Germany: 060. The German Tax Reform Proposals

Last Updated: 14 March 1997
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Announced on January 23rd of this year, the "Petersberg Tax Proposals" outline a plan of fundamental income tax reform authored by an expert commission headed by the Minister of Finance and endorsed by the three parties comprising the coalition which has been governing Germany for the past 15 years. Daring not just by comparison with the recently legislated 1997 Annual Tax Act, the recommendations would cut tax rates by around 25 % and greatly broaden the tax base.

While numerous aspects of the proposals are still controversial, their overall magnitude is impressive:

                                               DM billions

Lower tax rates (wo. solidarity surcharge)    -   81.95
Tax increases (broader tax base)              +   38.12
        Decrease in tax revenue               -   43.83

Lower tax rates (solidarity surcharge)        -    7.50
Increases in indirect taxes (e.g. VAT + 1 %)  +   15.00
                                              -   36.33

Strictly speaking, the Petersberg Proposals assume, but do not formally "recommend" a two percentage point reduction in the solidarity surcharge. More importantly, they make no recommendation on increasing indirect taxes, such as VAT or the tax on petrol. Political resistance is strong to even a 1 point increase, as VAT is regarded as a regressive tax by the opposition Social Democrats. Their consent, and to some extent that of the Greens, is necessary to enact the proposed legislation because the Government commands no majority in the Federal Council (Bundesrat).

The Petersberg Proposals have been controversially discussed in Germany in the two months since their release. This article focuses on the Proposals as originally released and mentions only what seems to be the most important subsequent developments. The article does not present the political debate regarding the Proposals. Nor does it attempt to detail all corrections and refinements since made in the figures initially released with the Proposals.

On 14 March 1997, the Government presented a mammoth 400 page draft of the proposed legislation based on the Petersberg Proposals. The length of the draft is largely a result of the Government's decision to completely renumber and reorganise the German income tax law for the first time since 1934. The March 14th draft legislation and the revised estimates it contains regarding the effects of the proposed changes on tax revenue have not been analysed for the purposes of this article.


The Petersberg Proposals are silent on the issue of repeal of the trade tax on capital. A measure passed by Parliament on 28 February 1997 would abolish the trade tax on capital from 1998 on and make changes reducing the impact of the trade tax on earnings on individuals. The measures are financed by a decrease in the rate for accelerated depreciation of movable fixed assets from 30 % to 25 %. Since the revenue from the trade tax largely goes to local government, the Government bill contains provisions granting local government a larger share of value added tax revenue. Overall, the packet of measures requires the approval of the Bundesrat and a constitutional amendment (two-thirds majority in both Parliament and the Bundesrat) to take effect. Since the bill was enacted against the votes of the Social Democrats, it may be presumed that the last word has not yet been spoken on this subject. The Social Democrats are not opposed to repealing the trade tax on capital as such, but their conditions have not yet been met by the Government.


The reasons advanced in support of the reform proposals are as follows:

1. From a tax perspective, Germany is presently considered unattractive as a business location compared with other countries. The danger is perceived that foreign businesses will pass Germany over when selecting the site for future expansion and above all that German businesses will invest abroad rather than at home. Consequently, measures are necessary to improve the conditions of production, investment, and employment in Germany in order to secure Germany's future as a business location.

2. High income tax rates are identified as a major cause of the competitive disadvantage at which Germany finds itself. Other negative factors are the complexity of the German tax system and the high share of gross national product claimed by direct taxation.

3. The present tax system should also be made more equitable (and at the same time simplified) by eliminating or curtailing special benefits of numerous sorts.

4. Lowering the tax rates while eliminating or attenuating various tax breaks will reward and stimulate economic activity by reducing both the availability of and the incentive for tax-driven investments. Presently, personal taxable income of DM 120,000 (DM 240,000 for joint returns) is subject to a marginal tax rate of 53 % + solidarity surcharge 7.5 % on 53 % = 56.5 %.

5. In conjunction with reform of the social security system, tax reform will stimulate German economic growth and create high-quality and long-lasting jobs. This latter objective appears particularly urgent in light of the new postwar unemployment record set in Germany in January of this year.


