German Tax Benefits Reduction Act: Taxation Plans Threaten Investments

The changes to corporation tax, proposed by the German government in the Tax Benefits Reduction Act (Steuervergünstigungsabbaugesetz), will result in increased tax burdens being placed on the companies affected.

This finding is the result of calculations carried out by the Mannheim Centre for European Economic Research (ZEW) and the University of Mannheim. Taxation policy is hereby diverging from the reported aim of cutting taxtes, and is subsequently putting the loyalty of investors to the test.

When it comes to corporate taxation, Germany is already one of the countries with the highest tax levels worldwide. Whilst France, for example, has reduced its corporation tax again this year, German firms are under growing pressure due to the adopted increase in corporate income tax from 25 to 26.5 per cent limited to 2003. The proposed, less favorable depreciation rules for property investments would trigger just a slight increase in the tax burden. Another measure will have a much greater impact on companies, particularly on those holding large stocks: companies have so far calculated the tax payable on their stocks according to the Lifo-method, a rather generous method of tax calculation currently in place, which is to be abolished soon. According to ZEW calculations, these measures may together result in an increase in the tax burden on individual companies, depending on the economic sector concerned, by anything from 3.95 to 11.35 per cent. (see Table).

In addition, numerous measures will be introduced to restrict the offsetting of losses. These will, however, have a particularly negative effect on innovative investment plans. Re-structuring processes will also be made more difficult since, in the future, companies will be unable to carry any losses forward. This will hardly help to disentangle the Deutschland AG (an intricate network of major banks, insurance companies, and industrial enterprises) as promised in the 2001 Corporate Tax Reforms. Both the willingness to invest in the domestic economy, as well as Germany’s international attractiveness for foreign investments will suffer.

The planned measures will also fail to ensure greater tax equality and transparency. Nor will they result in improved tax systems. Considerable elements in the proposed draft measures and changes, will rather lead to a further fragmentation of tax law. Capital gains, interest and the profits of small firms are now to be subject to reduced tax rates. This will create additional demarcation issues and legal loopholes in the German tax system. The fragmentation of tax law also opens the way for further sporadic tax deductions and inequalities.

For a number of very good reasons, private returns on interest are to be subject to a reduced tax rate of 25 per cent. The tax rate will not, however, be reduced for business profits. Many entrepreneurs will ask themselves why the profits from their high-risk and self-financed investments, are subject to tax rates which are essentially twice as high as they were previously. In addition, entrepreneurs face further tax disadvantages should they incur any losses. Shareholders in corporations might increasingly finance their corporations with shareholder loans and thus possibly benefit from the lower tax rate. This possibility is not, however, open to companies which do not exist in the form of corporations. The planned measures therefore accentuate the differences which already occur in taxation levels depending on the legal form of a business. 

Taxation policy should aim at a new structure for corporate taxation. It must therefore be decided how exactly corporate tax should be combined with income tax. Additional compehensible criteria are required in order to delineate the corporate, from the non-corporate sphere. Aspects such as the international activity of businesses as well as European legal regulations also need to be taken into account. Currently, however, the most important prerequisite for maintaining investors’ willingness to invest in Germany is ensuring that domestic and foreign investors have confidence in a consistent German tax policy which provides suitable conditions for investment.

Author of the Study

Otto H. Jacobs (University of Mannheim), Ulrich Schreiber (University of Mannheim), Christoph Spengel (University of Mannheim and ZEW), Gerd Gutekunst (ZEW), Lothar Lammersen (ZEW)

Contact

Dr. Gerd Gutekunst, E-mail: gutekunst@zew.de

Dr. Lothar Lammersen, E-mail: lammersen@zew.de