Kai Hofmann and Wolfgang Scherf
The Effects of the Tax Reform 2000 in Germany on Local Communities
Abstract: The burden on local communities as a result of the German Tax Reform 2000 has largely been neglected in the financial policy discussion. The considerable reductions in the income of local communities, which could be increased still further as a result of the overall economic situation, jeopardise the consolidation success achieved in recent years. There are also serious defects in the structural development. Trade tax is further eroded by unsystematic partial offsetting against the income tax payable by private companies. The increase in the trade tax apportionment is another step in the wrong direction. The tax reform as a whole underlines the great extent to which the financial autonomy of local government is limited by the influence of the national government and federal states. This could be remedied by replacing the trade tax with a local community tax on value added and a right to fix the tax factor in the local community share of the income tax.
2. The Financial Situation of the Local Communities
3. Presentation and Effects of the Tax Reform 2000
3.1 Summary of the Reform Measures
3.2 Effects on Local Community Budgets
4. Evaluation of the Reform Measures
4.1 Allowance of Trade Tax against Income Tax
4.2 Increase in the Trade Tax Apportionment
4.3 Erosion of the Financial Autonomy of Local Communities
With the tax reform which was passed in July 2000, the German government aims to provide extensive relief for business companies and private households. It hopes that this will lead to a major improvement in growth and the creation of new jobs. The tax reform is still a subject of dispute. It is especially criticised in view of the tax planning and distribution policy problems which are associated with the reform of company taxation. (1)
The financial policy discussion paid far less attention to the effects of the reform on local community budgets. The low level of public interest in local community affairs is partly due to the fact that the local communities, by contrast with private citizens and business companies, are tax creditors and not tax debtors. But this lack of attention is not justified in view of the financial problems which many local communities are struggling with, especially in structurally weak regions and in the new federal states, and the consolidation which has already been achieved by local government bodies (cf. Karrenberg/Münstermann 2000: 18 f.). It must also be feared that the reforming zeal of the German government has been largely exhausted with the passing of the tax reform. The urgently necessary reform of the local community tax system, which has been demanded for a long time, is therefore unlikely to be achieved in the coming years. (2)
This article deals with the effects of the Tax Reform 2000 on local communities. Chapter 2 contains a brief overview of the financial situation of local communities. In chapter 3 the reform measures of the federal government and the effects which the Federal Ministry of Finance expects the reform to have on local communities are presented and subjected to closer analysis. A critical discussion of the reform measures follows in chapter 4. This chapter also outlines some reform options for the local community finance system.
2. The Financial Situation of the Local Communities
Considerable efforts at consolidation have been observed in local community finance for several years. This is mainly apparent in the moderate development of expenditure on personnel, but also in a significant reduction of investment in fixed assets. And the burden on local communities was reduced by national reform measures in the area of social security (e.g. by the introduction of nursing care insurance) (for further details, cf. Federal Ministry of Finance 2000a: 6 ff.). An unexpectedly positive development of income also enabled local communities as a whole to achieve a budget surplus in the years 1998 and 1999. By contrast with the expectation, the local communities also ended the year 2000 with a positive balance of finance which was especially due to further consolidation efforts, proceeds from non-recurring sales and an increase in rate support grants (cf. Deutscher Städte- und Gemeindebund [German Association of Municipalities] 2001: 1).Table 1 gives an overview of the development of the debit and credit balance in the years 1992 to 2001.
Table 1: Local community revenue, expenditure and debit and credit balance 1992 to 2001, in bill. DM
Source: Deutscher Städtetag (Council of German Municipal Authorities) (2001). The figures for 2001 are estimates.
However, the relatively favourable data must not be interpreted to mean that the financial situation of the local communities in relation to the other levels of government is comfortable and that possible losses in income resulting from tax policy decisions of the national government can be absorbed with comparative ease. In fact, a comparison of the budget situation of the national government and federal states on the one hand and local communities on the other is not easily possible, because the local communities are subject to special borrowing limits under local community budgetary law. (3) And a consideration which is restricted to the overall debit and credit balance does not do justice to the considerable differences between local communities. Thus, the debit and credit balance of local communities in West and East Germany in 2000 is positive in its total, but especially the unaffiliated towns in the new federal states and a majority of local communities in West Germany have a financial deficit (cf. Deutscher Städte- und Gemeindebund [German Association of Municipalities] 2001: 7 f.).
3. Presentation and Effects of the Tax Reform 2000
3.1 Summary of the Reform Measures
Local communities are affected in several ways by the Tax Reform2000. The most important changes are briefly presented here. The TaxReduction Act (StSenkG) (4) includes not only a reform of the income tax rate and a revision ofcompany taxation, but also measures to make up for the reduced income,and these also have an effect on the budgets of local communities. Thereform of the income tax rate is taking place in a number of steps.First of all, the reduction in the tax rate in the second stage of theTax Reduction Act of 1999/2000/2002 is being brought forward to theyear 2001. This reduces the tax threshold rate to 19.9 per cent in2001, the top marginal tax rate is reduced to 48.5 per cent and thebasic personal allowance is increased to DM 14,093. In 2003 the taxthreshold rate will then be reduced to 17 per cent and the top marginaltax rate to 47 per cent, whereas the basic personal allowance will beraised to DM 14,525. For 2005 the national government plans a taxthreshold rate of 15 per cent and a top marginal tax rate of 42 percent for a taxable income of DM 102,000. At the same time it plans toraise the basic personal allowance again to DM 15,011. The share of thereduced tax income borne by local communities in the tax scale reformwill correspond to their share of the income tax revenue, which is 15per cent.
