Germany: Selected Issues

Selected Issues

Abstract

Selected Issues

Wealth Inequality and Private Savings in Germany1

Does the large current account surplus in Germany reflect export-driven income gains that are evenly shared among the population? The evidence strongly suggests this is not the case and underscores the important role of German business wealth concentration in this context. As high corporate savings and underlying profits largely reflect capital income accruing to wealthy households and increasingly retained in closely-held firms, the buildup of external imbalance has been accompanied by widening top income inequality, rising private savings and compressed consumption rates.

A. Introduction

1. Germany is the world’s leading exporter of high value-added manufacturing goods and, following the Euro adoption, has steadily increased its current account surplus and net foreign asset position. Germany was in a unique position to reap benefits from China’s (and other emerging markets’) integration into the world trading system and Eastern Europe’s integration into the EU due to its comparative advantage in industrial production, as well as its geographic and technological advantage in developing global value chains. Even following the GFC, Germany was much better positioned relative to the rest of the euro area to benefit from a positive external demand shock from China—China’s investment-heavy fiscal stimulus seems to have offset the drag from weaker demand in Europe. Domestic demand and household disposable income, however, did not increase in tandem with aggregate income (text chart). Instead, Germany’s aggregate saving rate and current account (CA) balance began to improve steadily starting in the early 2000s, reaching a peak of 8.5 percent of GDP in 2015, and boosting the NIIP to around 61 percent of GDP at present.

uA01fig01

Germany: Household Consumption and Disposable Income

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: Deutsche Bundesbank, Destatis, and IMF staff calculations,

2. Germany’s success on global export markets needs to be viewed against the background of its high wealth inequality to shed light on the drivers behind the rise in private savings and accumulation of current account surpluses. It has been widely documented that over the last two decades, the German non-financial corporate (NFC) sector’s gross and net saving rate has increased – while the relatively high household saving rate remained largely unchanged, boosting the private saving rate and CA surplus. This surge was initially driven by rising profits, on the back of wage restraint and falling labor shares, and since 2008, by lower dividend payout rates. In this paper, we show that the benefits of rising corporate savings and by extension, the current account surplus, were unevenly distributed: Growing corporate profits associated with globalization and wage restraint accrued mainly to households in the top of the wealth distribution, among which business ownership is concentrated. The interaction of pre-existing wealth inequality with rising corporate income therefore widened overall income inequality (correlation between the CA and top income share is 0.95, see chart). As the marginal propensity to consume typically declines when moving up the wealth and income distribution, such “top-biased” income growth is bound to raise savings and net worth of the richest households, further exacerbating wealth inequality over time (see flowchart in Figure 1).

Figure 1.
Figure 1.

Mechanism Illustration

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

uA01fig02

CA Balance and Top Income Inequality

(Percent)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: World Inequality Database and Haver Analytics.

B. Wealth Inequality in Germany: Stylized Facts

3. Notwithstanding the large stock of net foreign assets accumulated through the process of running increasing current account surpluses since the early 2000s, the median level of household wealth in Germany is among the lowest in the Euro area. At a median of 61 thousand Euro, household net wealth in Germany is just above the level in Poland, below the level in Greece, Portugal, and well below the euro area median of 100 thousand per household (Figure 2).2 This low level of wealth among the median household stands in stark contrast to the vast stock of national wealth measured at the aggregate level: financial net worth alone (excluding land, dwellings and other real assets) of the aggregate household balance sheet stood at over 4 Trillion Euro or 95 thousand Euro per household as of 2017, while total (financial and real) net worth is estimated to amount to 10 Trillion Euro, or over 235 thousand per household.3 The high level of national wealth coupled with the low level of median household wealth jointly imply that most of the aggregate wealth is concentrated among a small segment of the population in the top of the distribution.

Figure 2.
Figure 2.

Median Net Wealth

(Thousands of Euros)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: HFCS Second wave.

4. In international comparison, wealth inequality is very high in Germany. Wealth inequality, measured by the share of aggregate net wealth held by the top 1 percent wealthiest households, is high in most advanced economies. In Germany, it is among the highest in Europe, with the top 1 percent wealthiest households owning 24 percent of total national net wealth (Figure 3).4 A similar picture emerges when ranking countries in terms of the net wealth Gini coefficient, the top 10 percent wealth share, or other relative wealth ratios instead.

Figure 3.
Figure 3.

Wealth Share of Top 1 Percent1/

(Percent of total net wealth)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Source: OECD.1/ As of 2014 or latest available.

