The Economic Effects of a Wealth Tax in Germany PDF

FORUM Clemens Fuest, Florian Neumeier, Data from the German Panel on Household Finances Michael Stimmelmayr and...

FORUM Clemens Fuest, Florian Neumeier, Data from the German Panel on Household Finances Michael Stimmelmayr and (PHF) – a survey based on 3,500 households that was Daniel Stöhlker conducted in 2014 – provided by the German Bundes- bank offer a snapshot of wealth distribution in Ger- The Economic Effects of many. We summarise several types of wealth that a Wealth Tax in Germany would probably be subject to a wealth tax, including cash, equity, firm and government bonds, real estate holdings and tangible assets such as yachts and art col- lections, before subtracting the stock of debt in order to obtain a figure for current net household wealth – the relevant tax base for a wealth tax. Average and total net In recent years, the calls for a (re-)introduction of a wealth for each net-wealth-decile is depicted in Figure wealth tax in Germany have become louder for at least 1. A mere glance at the Figure suggests that private two reasons.1 Firstly, the proponents of a wealth tax wealth is highly unequally distributed, with the wealth- emphasise that the share of public revenues from iest individuals holding a significantly larger amount on wealth-related taxes collected in Germany is far below average than less wealthy households. For example, the OECD average and that a net wealth tax could cre- the wealthiest 10% of households hold an average 1.4 ate additional fiscal leeway. Secondly, wealth taxes are million euros of net-wealth, which is 27 times more than often claimed to be an effective instrument for foster- the median household. The share of aggregate wealth Clemens Fuest ing equity within societies. Lately, this view has received in Germany held by the wealthiest decile accounts for ifo Institute, CESifo, prominent support from French economist Thomas over 60% of total net private wealth. By contrast, the Ludwig-Maximilians- University Munich. Piketty, who has turned out to be a fierce opponent to least wealthy 10% in Germany tend to have a negative abolishing the wealth tax in France. stock of wealth, i.e. their debts exceed their assets. In the context of a recent policy report prepared on The distribution of wealth in Germany is often behalf of the German Federal Ministry for Economic shown to be relatively unequal compared to interna- Affairs and Energy (BMWi), we assess the economic and tional standards, judging from various measures such fiscal consequences of the introduction of a wealth tax as the Gini-coefficient and ratios of different wealth in Germany. This study represents a shortened version deciles (Pham-Dao 2016). Important motives for accu- of that report. Special emphasis is placed on the short mulating wealth are to provide for old age, i.e. stabilise and long-term impact of a wealth tax on important consumption levels after retiring, and to insure against macroeconomic aggregates, such as Gross Domestic several types of unforeseeable life risks, e.g., the loss of Florian Neumeier Product (GDP), private investment, employment as well employment. Based on cross-country data from the ifo Institute. as several other key economic variables. Moreover, we Household Finance and Consumption Survey (HFCS), also estimate the expected revenues from a wealth tax, Fessler and Schürz (2015) show that more generous as well as the effect a wealth tax would have on reve- welfare states are generally characterised by higher nues from other taxes, especially the consumption and wealth accumulation by those individuals with only income tax. Our computations are based on a dynamic limited or no access to social transfer systems and pen- computable general equilibrium (CGE) model that sion claims. For example, the social insurance scheme depicts the German economy and tax system in detail. in Germany is mostly tailored to ‘regularly’ employed In the course of our analysis, we compare the economic workers, while self-employed individuals mostly need and fiscal effects of different wealth tax concepts and to provide for risks and retirement on their own. Figure wealth tax rates. 