The reform of company taxation includes the taxation of joint stockcompanies and shareholders, and also the taxation of private companies.The most important changes in corporation tax law are the abolition ofthe full imputation system in favour of the so-called half-incomesystem and the future tax exemption for capital gains from the sale ofjoint stock companies. With the transition to the half-income system,the corporation tax rate is being reduced to a uniform rate of 25 percent and the spread of the corporation tax rates for retained anddistributed profit is being abolished. (5) Inaddition to the reduction of the income tax rate, the reform in thetaxation of private companies also includes the provision that thestandard income tax on commercial income is reduced by 1.8 times theassessment basis for trade tax. By this means, the German governmentintends to grant a large proportion of businesses complete relief fromtrade tax by means of trade tax credit and deduction of businessexpenses. (6)
To make up for the reduced income, the participation limit forprincipal shareholdings was lowered and a number of changes were madein the depreciation regulations. The depreciation rate for degressivedepreciation was reduced from 30 per cent to 20 per cent and thedepreciation rate for company buildings was reduced from four per centto three per cent. And the official depreciation tables were adjustedto more realistic useful life periods. The measures to finance thereform also include the abolition of the tax reduction for businessincome. (7)
The changes in the depreciation regulations are expected to lead toconsiderable extra income, especially in trade tax. This extra localcommunity income is to be absorbed by the increase in the trade taxapportionment. Table 2 below provides an overview of the changes in thetrade tax apportionment resulting from the tax reform for the years2001 to 2006.
Table 2: Development of the trade tax apportionment 2000 to 2006
|Total apportionment||Multipler in per cent|
Source: Gesetz zur Senkung der Steuersätze und zurReform der Unternehmensbesteuerung (Act on the Reduction of Tax Ratesand the Reform of Company Taxation).
The figures for the West German federal states do not take intoaccount the increase in trade tax apportionment to finance the localcommunity contribution to the German unity fund (Fonds DeutscheEinheit).
3.2 Effects on Local Community Budgets
Presentation of the Financial Effects (8)
In the reform of company taxation, the Federal Ministry of Financeassumes that the measures adopted, including the measures to make upfor the reduced income, will lead to considerable extra income for thelocal communities. The loss of income of local communities, which willresult especially from the tax exemption for capital gains and theallowance of 1.8 times the assessment basis for trade tax againstincome tax will, it is assumed, be offset by considerable extra incomefrom income tax and especially trade tax. This is especially attributedto the abolition of the tax rate limit for commercial income and thereorganisation of the depreciation regulations. However, the extraincome earned on balance by the local communities is to be absorbedagain by the increase in the trade tax apportionment in favour of thenational government and the federal states.
Table 3: Effects of the Tax Reform 2000 on local community budgets
|in bill. DM|
|Reform of company taxation, adjustment of depreciation tables||1,14||3,44||6,11||7,01||7,42||6,37|
|Change in trade tax apportionment||-1,40||-3,52||-5,63||-6,50||-6,68||-5,76|
|Company tax reform, total||-0,26||-0,08||0,48||0,51||0,74||0,62|
|Reform of the income tax rate||-4,06||0,18||-1,97||-1,88||-6,70||-6,84|
|Tax Reduction Act, total||-4,31||0,10||-1,49||-1,37||-5,96||-6,23|
|Resolution of the Federal Council||-0,15||-0,21||-0,30||-0,30||-0,93||-0,96|
|Direct reduction in income||-3,85||-1,96||-2,76||-2,39||-5,29||-5,67|
|Reduction in local community income||-8,31||-2,07||-4,55||-4,06||-12,18||-12,86|
|Total effect of the Tax Reduction Act||-45,39||-19,21||-29,34||-25,05||-62,76||-67,23|
|Local community share of the overall effects of the tax reform||18,3||10,8||15,5||16,2||19,4||19,1|
Source: Bundesministerium der Finanzen (Federal Ministry of Finance) (2000b); Karrenberg (2000a: 220). The indirect reductions in income were calculated on the basis ofthe tax-linked regulations for 2000 in the individual states.
Whereas the reform of company taxation over a period of six yearsmeans a slight relief on the whole, the reduction of the income taxrate leads to a major loss of tax income for local communities (cf.Table 3). In addition to the direct reductions in income in the localcommunity share of income tax revenue, the local communities also havean indirect loss of income in the framework of the local communityfiscal adjustment. Under article 106 subsection 7 of the Germanconstitution, the federal states are obliged to include the localcommunities in the federal state share of the joint tax revenue (incometax, turnover tax [VAT], corporation tax) (obligatory tax pool).Furthermore, the federal states are also entitled to include therevenue from federal state taxes (e.g. vehicle tax, trade taxapportionment) or the interstate fiscal adjustment in the tax pool(optional tax pool). The amount of the participation rates is fixed bythe federal states themselves. It depends to a great extent on thedistribution of tasks between the federal state and the localcommunities, but also on the "friendliness to local communities" of therespective federal state government. (9)
If the level of income tax or corporation tax revenue falls, the taxpool available for distribution also declines. If the participationratio is left unchanged, this will lead to lower rate support grantsfrom the federal states to the local communities. As the federal stateswill probably use the tax pool to make their local communities beartheir share of the tax reductions resulting from the reform, this willinevitably lead to new tension and disputes between these levels ofgovernment.
Evaluation of the Financial Effects
By contrast with the original fears of the local communities (cf. Bundesvereinigung der kommunalen Spitzenverbände [National association of central local community organisations] 2000: 11), the calculations of the Federal Ministry of Finance indicate thatthey will not bear an over-proportional share of the reductions inincome. In fact, the direct and indirect reductions in incomeespecially in the years 2005 and 2006 will approximately correspond tothe share of the local communities in the tax revenue up to now, whichis slightly below 20 per cent of the total tax revenue. The directreductions in income will also remain below the share of the localcommunities in every year, with 12.4 per cent in 1999 (cf. Karrenberg 2000a: 220). The criticism of the original tax plans by local communities thushad its effect and was taken into account to some extent by thelegislative body. Nevertheless, the local communities will be undertremendous pressure to consolidate in the coming years, and this willpush many local communities to the limits of their financial resources.
But the fiscal effects are not the only criterion by which thereform should be evaluated. In fact, it is doubtful whether the shareof any one level of government in the tax revenue can be regarded as asuitable measure of the extent to which this level of government sharesin the reductions in income resulting from the tax reform. Theone-sided concentration of this method on the income side is extremelyproblematical. This completely neglects the tasks of local communities,which are determined by other levels of government to a large extentand are thus beyond the control of the local communities themselves. (10)
The procedure for the increase in the trade tax apportionment canalso be criticised. The assumed extra income of the local communitiesis based only on estimates, and it is not certain that the end resultfor the local communities is in fact balanced. Rather, there is a riskthat the extra income may not reach the level anticipated by theFederal Ministry of Finance. In this connection it must be taken intoaccount that the extra income, which results from spreadingdepreciation over a longer period, will decline in the medium termbecause the extension of the depreciation period merely delays taxationto the future. (11) Thislong-term effect is not clearly shown in the calculations of theMinistry because the estimates also include the assumed positiveeffects of the tax reform on investments in plant and equipment. Thecalculated relief for the local communities thus depends to a greatextent on the development of investments in plant and equipment in thecoming years, but this can hardly be predicted with any degree ofreliability. (12)
Against this background, the increase in the trade tax apportionmentwhich has been decided as a way to recoup the anticipated extra incomeof local communities could turn out to be problematical. There is arisk that the national government and the federal states will receivemore trade tax revenue than is justified in view of the actual extraincome of the local communities. This must especially be expected ifthe tax reform does not provide the assumed expansive impetus for theeconomy as a whole. In view of this, it does not appear justified thatthe level of the trade tax apportionment has already been fixed for thenext six years. It would have been better to determine theapportionment annually in arrears so that it could be based on theactual development of local community income. This would have been away to avoid the impression that the national government and thefederal states are passing on the burdens of the tax reform to thelocal communities.
It must also be taken into account that the increase in theapportionment and compensation for reduced income do not balance out inevery local community. Even where the revenue as such is constant,there is a redistribution between the local communities. According tothe Federal Ministry of Finance, these shifts should be equalised inthe framework of the local community fiscal adjustment (cf. Bundesministerium der Finanzen [Federal Ministry of Finance] 2000c: 9). On the one hand, this is unlikely because the total amount offinance available for the adjustment is reduced because of the taxreform. On the other hand, the system of the local community fiscaladjustment is such that it cannot be assumed that all local communitieswill actually receive compensation (cf. Kuhn 1997: 220).
In the local community fiscal adjustment, the distribution of thefunds is based on the difference between the financial resources andthe financial requirements of a local community. Local communities inwhich the financial resources fall short of the financial requirementsare entitled to a rate support grant, but communities in which thefinancial resources exceed the financial requirements do not receive agrant. (13) Comparedwith the calculation of the financial resources, the calculation of thefinancial requirements is far more complicated. Calculation of thisfigure as such is not possible. Indirect factors are used instead, andthe population is the most important such factor. The financialrequirements of a local community in the adjustment procedure arecalculated by multiplying the population figure (which is often"refined") by the basic amount, which is calculated so that the entiregrant pool available is actually distributed in the local communityfiscal adjustment. If the fiscal adjustment parameters remain the same,a reduction in the available funds means that the basic amount islower. As a result, some communities which were previously eligible fora grant could be classed as affluent. This means that they do notreceive any compensation, nor do the communities which were previouslyclassed as affluent, which stand to lose by the tax reform in any case(cf. Kuhn 1997: 221).
4. Evaluation of the Reform Measures
4.1 Allowance of Trade Tax against Income Tax
Criticism of the Partial Allowance
Although the partial allowance of trade tax against income taxinitially came in for harsh criticism from local communities, they havenow given up their resistance to the plan. But this was not fromconviction, it was in view of the alternatives for the reform ofcompany taxation, which were even less favourable from the perspectiveof the local communities (cf. Karrenberg/Münstermann 2000: 30 ff.). However, this does not remove the constitutional misgivingsabout the reform. The partial allowance leads to a preferentialtreatment of commercial profits, thus violating the requirement of anequal burden on different types of income (ibid: 30 f.).
The reform proposal also seems problematical in relation to the tax system as a whole (cf. Roland 2000: 94). The different goals of trade tax and income tax are in fundamental conflict with a global or full allowance of trade tax. (14) Whereastrade tax is based on the objective profitability of the company andaims to create a link to the local community infrastructure, income taxis based on the individual earning capacity of the taxpayersirrespective of any utilisation of state services. The allowance oftrade tax - in material terms - actually involves a participation oflocal communities in income tax (15),it must be feared that in the course of the reform of the trade tax,there will be a further expansion of the general tax pool. The partialallowance is an attempt to provide tax relief for private companiesthat is comparable to that for joint stock companies. In the process,however, corporation tax regulations which are extremely questionablefrom a financial theory perspective are used as a starting point forother problematical measures in income tax and trade tax. (16)
The introduction of the partial allowance represents a furtherweakening of the trade tax as a local community tax (for a moredetailed treatment, cf. Scherf 2000: 12 f.). Against this background, a reform of local community companytaxation appears especially urgent. Possible alternatives are a greaterparticipation of local communities in the turnover tax (VAT), the grantof a local community right to fix the tax factor for income tax and theintroduction of a local community tax on value added.
A further increase in the local authority share of the turnover taxis not suitable because an expansion of the turnover tax pool does notpermit any right to fix the tax factor. The consequence would be aneconomically and politically undesirable erosion of the financialautonomy of local authorities. This would contradict the provision ofarticle 28 subsection 2 sentence 3 of the German constitution whichstipulates that to ensure their self-administration, the localcommunities must have a source of tax revenue which is related to thecommunal economic strength and can be affected by the local communitiesby changing the tax factor (within limits). Moreover, a furtherintensification of the tax pool between the national government, thefederal states and the local communities appears anachronistic againstthe background of the current discussion on a greater autonomy andself-responsibility of the individual levels of government.
The introduction of a local community right to fix the tax factorfor income tax is also not convincing as a replacement for the tradetax because it does not sufficiently take into account the balance ofinterest between local companies and the local communities. The onlyviable alternative seems to be the local community tax on value addedproposed by the academic advisory council to the Federal Ministry ofFinance (Bundesministerium der Finanzen 1982: 52 ff.). It meets the requirements for a local community company tax (cf. for example Zimmermann/Postlep 1980: 248 ff.) much better than the trade tax. Its implementation wouldprobably have a positive effect, particularly on the tax revenue ofEast German local communities. (17)
4.2 Increase in the Trade Tax Apportionment
In addition to the partial allowance of trade tax against incometax, the increase in the trade tax apportionment is another fundamentalproblem of the tax reform from the local community perspective.Irrespective of the correct assessment of the amount, a more detailedconsideration of the apportionment seems appropriate in view of thelocal community criticism of this "financial adjustment instrument".
