Introduction

In conjunction with the spread of economic globalization from the 1990s, great changes have taken place in the tax systems and tax structure of advanced nations as we enter the 2010s. In order to spur economic growth, create jobs and encourage investment/relocation by corporations, countries have lowered the top personal income tax rate and corporate tax rate, have reduced social insurance premiums, and have shifted the tax base from income to consumption. In this article, I will use the EU economic power Germany to examine the trends in tax reforms and the resulting impact, particularly the relationship with the problem of income disparity.

1. Structure and characteristics of the modern German tax system

Germany is an EU economic power, as well as a leader and core country in EU political economics. The German tax system has undergone significant changes from the 1990s to the 2000s in conjunction with economic globalization, particularly the intensification/expansion of EU economic integration. Before discussing those changes, let’s confirm the structure characteristics of the German tax system as of 2010 (refer to OECD, Revenue Statistics 1965-2011).

Firstly, Germany’s burden level is in the middle range of OECD nations. The total of taxation and social insurance premiums in Germany account for 36% of the country’s GDP. This is slightly higher than the OECD average of 34%. While it is higher than the 25% of the “small-government” United States, it is much lower than the 45% of Sweden, a big welfare nation with a big government. In other words, it is an intermediate level burden typical of an intermediate welfare nation.

Secondly, although the overall burden level is of intermediate scale, social insurance premiums alone comprise 14% of Germany’s GDP. This is significantly higher than the OECD average of 9%. Even in 1990, this percentage was at the same level as in Sweden. In 2010, it exceeds Sweden by 3%. This reflects how Germany is traditionally a welfare nation based on the social insurance system. At the same time, it also indicates the problem of an excessive burden for social insurance premiums.

Thirdly, the burden level for personal income tax and consumption taxes in Germany are both about 9% to 10%. This is equivalent to the average burden level (around 10%) for OECD nations. This means that Germany’s burden level is about average for personal income tax and consumption taxes, major sources of tax revenue in advanced nations. Within consumption tax, Germany’s general consumption tax is 7%. Although this is 4% to 5% higher than America, it is 2% lower than Sweden. Overall, it is around the average OECD level.

Fourthly, Germany has a notably low level for corporate tax and property tax, both of which are around 3%. This burden level is only about 40% to 60% of the OECD average.

2. Tax reform in Germany around 2000

In the section above, we used international comparison to examine 4 characteristics of the German tax structure. General speaking, these characteristics did not change from the 1990s to the 2000s. However, it is also true that the emphasis of taxation in Germany is shifting from income to consumption due to the series of tax system reforms implemented around 2000. Specifically, these reforms include the Tax System Reform 2000 program, the Environmental Tax Reform, the Corporate Tax Reform 2008, and an increased value-added tax rate. Let’s examine a few aspects of this condition.

Firstly, the tax rates on income and profit are decreasing. Due to the Tax System Reform 2000 program, the top personal income tax rate has decreased from 53% in 1998 to 42% in 2005. Due to reforms implemented in 2001, the corporate income tax rate fell from 40% to 25%. The Corporate Tax Reform 2008 cut the rate even further to 15%. As of 2008, the effective corporate tax rate (including local tax) had decreased to slightly below 30%, right around international levels.

Secondly, there is an inverse increase in tax rates related to consumption. In 1993, the average rate for sales tax (general consumption tax or value-added tax) in Germany was 15%. This increased to 16% in 1998 and then to 19% in 2007. Furthermore, reforms of the environmental tax system (1998 to 2003) implemented increased energy-related taxes such as gasoline tax and electricity tax. This places the same burden on household budgets as an increase in consumption tax.

Thirdly, the rate for social insurance premiums has decreased slightly, from 42% in 1998 to 40% in 2008. Main reasons for this decrease are that increased revenues from reforms of the environmental tax system are being used to reduce the national pension premium rate, and that increased revenues from a raise in the sales tax rate (2007) are being used to reduce the unemployment insurance premium rate.

