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1. Overview of tax legislation enacted so far
The draft legislation reported in articles nos. 151 and 154 has been enacted into law in three separate pieces of legislation, the last and most important of which acquired the force of law following ratification by the Federal Council on 19 March 1999. The three measures involved are as follows:
- Tax Amendment Act of 1998
- Tax Relief Act of 1999
- Tax Relief Act for the Years 1999, 2000, and 2002
This article provides an overview and analyses the economic effects of these three bills taken as a group. While many of the new provisions have been discussed in our previous articles, a number of changes did occur in the course of the legislative process. For a description of the individual provisions of the new legislation, see article no. 167.
2. A note on numerical data
The figures used in this article on the revenue impact of the tax reforms are taken or derived from Federal Parliament Printed Document 14/443 dated 3 March 1999, which contains detailed quantitative information on the estimated fiscal impact of the reforms. For purposes of this article, we have consistently used the figures given for the increase or decrease in assessed tax in the first assessment period to which a particular change applies. This figure is a rough approximation of the recurring annual effect of a measure. It should be distinguished, however, from the cash flow effect in a particular year, which may differ greatly because of the nature of the tax collection process.
We note that the government's figures are disputed in some respects. Industry estimates of the tax burden resulting from particular revenue-increasing measures are much higher than the government's. This debate is beyond the scope of the present article, however.
In analysing government's figures, we have made certain broad assumptions as to the taxpayer group affected by specific tax increases or decreases. The results obtained should be regarded as capable of further refinement. The picture emerging from our calculations is nevertheless clear (see sec. 4 below).
The new legislation makes no change in the solidarity surcharge (currently 5.5 % of corporate and personal income tax liability). The discussion of taxes and tax rates in this article ignores the solidarity surcharge.
3. Magnitude of the new legislation
The impressive magnitude of the new legislation is apparent from the following table (revenue outflux "-", revenue influx "+"):
|
DM billions |
|
|
|
|
|
|
|
Tax rate reductions + child supp. payments |
- 54.59 |
|
|
Increased pension accruals |
- 2.94 |
|
|
Tax increases (broader tax base) |
+ 35.70 |
|
|
Net benefit to taxpayers |
- 21.83 |
(Euro -11.16 bl.) |
One may recall that the overall tax reductions planned in connection with the tax reforms which the preceding government under Chancellor Kohl attempted to legislate in 1997 was approximately DM 30 billion.
The above figure of DM 54.59 billion includes increases in tax-exempt child support payments made directly by the government to families with children. Furthermore, increased child support payments of DM 1.9 billion from the year 2002 onwards are also contained in this figure, although they are not part of the legislation enacted. The government removed the increase in child support payments planned for 2002 from the law as enacted because of a ruling by the Federal Constitutional Court (see article no. 173). Since, if anything, the government will spend even more for increased child support payments, it appears reasonable to include the sum originally budgeted in the above calculation.
4. Contours of the new legislation
Broadly speaking, the new tax legislation provides sizeable tax breaks, including child support payments, to low and middle income taxpayers and families with children. A major portion of these benefits is financed by tax increases on businesses and on individuals who, while clearly on the high end of the German tax scale, certainly need not be wealthy.
The net tax burden on businesses and individuals of some means is increased substantially by the new legislation. That on low to middle income taxpayers and families with children is decreased substantially.
The tax breaks and increases in child support payments are divided into three phases (1999, 2000, 2002) covering a period of four years. However, virtually all of the revenue-increasing measures take effect in 1999.
The following table gives rough estimates of the distribution of tax increases and tax decreases over time (tax increases "+," tax reductions and child support payments "-"). The figures in the table refer to the change in the tax assessed beginning with a given year, not to cash flow in a particular year. For instance, a tax increase of DM 10 billion in 1999 would mean assessment of DM 10 billion of additional taxes (compared with 1998) in 1999 and in all subsequent years.
|
|
Businesses, Individuals of Some Means DM billions |
Average Taxpayers DM billions |
|
|
|
|
|
1999 |
+ 22.44 |
- 2.32 |
|
2000 |
- 3.06 |
- 10.51 |
|
2002 |
- 2.43 |
- 26.51 |
|
Cumulative |
+ 16.95 |
- 39.34 |
The net relief (tax reductions and child support payment increases) of DM 22.39 billion indicated by the above figures is further reduced by additional taxes of DM 565 million, falling mostly on the agriculture and forestry sector, to arrive at the net figure of DM 21.83 billion given in the preceding section.
The tax reforms as legislated so far thus markedly increase taxes on businesses and individuals of some means and distribute substantial sums among a large number of average taxpayers, especially low to middle income taxpayers (see also sec. 6 below).
