126 to the end of 1969) was – based on the number of reforms and new regulations – less active in tax policy. However, these observations are only preliminary. In the following parts we analyze the developments in more detail based on the fiscal effects of reforms, which are far better suited for a comparative analysis of tax policy under different political constellations than just the number of reforms and regulations. Descriptive Statistics – Adopted German tax reforms (1965-2003) Constellation AVERAGE (All years) Election year* Right Right and undivided Partisan Left Undivided Government** Grand Coalition 5.2 # of reforms p.a. 5.6 6.5 4.5 4.9 6.7 6 5.9 10.3 # of reductions p.a. 12.8 10.6 15.3 11.4 11.4 6.7 14.1 2.8 # of increases p.a. 10.1 3.3 9.0 2.8 12.3 2.7 13.7 14.3 # of new regulations p.a. 26.2 16.1 25.9 15.8 29.3 9.3 32.2 13 # of years 39 11 18 10 18 3 26 Extent of increases/ GDP p.a. 0.20% 0.44% 0.19% 0.44% 0.18% 0.46% 0.28% 0.56% Total fiscal effects/ GDP p.a. -0.21% -0.13% -0.13% 0.09% -0.31% -0.20% 0.12% -0.08% Extent of Reductions/ GDP p.a. -0.42% -0.57% -0.32% -0.64% -0.53% -0.49% -0.66% -0.16% Note: Number of new regulations without fiscal effect not displayed. 1965, 1969, 1972, 1976, 1980, 1982 (election in March 1983), 1986 (election in January 1987), 1990, 1994, 1998, 2002;. ** Including grand coalition. Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office(2007). Divided Government Table 9: Descriptive statistics of tax reforms by political constellation 3.3 Status quo bias and inertia in tax policy 3.3.1 General approach and related literature How much activity are we expecting if we chose a polit-economic perspective including self-interested politicians. From a polit-economic point of view tax reforms, which increase the tax burden, are attractive for governments because of the additional public goods and redistributive programs which can be financed with the additional tax revenues. These might help to increase the re-election probabilities. On the other hand, almost all changes in the tax system and especially overall tax burden increases create not only winners but as well losers who have to bear the 127 additional tax burden and can be expected to oppose these tax reforms. Based on this general trade-off there are especially three arguments in the literature which predict a high status-quo bias and only very low activity or even inertia in tax policy. Rose (1985) and Rose and Karran (1987) focus on the progressiveness of tax systems in modern industrialized countries (especially in the wage and income tax). They argue that revenue increases, which result automatically from taxes with a revenue over GDP elasticity higher than one, are not so directly linked to government policy and the government gets blamed less for these “automatic” tax burden increases. It follows that it is attractive for governments to abstain largely from tax reforms, which increase the tax burden, and pursue only tax burden reductions. Therefore, governments are expected to rely on automatic tax burden increases instead of changing the tax system and do only correct “automatic increases” for example in times of very high inflation. Resulting is a situation of “inertia in tax policy” following from a “maximization of revenue while minimizing political costs” (Rose 1985). A similar argument can be made based on the economic theory of reform which discusses how individual uncertainty about the individual gains and losses of reforms can lead to a strong status-quo bias prohibiting reforms (see Fernandez/Rodrick 1991). Based on this literature we would expect strong opposition to tax reforms with unclear distributional consequences. Finally, the argument of a grievance asymmetry, which stresses that individuals react often far stronger to losses than to gains of the same size,231 speaks as well in favor of a very limited activity in tax policy and especially for an avoidance of reforms that increase the tax burden. 3.3.2 Hypotheses There are two hypotheses which follow directly from the discussed arguments for a status-quo bias. The first is concerned with the extent of tax reforms. If there really is a strong status-quo bias – caused for example by politicians who try to minimize political costs of tax reform – we should see only marginal changes of the tax system (“inertia hypothesis”). The second hypothesis is related to the direction of tax reforms. If governments rely on revenue increases via progressive taxes and refrain from tax burden increases, we should see only a very small amount of tax burden increases while reductions are more frequent (“dominance of tax burden reductions hypothesis”). Both hypotheses can be tested directly based on our data-set. 231 See for general discussion of the grievance asymmetry in this context Nannestad/Paldam (1997) or Kinder/Kiewiet (1979). 