5. Income inequality in Germany may be less severe than in some other major advanced economies (for example, it is less than in UK, US, Japan, Korea), but its increase in recent decades has been steep, both in gross and even disposable income terms, as redistribution has overall weakened at the same time as market incomes have diverged.5 Importantly, the dynamics of post-reunification income inequality have been evolving overtime. Over 1999–2005, it has been the falling income of the bottom of the distribution that widened inequality, as high unemployment and declining union power dramatically reduced earnings in the lower end of the distribution (see IMF, 2017 and Dustmann et al. 2014). Starting in the mid-2000, however, the labor market strengthened and bottom incomes stabilized, resulting in a largely stable Gini coefficient. At the same time, however, top income inequality rose sharply as rising corporate profits and associated capital incomes disproportionately accrued to the wealthy (Figure 4). The last phase in the distribution dynamics, starting 2009, appears to be accompanied by stable or only moderately rising income inequality as measured by both metrics. However, this period also saw the sharpest rise in corporate retained earnings, which is not properly reflected in the income tax base and thus not completely captured by the measured top income share (see Bartels, 2018).6 Properly attributing retained earnings as incomes of ultimate shareholders would likely increase the top income share and its co-movement with the current account even further, particularly after 2009.

Figure 4.
Figure 4.

Evolution in Disposable Income Inequality

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: WID database, OECD.Note: Top 10 income share measures the share of total after-tax income accruing to the top 10 percent of population as derived from income tax data.

6. Wealth and income inequality are closely linked. As income/savings is a key source for wealth accumulation (Zucman, 2019), rapidly widening income inequality, particularly when driven by capital income as it has been the case in Germany, is both a driver of wealth inequality as well as its outcome. While time-series for wealth inequality are less readily available for long periods of time, studies employing German micro data show that wealth inequality in Germany has also increased since the early 2000s (Frick and Grabka, 2009; Bundesbank, 2016), with high levels of inertia in the top and bottom of the distribution.7

uA01fig03

Change in Top Inequality and Wealth Inequality

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Source: WID and OECD.

7. Private home ownership, typically the most important channel to build household wealth, is very low. Traditional reliance on generally well-functioning rental markets with strong tenant protection has contributed toward a low home ownership rate in Germany, in fact the lowest among Euro area countries. Consistent with the observed degree of wealth inequality, the home ownership rate is particularly low among households in the low-middle segment of the income distribution, while it does not vary much across countries among high-income households. The recent trend in appreciating house prices has therefore not benefited the broader population, while higher rents (particularly in major cities) have exerted increasing strains on housing affordability particularly among lower-income households. Dustmann et al. (2018) show that trend developments affecting relative housing expenditures (declining mortgage interest rate amid rising rentals and residential mobility among the young) have exacerbated income inequality.

8. German households also lack access to the German corporate equity stock as most of the corporate net worth is concentrated in privately-held firms. Unlike other advanced economies with a large industrial base, the bulk of corporate assets and profits (around 60 percent) in Germany are generated by firms in private ownership, consistent with a very low stock market capitalization relative to the size of the economy (Figure 5, right panel). Many Mittelstand firms remain in private, often family-controlled ownership, even when they expand internationally and grow into large multinationals. And even among the remaining 40 percent of firms that are publicly-listed, an astounding 65 percent of them are also controlled by a family -- either directly through at least 20 percent of stock ownership or through cross-holdings in a multiple control chain of interlinked entities. The largest controlling shareholder (in most cases an individual, family or endowment) holds an average of 54.5 percent of voting rights within a German publicly listed firms, compared with 20–25 percent in the UK and 31 percent in Sweden (Faccio and Lang, 2002). 8 The concentration of industrial power in the hands of wealthy families goes back many centuries and has only strengthened following the turbulences of World War II, or the dot com bubble of the early 2000s (Fohlin, 2005). Economic historians studying the patterns of German corporate ownership conclude that “families are central to the ownership of many firms, but equity ownership is unusual among the population at large” (Fohlin, 2005, p. 236).

Figure 5.
Figure 5.

Drivers of Wealth Inequality

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Source: HFCS 2nd wave, OECD National Accounts, Thomson Reuters, Bloomberg, Federal Reserve Bank of St. Louis.

9. Private business wealth, meanwhile, is also highly concentrated in Germany and in general, accounts for much of the variation in wealth inequality across countries. The 10 percent wealthiest households in Germany own around 60 percent of the aggregate net wealth in the economy, and 40 percent of this wealth is in the form of private business ownership (Figure 6). Indeed, the single most important source of wealth in the top of the distribution is accounted for by business ownership in Germany (Grabka and Westermeier, 2014). Apart from private business wealth, the concentration of other forms of wealth in Germany (bank deposits, private pension saving, real assets etc.), though still high, does not stand out as much relative to other countries in the euro area. The role of private business wealth for overall wealth inequality in Germany (and Austria) is due to two facts, as illustrated in the right panel of Figure 6: first, private business wealth accounts for a large share (25 percent) of overall national wealth, and second, it is highly concentrated among the top (95 percent of it owned by top 10 percent wealthiest households). An immediate implication of such high concentration of business ownership is that the persistent rise in corporate profits underlying the increase in corporate saving and current account surplus since the early 2000s mostly accrued to the wealthiest households in the form of dividends or appreciating equity valuation, boosting top income and wealth shares. At the same time, households in the lower deciles of the wealth distribution lost out due to the wage restraint that, over a long period, enabled the rise in corporate profits.