5. Summary of tax reduction measures
Increased child support payments are included in the following list of "tax reduction measures" as they have the same net effect as a tax reduction for the recipients and for the national treasury. The following table provides an overview of tax-reduction measures.
|
Phase 1: 1999 |
DM millions |
||
| 1. |
- Increase in income tax zero bracket amount |
||
|
from DM 12,365 to DM 13,067 |
|||
|
- Reduction in preferential max. inc. tax rate for |
|||
|
commercial business income from 47% to 45% |
|||
|
: together |
-1,160 |
||
|
2. |
Increase in permissible pension accruals |
-2,941 |
|
|
3. |
- Reduction of initial income tax rate |
||
|
from 25.9% to 23.9% |
|||
|
- Child support payments, + DM 30/month |
|||
|
for 1st and 2nd child |
|||
|
: together |
-7,105 |
||
|
4. |
Reductions of corporate tax rates: |
||
|
for retained earnings from 45% to 40% and |
|||
|
for perm. establishments from 42% to 40% |
-3,811 |
-15,017 |
|
|
Phase 2: 2000 |
|||
|
1. |
Increase in income tax zero bracket amount |
||
|
from DM 13,067 to DM 13,499 |
-3,825 |
||
|
2. |
Reduction of initial income tax rate |
||
|
from 23.9% to 22.9% |
-570 |
||
|
3. |
More gradual income tax rate progression |
-6,115 |
|
|
4. |
Reduction of top income tax rate |
||
|
from 53% to 51% |
-1,690 |
||
|
5. |
Reduction in preferential max. inc. tax rate for |
||
|
commercial business income from 45% to 43% |
-1,370 |
-13,570 |
|
|
Phase 3: 2002 |
|||
|
1. |
Increase in income tax zero bracket amount |
||
|
from DM 13,499 to DM 14,093 |
-4,950 |
||
|
2. |
Reduction of initial income tax rate |
||
|
from 22.9% to 19.9% |
-1,790 |
||
|
3. |
More gradual income tax rate progression |
-17,870 |
|
|
4. |
Reduction of top income tax rate |
||
|
from 51% to 48.5% |
-2,430 |
||
|
5. |
Child support payments, min. + DM 10/month |
||
|
for1st and 2nd child |
-1,900 |
-28,940 |
|
|
Total reductions, all three phases |
- DM 57.53 billion |
||
|
Total tax increases, all three phases |
+ DM 35.70 billion |
||
|
Net tax reduction |
- DM 21.83 billion |
||
6. More gradual income tax rate progression
As is apparent from the above, by far the most important tax reduction measure contained in the new legislation is the lowering of the graduated income tax rates intermediate between the starting rate and the maximum rate so that these rates do not rise so steeply. This realignment alone accounts for almost 42 % of all relief measures (tax reductions plus increases in child support payments) contained in the new tax package.
The point at which the highest marginal tax rate begins has not been changed, or rather it has been lowered. This point is presently DM 120,000 (EURO 61,355 = US-$ 65,000) for taxpayers filing singly (double this amount for joint filers) and has been unchanged for over 40 years, as has the 53 % top marginal tax rate. The points at which the future maximum income tax rates of 51 % (2000) and 48.5 % (2002) are reached have been lowered (to DM 114,695 and DM 107,568 respectively) to coincide with the points at which the respective future maximum marginal tax rates are reached under the system currently in effect.
Spot checks of taxes owing on taxable income ranging from DM 15,000 up to the amounts at which the future maximum rates begin show that the benefits of the realignment taking effect in the year 2000 are concentrated at the lower end. The taxes of a person earning taxable income of DM 15,000 are, for instance, almost cut in half. (savings of DM 339 - partly due to the lower initial tax rate and the higher zero bracket amounts.) Taxes of a single individual with taxable income of DM 107,000 fall by only DM 50 or 0.15 % of 1998 tax liability.
The benefits conferred on lower-end taxpayers are in part an attempt by government to improve incentives for people to go off social assistance programs and accept low-paying jobs instead.
The much more substantial realignment scheduled for the year 2002 is also weighted in favour of low to middle range taxpayers, but the proportions are not so heavily skewed. A single person with DM 100,000 of taxable income will pay DM 1,482 less in taxes, a savings of 4.82 % of his or her 1998 tax bill on the same income. However, a single person paying tax on income of DM 30,000 will have DM 1,069 less to pay compared with the 1998 rates, a savings of almost 22 %. Taxes on income of DM 15,000 fall to about one fourth of their 1998 rates (savings of DM 506).
7. Reductions in preferential income tax rate for commercial business income
Since 1994, the German income tax law has contained a preferential maximum rate of 47 % (six percentage points under the top marginal rate of 53 %) for commercial business income derived by individuals. The new legislation lowers the preferential rate still further to 45 % in 1999 and 43 % in the year 2000.