The proposed changes are to take effect in two phases. The Ministry of Finance presented in mid-February a draft of the proposed Phase I changes (Draft Tax Reform Act of 1998). This was originally to include a sharp increase, to take effect from 1 January 1997, in the reduced capital gains tax rate applying to individuals selling a business, a material ownership interest in a corporation, or an interest in a commercial partnership. In the meantime, however, the Government has decided to postpone the increase in the capital gains tax rate until 1999 (Phase II). Instead, the rate for accelerated depreciation of movable fixed assets is to be reduced by 3 percentage points in 1998. This is in addition to the 5 percentage point reduction planned to finance the repeal of the trade tax on capital (see section 2 above), bringing the rate for accelerated depreciation of movable fixed assets down from 30% to 22% in 1998. In 1999 (Phase II), a further cut of 2 percentage points to 20% is planned.

The Phase I changes apply from 1998. The principal 1998 changes broadening the tax base are as follows:

  • Mandatory reversal of write-downs taken by reason of declines in value of fixed or current assets when the asset recovers in value.
  • Prohibition on accruals by reason of losses anticipated on contracts of continuing obligation (Dauerschuldverhaeltnisse - e.g. loan and rental agreements, long-term delivery contracts).
  • Limitation of accrual for losses anticipated from other contracts (e.g. sales and purchases) to the excess of anticipated unrealised losses over unrealised gains.
  • Valuation of accrual for contingent liabilities with respect to anticipated actual net liability in light of past experience with comparable liabilities (as opposed to the nominal amount of claims raised - expected to affect insurance companies above all).
As mentioned at the end of section 1 above, a draft of the proposed Phase II reforms was released by the Government on 14 March 1997. This draft follows the Petersberg Proposals by and large, but has not been examined for the purposes of this article.

The contemplated tax rate changes for Phase I and Phase II are shown in the table which follows.


The proposed tax rate changes are as follows:

                              Presently     In 1998       In 1999


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      47 %          40 %          35 %


Rate for retained earnings    45 %          40 %          35 %
Rate for distributed earnings 30 %          28 %          25 %
Rate for PE of foreign        42 %          37 %          32 %

SOLIDARITY SURCHARGE          7.5 %         5.5 %         5.5 %


Min. rate for corporations 
to avoid tax haven treatment  30 %          unchanged     25 %


Dividend withholding          25 %          unchanged     15 %
With. on other income from    25 % - 35 %   unchanged     25 %


The principal revenue-generating measures in the Petersberg Proposals may be broken down into four categories depending on the class of taxpayers affected. The estimates as to gross revenue impact of the various individual measures are those contained in the Proposals. "Gross revenue impact" is calculated with respect to the existing tax rates. The Proposals put net revenue impact, considering the new reduced rates, at 75 % of the overall gross figure, but provide no figures for the specific measures. The tables which follow list the measures accounting for more than 98 % of the forecast revenue increases. Three quarters of the measures not covered relate to the taxation of farmers and foresters.

The draft legislation released on 14 March 1997 revises the following figures and may make changes in certain measures as well.

               PROPOSED MEASURES                 GROSS REVENUE IMPACT
                                                   (DM MILLIONS)


1. Repeal of tax exemption for gains, e.g.
cancelled debt,realised to rehabilitate 
insolvent businesses                                      50

2. Mandatory reversal of write-down of fixed or
current assets when asset recovers in value            5,000

3. Elimination of accruals for unrealised losses 
from contracts of continuing obligation; accrual
for unrealised losses on other contracts reduced
by amount of unrealised gain                           5,000

4. Lower valuation of accruals for contingent 
liabilities (especially those based on insurance
claims)                                                1,300

5.Limits on roll-over of gain realised on sale
of capital assets                                        200

6. Reduction in accelerated depreciation for
movable fixed assets from 30 % to 25 % p.a.            4,300

7. Reduction in straight-line depreciation 
for buildings held as fixed assets from 4 % p.a.
to 3 % p.a.(2 % for residential buildings)             1,800