The Present Trade Tax Apportionment
The trade tax apportionment was introduced in the local community taxreform of 1969 to compensate the loss of income of the nationalgovernment and federal states which resulted from the participation oflocal communities in the revenue from income tax. The apportionment wasalso designed to reduce the dominance of the trade tax in localcommunity tax income. (18) Itwas originally planned that the trade tax apportionment would beabolished with the reform of the trade tax. But it has evidently becomea "permanent provisional solution" (Hidien 1999: 33). With a volume of 10.2 billion DM in 2000, the apportionment absorbed about one fifth of the total trade tax revenue (cf. Deutscher Städtetag [Council of German Municipal Authorities] 2001 and own calculation).
To calculate the apportionment, the actual revenue of a localcommunity from trade tax is divided by the community's specific tradetax factor. This ensures that the tax factor policies of the localcommunities do not affect the amount of the apportionment. Thecalculated amount, which corresponds to the assessment basis for tradetax, is then multiplied by a multiplication factor which results fromthe sum of the national and federal state multiplication factors. Up to1960, half of the apportionment revenue fell to the national governmentand half to the federal states. But this balance was given up in thecourse of German unification because the old federal states made thelocal communities participate in the costs of German unity, and did sopartly via the trade tax apportionment. The national multiplicationfactor is currently 24 per cent. The federal state multiplicationfactor, taking into account the regulations of the "German unity" fund,is 67 per cent in the western federal states and 30 per cent in the newfederal states (cf. Karrenberg 2000b: 225).
Problems of the Trade Tax Apportionment
A large number of drawbacks are linked with this "transitionalsolution", and this means that a critical verification review of theapportionment is needed, at the latest, as part of a reform of thelocal community tax system. The Tax Reform 2000 compounds the problemsoutlined below.
(1) A high trade tax apportionment leads to a weakening of thebalance of interest between local business companies and localcommunities which is associated with the trade tax (cf. Bundesvereinigung der kommunalen Spitzenverbände [National association of central local community organisations] 2000: 6). As a result of the great rise in the multiplication factor in thecourse of the Tax Reform, the local communities are left with anincreasingly small proportion of the gross tax revenue. Based on theaverage tax factor for trade tax in 1998 which was 360 per cent, theincrease of the multiplication factor to 105 per cent in 2006, forexample, means that about 27 per cent of local community tax revenue istaken away. The trade tax therefore increasingly fails to fulfil itsfunction as a local community tax - a task which it already onlyfulfils very inadequately.
(2) In addition to the low level of transparency of the system,which is especially reflected in the difficulty of calculating thedeterminant for the apportioned amount, the irreversible nature ofdecisions which have been made is also a cause for criticism. In thisconnection, the increase in the trade tax apportionment in the"solidarity agreement" (in the context of reunification) in particularmust be called into question because it was much higher than wasjustifiable by the actual costs borne by the federal states (cf. Karrenberg/Münstermann 1998a: 162 f.). Due to the fiscal interests of the federal states, nocorrection has yet been made to the multiplication factor although theAct included a revision clause.
(3) Frequent changes in the trade tax apportionment countermand thestability of local community income which is desirable from theperspective of economic and growth policy. This is especiallyproblematical in view of the fact that the trade tax is stronglydependent on economic profitability, and is thus subject toconsiderable fluctuations (cf. also Karrenberg/Münstermann 1998b: 445).
(4) The trade tax apportionment enables the national government tointerfere directly in local community finance, and the localcommunities have no influence on this process. As a result of theincremental increases, the trade tax apportionment is increasinglybecoming an unsystematic instrument for vertical fiscal adjustmentbetween the national government, the federal states and the localcommunities. Hidien therefore rightly calls it a "negative model of(provisional) compromise solutions in financial law and the unnecessaryproliferation of transfers of funds which cancel each other out in thefederal state" (Hidien 1999: 33).
The Role of the Trade Tax Apportionment in Vertical Fiscal Adjustment
Vertical fiscal adjustment deals with the question of how tasks,expenditure and revenue should be distributed between the variouslevels of the state (for more detail cf. Peffekoven 1980: 608 ff.). The practical distribution between the national government,the federal states and the local communities is based on the provisionsof the German Constitution. (19) Inthe distribution of revenue, all levels must be provided withsufficient funds so that they can fulfil the tasks assigned to them.
For certain tax sources (e.g. the mineral oil tax), the constitutionstipulates that they must be assigned to the various levels ofgovernment in a divided tax system. In the tax pool, however, thenational government, the federal states and the local communities allparticipate in the revenue from the quantitatively most importanttaxes. A special role is played by the turnover tax, which acts as amovable hinge in the distribution of tax between the nationalgovernment and the federal states. This flexible feature is designed tocompensate for shifts in finance requirements between the two levels ofgovernment, and the financial requirements of the local communities,which are treated as part of the federal states in the structure of thegovernment system, are meant to be taken care of in the context of thefinance requirements of the federal states. (20)
The Constitution regards the distribution of the turnover tax as theinstrument which should be used to react to shifts in burdens betweenthe levels of government, such as those which occur as a result of theTax Reform. It can therefore be asked why the distribution of theturnover tax was not earmarked as the way to absorb the anticipatedextra income of local communities from trade tax, and why the trade taxapportionment was designated for this purpose instead. (21)
Two basic reasons can be given for the selected procedure. First ofall, the anticipated extra income particularly arises from trade tax.It therefore appears logical to draw on these extra funds at theirplace of origin. And secondly, there is a risk of renewed conflictbetween the national government and the federal states if their sharesof the turnover tax revenue were to be renegotiated, a fear that issubstantiated by a large number of disputes - e.g. in connection withthe solidarity agreement in 1993. Against this background, the tradetax apportionment was chosen in order to avoid new disputes between thenational government and the federal states. This means that thisprocedure, which contributes significantly to a greater lack oftransparency of the fiscal adjustment process, was mainly chosen foreconomic policy reasons.
The problem of the trade tax apportionment could have been solvedmore elegantly in the course of the Tax Reform. If the nationalgovernment and federal states had completely foregone the trade taxapportionment, this would have made a reduction of the trade taxfactors possible, and this could have provided more than ten billion DMin relief for business companies. The main problem in this approach isthe lack of a guarantee that the local communities would have passed onthis relief in full to business companies. But the competition betweenthe local communities as business locations and the possibility ofbinding agreements between the participating authorities relativisethis argument.
