ZEW President Wolfgang Franz on the Design of a Corporation Tax Reform – Tax Reform


Germany is still one of the highest taxed countries when it comes to corporation tax. This has been confirmed by international comparisons conducted by ZEW and the German Council of Economic Experts. As a result, Germany is becoming less and less attractive as a business location.

In addition to this tax disadvantage – which would in itself be a serious problem – Germany is suffering from another deficit: the lack of neutral decision-making in our corporate tax system. In many cases, firms do not base their decisions regarding, for instance, their legal form or investment financing schemes, solely on the overall economic impact, but to a considerable extent on tax implications. The distortions as well as the production and welfare losses associated with these considerations should not be underestimated. With regard to the corporate tax system, recent findings have shown that the amount of tax paid on each additional euro generates welfare losses of 49 cents for taxpayers that could, in principle, be avoided.

Recognising the urgent need for action, the German government has announced plans to implement corporate tax reforms. There are two different concepts to reform the corporate tax system. The first involves a model of the “dual income tax”, developed in detail by the Council of Economic Experts (SVR) in collaboration with ZEW and the Max-Planck Institute for Intellectual Property, Competition and Tax Law (MPI). An alternative proposal has been put forward by the “Tax Code” Commission at the German think tank Stiftung Marktwirtschaft (Market Economy Foundation), which constitutes, in essence, another dual taxation system. The difference between the two proposals is that the latter distinguishes between taxes for businesses and entrepreneurs, whereas the model of SVR, ZEW and MPI differentiates between capital and earned income. While both concepts are worthy of discussion, the proposal presented by SVR, ZEW and MPI offers several advantages.

The concept developed by SVT, ZEW and MPI deliberately targets the aforementioned shortcomings whilst placing particular emphasis on Germany’s attractiveness as a business location and neutral decision-making. Furthermore, this approach also aims to meet two important additional conditions: First, discrepancies in the transposition of the existing tax law should be kept to a minimum, which is why the dualistic system, which taxes corporations according to the corporate tax rate and partnerships according to the income tax rate, is retained in this proposal. Second, the implementation of the dual income tax system should not put partnerships in a worse position than they are under the applicable income tax law.

The dual income tax scheme aims to increase Germany’s attractiveness as a business location and ensure neutral decision-making through a system that involves a reduced tax rate of 25 per cent for capital incomes, while earned incomes are subject to a linear progressive tax rate. Profits generated by corporations are taxed according to a profit tax of 25 per cent; for shareholders, a maximum tax rate of 25 per cent is levied upon dividends if the standardised equity yield rate exceeds, for instance, a level of 6 per cent. Altogether, this results in an overall tax burden of 43.75 per cent (= 25 + 75 x 0.25), which corresponds to the current top marginal income tax rate of 44.31 per cent (including the solidarity surcharge). Profits earned by partnerships are in principle subject to the current income tax rate, whereas returns on equity are also taxed according to a proportional rate of 25 per cent. Furthermore, the trade tax could be replaced by communal supplementary taxes.

The dual income tax system does not only improve Germany’s attractiveness as a business location but also generates welfare gains by eliminating distortions. In this way, the dual system particularly benefits workers and plays a key role with regard to job creation.