2 shows that the difference in the average wealth hold- Michael Stimmelmayr ings of self-employed and non-self-employed individu- ETH Zurich, CESifo. DISTRIBUTION OF PRIVATE WEALTH IN GERMANY als increases with age before peaking at the usual retirement age of 65. Despite being only poorly documented empirically, the An assessment of the extent of inequality, espe- distribution of wealth and income in Germany and its cially as part of a cross-country comparison, without development has taken centre stage in the discussions properly accounting for country-specific rules for over wealth taxation. The argument has been triggered accessing social security schemes provides an incom- by recent studies from the International Monetary Fund plete picture only and is likely to overstate the inequal- (IMF) (Ostry et al. 2014) as well as the Organisation for ity that actually exists. Economic Co-operation and Development (OECD) (Cin- gano 2014) who claim to have found a negative link MODELLING A WEALTH TAX: THE CGE MODEL Daniel Stöhlker between economic inequality and economic growth ifo Institute. – a result that we show to be flawed for advanced The economic effects of a tax reform are very complex economies. and include more obvious first-order effects, but also less obvious second-order and feedback effects that 1 In Germany, a wealth tax was in effect until 1996 when the federal consti- tutional court declared it to be unconstitutional because of the differences in can be substantial in size. Computable general equilib- the valuation practices of real estate property compared to other assets. rium (CGE) models have proven to be a useful instru- 22 ifo DICE Report 2 / 2018 June Volume 16  FORUM Figure 1 the optimal inter-temporal Distribution of Net Wealth in Germany consumption and savings paths and optimal labour sup- Euros Total wealth Average wealth ply in the presence of various 6,000,000 tax distortions. With regard 5,000,000 to the savings decision, the household faces a portfolio 4,000,000 choice problem. There are 3,000,000 six different types of assets the household can invest 2,000,000 in, grouped into three asset 1,000,000 classes, namely firm equity/ bonds, government bonds, 0 as well as real estate hold- -1,000,000 ings. In the applied model, the 1 2 3 4 5 6 7 8 9 10 wealth tax is levied on these Wealth decile six assets. While the different Source: Bundesbank, 2nd wave of PHD data (2014). © ifo Institute assets within each class are perfect substitutes, the differ- Figure 2 ent asset classes themselves Comparison of Wealth Holdings among Self-Employed and Non-Self-Employed are imperfect substitutes, Workers reflecting, for example, differ- Self-employed Non-self-employed ences in default probabilities. Euros 1,750,000 The model also features a gov- ernment and a foreign sector 1,500,000 allowing for links between 1,250,000 the domestic economy and the rest of the world. The gov- 1,000,000 ernment consumes, imposes 750,000 taxes and collects tax reve- nues and pays transfers to 500,000 the household sector in a 250,000 lump-sum fashion. The gov- ernment’s budget is required 0 to be balanced. Like the 16-25 26-35 36-45 46-55 56-65 66-75 > 76 Age group domestic economy, the for- Source: Bundesbank, 2nd wave of PHD data (2014). © ifo Institute eign economy also comprises a representative firm, a re- presentative household and ment to simulate the consequences of counterfactual a government sector. The two economies engage in tax reforms. CGE models make it possible to quantify trade with each other and the model allows for cross- the economic and fiscal effects of tax reforms taking country ownership of the different types of assets. behavioural responses as well as the interactions and Overall, the CGE model represents a dynamic, interdependencies between economic agents and sec- micro-based two-country macroeconomic model, tors into account. Figure 3 illustrates the most impor- where the foreign economy is relatively large compared tant building blocks of the CGE model used in our anal- to the domestic economy. The dynamic nature of the ysis, which is based on Radulescu and Stimmelmayr model makes it possible to study the adjustment pro- (2010). cess from the initial to the final steady state equilib- The CGE model builds on neoclassical growth the- rium. This is particularly important since investment ory and incorporates several tax sensitive behavioural and savings decisions are, by nature, forward-looking. margins on the firm and household level. In detail, the It is worth noting that the introduction of a wealth tax model incorporates firms with different legal forms, is effectively equivalent to an increase in the tax rate on i.e., corporate and non-corporate firms, which differ the return of those