8. Elimination of special and anticipated
depreciation for small and medium sized
businesses                                             1,000

9. Elimination of the valuation discount for
certain imported goods purchased                         250

10. Elimination of tax free reserve for 
Bausparkassen of 3 % of deposits in home 
ownership savings plans                                  450


1. Taxation of 50 % of unemployment 
compensation and other wage substitute 
payments                                                -300

2. Elimination of exemption for severance
payments up to DM 36,000                                 900

3. Elimination of exemption for employer 
contributions to cost of commuting using 
public transport                                         100

4. Elimination of exemption for certain 
bonuses (e.g. after 10, 25 or more years of 
service)                                                 100

5. Elimination of exemption for supplements 
paid to civil servants working abroad                    100

6. Elimination of exemptions for supplements
paid for work at night and on Sundays/holidays         2,200

7. Higher taxation of employee rebates                    70

8. Reduction in the deduction allowed for cost
of commuting between home and work                     4,200

9. Reduction of standard deduction for job-
related expenses                                       3,900

10. Elimination of exemption for employee stock
issues                                                   180


1. Reduction in exemption for private pension
income                                                 1,100

2. Increased taxation of public pensions and 
annuities                                              1,500

3. Reduction in old age deduction amount                 400


1. Taxation of private capital gain on sale of 
shares in a corporation if interest exceeds
10 % instead of 25 %                                     500

2. Elimination of exemption for first DM 20,000
of gain on sales of above sort                            50

3. Increase in the holding period for tax-free
sale of real property from 2 years to 10 years         1,200

4. Increase of holding period for tax-free
capital gains on sales of shares and securities
from 6 months to 1 year                                   30

5. 10 % flat rate taxation of interest earned by
long-term whole life insurance policies 
(previously tax free)                                  3,400

6. Reduction in personal interest income 
exemption                                              2,100

7. Termination of accelerated depreciation for
rented residential housing (unless held as
business property)                                     2,400

8. Elimination of deduction for interest on 
overdue, deferred, and suspended taxes                   200

9. Elimination of exemption of DM 60,000 for 
gain on sale of professional service businesses          150

10. Elimination of exemption of DM 60,000 of
gain on sale of commercial businesses                    300

11. Elimination of deduction for pre-occupancy
costs under the German home-ownership subsidy 
system                                                   700

12. Elimination of taxation at half of normal
rate for gains on sale of businesses and other
payments; instead, spreading of gain over a 
5 year period                                          5,000

V. SUMMARY                                       GROSS          NET

1. Commercial businesses                        19,350

2. Employees                                    11,450

3. Senior citizens                               3,000

4. Other measures affecting individuals         16,030

                                   Subtotal     49,830

    Total revenue-increasing measures under
                   the Petersberg Proposals     50,830       38,120

                                 Difference      1,000

             Percentage of measures covered     98.03%

SUMMARY                             AS A PERCENTAGE OF TOTAL REVENUE-
                                    INCREASING MEASURES

1. Commercial businesses                        38.07%

2. Employees                                    22.53%

3. Senior citizens                               5.90%

4.Other measures affecting individuals          31.54%

By and large, the items contained in the category "other measures affecting individuals" fall on persons with some degree of wealth. Bearing this in mind, and speaking in very broad terms, it would appear that not quite 70 % of the revenue-generating measures in the Petersberg Proposals (categories 1 and 4 above) will affect persons in the upper income categories.


An analysis of the Petersberg Proposals must begin with the new personal income tax rate structure. 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

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

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

One immediately notes that, while the proposed rates bring relief to taxpayers at all income levels, the differences are largest at the lower and above all upper ends. 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. But they do not say why the marginal rates of persons with incomes above DM 120,000 per year should be reduced by up to 14 percentage points, while those of persons inside the progression range drop by only 3 to 4 percentage points.

