Germany: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
12 Nov 1999
ISBN:
9781451810417
Language:
English
Keywords:
ISCR; CR; wage; government; bank; rate; General government; government deficit; tax relief; business income tax reform; wage bill; Corporate income tax; Personal income tax; Tax allowances; Global; Europe
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This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.

Abstract

This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.

II. Fiscal Consolidation and Tax Reform Proposals27

A. Introduction

42. Fiscal policies in Germany have been dominated in recent years by determined consolidation efforts to observe the Maastricht criteria. The general government deficit was reduced to 2.6 percent of GDP in 1997, well below the 3 percent limit. Owing to the massive build up of unification-related debts, however, the debt/GDP ratio remained slightly above the 60 percent reference value. The fiscal position improved further in 1998, with the general government deficit declining to 1.7 percent of GDP, as lower government levels stepped up their consolidation efforts.

43. Nevertheless, the new coalition government that assumed office following the September 1998 elections was faced with several difficult challenges: at the federal level, the constitutional “golden rule” requirement—ex ante new borrowing can not exceed public investment spending—mandated a marked reduction in the level of the federal deficit from 2000 onwards; the general government’s projected fiscal position (assuming no policy change) fell short of the undertakings of the Stability and Growth Pact (SGP); Germany’s income tax system needed a long-delayed overhaul, in particular business income taxation; and, above all, the authorities recognized the need to tackle Germany’s labor market malaise while respecting the fiscal strictures of the golden rule and the SGP.

44. Germany’s Fiscal Stability Program, submitted to the EU Council of Ministers and the European Commission in January 1999, provided a first broad sketch of the new coalition government’s fiscal policy objectives and priorities: to bring down the general government deficit to 1 percent of GDP, with most of the fiscal adjustment effort occurring at the federal level; to propose a comprehensive reform of income taxation, to be phased in during 1999-02; to initiate an ecological tax reform, with an aim to use additional ecotax revenue to lower the pension contribution rate; to achieve meaningful progress on tax harmonization at the EU level; to effect a health care reform to stabilize the health care contribution rate; and to use tight spending policies as a means to achieve the Stability Program’s fiscal targets.

45. By April 1999, a first package of income tax reforms combining cuts in marginal tax rates and base broadening had been adopted by parliament. A first installment of the ecological tax reform was in place and financed a cut in the pension contribution rate by 0.8 percent. To shore up the contribution base of the social insurance system, the full exemption from social contributions of the so-called DM 630 jobs was rescinded, and new regulations were introduced to stem the increase in (social contribution exempt) self-employment jobs that in fact represented hidden dependent employment jobs.

46. On June 23, 1999 the federal government submitted the Fiscal Program for the Year 2000 and Beyond, proposing a comprehensive fiscal package to meet the fiscal targets set out in the Stability Program, continue the overhaul of the income tax system, and provide new initiatives to reform the social insurance system.

47. The purpose of this chapter is to review and assess the new coalition government’s fiscal objectives and plans. Section B provides some relevant background information on longer term fiscal trends and institutions. Section C describes the initial fiscal conditions at the time of the new government’s assumption of office and lays out the objectives and priorities of the Stability Program. Section D reviews tax and spending decisions taken during the first half of 1999. Sections E, the bulk of the chapter, discusses the main elements of the proposed fiscal package, highlighting important spending cuts, the proposed business income tax reform, and the preliminary plans for systemic pension reforms. Finally, Section F concludes with an assessment of the program’s effects on the medium-term fiscal outlook.

B. Background28

48. Germany’s fiscal structure assigns government tasks and responsibilities to three levels of government; the federal, the state and the local level. Fiscal deficits and debt accumulation are subject to two important constraints. The first, the golden rule provision of Germany’s constitution requires that federal borrowing should not exceed (ex ante) the projected outlays for public investment, unless there are severe disturbances to the general economic equilibrium. Most of the states have similar golden rule provisions in their basic laws; the finances of local governments are subject to state control. A second important constraint is provided by the Stability and Growth Pact, which contains the Maastricht limits on general government deficit (3 percent of GDP) and gross debt levels (60 percent of GDP) and requires members to achieve (at least) a medium-term fiscal position that is consistent with the normal operation of automatic fiscal stabilizers. Moreover, members are required to submit to the EU commission an updated national Stability Program each year, which describes the country’s short-, and medium-term fiscal policy goals and plans.