assets that are subject to the wealth with regard to their economic characteristics and their tax. If we assume that the (average) return on those legal tax treatment. Each firm faces an inter-temporal assets is 4%, then a wealth tax rate of 1% is equivalent investment problem, an optimal financing problem of to an increase in the tax rate on asset returns of 25 per- investments and a labour input problem. centage points. Thus we can expect even seemingly The household is modelled by a representative small wealth tax rates to have a significant economic agent who maximises her life-time utility by choosing impact. ifo DICE Report 2 / 2018 June Volume 16 23  FORUM Figure 3 Stylized Depiction of the CGE-Model Interest rates Consumption Government Taxes Consumption, Transfers, interest rates Taxes issueing of government bonds Taxes Firms Households Corporate firms, non- Wages, dividends, interest rates Utility maximization by opti- Real corporate firms, foreign mal choice of consumption, Estate direct investments Consumption labour supply and portfolio Profit maximization by composition optimal choice of investments, labour demand and financing Imports Interest Rents and rates leasings Interest rates Rest of the World Firm sector, government Exports and household Source: Authors’ illustration. © ifo Institute THE ECONOMIC EFFECTS OF A WEALTH TAX isation of a variable when accounting for the IN GERMANY introduction of a wealth tax and a reference value that is computed based on the assumption the status quo is We consider three different scenarios to study the con- maintained. Furthermore, the figures refer to the long- sequences of different wealth tax concepts and to test run effects of a wealth tax after economic agents have the sensitivity of the estimated effects with regard to fully adjusted to the new situation. In this respect, we different tax rates. In the baseline scenario, we model a assume that without the introduction of a wealth tax, comprehensive wealth tax with a uniform tax rate on all potential GDP in Germany would grow at an annual rate assets. In the policy scenario, we assume that the tax of 1.25% (Bundesbank 2012). The estimates set out in burden on corporate equity is lower than for the other Table 1 make clear that the introduction of a wealth tax assets. This scenario better reflects the actual propos- – no matter what form it takes – would have a noticea- als made by some German political parties. Most of ble adverse effect on economic activity in Germany. In these proposals foresee lower taxes on corporate the case of a comprehensive wealth tax with a uniform assets to protect jobs. In the CGE model, we account for tax rate on all assets (baseline scenario), long-run GDP the lower tax burden on firm equity by applying a lower is expected to be roughly 5% lower than without a wealth tax rate. In a third scenario, we move from a syn- wealth tax. Assuming that half of the adjustment pro- thetic to what we call a dual wealth tax and let the tax cess is completed after eight years (Cummins et al. rate vary across assets according to their degree of 1996), this implies that the annual growth rate of poten- mobility or tax elasticity, respectively. That way, the tial GDP declines by about 0.33 percentage points in welfare loss associated with the introduction of a response to the introduction of a wealth tax. On the wealth tax can be reduced. In this instance, we apply a firm side, we observe a significant decline in produc- relatively lower tax rate to financial assets and firm tion by over 5% and investments by over 10%. The rea- equity; and a relatively higher tax rate to real estate son for this is that the wealth tax dampens the rate of property. In our simulation exercise, we set the wealth return on investments, as the introduction of the tax rate equal to 0.8% in the baseline scenario. In the wealth tax is equivalent to a substantial increase in the policy scenario, the tax rate is 0.4% for firm equity and income tax. The effect is particularly pronounced 1.0% for all other assets. For the dual wealth tax, the tax among foreign investors, since they find it easier to rate is 0.4% on financial assets and firm equity and 1% withdraw capital from Germany in order to avoid being for real estate property. The tax rates are chosen so subject to the wealth tax. Similarly, turning to the that the (gross) revenues from the wealth tax are financing of projects within firms, we can see an roughly equal across the