Average As Opposed To Marginal Tax Rates

The data on average tax rates contains part of the possible answer. 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 not excessive by international comparison, especially when one recalls that married couples filing jointly pay tax calculated at double that owing on half their joint income (full splitting). The conclusion drawn by the authors of the Petersberg Proposals would appear to be that drastic tax relief is not needed within this range.

Withdrawal Of Tax Benefits To High-End Taxpayers

Average tax rate reductions do diverge significantly at higher amounts. Since this can hardly be unintentional, one must assume that the new tax rate structure is intended to provide significant relief to persons with incomes well above DM 90,000, at which the new structure reaches its peak rate. The average tax burden on a taxable income of DM 300,000 declines by DM 31,369 (- 23%) from DM 136,141 (45.5 %) to DM 104,772 (34.9 %) under the new tax rate structure. The tax saving for someone with taxable income of DM 100,000 is DM 3,976 (-12.9 %); that for a taxpayer with income of DM 50,000 is DM 1,936 (-17.5 %).

A simple comparison of taxes owing on income is misleading, however, because it ignores the fact that, with rising income, taxpayers become better able to afford and to profit from tax advice so as to reduce their taxable incomes. We have noted above that roughly two thirds of the revenue-generating measures in the Petersberg Proposals would appear to fall on relatively high-income level taxpayers, either directly or as the owners of businesses. It would be jumping to conclusions to assume that all or most of the significant reduction in tax rates accorded to higher-level taxpayers would be neutralised by revenue generating measures, the impact of which is likewise limited to this taxpayer group. Nevertheless, there are indications that at least one objective of the Proposals is to tax wealthy individuals at lower rates, but on a greater percentage of their gross income, in other words, to narrow the difference between gross income and taxable income for such individuals. To this extent, the reduction in tax rates for higher income individuals would not represent a reduction in net income taxes.

Inducement With Respect To Economic Decisions

However, even this is probably only a partial aspect. By reducing tax rates and withdrawing tax concessions for high-level taxpayers, the authors of the Petersberg Proposals are possibly seeking to permit persons of some means to retain roughly the same percentage of income without using of tax shelters as they were before able to secure with the benefit of tax planning, including in some cases semi-legal or downright illegal tax evasion strategies. By relieving the tax pressure on persons with large disposable incomes, the authors of the Proposals may be speculating that such persons will be induced to commit the funds at their command to the domestic economic process, thus creating economic growth and more jobs, instead of channelling them into tax-driven schemes the economic viability of which depends on high marginal tax rates (distortion of economic choices by tax considerations) and/or depositing them in foreign banks or foreign mutual funds paying rates of return which are only attractive if the revenue goes undeclared and so untaxed.

One thing is certain: Lower tax rates mean that the after tax return on straightforward economic activity inside Germany which does not depend on any of the special tax provisions being eliminated or curtailed under the Petersberg Proposals will be significantly greater if the Proposals are enacted into law than if the present structure is retained. And this at least means that a foreign passive investment opportunity would have to pay a higher return in the future to outperform a domestic economic venture on an after-tax basis.

Effect On Business

Turning to the effect of the Petersberg Proposals on business entities, it is obvious that this is going to be very different depending on the extent to which the business is affected by the measures which broaden the commercial income tax base. Certain of the measures are, for instance, targeted at specific industries (the insurance industry and Bausparkassen, a sort of savings-and-loan association). Commercial taxpayers engaged in activities not greatly affected by tax base expansion indeed have cause for elation, if the Petersberg Proposals ever become law.

A further fact to note is that, with a 25 % 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. And even with 5 % withholding tax the total burden would still be under 41 %.

Finally, we point out that the proposed revenue-generating measures pertaining to commercial businesses will lead to increased trade tax on earnings for the affected businesses.


It is rare in postwar Germany that fundamental change is legislated without broad support from all major parties. The German political system, which contains both parliamentary and federalist elements, is structurally inclined to consensus. It is at present very difficult to say whether the sort of consensus required to reshape the present tax structure will emerge or not. Talks have begun between the Government and the Opposition.

It should also be borne in mind that 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 of DM 30 billion 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. Regarding budget considerations, we point out that net tax reductions of DM 30 billion 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.

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