49. Germany’s fiscal performance during 1960-98 underwent large variations (Figure II-1). During the 1960s, the rapid growth of the Wirtschaftswunder era was accompanied by balanced budgets (averaged over the business cycle) and low levels of debt. The fiscal position deteriorated markedly in the early 1970s as a result of the first oil price shock and the slowdown in catch up growth. Both the federal and state governments started to run large deficits, while local governments and the social insurance sector remained roughly in balance. After the second oil price shock, a long fiscal consolidation period arrested the upward drift in indebtedness. But the historical event of German unification ushered in another period of protracted fiscal deficits and a sharp rise in the level of debt.

Figure II-1.
Figure II-1.

Germany: General Government Finances, 1960-1998

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A002

Source: IMF, World Economic Outlook database.

50. Social spending has been the major driving force behind Germany’s fiscal dynamics. Germany’s “social market economy” seeks to provide a comprehensive social insurance and safety net, with some of its elements established as early as the 1880s when Bismarck’s social reforms established the world’s first modern social insurance system. Since the early 1960s, social spending has risen sharply, partly related to adverse labor market developments (see Chapter I). But measures that further expanded Germany’s social security system and the internal dynamics of the system (e.g., an aging population; high income elasticity of demand for health care) also played a role in the seemingly inexorable upward trend in social spending. While primary non-social spending as a percent of GDP hardly increased between 1960 and 1997, social spending rose from 17 to 29 percent (Figure II-2). Social contribution rates had to be raised sharply to finance the upward trend in social spending, as required by the pay-as-you-go (PAYG) financing structure of the system. The central role of social contributions in accounting for the long-term trend in general government revenue is underscored by the fact that the tax-GDP ratio has remained stable since 1960 (at about 23 percent of GDP).

Figure II-2
Figure II-2

Germany: General Government Spending and Revenue, 1960-1997

(In percent of GDP)

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A002

Source: IMF, World Economic Outlook database; and Ministry of Labor.

51. Turning to background for income tax reform, Germany’s past income tax reforms have been driven by two main forces: one, the absence of formal indexation requires periodic discretionary adjustments of deductions, tax brackets, and/or tax rates to neutralize the impact of inflation; and two, large spreads between top marginal (around 55-60 percent including surcharges and local taxes) and effective average income tax rates on labor and capital (around 15-20 percent), are indicative of relatively narrow tax bases. Most of Germany’s past income tax reforms are best interpreted as discretionary attempts to mimic the adjustments implied by a formally indexed income tax system.

52. Germany’s present income tax system has high marginal tax rates on business incomes, and both high top and bottom rates on personal income, specifically when compared to most other countries in Europe (Table II-1). However, average effective tax rates are lower, due to a multitude of tax allowances and deductions that narrow the tax base.29 For businesses, for instance, special or accelerated depreciation schedules are available to promote the growth of small and medium-sized enterprises, and specific tax advantages encourage investments in shipbuilding, housing, and aircraft. Shortly after unification, Germany temporarily offered extra incentives for investment in eastern Germany, including a special depreciation allowance of 50 percent for investment projects. German companies also appear to have ample opportunities to create hidden reserves.30

Table II-1.

Marginal Tax Rates on Personal Income and Retained Corporate Earnings in the EU (Including Local Taxes)

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Sources: Buijink, Janssen and Schols (1999); Boss (1999); Ministry of Finance (March 1999); and staff calculations.

The personal income tax rate on non business incomes.

Distributed profits are taxed according to the personal income tax, with country-specific arrangements regarding credit towards the corporate tax that was already paid

The corporate rate includes a crisis-contribution of 3 percent of the tax.

This includes a temporary tax of 15 percent on businesses with an annual turnover of more than 50 million Francs. The corporate rate is 36.7 percent for businesses with less than 50 million Francs annual turnover.

Both the personal income tax rate and the corporate rate include a solidarity surcharge (currently 5.5 percent of the tax, and charged temporarily to help cover unification related expenditures). The rate in parentheses also includes the local trading tax (set here at 16,7 percent).

The corporate rate is 40 percent for banks and domestic companies with non-public shares.

The corporate rate is lower for small profits.

The corporate rate is only 10 percent for manufacturing and certain international financial services.

The corporate rate includes a local tax of 4.25 percent for which the measurement base is creation of value

The corporate rate includes a contribution to the unemployment fund of 4 percent of the tax.

The corporate rate includes a local surcharge of up to 10 percent.