4.3 Erosion of the Financial Autonomy of Local Communities
The major loss of income of local communities as a result of the TaxReform again underline the great importance of central statelegislation for local community finances. But the dependence of localcommunities is not restricted to the income side - examples such askindergartens and social welfare benefits illustrate that thisdependence also applies to expenditure. This situation is particularlyserious because the local communities have no possibility of directparticipation in the state decision-making processes. This is a ratherironic contrast to the relatively strong constitutional position of thelocal communities in the administrative structure of the FederalRepublic of Germany. As an organisational part of the federal states,the interests of local communities should actually be represented bythe federal states, but the federal states often have other goals thanthe local communities and, as the example of the trade taxapportionment and the disputes about the local community fiscaladjustment show, they do not always act as advocates of local communityinterests.
To solve this problem, first of all the coherence principle could bemore strongly adhered to in the vertical fiscal adjustment between thenational government, the federal states and the local communities. Thisprinciple demands that the decision-makers and the bearers of the costsof state measures must be the same bodies. The council of economicexperts argues: "Whoever is responsible for legislation, should alsobear the resulting expenditure. [...] That is the only way to organiseareas of responsibility and achieve control of the economic deploymentof public funds" (Sachverständigenrat [Council of economic experts] 1997: No. 349). For the local communities, the coherence principle means thatthey should be compensated in full for the costs resulting from tasksimposed by other bodies. (22)
The demand for a stricter application of the coherence principle,which has been voiced for some time, becomes even more important inview of the Tax Reform. Local communities are faced with an unchangedand largely externally imposed range of tasks, which must be tackledwith a declining income. In practice, however, the application of theprinciple involves a number of difficulties. For example, in areas inwhich local communities have a certain amount of discretion in thefulfillment of government-imposed tasks, it is often not possible todistinguish precisely between costs caused by the imposed task andcosts caused by the use of discretion (cf. Geske 1998: 559 f.).
A further possibility of strengthening the financial position oflocal authorities would be to increase their autonomy of revenue. Thisimmediately leads us to think of income tax (23), where it is not possible at present for local communities to have any direct effect on the level of tax revenue. (24) Ittherefore seems worth considering whether local communities could begranted a (limited) right to a surcharge on income tax as is envisagedin the Constitution in article 106 sub-section 5. (25) Theright to impose a surcharge would, among other things, be a way toreact to state-induced reductions of revenue from income tax and tocompensate them to a certain extent. In this case, however, there is arisk of misuse. "A local community right to adjust the tax factor orimpose a surcharge would perhaps improve the flexibility of localcommunities and thus their ability to react to changing situations, butthe main function of such a solution is not to compensate for budgetaryproblems caused elsewhere, it is to improve the level of agreementbetween the preferences of the citizens and the services offered by thelocal community." (Scherf 2000: 37) (26)
The Tax Reform 2000 will lead to major reductions in income forlocal communities, and these losses may become even greater if theestimates of the Federal Ministry of Finance are not fulfilled aspredicted, e.g. if the general development of the economy is lessfavourable. In view of the consolidation efforts that have been made inrecent years, local government is faced with a task which can only besolved with great difficulty.
The assessment of the individual reform measures is highly critical.Especially the allowance of 1.8 times the assessment basis for tradetax against the income tax debt is not convincing under financialtheory principles. This unsystematic compensation solution for privatecompanies weakens the trade tax, makes its continued justification as alocal community tax questionable and lends credibility to the idea ofreplacing it by a local community tax on value added. The increase inthe trade tax apportionment also appears doubtful in view of the risksin the estimation. In general, it can be asked what sensible functionthis apportionment, with all its shortcomings, can actually fulfil in afederal financial system. The fact that the local communities do notpress harder for an abolition of the trade tax can probably only beexplained as protecting the financial interests of the nationalgovernment and the federal states in the continued existence of thetrade tax.
The Tax Reform again underlines the extreme dependence of localcommunities on decisions made by the central government. Against thisbackground, a strengthening of local community financial autonomy seemsdesirable. In addition to strengthening the coherence principle, thefinancial autonomy of the local communities could also be noticeablyimproved by a right to fix the tax factor for income tax. But such ameasure cannot be implemented in the short term, it would need to bepart of an urgently necessary comprehensive reform of the localcommunity tax system.
(1) For example cf. Rosen (1999: 653 ff.); Peffekoven (2000: 80 ff.); Deutsches Institut für Wirtschaftsforschung (DIW) (German Institute for Economic Research) (2000: 139 ff.); Bareis (2000: 602 ff.); Homburg (2001: 8 ff.). (back)
(2) The suggestionof replacing trade tax by a local community income tax with anassociated right to fix the tax factor, which has been considered ingovernment circles, is not a suitable proposal for reform because itwould lead to a one-sided dependence of local community finance on theresidential population and thus run counter to the principle of abalance of interest between the residents and local business companies.(back)
(3) For example,local communities can only take out loans under relatively restrictiveconditions, loans must be repaid from current income and the localgovernment supervisory bodies demand that local communities withdeficits in their administrative budget must present binding strategiesto clear the deficits. Cf. Bundesministerium der Finanzen (FederalMinistry of Finance) (2000a: 6). (back)