Figure 6.
Figure 6.

Role of Private Business Wealth

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Note: The top 10 wealth share measures the share of total net wealth that is held by the top 10 percent wealthiest households.

10. Taxation of property in Germany is low compared to other OECD countries, contributing to the persistence of high wealth inequality. Revenues from property taxes in Germany (comprising real property, inheritance and other property taxes), at only 1 percent of GDP, are very low compared to peers (Figure 7). Moreover, it has been on a declining path, reflecting reductions in marginal tax rates in the 1990s, and most notably following the inheritance tax reform of 2009, which greatly increased the exemption of inheritance wealth through intra-family business transmission (see Hines et al. 2016). At the same time, the size of the average inheritance flow has been growing steadily, from 4 percent in 1980 to over 10 percent of national income annually in 2010, and almost entirely reflects the increase in inheritance and inter-vivos transfers of wealthy families (see Piketty, 2016). The inheritance tax regime primarily benefits the wealthiest, who can claim exemption of corporate assets, while average families face much higher burdens, given relatively low personal exemptions and substantial marginal rates – it is therefore a regressive tax. Taxes on real property meanwhile, at only 0.4 percent of GDP, are particularly low in international comparison, due to the widening gap between tax- and market valuations. The last encompassing updates of property values occurred in 1935 and 1964 (only West Germany). This under-valuation of real estate properties also benefits disproportionately the wealthy given their much higher home ownership rate and the recent house price appreciation.

Figure 7.
Figure 7.

Property Tax Revenues

(percent of GDP)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Source: OECD.

C . Implications for Household Disposable Income and Consumption

11. The mirror image to rising NFC gross saving has been a decline in household disposable income and consumption as a share of GDP (Figure 8). The rate of NFC gross saving (that is, retained earnings as a share of gross output or value added) has been on the rise since the early 2000s. Prior work has documented that this increase has been driven by rising profits of German corporations and more recently, declining dividend payout rates (Dao and Maggi, 2018; Allen, Chen and Pereira, 2019). Higher profitability, in turn, has been supported by wage restraint/lower labor income shares and declining interest payments on debt, spurring exports and profits of German firms but reducing household disposable incomes (in percent of GDP). The strong labor market performance after the mid-2000 contributed to the recovering labor income share starting in 2008, through higher employment and more recently, higher wage growth. At the same time, the decline in unemployment and retrenchment of the welfare state following the Hartz IV reforms contributed toward reducing disposable income through lower net benefits since 2005, offsetting the modest gains in labor incomes on aggregate. Over 2005–2017, household disposable income to GDP ratio declined by around 6 percentage points.

Figure 8.
Figure 8.

Contribution to Cumulative Change in Household Disposable Income to GDP ratio

(cumulative since 1991, in percentage points)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: Destatis, and IMF staff calculations.

12. The corporate tax reform in 2001 and 2008, which favored retained earnings as opposed to dividend distribution and new equity issuance likely reduced the payout share, while declining interest rates (which steepened particularly after the GFC) have been eroding household interest income. The 2008 German corporate tax reform substantially reduced the tax burden on retained earnings, while slightly increasing the effective tax rate on dividends, especially for unincorporated businesses, resulting in a strong incentive for firms to retain instead of distributing their profits.9 However, as corporations are owned primarily by wealthy households with very high propensity to save, the shift from dividend distribution to retained earnings triggered by tax incentives merely represents a shift from household to corporate saving among the wealthy. At the same time, interest rates on household deposits declined by 2–4 percentage points, depending on maturity, between end-2008 and 2018. A much higher share of total assets of lower-middle income German households is held as financial assets compared to other countries in the Euro area (44 percent in Germany compared to 13.5 percent elsewhere in the Euro area), and around half of those assets are in the form of sight deposits and saving accounts that are subject to declining interest rates (see HFCS 2nd wave).

