. The second
approach is based on macroeconomic considerations: Are tax reforms scheduled to
smoothen the business cycle? Then we discuss the linkage in between inflation and
tax policy. Do we see a reaction of tax policy to high inflation and the resulting
“cold progression” in progressive taxes? Finally, we shortly review the approach of
tax smoothing (see Table 5 for an overview of normative hypotheses).
Despite its importance in normative analysis, we do not integrate the theory of
optimal taxation as it has only very indirect implications for the variables covered in
our data-set.177
175 Please note that we have integrated here only changes on the federal level while changes of
the municipal multipliers, which have shown a general upward trend, are not covered.
176 For an overview of discussed approaches see Table 4 on p.90.
177 For a textbook-treatment see Myles (1995). See also Ramsey (1927), Mirrlees (1971), Mirrlees (1976), Auerbach/Hines (2002) and Slemrod (2004).
98
Normative hypotheses on taxation and tax reform
Hypothesis 2 Hypothesis 3 Hypothesis 4Hypothesis 1
Timing of tax reforms
takes the business cycle
into account
Tax policy reacts to cold
progression by correcting
for „bracket creeping“
Tax policy seeks to
minimize the excess
burden of taxation and tax
reform
Taxation is only a mean to
finance public good
provision
M
ec
ha
ni
sm
Tax burden reductions
are scheduled to
economic downturns
Tax burden increases
are scheduled to
economic upturns
Inflation has a direct
influence on tax policy,
especially in the
progressive wage and
income taxes
Tax burden reductions in
the progressive wage
and income tax are
more frequent and larger
in times of high inflation
Tax burden changes are
directly (and positively)
linked to expenditure
changes (e.g. expenditure increases are
linked to tax burden
increases)
Changes in the tax burden are directly (and
negatively) linked to fiscal deficits (e.g. deficits
are linked to tax
increases)
Taxation is largely
independent from
transitory deficits and the
business cycle
Changes in tax rates and
tax bases occur
relatively rarely
Pr
ed
ic
tio
ns
„Financing function
of taxation“
„Stabilization function
of taxation“
„Correcting of cold
progression by tax reform“ „Tax smoothing“
G
en
er
al
Ap
pr
oa
ch
Table 5: Normative hypotheses on tax reforms
With respect to each approach we first shortly review the general argument, then
derive hypotheses and finally test these hypotheses based on our data-set.178
We dispose of data on tax reforms by the date when they were adopted and when
they became effective. It is not always easy to decide which data should be used for
our empirical tests. This can be illustrated with respect to the stabilization function.
If we analyze the relationship of the macroeconomic state of the economy and fiscal
effects of tax reforms by the date of their adoption, we should find out whether the
macroeconomic conditions during the legislative process have influenced the tax
policy decision. On the other hand only data on implemented reforms reflect the
timing of tax burden increases and reductions which affect the business cycle. For
our empirical tests in this part we have decided to rely mainly on the data on adopted
reforms as they reflect the timing of political decisions more directly than data on
implemented reforms.179
178 For a description and analysis of the data-set see part III and IV.
179 However, we have pursued all empirical tests with the data on implemented reforms as well
and have derived very similar results.
99
2.1 The financing and the stabilization function
We start our analysis with a combined discussion and testing of the financing and
the stabilization function as both refer to the same variables.
2.1.1 The financing function of taxation
2.1.1.1 General approach
In many normative approaches the link in between taxation and expenditure is
straightforward. If we take Samuelson´s classical contribution “a pure theory of
public expenditures”, the optimal tax rate is just a results of the optimal level of
public good provision (Samuelson 1954). Another example is the allocation function
in Musgrave’s three classical function of public finance which sees taxation mainly
as a mean to finance public good provision (Musgrave 1973). But how close is the
relationship in between expenditure developments and tax reforms in our data?180
2.1.1.2 Hypotheses
Based on the approaches which mainly focus on the financing function of taxation
we can directly derive hypotheses that we can test based on our data-set.
First, we focus on the relationship of expenditure developments and tax policy.
Here we can derive two hypotheses. The first hypotheses is that tax increases facilitate spending increases. In this case we should find that expenditure increases follow
tax reforms which increase the tax burden (financing hypothesis I).181 However, the
timing of expenditure increases and tax increases could as well be reversed. In case
that tax policy would react to spending decisions in previous periods, we should see
that tax burden increases following expenditure increases in previous periods (financing hypothesis II).182
But expenditure increases are not the only indicator for a link in between tax reforms and expenditure developments. Tax policy might not be directly linked to
180 In the empirical literature the causal relationship in between tax policy and expenditure decisions is hard to determine as most studies need to rely on tax revenue data which is only indirectly linked to tax policy. Based on time-series data for the US, Sheffrin and Hoover (1991)
found that taxes appear to have caused spending before the mid-1960s. After the late 1960s,
taxes and spending have been causally independent in the US. See as well the discussion in
Winer (1983). Based on our data-set we are able to study the relationship in between expenditure developments and tax policy more directly.