The constitutionality of these measures is doubtful following a ruling by the Federal Tax Court released in April 1999. Further details are provided in article no. 165.
8. Revenue-increasing measures
The table in sec. 9 below lists the measures in the new tax legislation which broaden the tax base and increase taxes. Most of these measures take effect in 1999. For details on the provisions of the individual measures, see article no. 167.
The following table groups revenue-increasing measures according to the taxpayer group on which the increase falls. The groups defined are as follows:
- Commercial businesses in general
- Specific industries
- Individuals of some means
- Average taxpayers
- Other, especially agriculture and forestry
While some measures are easily classified according to the above system, others pose difficulties. The groups "commercial businesses in general" and "individuals of some means" overlap to some extent, as do the groups "individuals of some means" and "average taxpayers". For instance, the elimination of an important subsidy for persons who purchase their own homes has been placed in the category "average taxpayers," even though home ownership is still the exception rather than the rule in Germany today. This choice appears defensible, since the subsidy was not available to persons exceeding certain income levels, but the classification is still one on which reasonable persons can differ.
Furthermore, the category "commercial businesses in general" is a broad one. The government contends that small and medium sized businesses will actually pay less tax than before as a result of the reforms. This contention is disputed by industry organisations. We have not attempted to distinguish between "large corporations" and "small and medium sized businesses" (often operating as partnerships or sole proprietorships) in analysing the impact of specific tax-increasing measures.
Lastly, we note that the impact of the measures affecting specific industries is estimated by those industries to be significantly higher than the government's figures.
9. Revenue and taxpayer impact of measures broadening the tax base
|
Measure enacted |
Fiscal impact |
|
I. Changes affecting commercial businesses in general
|
DM |
|||||
|
1. |
Elimination of elective deductibility of losses from permanent establishments located in tax treaty countries - sec. 2a (3) (4) EStG |
|
|||
|
2. |
Restrictions on amending tax balance sheet after submission - sec. 4 (2) EStG |
|
|||
|
3. |
Denial of deductibility of domestic and foreign bribes |
(no estimate) |
|||
|
4. |
Obligation to reverse writedowns to going concern value when asset recovers in value - sec.6 (1) nos. 1, 2 EStG |
|
|||
|
5. |
Restrictions on writedowns to going concern value - sec. 6 (1) nos. 1, 2 EStG |
|
|||
|
6. |
Accruals, more realistic valuation and other changes - sec. 6 (1) nos. 3, 3a EStG |
|
|||
|
7. |
Valuation of accruals at present value - sec. 6 no. 3 EStG |
|
|||
|
8. |
Abolition of reorganisation possibilities under the Co-Entrepreneur Directive - sec. 6 (4) EStG |
|
|||
|
9. |
Abolition of reorganisation possibilities under the Exchange Opinion - sec. 6 (5) EStG |
|
|||
|
10. |
Limitations on rollover of realised gains - sec. 6b EStG |
566 |
|||
|
11. |
Limitations on anticipated depreciation benefits for small and medium sized businesses - sec. 7g EStG |
|
|||
|
12. |
Elimination of the deductibility of interest on payments of back taxes and deferred taxes - |
|
|||
|
13. |
Changes in loss carryforward and carryback, particularly limits on loss carrybacks in time and amount - sec. 10d (1) EStG |
(no affect on assessed tax; tax collected 2000 and 2001 + DM 315 mill. each, 2002 + DM 570 mill.) |
|||
|
14. |
Withholding tax for foreign contractors - |
|
|||
|
15. |
Repeal of valuation discount for certain imported goods - sec. 80 EStDV |
|
|||
|
16. |
Exclusion of corporate losses on sale of shares in foreign corporations - sec. 8b KStG |
|
|
||
|
17. |
Treatment of 15 % of tax free foreign dividends as deemed non-deductible expense - sec. 8b KStG |
|
|
||
|
18. |
Elimination of VAT input tax credit on extra meal expenses of employees on business trips - |
|
|||
|
19. |
Elimination of employer VAT input tax credit for employee travel and moving costs |
|
|||
|
20. |
Trade tax addback for writedown by reason of profit disbursements by dependent company to lead company in consolidated group - |
(no estimate) |
|||
|
21. |
Changes in real estate transfer tax - sec. 1 (3) GrEStG |
150 |
|||
|
22. |
Flat rate wage tax passed along to employees no longer reduces the base for calculation of wage tax owing |
|
|||
|
Subtotal I. 13,359 |
|||||
|
II. |
Changes affecting specific industries |
||||
|
1. |