13. Lower- and median income households bore most of the decline in disposable income share, which, given their high propensity to consume, led to a concomitant decline in the aggregate consumption to GDP ratio. The steepest decline in household disposable income to GDP occurred starting in 2005, with transfer retrenchment and interest income reduction contributing the most, while dividend (and other property income) ratio only started to decline in 2010 and stabilized in 2015. As lower- and middle-income households are more reliant on transfers and interest incomes than higher income ones (who own more housing and equity assets), we expect the decline in household disposable income to be disproportionately borne by lower income groups. Figure 9 (left panel) confirms that this is indeed the case. While in the aggregate, disposable income to GDP ratio declined by around 6 percentage points, it is highly concentrated among the bottom half of the income distribution. The lower quartile experienced a relative loss of 10 percent of GDP, the median a loss of 6 percent, while by contrast, the top 1 percent saw disposable income to GDP ratio actually rise by 8 percentage points. Lower income households experienced not only a relative, but also an absolute erosion or stagnation of their real purchasing power. Figure 9 (right panel) shows that widening income inequality and erosion of purchasing power in the lower deciles of the distribution is a long-standing trend that started in the early 2000, when the current account started rising.10 Survey data show that lower/median income households tend to have a propensity to consume close to one (see Börsch-Supan et al. 2006). The shift in income distribution toward the top (where propensity to consume is low) away from the median/bottom (where propensity to consume is high) explains why the aggregate consumption rate has declined in tandem with the disposable income ratio, contributing to the current account surplus, as documented above.

Figure 9.
Figure 9.

Dispersion of Real Disposable Income

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

D. NFC Gross Saving and Income Inequality

14. Given high wealth inequality, rising corporate profits (and savings) contributed to widening income inequality. Corporate ownership (and capital ownership in general) is highly skewed everywhere, but particularly so in Germany, where large industrial companies are often family-owned, and housing ownership is not widespread among the general population (see above Figures 56). Consequently, the increase in corporate profitability and retained earnings has boosted incomes and asset prices of the richest households, while the average and lower income households have been experiencing the opposite trend in their relative incomes, due to lower wage growth and lower interest incomes (Figures 89). The rise in NFC profits underlying its saving rate has, therefore, likely contributed to increasing income inequality in Germany, beyond and above the rise in inequality driven by lower labor shares. We proceed with testing this prediction.

15. Testing the relationship between NFC saving and income inequality. We show that the relationship between rising NFC saving (driven by profits) and rising income inequality over the medium-long term, enabled by skewed wealth distribution, holds across a panel of advanced economies over the last two decades. To this end, we estimate the following regression equation:

IncInequct=α+γc+βNFCGSct+δt+εct,

to test whether, within a given country, higher NFC gross saving rates are associated with higher income inequality over time as hypothesized (i.e. β>0). We collect sectoral national account data to compute the NFC saving rate (in percent of GDP) and gather income inequality indices from the World Inequality Database (WID), obtaining an unbalanced panel of 27 countries (both advanced and emerging) broadly from 1995–2015. Results are summarized in columns 1–2 of Table 1. Consistent with our hypothesis , an increase in the NFC saving rate is associated with an increase in income inequality, with the relevant coefficient estimates being statistically and economically significant: a 1 percentage point increase in NFC saving rate is associated with 0.3–0.4 ppt increase in the share of income going toward the top 10 percent highest-income individuals. The strong empirical relationship between corporate saving and income inequality also holds in long-run changes. Regressing 5, 7, and 10-year changes in the top 10 percent income share on the corresponding change in corporate saving rate in each country yields similar estimates (column 3–6 of Table 1).11 Figure 10 below illustrates the strong positive correlation across the sample by plotting the overlapping 10-year change in both variables against each other. Statistically, the variation in corporate saving over time can explain 20 percent of the long-run change in income inequality in the sample.

Table 1.

Germany: Corporate Saving and Top Income Shares

article image
Sources: OECD National Accounts, WID, IMF staff calculations. T-statistics based on robust standard errors in parentheses.
Figure 10.
Figure 10.

Correlation Between Long-run Change in Top Income Inequality and Corporate Savings

(in percentage points, 10-year changes)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: World Inequality Database, OECD National Accounts Statistics.

16. NFC profits interact strongly with wealth inequality in widening the income distribution. We unpack the above correlation further to test if the underlying pattern conforms to our predictions. If unequal wealth distribution allows higher corporate profits to disproportionately benefit high-income households who own the corporations, then a given increase in profits should give rise to a stronger increase in income inequality if wealth concentration is higher, particularly if variation in wealth inequality across countries reflects to a large extent variation in business ownership inequality (Figure 6). We test this prediction in the following regression:

ΔIncInequct=α+δt+β1ΔNFCGOSct+β2ΔNFCGOSct*WealthInequc+β3*WealthInequc+εct

If this hypothesis is true, the coefficient on the interaction term between change in corporate profits (∆NFCGOSct) and the country-specific wealth inequality index (measured by the top 10 percent wealth share) should be positive. Results of this regression are summarized in Table 2.