The result of these tax system reforms has been to create a shift from an income base to a consumption base in the structure of Germany’s tax and social insurance burdens. Taxes on income and profit (total of personal income tax and corporate income tax) have decreased by 1.0%, from 11.3% in 1990 to 10.3% in 2010. Conversely, consumption taxes have increased by 1.3%, from 9.0% to 10.3%. During the same period, the OECD average for income related taxes have decreased by 0.7%, while consumption taxes have increased by 0.5%. In comparison, it can be said that there is a conspicuous shift from an income base to a consumption base in Germany (refer to OECD materials listed above).

3. Examining the form of taxation: Neutral and simple? Fair?

Generally speaking, emphasis is usually placed on “equity,” “neutrality” and “simplicity” when discussing the form of taxation in modern nations. From the 1990s, reforms for the tax systems and tax structures of advanced nations were implemented with sole emphasis on neutrality and simplicity, concepts which requires economic efficiency and transparency. Such reforms were made in order to respond to globalization and maintain/promote the vitality of the national economy. However, the remaining taxation principle of “equity” is neglected by tax system reform which is based on reducing the top personal income tax rate, reducing the corporate tax rate and increasing dependence on general consumption tax. In particular, it cannot be denied that such systems lack the income redistribution function of tax systems based on vertical equity and the ability-to-pay principle. At the same time, another important issue is the increasing income/asset disparity among citizens in many advanced nations during this period. This issue is caused by factors including 1) economic globalization has created downtrend of wages and instability of employment due to the outflow of corporations and capital (manufacturing, etc.) from countries, competition with low-paid workers in developing nations, and deregulations of employment rules, 2) there is increased formation and expansion of a high income group including corporate managers and workers in IT, finance and securities, and 3) tax system reforms have caused the income redistribution function of tax systems to diminish. In other words, the concept of equity is being reexamined in the tax systems of today’s advanced nations.

4. Increasing income disparity and income tax in Germany

As discussed earlier, taxation in Germany is shifting from an income base to a consumption base. As a result, the issue of fairness of taxation is an increasingly important issue in modern Germany. Let’s look at a few examples.

1. When comparing personal market income (before taxation) in 1992 and 2001, although the average value remains unchanged at 20,000 euro, the intermediate value (income level of individuals at the middle of income rankings) decreased from 13,000 euro to 10,000 euro. Conversely, the top 1% has increased from 225, 00 euro to 240,000 euro (7% increased), the top 0.1% has increased from 838,000 euro to 914,000 euro (9% increased), the top 0.01% has increased from 3,252,000 euro to 3,811,000 euro (17% increased), the top 0.001% has increased from 11,083,000 euro to 14,981,000 euro (35% increased), and the top 0.0001% has increased from 31,438,000 euro to 48,152,000 euro (53% increased). This demonstrates market income increased more and more for higher income groups.
2. When comparing the income tax burden rate for 1992 and 2002, the overall average increased slightly from 12.7% to 12.9%. However, the tax burden rate of the top 1% has decreased from 34% to 32%, the top 0.1% has decreased from 41% to 36%, the top 0.01% has decreased from 42% to 35%, the top 0.001% has decreased from 41% to 34%, and the top 0.0001% has decreased from 42% to 32%. This shows that the benefit of income tax reform (tax cuts) is being enjoyed by higher income groups, particularly the super rich.
3. While the disparity in market income (initial income) was expanding in the first place, the series of income tax reforms implemented by Germany in the 2000s effectively created a greater income disparity after taxation of income.

When viewed in this way, it is apparent that “equity” in income distribution must be reconsidered in regards to the impact and results of income tax reforms, corporate tax reforms, consumption tax reforms and environmental tax reforms enacted in modern Germany. (For a detailed analysis of this perspective, please refer to Mitsuo Sekino’s book Tax Reforms in Modern Germany (Zeimukeiri Kyokai CO., LTD, July 2014)).