Extension of the period for building up accruals for decommissioning nuclear power plants from 19 to 25 years - sec. 6 (1) nos. 3, 3a; 52 (6b) sent. 2 EStG |
|
|||
|
2. |
Prohibition on establishment of accruals for cost of purchase or production, e.g. for when reprocessing nuclear fuel elements - sec. 5 (4b) EStG |
|
|||
|
3. |
More realistic valuation of accruals, in particular for the claims accruals of insurance companies - |
|
|||
|
4. |
Elimination of tax free reserve for building and loan associations - sec. 21 KStG |
|
|||
|
Subtotal II. 4,841 |
|||||
|
III. |
Changes affecting individuals of some means |
||||
|
1. |
Minimum taxation and tax shelter restrictions - |
|
|||
|
2. |
Limitation of "double account" structures - |
|
|||
|
3. |
Withdrawals from business property subject to rules for short term capital gains - |
|
|||
|
4. |
Valuation of contributions to business property at adjusted cost basis - sec. 6 (1) no.5 EStG |
|
|||
|
5. |
Elimination of standard rental expense deduction - sec. 9a no. 2 EStG |
|
|||
|
6. |
Limitations on offset of forward transaction losses - sec. 15 (4) EStG |
|
|||
|
7. |
Threshold for taxation of capital gains on private sales of shares in corporations reduced from 25+% to 10% |
|
|||
|
8. |
Expanded loss offset for negative "other income" - |
|
(measure reduces tax revenue) |
||
|
9. |
Holding period for tax-free private capital gain on sale of real estate increased from 2 years to 10 years |
|
|||
|
10. |
Holding period for tax-free private capital gain on sale of securities increased from 6 months to 1 year |
|
|||
|
11. |
Gain on private forward transactions subject to rules for short-term capital gains - |
|
|||
|
12. |
Inclusion in progression clause of tax free foreign income received through tax consolidation structure - sec. 32b EStG |
|
|||
|
13. |
Denial of preferential income tax rate for commercial business income derived from corporations through tax consolidation structure - sec. 32c EStG |
|
|||
|
14. |
Elimination of taxation of "extraordinary" income at half the normal tax rate |
|
|||
|
15. |
Elimination of income tax reduction by reason of inheritance tax paid - sec. 35 EStG |
|
|||
|
16. |
Improved reporting system for income from capital - sec. 45d EStG |
|
|||
|
17. |
Liberalised VAT taxation of self-supplies - |
|
(measure reduces tax revenue) |
||
|
18. |
Elimination of VAT input tax credit on property not used at least 10% for business purposes |
|
|||
|
19. |
Extension of withholding tax to include stock mutual funds - sec. 39 KAGG |
|
|||
|
20. |
Inheritance taxation of transfers to trusts - |
|
|||
|
Subtotal III. 12,152 |
|||||
|
IV. |
Changes affecting average taxpayers |
||||
|
1. |
Reduction in tax exempt severance payment on employer-initiated termination of employment relationship - sec. 3 no. 9 EStG |
|
|||
|
2. |
Limitation on exemptions for certain employee transition payments - sec. 3 (10) EStG |
|
|||
|
3. |
Elimination of exemptions for certain payments to employees on employee and business anniversaries - sec. 3 (52) EStG |
|
|||
|
4. |
Elimination of deduction of "advance costs" on home purchases - sec. 10i EStG |
|
|||
|
5. |
45% reduction of investment income exemption - |
|
|||
|
6. |
Increased limit on deduction for support payments - sec. 33a (1) EStG |
|
(measure reduces tax revenue) |
||
|
Subtotal IV. 4,784 |
|||||
|
V. |
Changes in other areas: |
||||
|
1. |
Agriculture and forestry |
337 |
|||
|
2. |
Other |
228 |
|||
|
Subtotal V. 565 |
|||||
|
Total increase in tax revenue: |
35,701 |
||||
10. Summary of distribution of revenue-increasing measures
The following table summarises the impact of the revenue-increasing measures according to the preceding calculations.
|
Summary |
DM |
|
|
|
1. |
Commercial businesses in general |
13,359 |
37.42% |
|
2. |
Specific industries |
4,841 |
13.56% |
|
3. |
Individuals of some means |
12,152 |
34.04% |
|
4. |
Normal taxpayers |
4,784 |
13.40% |
|
5. |
Other |
565 |
1.56% |
|
Total |
35,701 |
100% |
11. Conclusion
The tax reform legislation passed by the new government of Social Democrats and Greens increases still further what some considered to be an already unbearable tax burden on businesses and persons of some means. While it does provide significant net relief to average taxpayers, especially low to middle income taxpayers, the per capita reductions are not so large as to incite enthusiasm, especially when one remembers that the most important tax reduction measures do not take effect until the year 2002 (coincidentally the next national election year). It is therefore no wonder that the reforms presently have few, if any, ardent supporters, and many opponents.
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.
