How can we improve our tax system?

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The situation of the federal, state, local and social security budgets has steadily deteriorated since the mid-1990s. The public finances are currently in an extremely serious position. The current expenses are in some cases dramatically higher than the regularly flowing income. The resulting need for consolidation is enormous and cannot be managed in the short term.

Germany needs a national effort at all levels in order to increase overall economic growth and to eliminate the structural underfunding of public budgets through joint consolidation efforts and structural reforms. Every postponement of the necessary budget restructuring only increases the need for consolidation. Securing the sustainability and quality of public finances is a central challenge for financial and budget policy, not least against the background of intergenerational equity.

Budgetary policy cannot act in isolation from macroeconomic developments. Experience in other countries has shown, however, that thorough budget consolidation helps to set the course for growth again, because it promotes the confidence of investors and consumers in the continuity of future tax, financial and budgetary policies.

1. Sustainable budget consolidation

1.1 Initial situation

The general government deficit in 2005 was 4% of gross domestic product. The structural gap between current expenditure and current income in the federal budget requires an annual consolidation of 35 billion euros in order to comply with Article 115 of the Basic Law and the deficit criterion of the European Stability and Growth Pact.

The situation is serious and the pressure to consolidate is high if we want to hand over sustainable public finances to the next generation. For decades, the illusion has been fomented that the state can always satisfy new and more comprehensive performance requirements. The dynamism of tasks and expenditure has set a debt spiral in motion that must be broken. That is why we are making a structural fresh start in budget and financial policy.

1.2 Consolidation Targets

In view of the dramatic initial situation - despite courageous consolidation steps - it will not be possible in the next year to comply with the normal limit of Article 115 of the Basic Law or the Maastricht criteria without jeopardizing the economic recovery at the same time. From 2007 we will achieve the following goals:

  • The debt limit of Art. 115 GG is again undercut again in budget implementation.
  • The rules of the European Stability and Growth Pact are adhered to, and the resulting consolidation consequences for public finances are respected. Firstly, this means compliance with the 3 percent deficit limit of the Pact by 2007 at the latest. Secondly, we will continue the consolidation in the following years and also expect medium-term efforts from the federal states, municipalities and social security funds with the aim of a balanced national budget.
  • The federal government, the federal states and the municipalities have the duty to jointly contribute to the re-compliance of the European Stability and Growth Pact in the sense of a joint responsibility for the escalating national debt. We will agree the necessary savings and consolidation efforts for each level within the framework of a nationwide pact with the federal states.

1.3 Consolidation principles

In order to achieve the desired goals, we are assuming the following consolidation principles for the entire legislative period:

  • Our budget policy will consistently be economical. Therefore we will not be able to continue everything as usual. All issues are put to the test. All new financially effective projects and burdens on income and expenditure are checked for their necessity and financial feasibility and, in principle, balanced out by setting new priorities in the respective policy area. All measures of this coalition agreement are subject to financing.
  • The principle applies that cautious revenue and expenditure planning for the federal budget and the other public coffers, including social security, is carried out on the basis of cautiously estimated macroeconomic benchmarks.
  • During budget consolidation, all potential savings on the expenditure side are checked first. Further steps will be taken to improve income through the elimination of tax structuring options, the reduction of tax breaks and, if necessary, an increase in taxes.

1.4 Consolidation Measures

The promotion of economic growth and the consistent consolidation of public budgets go hand in hand. The weak growth in recent years in particular has made it clear which financial problems low macroeconomic growth rates bring with them for public budgets and social security systems. Conversely, strengthening growth and reducing unemployment make a major contribution to reducing national debt and putting the social security systems on a financially secure footing.