53. In the context of the EU, incentives to reduce the statutory tax rates on business incomes have increased because of the signal function that these rates have for the attractiveness of Germany as a business location, and the enhanced capital mobility that was brought about by the advent of monetary union. Germany has lagged behind several other countries in its reform of the business income tax,31 and at a total marginal tax rate of 56 percent (including local trading tax32), it tops the list as regards the taxation of retained corporate earnings.

54. Germany’s relatively slow pace in adapting its income tax system may in part reflect the decentralized nature of legal decision making—income tax legislation requires the approval of the lower and the upper house of parliament (Bundesrat), where the latter represents the interests of the Länder governments. Moreover, the constitutional court has made a number of rulings that questioned the constitutional basis of income tax legislation, typically appealing to violations of equity principles.

C. Initial Fiscal Conditions and Germany’s Stability Program

55. In 1997, in a push to meet the Maastricht fiscal criteria, fiscal consolidation efforts reduced the general government deficit to 2.6 percent of GDP, from 3.4 percent of GDP in 1996 and notwithstanding below-potential real GDP growth of 1.5 percent. (Table II-2). The implied (negative) fiscal impulse was equivalent to some 1 percent of GDP. However, gross public debt rose further to 61.5 percent of GDP, above the relevant Maastricht reference value of 60 percent, reflecting unification-related build up of debt. Fiscal policy stayed on a consolidation course in 1998. The general government deficit declined to 1.7 percent of GDP, on account of further spending-oriented consolidation efforts at the lower levels of government (Länder and communes).

Table II-2.

General Government Finances, 1994-1999 1/

(In percent of GDP)

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Sources: Ministry of Finance; and staff calculations.

Data are based on the new European System of Integrated Economic Accounts 1995 (ESA95).

Beginning in 1995, the debt and debt-service obligations of the Treuhandanstalt (and various other agencies) were taken over by the general government.

In percent of potential GDP.

Change in primary structural balance; minus sign indicates withdrawal of stimulus.

56. For 1999, the currently projected outcome is a general government deficit of 1.9 percent of GDP, close to the budgeted deficit. While economic activity was hard hit by the emerging market crisis, the deterioration in the fiscal position was kept in check by interest savings and a composition of the shortfall in aggregate demand that favored more highly-taxed components. Moreover, the labor market was resilient in the face of the external shock. Overall, staff estimates suggest a neutral fiscal stance in 1999.

57. The German Stability Program was presented by the coalition government in January 1999, specifying the fiscal policy goals up to 2002. The deficit targets were set at 2 percent for 1999, with a further decline towards 1 percent in 2002 (Table II-3). Public debt was set to remain at 61 percent of GDP for 1999 and 2000, fall to 60½ percent in 2001 and decline to 59½ percent in 2002. The 1999 targets are projected to be observed, while the medium-term goals will be the point of reference for the effectiveness of the fiscal program discussed in section E.

Table II-3.

General Government Deficit and Public Debt as Defined in the Stability Program

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Source: Deutsches Stabilitätsprogramm, January 1999. All entries are as a percentage of GDP,

58. The Stability Program also presented a broad overview of the coalition’s policy guidelines for the near future, listing a reduction in the unemployment rate as the number one priority, and also laying out specific tax reform measures and spending decisions. Included in these were; a reform of the personal and business income tax; an ecotax reform for environmental purposes as well as to lower wage costs; a solid fiscal policy with a continuation of public investment; savings in the government wage bill; increased government transparency; and, an enhanced coordination of macroeconomic policies within Europe. Finally, the program highlighted preliminary proposals for a reform of health insurance.

D. Tax and Spending Decisions in the First Half of 1999

59. The coalition’s first income tax reform package was legislated in March 1999. It focused mainly on lowering the personal income tax (including tax relief for families with children), but also reduced the marginal rates on business incomes. From 1999 to 2001, the budgetary costs of the reform are largely offset by base broadening measures, but in 2002 the personal income tax relief is expected to exceed the revenues from base-broadening by about ½ percent of GDP (Box II-1).

60. The ecotax reform (or green tax swap) was part of the coalition agreement between the SPD and Greens. It involves a phased-in increase in several ecotaxes to finance a reduction in social contribution rates (Box II-2). The first phase of the ecotax reform went into effect in April with the proceeds of an estimated DM 8 billion designated to lower social contribution rates from 20.3 to 19.5 percent of gross monthly income. The second phase of the reform will be initiated in April 2000 and will again be used to reduce contribution rates. The ecotax is levied on intermediate inputs and consumer goods, financing part of the costs of social insurance through indirect, rather than direct taxes. The scope for a large-scale green tax swap (combining significant increases in indirect taxes with an offsetting reduction in direct taxes) is limited, however, given that international differences in consumer taxes can cause distortions in border areas, thus requiring coordination in the EU.

61. Other decisions with an effect on spending and revenues, that were taken almost directly after the new coalition came to power, concern the government’s action against the exemption from social insurance for those holding DM 630 jobs and for the pseudo-self employed, as well as the coalition’s emphasis on active labor market policy. The DM 630 jobs are jobs of 15 hours per week or less which, until April 1999, were exempt from social insurance contributions. To eliminate unequal tax treatment between those holding DM 630 jobs as a second job, and those working overtime, the DM 630 jobs were subjected to social insurance contributions, which automatically also revealed the holders of multiple DM 630 jobs whose total income had exceeded the basic tax exemption. The pseudo-self employed were also made subject to social insurance contributions, and the self employed who resemble the status of employee are now subject to pension insurance contributions. On the spending side, the government made a deliberate choice to spend on active labor market policies such as the provision of jobs and training for 100,000 youth, lowering youth unemployment relative to 1998 by some 13 percent.

March 1999 Income Tax Legislation

(In percent of GDP)

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Sources: DIW Wochenbericht 34-35/99; Ifo Schnelldienst 5/99; Ministry of Finance, Entwurf eines Steuerentlastungsgesetzes 1999/2000/2002 (11/1998); and staff calculations.
1/ The numbers describe a full-year effect (Entstehungsjahr), which is close to the effect in 2002.

The Ecotax Reform

Phase I—legislated April 1999:

Introduction of an electricity tax of 2 pfennig per kWh.

Increase in mineral oil taxes on gasoline by 6 pfennig per liter, gas by 0.32 pfennig per kWh, and heating oil by 4 pfennig per liter.

Subsequent phases, planned for 2000 to 2003:

A further annual increase in the electricity tax by 0.5 pfennig per kWh and mineral oil taxes by 6 pfennig.

Reduction in social contribution rates:

Contribution rates fall from 20.3 to 19.5 percent of gross monthly income in 1999, financed by the proceeds of phase I of the ecotax, and further to 18.5 percent in 2003 financed by the proceeds of subsequent phases.

62. Further in the social insurance sector, the coalition made some important changes to the reform initiatives of the previous government. It froze the deterioration in the invalidity pensions and the implementation of the demographic factor that was planned to be incorporated into the pension formula, starting in 1999. The factor would take account of the increased longevity of pensioners, and would gradually reduce the replacement ratio from a current 70 percent to 64 percent by 2030. Both measures were put on hold for 1999 and 2000, during which time alternative solutions need to be found. On health insurance, finally, the coalition reversed the implementation of co-payments on the health expenses of the insured.

E. The Fiscal Program for the Year 2000 and Beyond

63. On June 23, 1999, the federal government submitted the “fiscal program for the year 2000 and beyond,” containing its budget plan for the short and medium-term. This package proposes to reduce federal spending in 2000 by DM 30 billion (¾ percent of GDP), and up to 1 percent of GDP in 2003. The proposed consolidation was triggered by the fact that, without action, the federal deficit for 2000 would be higher than originally anticipated, breaching both the golden rule constraint and the limits of the Stability Program.33 The fiscal package is proposed in order to guarantee the implementation of the Stability Program goals, to further emphasize the need to restore order to public finances, and to halt the accumulation of government debt. The spending cuts also make room for new income tax reforms, concerning a constitutionally required tax relief for families with children (starting in 2000) and a large-scale business income tax reform, that is planned for 2001. The second phase of the ecotax reform is also part of the tax measures. The budget plan for 2000 is currently being discussed in parliament.

64. The June 1999 fiscal package distinguishes itself from earlier consolidation efforts, in that it encompasses tax reductions rather than tax increases, and achieves consolidation through targeted spending cuts rather than savings across the board. As detailed below, the cuts aim specifically at stabilizing the social welfare state, further reducing subsidies, and economizing the public sector.

65. Table II-4 shows preliminary staff calculations of how the fiscal package can be disseminated over the main economic categories. For the purpose of the classification it was assumed that all unspecified (but designated) measures generate savings in public consumption. Measures for which the description is not necessarily conclusive, furthermore, are classified under the category where savings are most likely to accrue. Savings in absolute terms are concentrated on social transfers, public consumption (including the government wage bill), and subsidies, while cuts in investments are relatively small. As a percent of total federal outlays for each of these categories and relative to a baseline of no policy change, the 2000 reduction in both social transfers and public consumption is estimated at around 7 percent, subsidies would fall by about 5 percent, while investments decline by just under 5 percent. The progression over time is most prominent for public consumption (around 14 percent in 2003), and subsidies (about 13 percent in 2003).

Table II-4.

The Fiscal Program by Economic Category (In billions of DM)

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Sources: Ministry of Finance; and staff estimates.

Apart from federal consolidation, the package also includes small changes indicated for lower levels of government; DM -0.2 billion in 2000, DM 1.1 billion in 2001, DM 1.0 billion in 2002, and DM 0.5 billion in 2003.

Data refer to the decisions in Cabinet on August 25, 1999,

The category incorporates the changes mentioned in footnote 1/.

For 2003 this category includes DM 5.3 billion of expenditure cuts at the Ministry of Labor, that remain to be defined further in compliance with the medium-term budget plan.

The revenue reduction from the tax reforms falls on the federal budget and on lower levels of government The numbers provided here constitute both.

Data are from the tax reform-tables available as part of the Zukunftsprogramm, entitled: Finanzielle Auswirkungen der Neuordnung der Familienbesteuerung, einer Reform der Unternehmensbesteuerung sowie der 2. Stufe der Ökosteuerreform, June 1999.

Fiscal consolidation measures of the fiscal program 2000

66. Among the largest and most controversial measures in the category of social transfers is the indexation of pensions in the next two years to the rate of inflation rather than to net wage growth.34 The measure was prompted in part by the fact that tax reductions for purposes completely unrelated to pensions (e.g., tax relief for families with children) tended to drive up net wages and thus pensions.35 From 2002 onward, pension increases will again be linked to net wages, but the two-year restriction would generate permanent savings through its effects on the standard pension level. The measure will lower the replacement rate for new and existing pensioners from about 70 to 67 percent. As regards the country’s estimated implicit pension liability of some 110 percent, preliminary staff calculations suggest that this measure could reduce the liability by about one quarter. To ensure consistent treatment of all groups in society, the increases in unemployment insurance, unemployment assistance, and other social transfers, will also be temporarily indexed to the rate of inflation.36

67. The government has put forward plans for a structural reform of the pension system, proposing the introduction of a privately funded pillar to support the system, as well as a minimum pension (Box II-3). This proposal would yield a more permanent financing solution; downgrade the dominance of the PAYG financing of the system; and reduce the system’s sensitivity to the changing age structure in the economy. The proposal encountered opposition because of the ‘forced savings’ component, so that the options for reform are currently being re-assessed. A revised proposal is expected towards the end of 1999.

Pension Reform Measures

Ecotax reform—phase I implemented:

Revenues from a phased in ecotax reform are used to finance pensions and lower contribution rates by a total of 1.8 percentage points between 1998 and 2003.

Inflation indexation—part of budget plan 2000:

Pensions in 2000 and 2001 will be indexed to the rate of inflation, which is projected by the authorities at 0.7 percent in 2000 and 1.6 percent in 2001 (compared to projected increases in net wages of 3.7 and 3.4 percent respectively). The indexation will permanently lower the standard pension replacement rate, and will help to contain the rise in contribution rates.

Plans for a structural reform of the pension system—under revision:

  • Funded pension scheme; in an initial scheme for a structural reform of the pension system, the Ministry of Labor proposed the formation of a third pillar of mandatory savings (with the first and second pillar being the statutory pension fund, and the private company funds, respectively). Mandatory contributions to the private fund would be measured as a percent of gross wages and would be increased over time to reach 2.5 percent. Apart from securing additional finances for future pensions, a construct of this kind will also suppress net wage growth (and thus pension increases) since a part of the gross wage goes to the pension account.

  • Minimum pension; the ministry proposed to introduce a minimum pension to prevent ‘old age poverty.’