(4) For the details of the content, cf. the "Gesetz zur Senkung der Steuersätze und zur Reform der Unternehmensbesteuerung" (Act on the Reduction of Tax Rates and the Reform of Company Taxation -StSenkG) and the "Gesetz zur Ergänzung des Steuersenkungsgesetzes"(Supplementary Tax Reduction Act - StSenkErgG). (back)
(5) However, theproblematical difference between the top marginal tax rate for incometax and the top marginal tax rate for retained profit continues toexist. (back)
(6) Originally itwas planned that private companies should be able to deduct twice theassessment basis for trade tax from their income tax. But this plan wasgiven up to prevent over-compensation. In addition, private companieswere to be granted the option to be treated like joint stock companiesfor tax purposes. Cf. Bundesministerium der Finanzen (Federal Ministryof Finance) (1999: 14 f.). However, thismeasure, which would be an unjustifiable departure from the taxationsystem, was withdrawn as a result of the further reduction of the topmarginal tax rate to 42 per cent. (back)
(7) Thereafter,income from business activities had a top marginal tax rate of 47 percent, which was lower than the top marginal tax rate for other types ofincome. (back)
(8) For more detail, cf. Karrenberg (2000a: 218 ff.). More recent estimates of the financial effects of the TaxReform 2000 taking the general development of the economy into effectare not yet available. (back)
(9) In 2000 thelocal communities received a total of 94.2 billion DM in such grants.Of this amount, 66.0 billion DM were granted in the old federal statesand 28.2 billion DM in the new federal states. The weak tax income ofthe East German local communities is reflected in a high need for ratesupport grants, which makes up 56.5 per cent of their overall revenue.In West Germany only 27.8 per cent of revenue comes from rate supportgrants. Cf. Deutscher Städtetag (Council of German MunicipalAuthorities) (2001); own calculation. (back)
(10) A furtherproblem in this connection is that the local community share of the taxrevenue also includes revenue which depends on the tax factor. Thecalculation of the share of local government in the tax revenue doesnot include a "uniform tax factor", which means that autonomousdecisions by the local communities are included in the vertical fiscaladjustment although they are in no way relevant. (back)
(11) Extra incomein the first few years due to the lower depreciation potential will beoffset by a decline in income in later periods because of the higherdepreciation which will then apply. (back)
(12) Cf. Karrenberg/Münstermann (2000: 32 ff.). As a result of the significant decline in the economic climatein 2001, the level of investments in plant and equipment is also likelyto be reduced. This is bound to lead to further reductions in incomefor local communities. (back)
(13) They may,however, still be recipients of special rate support grants. These canbe used, for example, to compensate for the costs of administration onbehalf of the national government. (back)
(14) Cf.Wissenschaftlicher Beirat beim Bundesministerium der Finanzen (AcademicAdvisory Council to the Federal Ministry of Finance) (1988: 589). A correct measure consistent with the tax system - especiallywith regard to the (attempted) equivalence - would be the deduction oftrade tax as operating expenditure from the tax base for income tax. (back)
(15) Cf. Krause-Junk (1999: 337). However, this aspect must not be overstressed because the partial allowance is limited to private companies. (back)
(16) Concerning the criticism of the Tax Reform, cf. also Bareis (2000: 602 ff.); Homburg (2001: 8 ff.); Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichenEntwicklung (Council of Economic Experts to Review the General EconomicDevelopment) (2000: No. 319 ff.). (back)
(17) Concerning the local community incidence of such a reform, cf. for example Junkernheinrich (1991) and Strauss (1988). (back)
(18) Thereduction of the financial importance of the trade tax also leads to ahorizontal financial equalisation between local communities because theconsiderable differences in the tax base are weakened (cf. Zimmermann 1999: 184). But this financial equalisation relates to absolute figures; therelative positions of the local communities remain unchanged by theintroduction of the trade tax apportionment. Additional horizontalfinancial equalisation effects arise from the inclusion of the tradetax apportionment in the pool for the local community fiscaladjustment. (back)
(19) The tasks ofthe national government and federal states are governed by theprovisions of articles 70 ff. and 83 ff. of the Constitution. The tasksof local communities are basically derived from article 28 subsection.II of the Constitution and the associated right of local communityself-administration. The distribution of responsibility for revenue andexpenditure is governed by the constitutional financial system. Anoutstanding role is played by 104a subsection 1 of the constitutionwhich expresses the coherence principle and article 106 which providesfor the distribution of taxes. (back)
(20) This isbased on the two-level character of the state prescribed by the GermanConstitution. It is therefore not permissible for direct financiallinks to exist between the national government and the localcommunities, because this would undermine the organisationalsovereignty of the federal states (cf. Henneke 1998: 64). (back)
(21) A possiblealternative could have been to assign the national government a highershare of the turnover tax revenue. The federal states could havecompensated the resulting reduction in income by reducing the volume offunds in the fiscal adjustment. However, this would lead todistribution problems between local communities. Such a measure wouldparticularly affect financially weak communities and communities inwhich income tax plays a major role in comparison with the revenue fromtrade tax. But the latter aspect must be relativised because, with theexception of Bavaria and North Rhine-Westfalia, the local communitieswith a high income tax revenue in all West German federal statesbenefit from the financing of the local community contribution toGerman unity via the increased trade tax apportionment (cf. Münstermann 1999: 165 ff.). (back)
