Germany: 196. Tax Reform 2000: Legislative Status And Political Outlook

On 10 January 2000, the government released a draft of its proposed legislation for comment by business and industry. On 9 February 2000, a slightly revised draft bill was adopted by vote of the Federal Cabinet and sent to the Federal Parliament (the Bundestag) as the Act for the Reduction of Tax Rates and Reform of Business Taxation, or Tax Reduction Act (Steuersenkungsgesetz) for short (BT-Drucks. 14/2683 of 15 Feb. 2000).

On 10 May 2000, the Finance Committee approved the bill with a considerable number of revisions and sent it to the Federal Parliament, which passed it on May 18th.

From Parliament, the bill went to the Bundesrat or the Federal Council of German States. Since the revenue of the taxes affected by the legislation is either shared by the federal, state, and local governments or, in the case of the trade tax for instance, assigned exclusively to local government by the German constitution, the bill cannot become law without the consent of the Federal Council.

The deliberations in the Federal Council promise to be interesting because the Red-Green coalition government lost its majority in the Federal Council in 1999 as a result of defeats in state elections. The Federal Council is composed of delegates appointed by the various state (Länder) governments. Currently, a majority of the delegates are appointed by states where the CDU or CSU holds office (in some cases in coalition with the Liberal Party – FDP). Hence, the consent of the opposition parties, in particular the CDU/CSU alliance, must be obtained if the bill is to become law. However, the state governments (whose delegates in the Federal Council must vote as they direct) sometimes depart from the national party line (for reasons of principle, in furtherance of specific state interests, etc.).

The CDU and CSU national parties have agreed amongst themselves on a tax reform plan which is at loggerheads with the government's legislation. The CDU and CSU in particular criticise the unequal tax treatment accorded to corporations on the one hand and personal businesses (partnerships and sole proprietorships) on the other and deny vehemently that this inequality is adequately addressed by allowing personal businesses to opt for taxation as corporations.

The key points in the CDU/CSU plan are as follows:

• retention of the present imputational corporate tax system with reduction of the corporation tax rates for distributed and retained earnings to 30 % and 25 % respectively
• reduction of the trade tax rates
• reduction of the top individual income tax rate to 42 % in 2001 and 35 % in 2003
• rejection of the proposed credit of trade tax against personal income tax
• rejection of the proposed elective taxation of partnerships as corporations
• rejection of the dividends received deductions (100 % deduction for corporations, 50 % deduction for individuals), which are central to the government's proposals

The CDU and CSU in essence advocate a modified version of the tax reform package they tried to legislate in 1997/98, but could not for want of the consent of the Federal Council, which was then controlled by the SPD and Greens. Needless to say, there is little chance of these parties being won over to the CDU/CSU position at this late stage.

However, a repetition of the tax reform standoff experienced in 1997/98 also seems unlikely because the CDU and CSU do not appear willing to take the political responsibility for blocking a tax bill which, while complicated and arguably ill-conceived, would bring a significant measure of tax relief and is likely to be regarded by private taxpayers and business alike as much better than nothing at all.

Hence, the current expectation is for the government's bill to pass the Federal Council after considerable conference committee wrangling between the Federal Council and the Federal Parliament. Significant changes are possible and even likely in the conference committee process. The most recent statements from CDU and CSU politicians indicate determination to secure major changes in the government bill, perhaps also with a view to claiming political credit for the tax reform at the next national elections in 2002. The SPD and Greens will, on the other hand, not be inclined to let the opposition "steal their thunder."

Changes appear likely to fall into one of the following four categories:

• concessions bringing the government's scheme closer to the CDU/CSU plan
• correction of technical deficiencies and inconsistencies (of which there is no dearth)
• reduction of the overall tax relief provided, e.g. at the behest of state and local government, which bear roughly half of the reductions
• modification of politically controversial aspects of the scheme, notably the tax free profits to be reaped by corporations on sale of stock under the planned 100 % dividends received deduction for corporations

On 9 June 2000, the Federal Council voted unanimously to reject the bill in its present form and send it to a conference committee composed of Federal Council and Parliament representatives to negotiate amendments.

The last sessions of Parliament and the Federal Council before the summer recess are on July 7th and July 14th respectively. If the bill does not emerge from the conference committee in time for ratification on these dates, uncertainty as to the outcome of legislative initiative will continue into the autumn, or beyond.

The two legislative bodies whose consent is needed to enact the Tax Reduction Act are controlled by opposing political factions which have widely differing notions as to what sort of tax reform is best for Germany. They agree, however, on the basic premise that the present tax system is antiquated and should be radically modified. Furthermore, expectations of fundamental change are running high in the population at large and even higher in the business community. While political gridlock remains a distinct possibility, neither side is anxious to be seen as responsible for inaction.

This appears to be a recipe for compromise, probably along lines which are closer to the Tax Reduction Act which is currently on the table than to the CDU/CSU alternative plan. But the outcome is still very much in doubt.

For further information, please send a fax or an e-mail stating your inquiry to KPMG Frankfurt, attn. Christian Looks: Fax +49-(0)69-9587-2262, e-mail cLooks@kpmg.com. You may also send an e-mail to KPMG Germany by clicking the Contract Contributor button on this screen.

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