68. Measures related to the social insurance sector also incorporate a proposal for health reform in 2000. In light of the large increases in hospital related expenses and medications, it is proposed that the rise in healthcare contribution rates be contained by aiming at high quality, but cost-efficient health care provisions. The coalition has proposed nominal ceilings on health care expenditures with excessive costs to be reduced by efficiency gains (e.g., by avoiding duplicative tests and check-ups due to a lack of integration between out-, and inpatient care, or through sharing of expensive technical equipment), and greater cost awareness of health suppliers. Expenses on medications would be kept under control via a positive list of those prescription drugs that are financially acceptable.

69. Some of the federal savings in social spending will constitute a shift in the burden to lower levels of government, or to the social insurance sector. One of these measures concerns the federal government’s proposal to lower the contributions it pays to the federal institute of labor (Bundesanstalt für Arbeit) for the pension, and long-term care insurance of those who receive unemployment assistance. Future contributions should be based on the amount of unemployment assistance, rather than on the basis of 80 percent of the last earned gross wage. Another measure is the proposed federal reduction in the payment of housing subsidies. It was proposed that housing subsidies for those who receive social assistance should in the future be paid by the responsible local governments, rather than the federal government.

70. For the government sector per se, the fiscal consolidation plan features large cuts in public consumption, including in the government wage bill. The reduction in non-wage public consumption is obtained through a variety of measures distributed over all ministries. The decline in the wage bill is achieved through a temporary cap on wage increases for civil servants37 (in line with the provision for pension increases), and by a zero-wage-round for ministers, state secretaries and members of parliament. Federal wage costs will further be condensed through a reimbursement by the German railway company (Deutsche Bahn) for wages paid to the railway police, and through an extensive restructuring of arrangements for conscripts engaged in civilian service. Relative to a baseline of no policy change, the measures will reduce the federal wage bill (currently DM 53 billion, or 1¼ percent of GDP) by about 6 percent in 2000 and over 10 percent in 2003. The streamlining of employment at all levels of government will also continue to compress the wage bill.

71. Proposals for a further reduction in subsidies, are initially quite modest, but are proposed to increase over time. Consolidation measures would, inter alia, affect financial assistance to gas-oil companies, low-rent housing construction, and agricultural and coastline protection.

72. The three final spending categories listed in the table are investment spending, other transfers and a category labeled global spending reductions. The reductions in investment spending are relatively small and over time roughly maintain a constant share of total outlays for this category. The global spending reductions refer to budget reductions at a number of ministries that still need further specification.

Tax reform measures of the fiscal program 2000

73. The tax reform plans in the June 1999 package entail a constitutionally required tax relief for families with children, the implementation of the second phase of the ecotax (see Box II-2), and an extensive reform of the business income tax.

74. The family income tax reform comes on top of the tax relief that was provided as part of the March package (see Box II-1). The new relief for families was mandated by the Constitutional Court so as to eliminate differential treatment of families with children and single parents. The new reform will, in 2000, raise child allowance to DM 270 per month or increase the annual deduction to DM 10,00038 and, in 2002, further increase the annual child deduction to DM 12,000 and extend part of it to children over the age of sixteen.

75. The reduction in tax subsidies (see Table II-4) reflects a substantial change in the depreciation schedules, adjusting them to more realistic product lives. The reduced tax burden on businesses is a revision of the March 1999 package and will slightly reduce the weight that the base broadening measures of the March package have on businesses.

76. Finally, a comprehensive reform of the business income tax is planned for 2001. The proposal would reduce the tax on retained earning of corporate and non-incorporated businesses to 25 percent, which—together with the local trading tax and the solidarity surcharge—would result in a top rate of 35-38 percent. The reform will also replace the system’s full imputation system for distributed profits by a partial imputation system that is more common internationally and that would reduce the differential treatment of domestic versus foreign shareholders. Although the impact of the reduced tax rates is partially offset by base broadening measures, the reform would still yield a net tax relief to businesses of about ¼ percent of GDP in 2002 (Box II-4).

Business Income Tax Reform, Proposed to Begin in 2001

(In percent of GDP)

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Sources: Ministry of Finance, June 1999, Deutschland Erneuern: Zukunftsprogramm zur Sicherung von Arbeit, Wachstum und Sozialer Stabilität; and Finanzielle Auswirkungen der Neuordnung der Familienbesteuerung, einer Reform der Unternehmensbesteuerung sowie der 2 Stufe der ÖkoSteuerreform.