(22) On these problems, cf. for example Mückl (1999: 841 ff.); Kirchhof (1997: 45 ff.); Wimmer (1996: 678 ff.). The example of social welfare benefits clearly shows that anincreased application of the coherence principle would provideconsiderable relief to local communities, at least in the medium term.Cf. Junkernheinrich/Notheis (1996: 52 ff.). (back)
(23) Inprinciple, it is also conceivable to improve the financial situation oflocal communities by strengthening their position in the localcommunity fiscal adjustment. But apart from the difficulty of enforcingsuch a solution - in view of their own poor financial position thefederal states are hardly likely to increase the tax pool in the localcommunity fiscal adjustment - a greater weighting of rate supportgrants as against tax revenue would countermand the goal of greaterautonomy. (back)
(24) A local community can try to increase its income tax revenue indirectly by attracting new residents. (back)
(25) For greater detail cf. Hansmeyer/Zimmermann (1993: 221 ff.); Beland (1998: 104 ff.); Scherf (2000: 34 ff.). By comparison, other forms of alternative local communitytaxes on income, such as a separate local community income tax or asimplified tax for citizens have little chance of being implemented.Cf. Hansmeyer/Zimmermann (1993: 228 f.). (back)
(26) However, thepositive aspects of a local community right to fix the tax factor forincome tax should not blind us to the fact that the introduction ofsuch a system involves considerable difficulties. For example, the TaxReform alone causes considerable extra work for the tax authoritiesbecause of the large number of changes. The additional implementationof a right to fix the tax factor would involve even more extra work,and this could easily exceed the capacity of the tax authorities. Andlocal community representatives can be expected to be extremelysceptical of any right to impose a tax surcharge. (back)
Bareis, Peter (2000), DieSteuerreform 2000 - ein Jahrtausendwerk? (The Tax Reform 2000 - theachievement of the millennium?), in: WirtschaftswissenschaftlichesStudium, vol. 11, p. 602 ff. (back)
Beland, Ulrike (1998),Eine eigene Einkommensteuer für die Gemeinden und das Problem desWanderungswettbewerbs (A proprietary income tax for local communitiesand the problems of relocation competition), in: Archiv fürKommunalwissenschaften, vol. I, p. 104 ff. (back)
Bundesministerium der Finanzen(Federal Ministry of Finance) (2000a), Entwicklung der Kommunalfinanzenin den Ländern 1992 bis 1999 (Development of local community finance inthe federal states 1992 to 1999), Berlin. (back)
Bundesministerium der Finanzen(Federal Ministry of Finance) (2000b), Finanzielle Auswirkungen desGesetzes zur Senkung der Steuersätze und zur Reform derUnternehmensbesteuerung sowie der Entschließung des Bundesrates vom 14.Juli 2000 (Financial effects of the Act on the Reduction of Tax Ratesand the Reform of Company Taxation and the decision of the FederalCouncil of 14th July 2000 - StSenkG),http://www.bundesfinanzministerium.de/infos/auswisteu.pdf (12.11.2000). (back)
Bundesministerium der Finanzen(Federal Ministry of Finance) (2000c), Bundespolitik undKommunalfinanzen (Federal politics and local community finance),Berlin. (back)
Bundesministerium der Finanzen(Federal Ministry of Finance) (1999), Steuerreform 2000. Steuern senken- Wachstum stärken - Arbeitslosigkeit bekämpfen (Tax Reform 2000.Reducing taxes - strengthening growth - fighting unemployment), Berlin. (back)
Bundesvereinigung derkommunalen Spitzenverbände (National association of central localcommunity organisations) (2000), Stellungnahme zum Entwurf einesGesetzes zur Senkung der Steuersätze und zur Reform derUnternehmensbesteuerung (Statement of opinion on the draft of the Acton the Reduction of Tax Rates and the Reform of Company Taxation),Cologne. (back)
Deutsches Institut fürWirtschaftsforschung (DIW) (German Institute for Economic Research)(2000), Unternehmenssteuerreform - Einstieg in die dualeEinkommensteuer? (Company taxation reform - the start of a dual incometax?), in DIW-Wochenbericht, vol. 11, p. 139 ff. (back)
Deutscher Städte- undGemeindebund (German Association of Municipalities) (2001),DStGB-Analyse zu Kommunalfinanzen 2000 (DStGB analysis of localcommunity finance 2000), Berlin (DStGB documentation 19). (back)
Deutscher Städtetag (Council ofGerman Municipal Authorities) (2001), Einnahmen und Ausgaben derGemeinden (GV) in Deutschland 1991 bis 2001, unveröffentlichte Daten(Revenue and expenditure of local communities in Germany 1991 to 2001,unpublished data), Cologne. (back)
Deutscher Städtetag (Council ofGerman Municipal Authorities) (2000), Steuerreform: Bund und Ländersollten nun Entlastung der Städte prüfen (Tax reform: nationalgovernment and federal states should check the relief formunicipalities),http://www.staedtetag.de/php/print.html?/10/Schwerpunkt/artikel/29/index.html(24.08.2000). Bundesgesetzblatt, Teil 1. Gesetz zur Ergänzung desSteuersenkungsgesetzes (StSenkErgG), No. 57, p. 1812 ff. (back)
Gesetz zur Senkung der Steuersätzeund zur Reform der Unternehmensbesteuerung (Act on the Reduction of TaxRates and the Reform of Company Taxation) (StSenkG), Bundesgesetzblatt,Teil 1. No. 46, p. 1433 ff. (back)
Geske, Otto-Erich (1998),Eine neue Finanzverfassung zur Wiederherstellung eines striktenKonnexitätsprinzips? (A new financial constitution to restore a strictcoherence principle?), in: Wirtschaftsdienst, vol. 9, p. 556 ff. (back)
Hansmeyer,Karl-Heinrich/Zimmermann, Horst (1993), Möglichkeiten der Einführungeines Hebesatzrechts beim gemeindlichen Einkommensteueranteil(Possibilities to introduce a right to fix the tax factor in the localcommunity share of income tax), in: Archiv für Kommunalwissenschaften,vol. I/1993, p. 221 ff. (back)
Henneke, Hans-Günter(1998), Die Kommunen in der Finanzverfassung des Bundes und der Länder,Darstellung (The local communities in the financial constitution of thenational government and federal states, presentation), Wiesbaden. (back)
Hidien, Jürgen W. (1999),Erläuterungen zum Gesetz zur Neuordnung der Gemeindefinanzen(Gemeindefinanzreformgesetz) (Explanations of the Reorganisation ofLocal Community Finance Act), Das Deutsche Bundesrecht (German nationallaw), no. 836 (Nov. 1999), p. 9 ff. (back)
Homburg, Stefan (2001),Die Unternehmenssteuerreform 2001 aus Sicht der Wissenschaft (Thecompany tax reform 2001 from an academic point of view), in:Steuerberatung, no. 1, p. 8 ff. (back)
Junkernheinrich,Martin (1991), Reform des Gemeindesteuersystems (Reform of the localcommunity tax system), vol. 1: Analyseergebnisse (Results of analysis),Berlin. (back)