181 Sheffrin and Hoover (1991) would name this the “sand in the sandbox” hypothesis.
182 Sheffrin and Hoover (1991) would call this the “tax collector for the welfare state” hypothesis.
100
expenditure increases – which for example could as well be financed by tax revenue
increases based on cold progression – but to fiscal deficits. In this case we should
expect to see tax burden increases via tax reforms as a reaction to fiscal deficits
(financing hypothesis III), eventually with one or more time lags to account for
delays in political reactions to fiscal developments.
2.1.2 The stabilization function of taxation
2.1.2.1 General approach
The second classical function of public finance is – according to Musgrave (Musgrave 1973) – the stabilization function of the state which includes the use of tax
policy to stabilize business cycles. If tax reductions have c.p. a stimulating effect on
economic growth while tax increases are cooling down the economy, tax policy
should take the current state of the business cycle into account. Based on the stabilization function the government is expected to schedule tax burden reductions in
times of recessions while tax burden increases should be scheduled to economic
booms. As deficits are likely to occur in times of economic downturns (when revenues are reduced stronger than expenditure), deficits should – based on the stabilization function – be correlated to tax burden decreases as well.183
2.1.2.2 Hypotheses
The most important indicator for the current state of the business cycle is real GDP
growth. High real GDP growth indicates an economic boom and low or negative real
GDP growth an economic downturn. Based on the stabilization function we should
expect a correlation of real GDP growth and fiscal effects of tax reforms. In times of
high GDP growth (eventually with one or two time lags to account for the slack of
policy making) we should see tax burden increases by tax reforms, while there
should be tax burden reductions in times of low growth (stabilization hypothesis I).
With respect to deficits a similar relationship can be expected based on the stabilization function: high deficits should go hand in hand with tax reforms, which reduce
the tax burden, while low deficits or even surpluses should be correlated with tax
burden increases (stabilization hypothesis II).184
183 Here we do not refer to “automatic stabilization” by taxes as discussed in Auerbach and
Feenberg (2000). Furthermore, we do not incorporate temporary tax policy measures to
smoothen the business cycle which were only applied from 1967 to 1975. See excursus on
temporary measures in part III.3.
184 This is contrary to the predicted relationship in between deficits and tax reforms of the financing hypothesis 3.
101
2.1.3 Empirical testing of the financing and the stabilization hypotheses
In the following part we test the hypotheses derived from the financing and the stabilization function of tax policy empirically. We discuss both approaches together as
their hypotheses rely partly on the same independent variables (e.g. fiscal deficits).
We first present general data on expenditure developments, tax revenue developments and deficits, then perform tests based on annual data and finally analyze tax
policy based on legislative periods.
2.1.3.1 Revenues, expenditure and deficits
15%
20%
25%
30%
35%
40%
19
50
19
52
19
54
19
56
19
58
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
PUBLIC EXPENDITURES/GDP
PUBLIC REVENUES/GDP
TAX REVENUES/GDP
-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
19
50
19
52
19
54
19
56
19
58
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
FISCAL DEFICITS/GDP
REVENUE AND EXPENDITURE DEVELOPMENTS 1950-2004
Data source: Deutsche Bundesbank. Fiscal deficits according to national budget calculations.
Figure 46: Revenues, expenditures and deficits in Germany 1950-2004
Figure 46 maps the development of tax revenues, expenditures, and deficits over
GDP for all levels of government in the Federal Republic of Germany from 1950 to
2004.
We see that public expenditure over GDP was relatively stable until the end of the
1960s while tax revenues over GDP expanded. Fiscal deficits, which depend not
102
always only on tax revenues and expenditures but on other revenues as for example
privatization receipts or fees for services as well, started to increase in the early
1960s. From 1970 until 1982 expenditure showed a strong upward trend, while tax
revenues increased only slowly. This led to high deficits. After 1982 expenditures
over GDP showed a downward trend which led – as tax revenues over GDP stayed
relatively stable – to a fiscal consolidation and decreasing deficits. Reunification in
1990 pushed deficits up again, but consolidation made progress again at the end of
the 1990s based on increasing tax revenues. In 2000 high revenues from the auctioning of UMTS licenses had a strong upward effect on revenues over GDP and even
led to a surplus.