77. One salient difference between the March reform and the proposed business income tax reform stands out: while the March legislation rendered similar—across the board— reductions in marginal tax rates, the current proposal specifically aims at lowering rates on retained corporate earnings. Thus, where the March package would render relatively small deviations between the top marginal rates on different types of income, the business income tax reform would produce much larger discrepancies: after the business income tax reform, the marginal tax rate on distributed profits will be about 40 percent, while the rate on retained earnings will only be 25 percent. These rates rise to about 50 percent and 38 percent when including the local trading tax. The unequal treatment of retained versus distributed profits creates a potential lock-in of profits, providing a tax-based incentive to keep profits within the firm rather than distribute them for possible intermediation through the capital markets.

78. The spread between distributed and retained earnings is driven by the partial imputation system as well as by a relatively high tax rate on personal income (still 48.5 percent in 2002), relative to the new rates on business income. The spread between the personal income tax and the tax on business incomes is, however, not specific to Germany. Table II-1 in section B shows that many EU countries apparently tolerate a large discrepancy between the tax rates on these types of income.

79. Several studies have suggested that both size and composition matter for the longevity of a fiscal adjustment and its effects on the rest of the economy.39 These studies have shown that cases of successful and persistent fiscal tightening in OECD countries have relied heavily on the expenditure side, as well as on categories other than public investment, with an emphasis on transfers and the public wage bill. Packages that focus on cuts in transfers and public wages (and tax increases that do not fall on households, or those that rely on base-broadening measures) are referred to as type 1 adjustments,40 while increases in the taxation of households, higher social contributions, and cuts in investment spending are type 2. Successful tightening is of type 1, generating a persistent consolidation and positive, confidence inducing, effects on the economy Type 2 adjustments, on the other hand, tend to be of a temporary and less successful nature.41 Germany’s fiscal program, with its emphasis on reducing current spending and taxation, is clearly of type 1: as detailed below, revenues are projected by staff to fall from 47.1 percent of GDP in 1999 to 46.2 percent in 2003, while the spending ratio would decline from 49 to 46.4 percent42

F. Impact of the Fiscal Program on the Medium-Term Fiscal Outlook

80. The official fiscal targets as well as the staff estimates on the medium-term fiscal outlook are depicted in Table II-5. The medium-term projections are based on specific macroeconomic assumptions and incorporate the estimated effects on the general government budget of the fiscal consolidation and tax reform package for the year 2000 and beyond. Particularly relevant is the impact of the package on the general government budget. In this respect, the medium-term goals of the Stability Program provide a point of reference for the effectiveness of the fiscal program.

Table II-5.

Medium-Term Projections of General Government Finances, 1999-2003 1/

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Sources: Ministry of Finance; and staff projections.

Based on the new European System of Integrated Economic Accounts 1995 (ESA95).

Based on Germany’s Stability Program as submitted to the Council of Ministers-and the European Commission in January 1999.

In percent of potential GDP.

Change in primary structural balance; minus sign indicates withdrawal of stimulus.

81. The federal consolidation measures for 2000 must be set against a new baseline that exceeds the original estimation, as well as against the revenue-reducing effects of the income tax reforms. Regarding the effect on general government, staff estimates suggest that the fiscal package will improve the general government primary structural surplus in 2000 by about 0.4 percent of GDP, raising it from 3.1 to 3.5 percent of GDP.

82. The impact on the general government budget between 2001 and 2003 is largely determined by the expected implementation of the business income tax reform in 2001, and the final phase of the March 1999 income tax reform package in 2002. The costs of the business income tax reform lower the primary structural balance by 0.3 percent of GDP. In 2002 the estimated costs of the March package kick in. In 2003, finally, the primary structural balance is set to increase by 0.2 percent, driven by a further elimination of tax subsidies and the base broadening measures of the business income tax reform.

83. The general government’s overall structural position is at or near balance throughout the medium-term. The fiscal deficit (1.1 percent in 2000, down to 0.2 percent in 2003) stays well within the limits of the Stability Program. The balanced structural position creates room for the operation of automatic stabilizers; staff calculations suggest that even on the unlikely assumption of no growth for the remainder of 1999 and the year 2000, the general government deficit would still remain well within the 3 percent limit of the Stability and Growth Pact.

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  • Boss, Alfred, 1999, “Do We Need Tax Harmonization in the EU?” Kiel Working Papers No. 916.

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  • Bundesministerium der Finanzen, 1999, Deutschland Erneuern: Zukunftsprogramm zur Sicherung von Arbeit, Wachstum und Sozialer Stabilität, June 1999.