scenarios. In all three scenar- increase in the debt ratio of around three percentage ios, we assume a tax-free amount of 1 million euros for points, as firms can avoid paying the wealth tax when singles and 2 million euros for married couples. Thus, they use borrowed capital instead of their own retained the wealth tax concepts considered in our analysis wealth to finance investments. The slump in produc- would only target the 2-3% wealthiest households in tion and investment has important implications for the Germany. labour market, too. The estimated long term drop in Table 1 shows the results of the simulations. It is employment due to the introduction of a wealth tax is important to note that caution is required when inter- about 2%. preting the estimates. The numbers indicate the rela- Turning to the household sector, we find a drop in tive deviation (measured in percent) between the real- the stock of wealth by almost 25% and aggregate sav- 24 ifo DICE Report 2 / 2018 June Volume 16  FORUM ings by over 40%. The reason for this finding is twofold: the annual growth rate of potential GDP of about 0.29 firstly, the adverse effect of the wealth tax on economic (policy scenario) and 0.25 percentage points (dual activity is associated with a decline in income per cap- wealth tax), respectively. The adverse effect of the two ita, involving lower savings. Secondly, as the wealth tax alternative wealth tax concepts on the other macroeco- reduces the income from wealth, the incentives to save nomic aggregates is smaller as well. part of their income and accumulate wealth decreases. Instead, households tend to consume a larger share of TAX REVENUES FROM WEALTH TAXATION their income, which is why the effect of the wealth tax on consumption is rather modest. Does the wealth tax pay off in fiscal terms, as often sug- The estimates presented in Table 1 also reveal that gested in the current debate? Considering the wealth the economic costs associated with the introduction of tax in isolation, we can see that is does indeed have a a wealth tax are somewhat lower in the policy scenario, substantial revenue potential (Table 2). The (gross) as well as in the case of a dual wealth tax. The reason for annual wealth tax revenues vary across the three sce- this is that the tax burden on firm equity (policy sce- narios between 16 and 18 billion euros in the short-run nario), as well as on financial wealth (dual wealth tax), and 13 to 15 billion euros in the long-run. At the same is lower than in the baseline scenario. Both firm equity time, though, we find that the public revenue increase and financial wealth are particularly sensitive to taxa- stemming from the wealth tax is more than offset by a tion and important for production. The adverse effect decline in revenues from other taxes. The drop in reve- on economic activity is nevertheless still notable. The nues from the labour income tax and the sales tax in estimated long-run decline in GDP is about 4.5% in the particular are substantial. As a result, the overall fiscal policy scenario and 4% in the case of a dual wealth tax. effect of introducing a wealth tax is expected to be neg- Assuming again that half of the adjustment process is ative, generating a loss of around 24 billion to 31 billion completed after eight years, this implies a reduction in euros annually, depending on the wealth tax concept. The main reason for this is Table 1 that, while the wealth tax reve- Economic Implications of a Wealth Tax in Germany nue itself is generated only by Baseline Scenario Policy Scenario Dual Wealth Tax a small number of taxpayers – Wealth tax = 1.0% Wealth tax = 1.0% Variable (in %) Uniform wealth tax = 0.8% Tax on firm equity Favoured wealth tax only around 2-3% of the Ger- = 0.4% = 0.4% man population have wealth Gross Domestic Product (GDP) −5.14 −4.49 −3.96 holdings that are higher than Firm Sector Production −5.16 −4.50 −3.95 the tax-free allowance of 1 mil- Domestic Firms −4.30 −4.94 −4.20 lion or 2 million euros, respec- Foreign Firms −11.99 −0.98 −1.95 tively – its burden is carried by Investments −10.25 −8.82 −7.79 virtually everyone, as indi- Domestic Firms −9.22 −9.47 −8.18 cated by the decline in GDP, Foreign Direct Investments −16.97 −4.59 −5.24 investment, and employment. Employment −2.08 −1.86 −1.63 It is important to note that the Debt Ratio (in % points) +3.81 +3.17 +2.89 administrative costs, as well Real Estate Sector as the compliance costs asso- Property & Housing −1.27 −1.46 −1.32 ciated with a wealth tax, are Household Sector not included in our estimates. Consumption of Households −4.07 −4.24 −3.50 Savings of Households −41.33 −39.48 −31.26 RE-DISTRIBUTIONAL Wealth of Households −24.65 −26.92 −23.28 EFFECTS OF Source: Authors’ computations. THE WEALTH TAX Table 2 Our analysis also sheds light Fiscal Consequences of a Wealth Tax in Germany on the redistributive effects of Baseline Scenario Policy Scenario Dual Wealth Tax a wealth tax in the sense that it Variable (in bn. €) Uniform wealth tax Wealth tax = 1.0% Wealth tax = 1.0% = 0.8% Tax on firm equity Favoured wealth tax allows us to assess how intro- = 0.4% = 0.4% ducing a wealth tax affects the Wealth tax revenues (short-run) +18.12 +17.90 +15.85 ratio between capital and Wealth tax revenues (long-run) +14.74 +14.04 +13.11 Revenues from other taxes −46.10 −43.55 −37.26 labour income. Since the Labour income tax −22.13 −19.84 −17.36 wealthiest households typi- Value added tax (incl. indirect taxes) −12.76 −13.29 −10.98 cally mostly receive income Corporate taxes −6.78 −5.26 −4.59 from capital rents and busi- Capital gains taxes −4.39 −5.13 −4.29 ness profits, the capital/labour Net (long-run) −31.36 −29.52 −24.14 income ratio tells us how effec- Source: Authors’ computations. tive the wealth tax is in pro- ifo DICE Report 2 / 2018 June Volume 16 25  FORUM Figure 4 Functional Distribution of Income after the Introduction of a Wealth Tax (Firm profits + interest income) / labour income Uniform wealth tax of 0.8% Policy scenario % Dual wealth tax 0.36 0.35 0.34 0.33 0.32 0 10 20 30 40 50 Years since introduction of the wealth tax Source: Authors’ computations. © ifo Institute moting economic inequality. Figure 4 illustrates the REFERENCES development of the ratio between capital income – or, Cingano, F. (2014), “Trends in income inequality and its impact on eco- more precisely, corporate profits and capital rents – nomic growth”, OECD Working Paper No. 163. and labour income. The ratio decreases in all three sce- Cummins, J. G., K. A. Hassett, and R. G. Hubbard (1996), “Tax reforms narios, indicating that the gap between capital and and investment: A cross-country comparison”, Journal of Public Eco- nomics 62 (1-2), 237–273. labour income diminishes over time. A smaller ratio can Deutsche Bundesbank (2012), Potential growth of the German economy be explained by the fact that capital income growth is – medium-term outlook against the backdrop of demographic strains, reduced more than labour income growth – it does not Monthly Report April, Frankfurt am Main. reflect a re-distributive effect of the wealth tax in the Fessler, P. and M. Schürz (2015), “Private wealth across European coun- tries: the role ofincome, inheritance and the welfare state”, ECB Work- strictest sense of the term. To put it bluntly, instead of ing Paper no. 1847. giving wage earners a larger piece of a given cake, the Ostry, J., A. Berg and C. G. Tsangarides (2014), Redistribution, inequality, cake becomes smaller and wage earners lose a smaller and growth, IWF Staff Discussion Note. piece than capital earners. It is interesting to note that Pham-Dao, L. (2016), “Public Insurance and Wealth Inequality – A Euro Area Analysis”, mimeo. this effect is most pronounced in the policy scenario, Radulescu, D. and M. Stimmelmayr (2010), “The impact of the 2008 Ger- despite the reduced wealth tax rate for firm equity. man corporate tax reform: A dynamic CGE analysis”, Economic Modelling 27 (1), 454–467. SUMMARY AND CONCLUDING REMARKS Taxing wealth in order to alleviate economic inequality and to generate additional public revenues is a recur- rent theme in the political debate. However, our analy- sis demonstrates that a wealth tax can have a notable adverse impact on economic activity, reducing eco- nomic growth, investment and employment. As a result, the burden of a wealth tax is practically borne by every citizen, even if the wealth tax is designed to target only the wealthiest individuals in society, via high tax- free allowances, for instance. Moreover, the introduc- tion of a wealth tax in the form considered in our anal- ysis would actually lead to a decline in total tax revenue, as the revenue gains from a wealth tax are notably lower than the decline in revenues from other taxes, especially the labour income tax and the sales tax. Thus, a wealth tax fails to significantly promote eco- nomic equality or create additional fiscal leeway. 26 ifo DICE Report 2 / 2018 June Volume 16