2.1.3.2 Tests based on annual data
How can we test the financing and the stabilization function? Most studies rely –
based on a lack of alternative data – on revenue and expenditure developments.
However, it is problematic to evaluate tax policy based on revenue and expenditure
developments which are affected by many different factors. As we dispose of firsthand data on the timing and the fiscal effects of tax reforms, we can study far more
directly whether tax policy is linked to expenditure developments (financing hypothesis I and II), to deficits (financing hypothesis III and stabilization hypothesis
II), or to real GDP growth (stabilization hypothesis I).
We start with an analysis of annual data. Our independent variable is the net fiscal
effect of tax reforms for each year in between 1965 to 2003.185 To make fiscal effects comparable over different years, we have divided them by nominal GDP.
Our independent variables are – based on the financing and stabilization hypotheses – the growth rate of expenditure (t, t+1, t-1, t-2), the deficit over GDP (t, t-1, t-2)
and real GDP growth (t, t-1, t-2) in the same period as well as with several time lags.
We have estimated the following equation:
D tt10 ??? ++=? ITt
With:
0? , x? Constant, coefficients ?Tt Fiscal effects of tax reforms (adopted)/GDP
IDt/t-1/t-2 Independent variables (expenditure growth rate; deficit over GDP,
real GDP growth rate) with different lags
t? Stochastic error term
185 We haven taken out the years 1964 and 2004 for these analyses because our data-set does not
cover all tax reforms in these two years. We use tax reform data adjusted for temporary
measures for our tests (see part III.2 for details). However, we have tested the hypotheses
with unadjusted data as well and have derived very similar results.
103
R2 (adjusted)
Dependant
Variable:
Explanatory
Variables:
DW
Notes: t-statistics of the estimated parameters in parantheses. * significant at the 10% level; ** significant at the 5% level; *** significant at the 1% level
Observations
Testing normative theories of
tax reforms in Germany 1965-2003
Net fiscal effects of
tax reforms/GDP
Deficit/GDPt-2
Real GDP growtht
Expenditure growtht
Expenditure growtht-1
Expenditure growtht-2
Expenditure growtht+1
Real GDP growtht-1
Real GDP growtht-2
Deficit/GDPt-1
Deficit/GDPt
Constant
i.
-0.002327
(-1.580312)
-0.00
1.87
39
0.000185
(0.985183)
ii.
-0.002853*
(-1.895796)
0.02
1.98
39
0.000263
(1.394108)
iii.
-0.003443**
(-2.264282)
0.06
1.84
39
-0.000346*
(-1.848676)
iv.
-0.001129
(-0.771050)
0.03
1.84
39
-0.0000189
(-0.099581)
v.
-0.005394**
(-2.586195)
0.09
1.69
39
-0.157856**
(-2.229007)
vi.
-0.003455
(-1.623795)
0.01
1.85
39
-0.085207
(-1.1702271)
vi.
0.001072
(0.511539)
0.01
1.85
39
0.089965
(1.240629)
iix.
-0.000242
(-0.155715)
-0.01
1.85
39
-0.000397
(-0.819680)
ix.
0.00000645.
(-0.004142)
0.00
1.76
39
-0.000466
(-1.010055)
x.
-0.004173*
(-2.751364)
0.12
1.98
39
-
0.001081**
(2.427889)
OLS OLS OLS OLS OLS OLS OLS OLS OLS OLS
Table 6: Testing the financing and the stabilization hypotheses
In Table 6 we display the results of our statistical analysis for bivariate linear relationships applying OLS estimations.186 The coefficient for expenditure growth with
two time lags is significant at the 10% level but points at the opposite direction of
the financing hypotheses (high expenditure increases led to tax reductions). Nonetheless, we find some support for the financing function. The deficit in the same
period is significant on a 5% level and supports the financing hypothesis III: high
deficits are correlated with tax burden increases via tax reforms in the same year.
The coefficient of -0.16 indicates, that an increase of the deficit over GDP by one
percentage point would lead c.p. to a tax burden increase of 0.16 pecentage points in
the same year. Finally, we find that real GDP growth with two time lags is significant on a 5% level with a positive coefficient (which supports the stabilization hypothesis). However, the explanatory impact of all specifications is disappointing.187
Altogether, there is only very limited evidence for any of our hypotheses based on
the financing and the stabilization function of tax policy in the annual data.
186 The Durbin-Watson test statistics for our OLS regressions (reported in table 6) do not support
the hypothesis of serial autocorrelation in the error terms.
187 Different combinations of the discussed variables do not improve the evidence for the financing or the stabilization function either. See for a discussion Koester (2005).