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  • Bundesministerium der Finanzen, 1999, “Deutsches Stabilitätsprogramm,” Volks- und Finanzwirstchaftliche Berichte, Bundesministerium der Finanzen, Referat Öffentlichkeitsarbeit, January 1999.

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27

Prepared by Caroline Kollau.

28

This section draws on Owen (1994); see also Chapter I “Fiscal Stabilization Policy Under EMU” in the IMF Staff Country Report No. 98/111 for Germany.

29

The magnitude of the spread between the statutory and the effective tax rate on corporate incomes has been a topic of research, but results tend to differ depending on the exact method of investigation. A report commissioned by the Dutch Ministry of Finance (Buijink, Janssen, and Schols, 1999) uses a sample of firms to assess the average effective rates in EU countries. The study shows considerable differences between statutory and average effective corporate tax rates in most EU countries. In an international comparison of the filtered median results, a sample of 419 German firms reveals a statutory rate of 50.1 and an average effective rate of 38.5 percent. Both of these rank at the top of all EU countries considered.

30

See Chapter IV on “Tax Reform in Germany” in IMF Staff Country Report No. 97/101 for Germany.

31

The corporate tax rates in France, the United Kingdom, and the United States, for instance, were all cut in the early- to mid-1980s. The German tax rate not only exceeded these countries’ rates but also did not decline until the early 1990s (See Rimbaux, 1996, p. 93).

32

The local trading tax is levied on almost any type of business and can run up to some 18 percent. Modification of this tax is on the tax reform agenda but represents a difficult issue, as it is the most important source of income for local governments. The trading tax is deductible so that corporations pay a corporate tax over the earnings net of local trading tax.

33

The increase in the deficit is largely affiliated with a loss of about DM 20 billion in privatization revenues for 2000, relative to 1999. The revenues had, thus far, covered a part of federal spending, thus keeping the federal deficit within the golden rule requirements.

34

The pension scheme is based on a “contract between generations,” introduced with the pension reform of 1957, and relying on a wage-related system that ensures that pensioners will also benefit from the progress in productivity and income. As of 1992, pension increases are, de facto, linked to net wage increases, with the objective of maintaining a replacement rate (standard pension over net wage) of around 70 percent. With the changing demographic structure, the pension financing on a PAYG basis will soon become unaffordable. Already the ratio of contributors to pensioners is about 5 to 2, so that less than 3 contributors finance a single pension

35

The reduced social contribution rates that are brought about by the ecotax reform would have a similar effect.

36

Apart from savings for the federal budget, the limited pension increase in 2000 and 2001 will also help to contain the rise in contribution rates.

37

Only about half of all employees in the public sector are civil servants. The government can determine wage increases for these employees but has no say in the negotiated wages for other public sector workers. It is possible that the limited wage increase for civil servants will have a positive spillover effect on the wage negotiations for the other workers. If this is the case, the additional savings will arise at lower levels of government, which employ most of the civil servants (thus making spillovers more likely).

38

The annual deduction and the child allowance are not complements: families can select either the annual deduction or the child allowance.

39

See, for instance, Giavazzi and Pagano (1996), Bertola and Drazen (1993), Alesina and Perotti (1995a, 1995b, 1997) and Perotti (1996).

41

The observed differences in success are explained by the expectation-cum-wealth effect of a fiscal consolidation, which occurs because consumers expect lower future taxation from consolidations that are perceived to be permanent. Reductions in social transfers and the government wage bill signal a more permanent consolidation than cuts in investment spending, which may reflect a temporary delay of necessary maintenance. A reduction in the government wage bill may have an additional effect through the downward pressure it puts on wages (particularly when labor markets are unionized). A cut in transfers can reduce wage costs through lower contribution rates, while a reduction in unemployment benefits will lower the reservation wage. Increases in taxes and transfers would do the opposite.

42

The 1999 Economic Report of the Ministry of Economics, notes that it is the intention to eventually reach a government spending level of only 40 percent of GDP.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Germany: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 1999: Issue 130
Publisher:
International Monetary Fund
ISBN:
9781451810417
ISSN:
1934-7685
Pages:
172
DOI:
https://doi.org/10.5089/9781451810417.002
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    Germany: General Government Finances, 1960-1998

    (In percent of GDP)

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    Germany: General Government Spending and Revenue, 1960-1997

    (In percent of GDP)

Germany: General Government Finances, 1960-1998

(In percent of GDP)

Germany: General Government Spending and Revenue, 1960-1997

(In percent of GDP)