  • To strengthen innovation, investment, growth and employment as well as to strengthen consumer confidence, we will provide concrete impulses in five central areas with a total volume of around 25 billion euros for the legislative period. About half of the additional expenditure will be financed by a future fund, which will be fed from the mobilization of federally owned assets. In addition, we will permanently reduce the additional wage costs below 40% in order to promote employment. To do this, we will reduce the unemployment insurance contribution by two percentage points.
  • We will support particularly promising areas such as biotechnology and genetic engineering, information and communication technology, nanotechnology and microsystem technology, optical technologies, energy technology, environmental and space technology with an additional total volume of 6 billion euros. With the Excellence Initiative to strengthen university research and the Pact for Research and Innovation, we are strengthening German research in international competition. Research and development spending is expected to rise to at least 3% of gross domestic product by 2010. This requires considerable efforts on the part of the federal, state and business communities.
  • On the way to a fundamental corporate tax reform, we will improve the depreciation conditions for a limited time until December 31, 2007 in line with the status before the year 2000 in order to quickly revive investment activity. In cooperation with other actors, we will give important impulses for construction and trade with a considerable increase in the CO2 building renovation program and at the same time contribute to improving the climate. We will also continue the investment allowance in the new federal states. It is focused on growth-relevant and job-creating investments. Actual taxation will continue in the new federal states beyond 2006. In the old federal states, the turnover limit for actual taxation will be doubled from EUR 125,000 to EUR 250,000 from 2006. The measures to stimulate the economy have a total volume of 6.5 billion euros.
  • Transport investments will be increased significantly and maintained at a high level. The volume will rise by EUR 4.3 billion in the coming legislative period. This makes it possible to improve the performance of the transport network, to continue to expand it in line with demand and to make it future-proof. In this way, a basis is created so that Germany can sustainably secure and expand its position as one of the leading industrial nations.
  • Germany needs more children. The well-being of the families, their children and the goal that more people fulfill their wishes for children is therefore the most important social concern of the coming years. For this reason, from 2007 onwards we will create an income-related benefit for parents of newborn children with the parental allowance, which will support them with a total volume of 3 billion euros. For one year, one parent receives 67% of the last net income up to 1,800 euros per month. The needs of low-income parents are taken into account through a minimum benefit that ensures social equilibrium. In conjunction with the expansion of childcare, the parental allowance will enable the parents to fulfill their children's wishes and thus make an important contribution to solving the pressing societal, economic and social problems.
  • The private household is increasingly becoming an important field for new employment opportunities. That is why we will be promoting household-related services, private expenses for maintenance and modernization measures in the household and childcare costs with a total volume of 5 billion euros more than before. This increases the incentives to create jobs that are subject to social insurance contributions. Not only families, but also trades and service providers will benefit in a special way from these two measures.

The state will not be able to provide everything that is desirable in the future. The individual grows greater personal responsibility. We will shape this transition with a social sense of proportion. We need a fresh start in budgetary policy that strengthens the confidence of business and citizens and thus promotes economic growth.

The necessary consolidation volume of 35 billion euros by 2007 will essentially be ensured by a budget accompanying law. The Budget Accompanying Act will be launched parallel to the budget deliberations on the 2006 federal budget. The aim is also to relieve state and municipal budgets where they are burdened by federal regulations (e.g. standards, bureaucratisation, etc.).

Federal spending is largely determined by major legal obligations. Therefore, the consolidation must be based on expenditure and income. We set the following priorities:

  • The public administration makes its possible solidarity contribution. The total expenditure of 15 billion euros will be reduced by 1 billion euros annually.
  • Targeted savings on individual subsidy items are overdue, growing from around 1 billion euros in 2007 to around 1.4 billion euros in 2009. Corrections are pending for the regionalization funds, the joint task "regional economic development" and in the field of agriculture.
  • We stand by the merging of unemployment benefits and social assistance for those able to work as well as the principle of promoting and demanding. The basic security for job seekers, however, requires corrections. Their expenses got out of hand this year. We will adapt the service structure and thus save around 3 billion euros in 2006 and around 4 billion euros in each of the following years.
  • The allocations from the federal budget to the statutory health insurance will gradually be reduced to zero. Allocations to the Federal Employment Agency are not planned. The dynamics of allocations from the federal budget to the statutory pension insurance will be stopped.
  • By reducing tax breaks, we are simplifying tax law and broadening the tax base. In 2007 this will result in relief for the federal government in the order of 4 billion euros, which will continue to grow in the following years.
  • In order to give the beginning upswing time to develop, the VAT rate will not rise until 2007 by three percentage points to 19%. Of this, the federal government is entitled to one percentage point to reduce additional wage costs. The reduced VAT rate of 7% remains unchanged to maintain social balance.
  • The CDU, CSU and SPD agree that, as part of the necessary consolidation efforts, there should be an increase in private income tax for particularly high incomes (over 250,000 / 500,000 euros) from 1.1.2007. This increases the tax rate to 45% for income above this level.