128 3.3.3 Empirical analysis One of the stylized facts we established on the German tax system was that the revenue structure was always relatively stable (see part II.2). Only the share of tax revenues from income and wage taxes increased strongly. This increase resulted especially from the high GDP elasticity of the progressive wage and income taxes. -30% -20% -10% 0% 10% 20% 30% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 CUMULATED EFFECTS OF TAX REFORMS, 1964-2004 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 INCREASES AND REDUCTIONS/GDP (ABSOLUTE VALUES, CUMULATED) TAX REVENUES/GDP Fiscal effects of reforms (cumulated)/GDP Fiscal effects of reforms (cumulated)/GDP Cumulated Increases/GDP Cumulated Reductions/GDP Tax revenues/GDP Tax revenues/GDP Own calculations based on: Federal Ministry of Finance (2004)/Federal Statistical Office(2007). Figure 57: Cumulated fiscal effects of tax reforms At first sight this observation seems to be in line with the inertia hypothesis. But what do we observe if we analyze tax policy based on our first-hand data? Figure 57 displays the cumulated fiscal effects of tax increases and tax reductions over GDP from 1964 to 2004. As a yardstick, we include the annual tax revenue over GDP ratio in the graph.232 Our graphical illustration shows that there has been a massive change in the tax system within the period covered in our data-set. If we add up the absolute amount of fiscal effects of tax reforms, we see that the total reductions and the total increases equaled twice the average annual tax revenues. 232 As a yardstick for the cumulated fiscal effects of tax reductions, we display the annual tax revenue over GDP ratio with a negative sign. 129 We think that this total change is a lot more far-reaching than we should expect based on the inertia hypothesis. Additionally, we found that (although reductions dominate) cumulated increases and reductions were not so very different in extent. This contradicts our second hypothesis of the dominance of tax reductions. Therefore, we find no evidence for the inertia hypotheses in our data. 3.4 Fiscal illusion by timing of tax reforms 3.4.1 General approach Governments can not only refrain from changes in tax policy but can as well try to create “fiscal illusions” to camouflage the real effects of tax policy decisions to avoid political opposition.233 For our analysis the possibility of manipulating the citizens by the timing of tax reforms is especially important.234 If the citizens focus on the fiscal effects of adopted new regulations of tax policy but not so much on the dates when they become effective, the government can improve its revenue position at least in the short run. 3.4.2 Hypotheses From an approach of fiscal illusion with respect to the timing of new regulations in tax policy we can directly derive two hypotheses which are testable based on our data-set: If governments tried to camouflage the real tax burden changes and to improve their revenue position in the short run, we should expect that a larger part of tax burden increases was implemented retrospectively while reductions were implemented only with a time-lag (fiscal illusion hypotheses I). Citizens who just focus on the extent of changes could be fooled by this timing of reforms. Additionally, we would expect that retrospective increases dated back longer than retrospective reductions (fiscal illusion hypothesis II). 233 James Buchanan discusses in “Public finance in democratic process” (1967) several possibilities for governments to camouflage the costs of taxation and to stress the benefits of public spending. An alternative treatment is Wagner (1976). A general overview of empirical work on fiscal illusion is given in Dollery/Worthington (1996). Studies which test the relationship in between the complexity of the tax system and fiscal illusion are for example Heyndels/Smolders (1994) or Worthington (1994). 234 We are not discussing the possibility of biased predictions of financial consequences of tax reforms here as we have already shown that the expected fiscal effects are largely reliable (see part III.3).