Ifo Viewpoint No. 40: More Big Government – The Ten Point Programme of the New Ruling Coalition

Hans-Werner Sinn
Munich 24 October 2002

Germany has been on the wrong track for thirty years. The government's share in GDP has risen from 39% to 48%. Unemployment has increased from 150,000 (West Germany) to about four million. These factors are connected, and a reversal of trends is not in sight for either. The most recent proposals of the Federal Government will take the country even further down the wrong track, since what is euphemistically designated as a “savings programme” is in fact a massive ten point tax increase programme.

1. The environment tax on energy will be raised again on the first of January. This is not the worst of all taxes, but it contributes to the already very high taxes that are crushing this country. For this reason it has no legitimisation.

2. The next stage of the already approved income tax reform would have offset the increase in the average wage and income tax burden caused by tax progression. The postponement of this stage will prevent this effect. Germany is and remains the country with the highest marginal tax burden on the value added by the average employee in the world, at approximately 66%.

3. A minimum corporation income tax is understandable in light of the negative corporate tax revenue observable in 2001 and in the first half of 2002. The government made a mistake when reforming the corporation tax. It failed to take into consideration that the distribution of old equity capital and the substitution of old, heavily taxed equity capital by new, low taxed equity capital would lead to a subsequent tax reduction on the entire equity capital stock of firms built up by retained earnings since 1977. The minimum tax on corporations is meant to correct this error. It is debatable whether this is the best way to react. However, the introduction of a minimum tax is a massive tax increase in any case.

4. The abolition of the (falsely designated) "speculation" period is in fact the introduction of a genuine capital gains tax, the likes of which Germany has never known. It also taxes the yield on long-term retirement savings. Capital gains on company shares arise from retained earnings for the purpose of in-house investment. The capital gains tax is a double burden on retained earnings. It discriminates against investments that are financed by retained earnings and it encourages profit distribution. It induces the opposite of what was intended with the tax reduction on corporations’ retained earnings introduced two years ago.

5. The contribution rate for the pay-as-you-go pension system will be raised by 0.2 percentage points. Since this is not offset by higher entitlements for the paying employees, it is a pure tax increase.

6. The increase of the monthly income limit up to which payments are made to the pension system from €4,500 to €5,100 is a clear increase in the tax burden for persons in this income group, and is essentially a tax. Approximately 40% of the additional tax burden is offset by a rise in the present value of pension entitlements. This portion is a hidden additional government debt. The remaining 60% of the additional burden is a pure tax increase that is not offset by additional entitlements.

7. The increase in the monthly income limit for statutory pension insurance is accompanied by an increase in the compulsory insurance threshold for health insurance, which stands at 75% of this threshold. Persons whose monthly earnings range from €3,375 to €3,825 will now be obliged to pay contributions** to the statutory health insurance system. Even if the contribution rate remains based on the old threshold, this is still a hidden tax increase of considerable proportions since the services of the statutory health insurance system are the same for all, whereas the contributions depend on earnings.

8. Aviation petrol, agricultural products and other goods will be subject to the full value-added tax rate. Whether the different tax rates were justified or not, this, too, is a clear tax increase and not a savings effort of the government.

9. The tax on natural gas is a similar case in point. Adjusting it to the tax on petroleum could be justified on the principle of equal treatment of all energy sources, although favourable tax treatment of natural gas makes sense for environmental reasons. This, too, is a tax increase. Calling this the elimination of a subsidy is a confusion of terms.

10. The increase in the national debt by 0.13% of GDP as well as the increase in hidden government debt through the increase in the threshold for statutory pension insurance must be seen as indirect tax increases, since someone will have to pay the bill later when the debts are paid off and the additional pension entitlements are honoured.

These things taken together will raise the public sector share in GDP significantly and will continue to hamper economic growth. The problem does not concern the business cycle, as the money that is withdrawn from the circular income flow is also re-injected. But tax increases are poison for the growth of production capacity. To be sure, the tax increases will not ruin the country. But the potential risks have been raised. Past ruling coalitions in Germany did not have the courage to cut back big government. This coalition doesn’t even want to.

Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute