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Announced on January 23rd of this year, the "Petersberg Tax Proposals" outline a plan of fundamental income tax reform endorsed by the three parties comprising the coalition which has been governing Germany for the past 15 years. The recommendations would cut income tax rates by around 25 % and greatly broaden the tax base. While numerous aspects of the Proposals are controversial, their overall magnitude is impressive:
DM billions
Lower tax rates (wo. solidarity surcharge) - 81.95
Tax increases (broader tax base) + 38.12
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Decrease in tax revenue - 43.83
Lower tax rates (solidarity surcharge) - 7.50
Increases in indirect taxes (e.g. VAT + 1 %) + 15.00
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- 36.33
The Petersberg Proposals make no recommendation on indirect taxes, such as VAT or the tax on petrol. Political resistance is strong to any increase in the value added tax. The consent of the opposition Social Democrats is necessary to enact the proposed legislation because the Government commands no majority in the Federal Council (Bundesrat). However, the Government passed a measure in Parliament on 28 February 1997 repealing the trade tax on capital from 1998 on. This law can likewise not take effect without the cooperation of the Social Democrats.
The Proposals schedule the greater part of the proposed changes for 1999, to be preceded in 1998 by preliminary reductions in certain tax rates and by tax-increasing countermeasures in 1997 and 1998 which will make the 1998 cuts more or less revenue-neutral.
Reductions in Tax Rates
The proposed tax rate changes are as follows:
Presently In 1998 In 1999
PERSONAL INCOME TAX
Zero bracket amount DM 12,095 DM 12,365 DM 13,014
Lowest marginal tax rate 25.9 % unchanged 15 %
Highest marginal tax rate DM 120,000+ unchanged DM 90,000 +
Highest tax rate
Normal income 53 % unchanged 39 %
Commercial business
income 47 % 40 % 35 %
CORPORATION TAX
Rate for retained earnings 45 % 40 % 35 %
Rate for distributed
earnings 30 % 28 % 25 %
Rate for PE of foreign
corporations 42 % 37 % 32 %
SOLIDARITY SURCHARGE 7.5 % 5.5 % 5.5 %
INTERNATIONAL TAXATION ACT
Min. rate to avoid tax
haven treatment 30 % unchanged 25 %
WITHHOLDING TAX RATES
Dividend withholding 25 % unchanged 15 %
With. on other income from
capital 25 % - 35 % unchanged 25 %
BROADENING OF THE TAX BASE
The principal revenue-generating measures in the Petersberg Proposals may be broken down into five categories depending on the class of taxpayers affected:
DM millions Percent
1. Commercial businesses 14,513 38.07 %
2. Employees 8,588 22.53 %
3. Senior citizens 2,250 5.90 %
4. Other measures affecting individuals 12,023 31.54 %
5. Other (primarily farmers and foresters) 749 1.96 %
Total 38,123 100 %
By and large, the items contained in the category "other measures affecting individuals" fall on well-to-do persons. Roughly 70 % of the revenue-generating measures (categories 1 and 4) thus appear to fall on persons in the upper income categories.
ANALYSIS OF THE PETERSBERG PROPOSALS
The following tables compare marginal and average income tax rates for single and joint filers under present law and under the Petersberg Proposals:
SINGLE FILERS
Marginal Rate Average Rate
Taxable Old (%) New (%) Change Old (%) New (%) Change
income
20,000 27.3 22.9 -4.4 10.2 6.0 -4.2
40,000 30.9 27.5 -3.4 19.6 15.6 -4.0
60.000 34.8 32.1 -2.6 24.0 20.4 -3.7
80,000 40.8 36.7 -4.1 27.5 23.9 -3.6
100,000 46.9 39.0 -7.9 30.7 26.8 -4.0
120,000 53.0 39.0 -14.0 34.0 28.8 -5.1
200,000 53.0 39.0 -14.0 41.6 32.9 -8.7
300,000 53.0 39.0 -14.0 45.4 34.9 -10.5
JOINT FILERS
Marginal Rate Average Rate
Taxable Old (%) New (%) Change Old (%) New (%) Change
income
40,000 27.3 22.9 -4.4 10.2 6.0 -4.2
60,000 29.1 25.2 -3.9 16.2 12.0 -4.2
100,000 32.8 29.8 -2.9 22.1 18.2 -3.9
200,000 46.9 39.0 -7.9 30.7 26.8 -4.0
300,000 53.0 39.0 -14.0 37.8 30.8 -6.9
The authors of the Proposals explain the relief for modest incomes in terms of the need to distinguish more clearly the standard of living one can earn at a low-paying job from that to be had without effort by staying on welfare. They do not say why the marginal rates of high-income individuals should drop by 14 percentage points, while those of persons inside the progression range fall by only 3 to 4 percentage points.
We make the following observations on this question and on the Proposals in general.
AVERAGE AS OPPOSED TO MARGINAL TAX RATES
The average tax rate is reduced uniformly (4 to 5 percentage points) up to DM 120,000 for single filers and double this amount for joint filers. An advantage for higher incomes does not emerge until significantly above these figures. Furthermore, Germany's average income tax rates within this range are even now not excessive by international comparison. Germany's full splitting system is reflected in the even lower rates for joint filers. The authors of the Petersberg Proposals would appear to believe that sufficient tax relief is provided, and evenly divided, among taxpayers in the low to high middle range.
WITHDRAWAL OF TAX BENEFITS TO HIGH-END TAXPAYERS
Average tax rate reductions do diverge at higher amounts. However, with rising income, taxpayers are better able to profit from tax planning so as to reduce their taxable incomes. Roughly two thirds of the revenue-generating measures in the Petersberg Proposals appear to fall on relatively high-income level taxpayers. The higher reductions in average tax rates accorded to high-end taxpayers are to a considerable extent counterbalanced by the withdrawal of tax benefits which were previously available to this class of taxpayer.
INDUCEMENT WITH RESPECT TO ECONOMIC DECISIONS
The authors of the Proposals are possibly seeking to permit persons of some means to retain roughly the same percentage of income without resort to tax shelters which they were before able to secure with their benefit, including in some cases semi-legal or downright illegal tax evasion strategies. At present, highly skilled individuals might also prefer employment abroad to work in Germany for tax reasons. By relieving the tax pressure on such persons, they may be induced to commit their labour and capital to the domestic economic process, thus creating economic growth and more jobs, instead of channelling them into tax-driven schemes (distortion of economic choices by tax considerations) and/or depositing them abroad at rates of return which are only attractive if the revenue goes undeclared and so untaxed.
EFFECT ON BUSINESS
The Proposals' effect on business entities will vary depending on the extent to which the business is affected by the measures which broaden the commercial income tax base. Furthermore, with a 25 % corporation tax distribution rate on corporate dividends to non-resident shareholders, the tax burden on income earned in Germany will fall to under 38 % (assuming 17 % trade tax on earnings) on dividends to EU parent companies. With 5 % withholding tax the total burden would still be under 41 %.
OTHER CONSIDERATIONS
Tax reform is but one of three fundamental economic policy decisions which Germany is facing. The other two are drafting a national budget which reflects the planned net decrease in income taxes and reforming the health insurance and social security systems. All three decisions will have enormous impact on both net disposable income for the working population and the cost of wage labour to employers. Tax reductions would have to be financed by increased borrowing, decreased spending, or some combination of the two. There is as yet no inkling as to how the Government proposes to solve this conundrum, and at whose expense.
Disclaimer and Copyright
This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.