104
2.1.3.3 Tests based on legislative periods
One could argue that annual data are not suited to analyze the relationship in between expenditure developments, deficits, macroeconomic developments, and tax
reforms as tax policy needs to be studied based on legislative periods to cover governments´ reactions to expenditure needs or stabilization goals. Therefore, we have
calculated average annual values for all relevant variables for the 10 legislative periods covered in our data-set. We display our findings graphically in the next three
figures.
EXPENDITURE GROWTH AND TAX REFORMS
-0,8%
-0,6%
-0,4%
-0,2%
0,0%
0,2%
0,4%
0,6%
0 2 4 6 8 10 12 14
EXPENDITURE (AVG. GROWTH RATE P.A. - LEGISLATIVE PERIOD)
FI
S
C
A
L
E
FF
E
C
TS
O
F
TA
X
R
E
FO
R
M
S
(L
E
G
IS
LA
TI
V
E
P
E
R
IO
D
S
, A
V
G
. P
.A
.)
-1990
-1980
-1972
-2002
-1987
-1976
-1994
-1998
-1983
-1969
over
GDP
%
Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office(2007).Data on adopted tax reforms.
Figure 47: Expenditure growth and tax reforms (based on legislative periods)
With respect to expenditure growth (see Figure 47) we see that the relationship predicted by the financing function (expenditure growth is positively correlated with an
increase of the tax burden via tax reforms) is reflected in our data on legislative
periods, but that the correlation is not strong.
With respect to fiscal deficits (see Figure 48) we find that high deficits are correlated with high tax burden increases. This speaks in favor of the financing function
and not of the stabilization function. But here again the correlation is not strong.
105
-0,8%
-0,6%
-0,4%
-0,2%
0,0%
0,2%
0,4%
0,6%
-5,0% -4,5% -4,0% -3,5% -3,0% -2,5% -2,0% -1,5% -1,0% -0,5% 0,0%
FISCAL DEFICIT/GDP (NATIONAL DEFINITION)
FI
S
C
A
L
E
FF
E
C
TS
O
F
TA
X
R
E
FO
R
M
S
(L
E
G
IS
LA
TI
V
E
P
E
R
IO
D
, A
V
G
. P
.A
.)
FISCAL DEFICITS AND TAX REFORMS
-1990
-1980
-1972
-2002
-1987
-1976
-1994
-1998
-1983
-1969
over
GDP
Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office (2007).Data on adopted tax reforms.
Figure 48: Fiscal deficits and tax reforms (based on legislative periods)
Finally, we see in Figure 49 that real GDP growth is negatively correlated with tax
burden increases via tax reform, contradicting the stabilization hypotheses (which
had received some support based on annual data).
Our analyses based on legislative periods is therefore supporting the results of our
previous analyses based on annual data: there is some evidence for a weak correlation in between deficits and tax reforms as predicted by the financing function (high
deficits are correlated with tax increases). For the stabilization function we find only
some very limited evidence in the annual data and no evidence in the data based on
legislative periods. Altogether the results do not point at an important role of the
financing or stabilization function for tax reforms.
106
-0,8%
-0,6%
-0,4%
-0,2%
0,0%
0,2%
0,4%
0,6%
-1 -0,5 0 0,5 1 1,5 2 2,5 3 3,5 4 4,5
REAL GDP GROWTH (AVG. P.A., LEGISLATIVE PERIOD)
FI
S
C
A
L
E
FF
E
C
TS
O
F
TA
X
R
E
FO
R
M
S
(L
E
G
IS
LA
TI
V
E
P
E
R
IO
D
S
, A
V
G
. P
.A
.)
GDP GROWTH AND TAX REFORMS
-1990
-1980
-1972
-2002
-1987
-1976
-1994
-1998
-1983
-1969
over
GDP
%
Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office(2007).Data on adopted tax reforms.
Figure 49: Real GDP growth and tax reforms (based on legislative periods)
2.2 Tax reforms as a reaction to cold progression
2.2.1 General approach and hypotheses
From a normative point of view, inflation can be linked to tax reform as well. In the
progressive wage and income taxes (which are not inflation-indexed in Germany)
inflation pushes up the tax burden by “bracket creeping” or “cold progression”: the
nominal and real tax burden of individuals increases without tax policy changes, as
wage and income inflation increases the applicable tax rates. Based on this cold
progression one could expect that many tax reforms are just a reaction to inflation,
moderating or even offsetting inflationary effects on the tax burden in the progressive wage and income taxes.
Based on the mechanism of cold progression we would expect that the overall
tax burden in the progressive wage and income taxes is reduced stronger in times of
high inflation (cold progression hypothesis 1). Furthermore, we would expect that
especially tax reductions in wage and income taxes are larger in times of high inflation (cold progression hypothesis 2).
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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.