The Positive Effects of the German Economic Recovery Package Are Overshadowed for Tax Purposes by the Unmodified Discrimination of Equity Capital Financing

The tax allowances modified by the German economic recovery package only cause slight relief of the companies’ tax burden, but still, this measure is not appropriate for stimulating investment activity. In this regard, a systematic elimination of old burdens inherited by the German corporation tax reform of 2008 would be much more important. This approach focuses on corporate financing and requires a tax relief on equity capital rewards.

The Federal Government aims to counteract the economic downturn with a bundle of target-aimed measures, directed towards stimulating the investment and consumption activity (50 billion Euros in total). The Federal Cabinet aims to implement the necessary legal modifications within this very week. Besides reliefs for private households, infrastructural measures, and the securing of credit supplies, the German government plans to introduce improvements in corporate tax allowances. This means that for small and medium-sized enterprises the limits of business assets and profits for special allowances will increase, allowing more companies to apply these improved allowance methods. Furthermore, there are plans to reintegrate the digressive allowance of 25 per cent for a term of two years, independent to the size of a company. The digressive allowance recently has been eliminated within the corporation tax reform in 2008. During the years before, the rate had been modified several times.

Tax cuts as positive effects of the planned reintegration of the digressive allowance can be observed, though there is only a slight relief in tax burdens. This is shown by calculations conducted at the Centre for European Economic Research (ZEW) in Mannheim, Germany. On the basis of the investment theory model by Devereux and Griffith, the effective average tax rate for companies has been calculated for the 27 EU member states based on the legislation of 2007. Furthermore, for Germany the business tax reform (legislation of 2008) and the planned reintroduction of the digressive allowance (legislation of 2009) have been considered. Due to the business tax reform in 2008, Germany is able to improve significantly and advances five ranks to the 22^nd position on an international scale. Especially the reduction of the corporate tax rate from 25 to 15 per cent minimises the effective average tax rate by 7,5 percentage points. In contrast, the relief on the tax burden by the reintroduction of the digressive allowance with 0,02 percentage points turns out quite insignificant. It also does not improve Germany’s position in an international comparison. The constant changes in allowance are rather disturbing a stable investment climate.

Considering the insignificant impact on taxation achieved by reintroducing the digressive allowance, it may be assumed that within the current economic situation, this measure will create only slight incentives to further investment. Besides, there is a time limit of two years, preventing security for long-term investors.

Therefore, the question arises, why the German government does not make any efforts to solve the financing problems of companies emerging in the face of the financial market crisis. As a result of the business tax reform of 2008, there is a growing fiscal discrimination of equity capital financing. The reason for this is the missing integration of the German Abgeltungssteuer (a definite flat rate withholding tax on capital income and realized capital gains) into the corporation tax regime. Within the current economic situation, this has serious consequences.

From an investor’s point of view, rewards on private capital contributed to corporations are taxed twice within the current tax regime: with corporation taxes and the definite flat rate withholding tax on payouts. Whereas debt capital rewards are taxed only once by the so-called Abgeltungssteuer. This means that the demands for returns on private capital are raised systematically. Companies that cannot match these elevated requirements of investors are not able to access new capital. But, during times of crisis, equity capital is crucial as a life-saving buffer. Instead of being able to built up such a buffer, in times of decreasing returns – as we can observe at the moment – companies must borrow external capital. But due to the developments on worldwide financial markets, interest rates are high. As a consequence the demanded return on equity capital keeps increasing, so that it becomes harder for companies to meet these requirements. Therefore, the way towards an improvement of equity capital supply is finally blocked.

A solution of the described dilemma would be a tax regime which is neutral to financing, wherefore the taxation of equity and outside capital has to be levelled out. Therefore it is strongly recommendable to counteract obvious financing shortfalls for investments with a fiscal relief on self-financing. Distortions could be permanently and significantly reduced by the dual income tax, as put forward by the German Council of Economic Experts in cooperation with Max Plank Institute, Munich. By this, additional obstacles for raising equity capital caused by taxation could be avoided.

For further information please contact

Katharina Finke, Phone: +49 621/1235-397, E-mail: finke@zew.de

Prof. Dr. Christoph Spengel, Phone: +49 621/1235-142, E-mail: spengel@zew.de