Table 2.

Germany: Interaction with Wealth Inequality

article image
Sources: OECD Sectoral National Accounts, WID, IMF staff calculations.Note: Income inequality measured by top 10% income share, wealth inequality by the top 10% wealth share. Columns 1–2 and 4–5 use overlapping 5 and 10-year changes. Columns 3–4 and 6–7 use non-overlapping changes. T-statistics based on robust standard errors in parentheses.

17. Results are consistent with our hypothesis. Higher corporate profits are associated with lower income inequality only for countries with low wealth inequality (below the 40 percentile of the sample). For higher levels of wealth inequality (and Germany far exceeds this threshold), an increase in corporate profits is associated with higher income inequality over time, with the increase being larger if wealth inequality is higher. We obtain similar results for the interaction between wealth inequality and corporate saving (instead of profits), consistent with the view that higher corporate saving (due to higher profits that are retained and boost long-term capital income) benefit the rich households and widen income inequality in an environment with high wealth inequality. The regression results imply that the rise in corporate saving, coupled with the degree of wealth inequality, can explain about half of the rise in top income inequality in Germany over the period 2000–2015.

E. The Blurred Boundary Between Household and Corporate Savings

18. Marginal propensity to save increases in income and wealth. The empirical evidence so far has shown that widening income inequality in Germany, driven in large part by higher corporate profits, was associated with lower disposable incomes of households in the bottom deciles of the distribution and higher incomes of top wealth households (who own the corporations), both in absolute and relative terms (see Figure 9). It is widely documented that the marginal propensity to consume declines with income and wealth (see e.g. Dynan et al. 2004 for the US, Arrondel et al. 2015 for France and Späth and Schmid 2018 for Germany). Survey data show that one third of German households do not save, while the wealthiest save a very high share of their income (see Börsch-Supan et al. 2006). As households with high MPC (in fact, close to one) experience a decline in disposable income (in relation to GDP) and households with low MPC the opposite, the average consumption/GDP ratio is bound to decline, boosting the aggregate private saving rate.

19. Higher corporate saving is associated with higher overall private saving when ownership is more concentrated and corporations more likely to respond to their controlling owners’ tax incentives. Firms may have a motive to accumulate saving for precautionary reasons, especially to finance investment in innovation and intangible capital (see Falato et al. 2013; Adler et al. 2018). This business-driven motive for corporate saving, however, should be independent of the degree of ownership concentration. If, however, there are also strong tax incentives for shareholders to retain savings within the firm rather than have them distributed, then we should see a stronger correlation between corporate and overall private saving when wealth distribution is more concentrated. Two reasons underly this prediction. First, a higher ownership concentration implies a higher incidence of “closely-held” firms (as opposed to arms-length shareholder-manager relationships), where the saving/investment behavior of the firm at least partly reflects personal incentives (especially tax incentives) of the largest owners rather than pure profit maximization.12 Indeed an established feature of the German corporate governance system is the high concentration of control (Becht and Boehmer, 2001; Faccio and Lang, 2002). Corporate savings would then partly reflect disguised savings of wealthy households. Second, high wealth inequality also implies high concentration of aggregate private savings among the wealthy: using German household survey data, Späth and Schmid (2016) estimate that 54–65 percent of aggregate saving is carried out by the top 10 percent wealthiest households. Therefore, by simple composition effect, aggregate private saving rates are more strongly driven by household saving behavior at the top when wealth concentration is high. Putting both arguments together: as corporate savings reflect to a large extent household saving at the top and, at the same time, private saving is driven by top savings when wealth is concentrated and firms are closely-held, the positive correlation between private saving and corporate saving should be stronger when wealth inequality is higher. We test this prediction in the following by regressing the private saving rate on the corporate saving rate and its interaction with measures of wealth inequality:

ΔPrivateSavingct=α+δt+β1ΔNFCGSct+β2ΔNFCGSct*WealthInequc+εct

Results in Table 3 strongly support the prediction that with higher wealth inequality, overall private saving rates are more closely linked with corporate savings, as the interaction term between NFC saving and wealth inequality (measured either by top 10% wealth share or net wealth Gini coefficient) is positive and strongly statistically significant. This result, in turn, supports the view that at least part of the change in corporate saving over time is indeed disguised household saving when wealth is highly concentrated.

Table 3.

Germany: Corporate Savings and Aggregate Private Savings

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Sources: OECD Sectoral National Accounts, WID, IMF staff calculations.Note: NFC Saving change are 5-year non-overlapping changes in the gross saving rate of the non-financial corporate sector; t-statistics based on robust standard errors in parentheses. Regression constant included but now shown.

