Federal Constitutional Court Decides on Inheritance Tax – ZEW President Fuest Argues for a Fundamental Reform

The Federal Constitutional Court in Karlsruhe has ruled the German inheritance tax in its current form illegal. Inheritance tax breaks for family-run businesses, the judges decided, violate the constitutional principle of equal tax treatment. ZEW’s President Professor Clements Fuest comments on the ruling and recommends fundamental changes to the German inheritance tax law.

"Against the backdrop of the ruling of Germany’s highest court, policy-makers should implement a fundamental reform of the inheritance tax. Tax rates should be lowered notably for all heirs to a level of eight to ten per cent. Special tax breaks should be abolished and replaced by a non-bureaucratic extension rule to mitigate liquidity problems. Then, a fair and economically sustainable inheritance tax can be ensured.

Unfortunately, the judges did not forcefully call for a substantial revision of the current law. The ruling allows for a reform that is limited to introducing tighter restrictions for family-owned companies to qualify for inheritance tax breaks, thereby preserving exemption rules as well as high inheritance tax rates of up to 50 per cent. The current rules, however, entail economically detrimental side-effects. This is in particular true for the regulation that company assets are only spared ifthe total amount of wages paid to employees is kept above a minimum level over a period of five years after the business is passed on to the next generation. This requirement may cause considerable economic damage, as it is an obstacle to necessary business restructuring. Especially after a generational change, the need to reorganise a company is likely to increase.

The ruling of the judges in Karlsruhe demands the extension of the payroll regulation to small enterprises with less than 20 employees, which have so far been exempted. Large enterprises must meet additional requirements to qualify for tax breaks. We should be aware of the risk that the inheritance tax law could become even more bureaucratic, and that new exemption requirements could cause even greater harm than the current ones."