After the corporate tax reform came into effect on January 1, 2008, this surcharge only affects non-commercial income.

For the period from January 1, 2007 until then, commercial income is excluded from this regulation by means of a transitional law in the current tax law.

We will measure the success of the consolidation process by the sustainability of public finances, not least against the background of intergenerational equity. An essential task of politics in this context is to inform the public comprehensively about the future burdens caused by the aging of society and at the same time to point out political solutions. The Federal Ministry of Finance is therefore requested to submit a "report on the sustainability of public finances" also in the next legislative period.

2. Future-oriented reforms in tax law

The federal government is continuing its reforms of tax law with the aim of simplifying German tax law and making it internationally competitive. In view of the international competitive pressure, the reform of corporate tax law has priority. Only with further development of corporate taxation will we secure the tax base in Germany, set investment incentives and thus create new jobs and stimulate economic growth as a whole. In addition, it is important to thoroughly modernize German tax law, to stabilize municipal finances and to step up action against tax abuse. In view of the existing pressure to consolidate in all public budgets, it will hardly be possible to achieve net relief.

2.1 Reform of corporate taxation

Germany must also be able to hold its own in international tax competition in the future. That is why we will fundamentally develop corporate tax law in this legislative period on January 1, 2008 and implement internationally competitive tax rates. In addition to corporations, this reform must also include partnerships, since more than 80% of German companies are organized in this legal form. In doing so, we will be guided in particular by the following objectives:

  • Improvement of international competitiveness and suitability for Europe,
  • extensive legal form and financing neutrality, restriction of design options,
  • Improving planning security for companies and public budgets,
  • sustainable securing of the German tax base.

We will make a fundamental decision between synthetic and dual income taxation. In this legislative period, we will implement a new regulation for the taxation of investment income and private capital gains.

The determination of taxable profits will also be an essential element of a fundamental corporate tax reform. We will actively help shape the work at EU level to create a uniform consolidated tax base in order to develop modern and competitive accounting tax law. At the European level, we will demand stronger rules against unfair tax competition.

In order to promote small and medium-sized companies, we will extend the regulation of taxation based on income received (actual taxation) in the new federal states beyond 2006 and double the turnover limit in the old federal states in 2006.

On the way to a fundamental corporate tax reform, we will improve the depreciation conditions for a limited time until December 31, 2007. This is intended to stop the tax base from migrating in the short term and provide incentives for new, particularly promising, technology-intensive investments that stimulate economic growth.

2.2 Solid basis for municipal finances

Local finances must continue to be on a solid footing in the future.

The further development of the trade tax is to be decided in the temporal and factual connection with the further development of the corporate taxation. Our goal is economic power-related municipal corporate taxation with tax assessment law, which is administratively manageable, ensures a steady revenue for the municipalities as a whole, maintains inter-municipal fairness and does not provide for any postponement of financing at the expense of employees. We will only reimburse the trade tax if we have sufficiently precise knowledge of the distribution consequences for an alternative.

The property tax will be reorganized on the basis of the preparatory work by Bavaria and Rhineland-Palatinate with the aim of simplification.

2.3 Income tax reform - tax simplification priority

Taxation based on economic capacity remains the dominant principle in German income tax law. It ensures equal and fair taxation of all citizens. We are therefore sticking to the linear, progressive income tax rate.