Junkernheinrich,Martin/Notheis, Thomas (1996), Bausteine einer Gemeindefinanzreform:Gewerbesteuer und Sozialhilfe (Elements of a local community financereform: trade tax and social welfare), Halle. (back)
Karrenberg,Hanns (2000a), Das verabschiedete Steuersenkungsgesetz und seineAuswirkungen auf die Kommunalfinanzen (The Tax Reduction Act that hasbeen passed and its effects on local community finance), in:Zeitschrift für Kommunalfinanzen, No. 10, p. 218 ff. (back)
Karrenberg,Hanns (2000b), Neue Steuerschätzungen für 2000 und 2001 (New taxestimates for 2000 and 2001), in: Kommunale Steuerzeitschrift,Zeitschrift für das gesamte Gemeindeabgabewesen, vol. 12, p. 221 ff. (back)
Karrenberg,Hanns/Münstermann, Engelbert (2000), Gemeindefinanzbericht 2000. Städteim Griff von EU, Bund und Ländern (Local community finance report 2000.Towns and cities in the hands of the EU, national government andfederal states), in: der städtetag, vol. 4, p. 4 ff. (back)
Karrenberg,Hanns/Münstermann, Engelbert (1998a), Gemeindefinanzbericht 1998.Städtische Finanzen Ž98 - Im Zeichen des Steuerverfalls (Localcommunity finance report 1998. Municipal financeŽ98 - marked by taxerosion), in: der städtetag, vol. 3, p. 143 ff. (back)
Karrenberg,Hanns/Münstermann, Engelbert (1998b), Kommunale Finanzen (Localcommunity finance), in: Hellmut Wollmann/Roland Roth (ed.),Kommunalpolitik. Politisches Handeln in den Gemeinden (Local communitypolitics. Political action in local communities), Bonn, p. 437 ff. (back)
Kirchhof, Ferdinand(1997), Wer bestellt, bezahlt - das Konnexitätsprinzip zwischen Bund,Ländern und Kommunen (You pay for what you order - the coherenceprinciple between the national government, federal states and localcommunities), in: Deutscher Städtetag (Council of German MunicipalAuthorities) (ed.): Gelebte Demokratie. Festschrift für Manfred Rommel,Stuttgart, p. 45 ff. (back)
Kuhn, Thomas (1997), Derkommunale Finanzausgleich - Argumente für eine Reform (The communalfiscal adjustment - arguments for a reform), in: Archiv fürKommunalwissenschaften, vol. I/1997, p. 211 ff. (back)
Krause-Junk, Gerold(1999), Zwischen Dividendenfreistellung und klassischem System:Halbheit als Steuerprinzip, in: Wirtschaftsdienst, vol. VI, p. 335 ff. (back)
Mückl, Stefan (1999),Kommunale Selbstverwaltung und aufgabengerechte Finanzausstattung(Communal self-administration and appropriate finance for the task),in: Die Öffentliche Verwaltung, vol. 20, p. 841 ff. (back)
Münstermann,Engelbert (1999), Räumliche Verteilung der kommunalenFinanzierungsbeiträge zur deutschen Einheit (Spatial distribution oflocal community finance contributions to German unity), in: Akademiefür Raumforschung und Landesplanung (Academy for regional research andfederal state planning) (ed.), Fiskalische Krise: Räumliche Ausprägung,Wirkungen und Reaktionen (Fiscal crisis: spatial characteristics,effects and reactions), p. 155 ff. (research and meeting report 209). (back)
Peffekoven, Rolf(2000), Nach wie vor: Konzeptionelle Unterschiede bei den Plänen füreine Steuerreform (Still there: conceptual differences in the plans fora tax reform), in: Wirtschaftsdienst, vol. II, p. 80 ff. (back)
Peffekoven, Rolf(1980), Finanzausgleich I: Wirtschaftstheoretische Grundlagen (Fiscaladjustment I: the basis in economic theory), in: Willi Albers et al(ed.), Handwörterbuch der Wirtschaftswissenschaften (Dictionary ofeconomics), vol. 2, Stuttgart et al., p. 608 ff. (back)
Roland, Frank (2000),Gewerbesteuer - Ein Problem bei der Reform der Unternehmensbesteuerung(Trade tax - a problem in the reform of company taxation), in:Wirtschaftsdienst, vol. II, p. 90 ff. (back)
Rosen, Rüdiger von (1999),Reform der Dividendenbesteuerung und ihre Folgen für die Aktienkultur(Reform of dividend taxation and its consequences for share culture),in: Wirtschaftsdienst, vol. XI, p. 653 ff. (back)
Scherf, Wolfgang (2000),Perspektiven der kommunalen Besteuerung (Prospects for local communitytaxation), manuscript for the 43rd conference of the Finance TheoryCommittee of the Verein für Socialpolitik (Social policy association),Giessen, http://www.uni-giessen.de/VWL-II/ download/sem/01/Konstanz.PDF(07.03.2001). (back)
Sachverständigenrat zurBegutachtung der gesamtwirtschaftlichen Entwicklung (Council ofEconomic Experts to Review the General Economic Development) (2000),annual report 2000/2001, Berlin. (back)
Sachverständigenrat zurBegutachtung der gesamtwirtschaftlichen Entwicklung (Council ofEconomic Experts to Review the General Economic Development) (1997),annual report 1997/98, Berlin. (back)
Strauß, Wolfgang (1988),Ökonomische Wirkungen einer Substitution der Gewerbesteuer(Realsteuern) durch die Wertschöpfungsteuer (Economic effects of asubstitution of the trade tax (real taxes) by a tax on value added),Frankfurt/Main. (back)
Wimmer, Raimund (1996),Wieviel Geld schulden die Länder den Kommunen? Zur Höhe derFinanzausgleichssätze in den Länderhaushalten (How much money do thefederal states owe the local communities? The fiscal adjustment ratesin the federal state budgets), in: der städtetag , vol. 10, p. 678 ff. (back)
Wissenschaftlicher Beiratbeim Bundesministerium der Finanzen (Academic Advisory Council to theFederal Ministry of Finance) (1988), Stellungnahme zuAbsichtserklärungen über eine Steuerreform in der Wahlperiode desDeutschen Bundestages vom 14.02.1987 (Statement of opinion on lettersof intent of a tax reform in the electoral period of the Germanparliament of 14.02.1987), in: Bundesministerium der Finanzen (FederalMinistry of Finance) (ed.), Der Wissenschaftliche Beirat beimBundesministerium der Finanzen, Gutachten und Stellungnahmen 1974-1987(The Academic Advisory Council to the Federal Ministry of Finance,expertises and statements of opinion 1974-1987), Tübingen. (back)
WissenschaftlicherBeirat beim Bundesministerium der Finanzen (Academic Advisory Councilto the Federal Ministry of Finance) (1988), Gutachten zur Reform derGemeindesteuern (Statement of opinion on the reform of local communitytax), Schriftenreihe des Bundesministeriums der Finanzen (publicationof the Federal Ministry of Finance), vol. 31, Bonn. (back)
Zimmermann, Horst(1999), Kommunalfinanzen. Eine Einführung in diefinanzwissenschaftliche Analyse der kommunalen Finanzwirtschaft (Localcommunity finance. An introduction to the financial analysis of localcommunity finance), Baden-Baden. (back)
Zimmermann,Horst/Postlep, Rolf-Dieter (1980), Beurteilungsmaßstäbe fürGemeindesteuern (Criteria for assessing local community taxes), in:Wirtschaftsdienst, vol. V, p. 248 ff. (back)
Quelle: The Effects of the Tax Reform 2000 in Germany on Local Communities, German Journal of Urban Studies, Vol. 40-2001, No. 1.