ifo Viewpoint No. 5: Tax Reform

Hans-Werner Sinn
Munich, 3 Nov. 1999

The tax reform proposed by the German government focuses on relief for retained earnings. Businesses will be induced not to distribute their profits but to retain them and invest them in domestic or foreign capital markets. This will only intensify the concentration of power of existing corporations and impede the formation of new businesses. In contrast to the significant relief for corporate leaders and their enterprises, the earnings of human labour will continue to be burdened by a strongly progressive tax scale. The reform will not help mobilize the labour market or promote investment in human capital.

The Ifo Institute has presented an alternative that removes the asymmetries of the government proposal. In the personal income tax, the Ifo alternative calls for only three marginal tax rates of 20%, 30% and 40%; corporate earnings should be taxed at a rate of only 30%, accompanied by a reduction in the local business tax (Gewerbesteuer) to effectively 10%. The maximum tax on all types of revenue is a uniform 40%. Despite the broadening of the tax base, which in itself would lead to increased revenue of DM 30 billion, the Ifo reform proposal would lead to net savings of DM 50 billion for taxpayers. This tax cut can be financed by reducing subsidies by 10% and cutting social benefits by 3%.

The tax regime proposed by the Ifo Institute is revenue neutral for enterprises, it is simple, clear and practicable, and investment will no longer be motivated by tax loopholes but will go where the highest real income can be earned. It will provide greater incentives to invest in education and training, it will reduce the shadow economy, and it will create new jobs since it will contribute to moderation in wage negotiations.

Hans-Werner Sinn
President of the Ifo Institute