20. Complementing the macro results, micro data analysis further supports the finding that concentration of wealth and saving in the top of the distribution in Germany is strongly driven by closely-held firms. Figure 11 plots the estimated profile of wealth to income ratio across income quintiles in Germany versus elsewhere in the Euro area, separately for business owners with controlling stakes in private businesses and the rest of the population. Differences in wealth/income ratios reflect (in steady state) differences in initial wealth endowments, income growth and most importantly, saving rates (Piketty and Zucman, 2014). Economic theory predicts that business owners will generally accumulate more wealth relative to incomes. However, the fastest accumulation occurs typically at lower levels of income, as entrepreneurs have less access to outside capital when revenues/incomes are relatively low (Quadrini, 1999), which is the pattern we observe elsewhere in the Euro area. In Germany, by contrast, the highest implied saving rates and saving differentials between business owners and non-owners occur toward the top of the income distribution. Therefore, not only is private saving highly concentrated in the top in Germany, it is particularly concentrated among rich business owners of closely-held firms where the boundaries between household and business savings are most prone to be blurred.13

Figure 11.
Figure 11.

Wealth/Income Ratios Across the Income Distribution

(ratios relative to lowest income quintile)

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: HFCF 2nd wave, and IMF staff calculations.

21. Persistent, concentrated rise in private saving exacerbates wealth inequality over time. Wealth inequality itself widens with rising income inequality, especially if these income inequalities are sustained over a long period of time. As richer households have higher saving rates, top-biased income trends such as higher corporate profits naturally lead to higher saving rates by these households, which over time, lead to even more wealth accumulation at the top, exacerbating wealth inequality (Figure 1). In fact, the large body of literature on wealth inequality has shown that saving rates increasing in wealth is essential to match the tail of the empirical wealth distribution (see Benhabib and Bisin, 2018 for a survey of the literature). Taken together, our results imply that rising corporate and private saving rates, accruing to the top of the wealth distribution, are eventually associated with yet higher wealth inequality. The interaction between wealth inequality and private saving therefore goes both ways and is thus mutually reinforcing. Cross-country data on private saving evolution and wealth inequality bear this prediction out: In Figure 12, we find a strong positive correlation between long-term changes in private saving rates and the resulting level of wealth inequality (and a similar one using corporate saving rates). Variation in private saving evolution over the past 20 years explains over 23 percent the current cross-sectional variation in current wealth inequality across 27 countries in our sample.

Figure 12.
Figure 12.

Correlation Between Long-run Change in Private Saving and Wealth Inequality

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Sources: WID and OECD.

F. Conclusion

We can summarize the key takeaways of the paper as follows:

  • Trends in increasing corporate profits and gross savings have widened top income inequality, as corporations are typically owned by households in the top of the wealth distribution. The impact on income inequality is more pronounced in countries where the rise in profitability was a result of lower wage growth and labor income shares to start with, as was the case in Germany.

  • The association between rising corporate profits and income inequality is stronger in countries with higher wealth inequality, where corporate ownership tends to be more concentrated among the wealthiest households.

  • Richer households have higher propensity to save, so that higher corporate profits and savings (or any other top-biased income growth) are associated with increased aggregate private saving rates when corporate wealth is concentrated.

  • The income-wealth inequality loops are self-reinforcing. Over time, top-biased income growth, reflected in rising private saving rates, results in even higher wealth inequality.

22. The analysis sheds light on the central role wealth inequality plays for macroeconomic adjustments and imbalances. Not only does wealth inequality affect the distribution of returns to capital and labor at the micro level, it is a powerful force shaping the macroeconomic adjustment to external shocks/secular trends, as illustrated with the case of German aggregate private saving (and by extension, current account balance) in response to rising corporate profitability.

23. In Germany, a source for skewed wealth distribution is the low average rate of home and equity ownership. Household assets are not diversified, with the bulk of savings by households below the top of the distribution stored in saving accounts bearing low (or even zero) deposit rates. While this may limit households’ financial vulnerabilities, the high risk/debt aversion and lack of portfolio diversification also hurts long-term prospects for wealth accumulation among large segments of the population.

24. The concentration of privately-held and publicly-listed firm ownership in the hands of industrial dynasties and institutional investors is especially prevalent in Germany, possibly reflecting distortions in firm entry, financing conditions and tax incentives. Recent literature has shown that corporate ownership concentration may be partly a result of financial market frictions, particularly frictions in credit markets, equity issuance and governance. Peter (2019) shows that reducing the fixed costs for IPOs would significantly lower the share of private firms and wealth inequality in Germany. Franks and Mayer (2001) provide evidence that concentrated corporate ownership in Germany is conducive to exploitation of private benefits by block shareholders. This suggests that further expanding venture capital financing along with “exit” opportunities for startups, while reducing cost of equity issuance, would not only contribute to more business dynamism but also allow the resulting productivity gains to be shared more broadly. Lastly, the family business asset exemption of the German inheritance and gift tax regime, while commonly associated with ownership stability of the Mittelstand, also plays an important role in entrenching wealth inequality and thus inequality of opportunity across generations.

Appendix I. Wealth-to-Income Profile Estimation

Table A1.

Wealth/Income profiles across income quintiles and business owner status

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Notes: ***, **, * denote significance at the 1 %, 5% and 10% level respectively. T-statistics in brackets. Constant term is included but not reported.

Table A1 summarizes results of median regressions with the net wealth to income ratio as the dependent variable. The regression specification follows Quadrini (1999). The regressions are performed on alternating samples with and without Germany. Quintile dummies refer to household income quintiles which are calculated on pre-tax income at the country level. Business owner is a dummy variable for households which have a controlling stake in a private business, that is, draw net profits from an unincorporated enterprise, where household members “make the operational decisions affecting the enterprise, or delegate such decisions while retaining responsibility for the welfare of the enterprise”.

As the HFCS provides multiply imputed values to cover for item non-response via stochastic imputation, we follow the standard procedure to estimate model parameters from multiply imputed data and adjusts coefficients and standard errors for the variability between imputations.

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1

Prepared by Mai Chi Dao (EUR).

2

This measure of net wealth does not encompass pension wealth, i.e. the present value of future pension entitlements from public and employer-provided pension schemes, which is estimated to be large in Germany (see Bönke et al. 2018).

3

See OECD Sectoral Balance Sheets statistics and DIW Wochenbericht Nr. 49/2018.

4

Household surveys are known to under-sample the richest households. Supplementing such surveys with the so-called rich lists increases the top 1 percent wealth share in Germany to 33 percent, the highest in Europe, see Bach et al. (2018) and Vermeulen (2016).

5

For an analysis of the evolution of wage and income inequality in Germany, highlight rising relative poverty risk, see the 2017 Selected Issues Paper “Income distribution and labor market developments in Germany” and more recently, DIWWochenbericht 19/2019.

6

It is also not visible in the Gini coefficient which relies on household survey and typically under-samples rich households and capital incomes.

7

Between 2010 and 2017, the interquartile range of net wealth in Germany increased by 30 percent (Bundesbank Monthly Report April 2019).

8

These shares are computed among publicly listed firms where the largest controlling owner has at least 5% of voting rights.

9

The effective marginal tax rate (EMTR) on retained earnings was reduced from 38.6% to 29.8%. At the same time, a withholding tax of 25% percent was introduced on dividends (while prior to the reform, only half of distributed profits were subject to the personal income tax) and the top income tax rate affecting the EMTR of dividends of unincorporated firms was also raised, widening the tax differential between retained and distributed income for both types of firms (see BundesbankMonthlyReportOctober2008).

10

Large-scale immigration after 2010 also played a significant role for the dynamics of bottom incomes in most recent years (see DIW Wochenbericht 19/2019).

11

That is, we estimate the equation in long changes in stead of levels: ∆IncInequct = α+ ∆βNFCGSct + δt + εct.

12

Peter (2019) shows in a structural model why high wealth inequality tends to be accompanied by high share of closely-held firms. Corporate taxation regimes that favor retained earnings have been shown to induce closely-held firms to partially serve as tax shelters among others in Norway (Altstadsaeter et al, 2014), Sweden (Jacob and Alstadsaeter, 2013), while the more general view that principal-agent issues play an important role in corporate responses to taxation has also been documented for the US (Chetty and Saez, 2005, 2006).

13

The empirical framework underlying the wealth/income profiles estimates is summarized in the Appendix.

Appendix I. Additional Table and Figures

Table A1.

The Distribution of LBT Rates, 2018

article image
Source: Statistisches Bundesamt, IMF staff calculation.
Figure A1.
Figure A1.

German and US FDI and the Tax Treaty Network

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Notes: The size of the nodes represents the average withholding tax rate on dividends in the tax treaties of the corresponding country (lower rate corresponds to larger nodes). The size of the links between the nodes corresponds to the share of inward FDI from a country in total inward FDI of the node country.Source: IMF staff illustration using IBFD data and IMF Coordinated Direct Investment Survey
Figure A2.
Figure A2.

Tax Wedge Progressivity in OECD Countries, 2018

Citation: IMF Staff Country Reports 2019, 214; 10.5089/9781498324632.002.A001

Note: The figure shows the average increase in the average tax rate as income rises by one percent of average per capita income over the given range. E.g., in the top panel, this is calculated as the difference of the tax wedge at 100 and 67 percent of per capita income, divided by 33.Source: IMF Staff Calculation using OECD Taxing Wages.

