Mannheim Tax Index

The current economic landscape in Germany is marked by a recession and anticipated low potential growth in the upcoming years. The ongoing high inflation, driven by the energy crisis, is straining businesses as purchasing power diminishes. These economic challenges are exacerbated by a decade-long negative trend in Germany’s business environment, characterised by increasing regulation, bureaucratisation, insufficient digitalisation, and a shortage of skilled workers. Compared internationally, the high corporate tax burden in Germany adds to the challenges. To counter the low potential growth and foster economic transformation towards climate neutrality, mobility transition, and digitalisation, it is imperative to enhance Germany’s attractiveness for businesses and encourage investments, particularly in terms of taxation.

Despite its significance as a leading European country for foreign direct investments over the past fifteen years, Germany has lost its tax attractiveness compared to key partners. In 2023, Germany exhibited the highest tax burden for traditional business models compared to France, Italy, the United Kingdom, and the EU average. Germany’s high-tax profile has become all the more apparent, with France reducing its corporate tax rate in recent years, and even the UK’s increase in corporation tax to 25 per cent hasn’t changed Germany’s leading position. Despite a potential stabilisation in the downward trend of the effective tax burden due to the newly introduced global minimum tax, Germany remains relatively unattractive for companies with international investment alternatives.

The effective average tax burden of a profitable investment project in Germany in 2023 is 28.5 per cent, exceeding the EU average by almost 10 percentage points. On an international scale, only two countries (Spain and Japan) in the Mannheim Tax Index had a higher tax burden. Currently, various approaches to improve Germany’s tax attractiveness are being discussed. The draft of the Growth Opportunities Act suggests continuing the degressive depreciation for movable assets, while the coalition agreement even proposes a so-called “super depreciation”. Additionally, the abolition of the solidarity surcharge and a reduction in the corporate income tax rate to 25 per cent are under discussion.

Analysing the individual proposals shows that neither the introduction of degressive depreciation nor the abolition of the solidarity surcharge significantly impacts Germany’s location attractiveness. Implementing these measures would only marginally reduce the effective average tax burden for companies from 28.5 per cent to 28.3 per cent with degressive depreciation and to 27.8 per cent with the abolition of the solidarity surcharge. A super depreciation based on the UK’s approach of an immediate write-off for movable assets, would align Germany with the US in the international ranking of the Mannheim Tax Index, with an effective tax burden of 27.4 per cent. It is noteworthy that immediate write-offs target direct investments, instantly promoting investment. A reduction of the German corporate income tax rate to 25 per cent has a more pronounced signalling effect in the Mannheim Tax Index, positioning Germany in the mid-range of Western European investment locations, with an effective tax burden of 23.5 per cent. However, achieving a noteworthy improvement in Germany’s tax attractiveness is not possible without a significant reduction in tax revenue in the short term.

The calculation of the Mannheim Tax Index is based on the established investment theory approach by British economists Devereux and Griffith (1999, 2003). By taking into account several tax parameters and their effects on a hypothetical future investment, the effective tax burden of a country is calculated and tax-induced distortions in the choice of location are shown. Both the cost of capital and the effective marginal tax rate of a marginal investment, which influences the scope of investment at a specific location, as well as the average effective tax burden on a profitable investment, are calculated.

The “Model Structure” chart shows the structure of investment and its financing. The calculation of the Mannheim Tax Index is based on a corporation in the manufacturing industry, which invests in a specified combination of various assets either through itself or a foreign subsidiary. The hypothetical investment project consists in equal parts of intangible assets, industrial buildings, machinery, financial assets and inventory. Various forms of financing are also taken into account. In order of their weighting, financial sources are retained earnings, borrowed capital and new equity capital.