We agree to simplify income tax law in order to achieve greater transparency, efficiency and fairness. With tax simplification, we are making a contribution to making tax enforcement noticeably easier for citizens, companies and administrations. Therefore, starting January 1, 2006, we will reduce the number of exceptions and modernize the taxation procedure and reduce bureaucracy through typifications and flat rates.Against the background of increasing personal responsibility of the citizens, we strive to make the donation law simpler, clearer and more practicable. These measures must be implemented in a socially balanced way.

The tax exemption for Sunday, public holiday and night surcharges is retained. The social security exemption of the supplements is limited to a basic hourly wage of up to 25 euros.

In order to promote growth and employment, we aim to promote household-related services, private expenses for maintenance and modernization measures in the household and childcare costs more than before. We will limit the deduction to labor costs, thereby ensuring that the regulation serves to promote labor-intensive services and combat illegal work even more precisely.

Existing tax sources must be better exploited and taxation rights must be resolutely enforced. Together with the federal states, we will strive for more effective and efficient tax enforcement with the aim of further optimizing enforcement processes in the interest of cost and resource-saving exhaustion of the existing tax sources.

In Europe, we will work to ensure that existing loopholes in the recording of investment income are closed in taxation under the EU Savings Directive.

The federal government will implement a systematic expansion of electronic data transmission and data processing with the federal states in order to reduce tax declaration and tax assessment costs. In the case of employees, filing a tax return should be completely superfluous (pre-filled tax return).

In addition to the structural reform of corporate taxation planned for 2008, we are striving to reformulate income tax law.

In order to distribute the wage tax burden fairly between the spouses and, in particular, to reduce disadvantages for women when they (re-) take up employment, we will better align the tax system with greater flexibility in labor force participation. Instead of the previous tax brackets, we will introduce a share system with which each spouse will in future pay as much wage tax as it corresponds to his share of the joint gross wage. In addition to its family and gender equality policy objectives, the pro rata procedure also brings about a considerable simplification of taxes for married employees, for whom the previous choice of tax class is no longer applicable. It fits into the new electronic wage tax procedure. Mandatory assessments can be waived in the future. Taxes will be collected earlier than before. Liquidity advantages result in a positive effect on the budget in terms of tax revenue.

2.4 Home Ownership Allowance

The home ownership allowance will be abolished on January 1, 2006. Home ownership enjoys a particularly high level of acceptance among citizens in the context of private retirement provision. As a result, we will be better integrating owner-occupied residential property into our subsidized old-age provision from January 1, 2007. Discrimination against other forms of old-age provision will be eliminated in the interests of real freedom of choice for citizens.

2.5 Inheritance tax

Every year there is a generation change for a large number of companies. Against this background, we will reform the inheritance tax by January 1, 2007 at the latest, taking into account the expected ruling by the Federal Constitutional Court.

For each year of going concern, the inheritance tax liability payable to the transferred company is to be reduced in order to preserve jobs. It does not apply at all if the company is continued for at least ten years after the handover.

2.6 Promotion of the German film industry

We want to improve the framework conditions for the German film industry in order to ensure its international competitiveness. By July 1, 2006 at the latest, we will create internationally competitive conditions and incentives comparable to those in other EU countries in order to improve private capital for film productions in Germany.

2.7 Combating VAT fraud

We will intensify the fight against sales tax fraud. In order to get to the root of the problem, all administrative possibilities must be exhausted. In doing so, we will also make use of the possibilities assigned to the federal government within the framework of the Federalism Commission to coordinate the audit services and combat tax crime. In addition, we will examine the extent to which the responsible prosecuting authorities need to be provided with further instruments in order to be able to detect sales tax fraud more effectively. It is necessary to replace the current system with input tax deduction for transactions between companies by the "reverse charge model" in order to prevent nationally and internationally organized tax fraud and to reduce the loss of tax substrate in the event of company insolvencies. At the European level, we want to work towards creating the legal prerequisites for this system change.