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1

Prepared by Victoria Perry, Alexander Klemm, and Shafik Hebous (all FAD).

2

For companies operating in more than one municipality, tax bases are allocated using a payroll-based formula.

3

Other additions include ¼ of the following: 1/5 of rent and leasing rates for movable property, ½ of rent and leasing rates for immovable property, ¼ of license fees and royalties (note that this indeed means that ¼ is multiplied by the other fraction given). There are also deductions, for example, for 1.2 percent of the official value of real estate to reflect the fact that this is already covered by the municipal property tax.

4

See Annex Table 1 for details.

5

Source: Federal Statistical Office. Total revenues of municipalities include their revenue share of PIT and VAT.

7

There is no obvious tax reason for the low incorporation, as the top PIT rate is very close to the combined CIT and dividend tax.

8

All cited studies correspond to periods before the implementation of the minimum standards of the G20-OECD BEPS initiative and the ATAD measures.

9

While 10 percent of German inbound FDI comes directly from the US, 36 percent comes through the Netherlands and Luxembourg (Table 1)—a significant though unknown portion of which is ultimately from the US.

10

Base Erosion and Anti-abuse Tax and Global Intangible Low-Taxed Income. For details on their definition and their international implications see Chalk, Keen, and Perry (2018) and Beer, Klemm, and Matheson (2018).

11

Interestingly, this appears to be anecdotally in line with Spengel and others (2018), above.

12

I.e., the G20-OECD Base Erosion and Profit Shifting initiative and the European Anti-Tax Avoidance Directive.

13

This particular area is one where the huge cut to the U.S. CIT rate actually does have a quite problematic impact.

14

Nor is “regular” foreign tax on active income, but since most such foreign income would be exempted by treaty in Germany it poses less of an issue in that case.

15

The Ministry of Finance notes that since the German rules were adopted in their present form in the 2008 Foreign Tax Act, they have been applied in about 160 adjustments.

16

An analysis of the history and effect of these rules is given in Van der Vlies (2018). The principal difference between the German rules and the OECD guidelines lies in the valuation of the transferred function. Under the OECD guidelines, ongoing businesses that are moved offshore should be valued as going concerns—which may as in Germany cover valuation by discounting the expected future income stream. But rather than taking the value from the point of view only of the “buyer” offshore, the German rules require also valuing from the perspective of a prudent German manager the potential lost future profits from the transfer. The transfer price is then determined as the average of the two estimates. This can have the effect of twice taxing half of the gain realized by the enterprise from the benefit of moving abroad—once abroad, as profits are actually realized there, but also in Germany ex ante.

17

One possibility is to offer a higher depreciation rate in the first year (e.g., in 2018, Canada introduced a triple first year depreciation for capital spending). The United States introduced full expensing of capital goods, the most generous form of accelerated depreciation, in 2018.

18

It is understood that this issue is under study in the Ministry of Finance.

19

South Dakota v. Wayfair, Inc., 585 U. S. ___ (2018) (138 S. Ct. 2080)

20

“Sales” would then need to be measured on a destination basis, as is the case in the existing subnational FA schemes, such as in the United States.

21

The CCCTB as proposed in 2016 also foresaw allowing for super R&D deductions and an allowance for corporate equity (ACE).

22

Table 39, page 150.

23

The main argument is that taxing rights are allocated to different levels of government and if tax bases were the same, municipalities do not have a right to levy a CIT.

24

The study uses that year because it allows the greatest number of observations across countries.

25

Exceptions include the United States.

26

They have been made by various experts, see previous discussion in Sachverständigenrat (2013).

27

The current joint system costs €22.6 billion compared to individual taxation (BMF, 2018b). The cost of the tax credit would be up to €22.5 billion (calculated as €1277 per couple for 17.6 million couples (Statistisches Bundesamt), which is a slight over-estimate, as not all couples will have sufficient tax liabilities to use up the full credit).

28

They are deductible up to a limit of €1900. However, if long-term care and 96 percent of health contributions alone exceed this amount, they are deductible without limit.

29

Indeed, over the range of 67 to 100 percent of per capita in come, Germany’s tax and social security system is more progressive than in the average OECD member, while Germany’s system is among the less progressive systems as incomes rise from 100 to 167 percent of per capita income (Annex, Figure A2). Comparative data for further income increases are not available, but Germany’s system would certainly turn regressive over ranges where the social security contribution is phased out.

30

See also Bach, Haan, and Harnisch (2018) for suggestions on how to make social security contributions progressive.

Germany: Selected Issues
Author: International Monetary Fund. European Dept.