2.8 Tax Policy in Europe

In the short term, we will review and adapt the norms that are dubious under European law in order to avoid legal uncertainties for Germany as a business location. We will actively participate in the development of cross-border effective joint tax solutions in the member states of the European Union as well as in the OECD. We will therefore continue our intensive cooperation with the Commission and the other Member States of the Union. In doing so, we will particularly value fair competition and compliance with fair tax practices.

Due to the increasing importance of the European Court of Justice in tax matters, we will, where necessary, defend the norms of German tax law in order to preserve the principles of international tax law that have been achieved so far and thus to avoid serious financial effects on our national budgets.

2.9 Energy taxes

As a state centrally located in the European internal market, Germany has an outstanding interest in promoting the harmonization of energy taxation in the EU. We will work towards simple and transparent regulations. In view of the high energy prices, it is important not to impair the international competitiveness of the energy-intensive economy.

3. Financial market policy

One of the most important prerequisites for economic and employment growth is an internationally competitive "financial center Germany". It is the basis for efficient financial services for consumers and a good and inexpensive supply of capital to the economy. The German financial market has great potential, which is to be further expanded in the coming legislative period, taking into account the constant development of the global financial markets. For this we want:

  • Further improve the financing conditions for small and medium-sized enterprises. To this end, the promotion of SMEs must be further developed. For many medium-sized companies, the need has increased to structure their financing closer to the capital market. We want to promote awareness and the spread of such alternatives to traditional bank loans. We are also examining the establishment of a "German Mittelstandsfonds".
  • Promote the integration of the European single financial market for the benefit of all market participants, consumers and businesses. Before every new legislative measure, a cost-benefit analysis must be carried out to determine whether the new measure can create added value or whether the market can better regulate it itself or subsidiarity can take effect. The national implementation of guidelines is one-to-one, national leeway is used in the interests of competitiveness. This principle also applies to the implementation of the new European equity standards (Basel 2). For consumers, the better integration of retail markets and payment transactions is of the utmost importance; We want to actively promote both within the European framework.
  • Product innovations and new distribution channels must be emphatically supported. To do this, we want to create the framework for new asset classes in Germany. These include:
    • The introduction of real estate investment trusts (Reits) on the condition that reliable taxation is ensured for the investor and positive effects on the real estate market and location conditions can be expected,

    • the expansion of the securitization market, - the expansion of investment and investment opportunities for public-private partnerships,

    • the revision of the regulations for the area of ​​private equity by way of the further development of the existing corporate participation law into a private equity law.

  • A financial market supervisory authority that, while maintaining the primary goal of financial market stability, applies the existing supervisory standards with a sense of proportion and in the same way as in the other member states of the European Union. In the light of experience since the creation of the BAFin as an all-round financial supervisor, the results must be assessed and, if necessary, work processes and organization adjusted. The legal and technical supervision of the Federal Ministry of Finance over the BAFin is to be strengthened. The exchange supervision is to be reformed in agreement with the federal states in favor of uniform supervision. The integration of the national financial supervisory authorities within the European single market must be driven forward, taking into account national market structures. At the international level, the Federal Government will advocate adequate supervision and transparency of hedge funds.
  • Eliminate superfluous regulations. To this end, we will set up an inter-ministerial working group which, in dialogue with market participants, is to present a "possibility paper" on reducing bureaucracy in the financial sector. Existing laws, ordinances and other regulations must be checked to see whether they can achieve their goal cost-effectively or whether they are still necessary. The upcoming amendment to the Investment Act is a good start-up project.
  • Investor protection is to be designed appropriately based on the model of the responsible citizen.
  • We want to apply the existing corporate governance rules and adapt them to new requirements in the light of international developments. Both institutional and private investors are very interested in the principles according to which companies are organized and managed, especially in terms of comparability. The transparency of the ownership structure of listed companies is to be improved. The modernization of accounting law and the mutual recognition of German, European and American accounting regulations are urgent measures to strengthen Germany's financial center.