Reintroduction of Wealth Tax

A Law & Economics Perspective on the current discussion in Germany

Rixa Hasenkamp

EMLE 2022/2023

Warsaw School of Economics (SGH)

Dept. of International Comparative Studies

Tax Law and Economics

The discussion about the introduction of a wealth tax in Germany has never completely disappeared as a demand from the left spectrum, but with the support of two governing parties it has gained new relevance and became a central topic in the political debate on taxation in Germany.

A wealth tax basically means a recurring tax on the individual total net assets of a taxpayer, be it a natural or legal person, usually with a certain exemption capital threshold.^[1]

The collection of the original wealth tax under the Wealth Tax Act^[2], as amended in 1990, was suspended in 1997 after the Federal Constitutional Court (Bundesverfassungsgericht) had ruled that this wealth tax was unconstitutional due to the incompatibility of a different tax burden on real estate assets and other assets with the principle of equality (Article 3 (1) Grundgesetz).^[3] However, a wealth tax was not considered unconstitutional per se, in fact it is presupposed by Article 106 (2) Grundgesetz^[4]. In view of the increasing wealth inequality in the German society and the growing political challenges that need to be financed, the (re)introduction of a wealth tax receives increasing support in public opinion polls.^[5] Nevertheless, the debate focuses mainly on concerns of constitutional compatibility and fairness. In order to contribute to this discussion, this paper briefly examines the proposal from a tax law and economic perspective and asks whether it would be possible to balance the benefits of redistribution against the inevitable costs of the tax-induced distortions to produce an overall welfare-maximizing regime. Interestingly, welfare maximization can be viewed critically both in the context of the classical orientation towards economic growth as well as decoupled from it on the basis of the currently demanded de-growth policy goals aiming at a sustainable welfare system that provides for a fair distribution of resources and opportunities.^[6] All in all, it is shown that from this perspective a wealth tax in Germany does not appear to be an efficient solution to address the wealth inequality and to finance upcoming needs in the society.

The proposal for a new wealth tax as put forward by the Social Democrats (SPD^[7]) and supported by the Greens and the Left Party (Die Grünen^[8], Die Linke^[9]), aims at a redistribution to counteract the concentration of wealth by setting a high tax exemption threshold and levying a tax of 1 % of total net debt assets only on particularly wealthy segments of the population (possibly, rising progressively). The exact exemption threshold has not yet been determined, but a threshold of 2 million Euros dominates the discussion. Legal persons shall also be taxed independently, although privileges for business assets are in question. It remains to be seen how to prevent double taxation through the company's assets and the value of its shareholdings. In order to overcome the constitutional problems with estimating the value of the assets, the proposal suggests to adapt the standards of the inheritance tax for the valuation.

From a tax law and economic perspective, it must be assessed whether the benefits of the potential wealth tax relative to its costs create a welfare-maximizing regime.^[10]

First of all, the potential revenue of the wealth tax is estimated to be about 10 billion Euros, partly even around 15 billion Euros.^[11] However, the potential tax revenue is reduced by high collection costs. It is assumed that the additional administrative costs of determining the value of assets already lowers the income by about 5-9 %.^[12] Thus, a wealth tax is associated with an extraordinary high cost-yield ratio.^[13] Even more, since wealth tax revenues typically represent a relatively small share of tax revenues, which also do not necessarily increase with overall wealth growth.^[14]

In addition, the actual revenue depends to a large extent on the specific design of the wealth tax. This also affects the suitability of the wealth tax to achieve its objectives. The revenue from the tax is supposed to support fairer redistribution by making the wealthy more accountable and reducing the tax burden on small and medium incomes.^[15] Yet, this depends very much on the exact exemption threshold. Depending on the level of the threshold, the wealth tax runs the risk of either being ineffective or of burdening mainly on the middle class beyond the purpose of the tax.

To begin with, if the exemption threshold is too low, there is a risk that the tax will fall mainly on the middle class and will therefore not contribute to a fairer distribution of the tax burden. It is likely that liquidity problems will arise, forcing taxpayers to sell assets: Especially in the middle class, a person may be subject to the tax based on book values, without having the required liquidity to meet the obligation, e.g. a student who has inherited a house or a business whose book value increases, without recording more liquidity.^[16] Then, a wealth tax indirectly affects society as a whole, even the poor, if taxpayers pass on the additional burden by pricing it into rents or by trying to offset it through higher product prices without rising wages.^[17] In this case, the legitimacy of the tax fails already in terms of its suitability for the tax principle of performance as well as for the degrowth idea of fair distribution, and from a tax law and economics perspective a balance for an overall welfare-maximizing regime seems far away.

In contrast, risks to the effectiveness, especially if the threshold is too high, can be derived from behavioral insights. The above revenue figures do not yet take into account adjustment reactions. It should be noted, that the reintroduction of a wealth tax is a fairly large reform that taxpayers will pay attention to.^[18] The salient tax is associated with stronger reactions,^[19] including efforts to avoid or even evade the tax. The deductibility of debt gives an incentive to borrow heavily instead of investing one’s own money, with the inherent risks of excessive debt financing for financial stability, as we should have learned after 2005.^[20] Apart from that, aggressive tax optimization can be expected especially from the wealthiest who can afford to invest in finding the perfect tax minimization with techniques to avoid taxes by spreading their wealth and storing it in tax havens and hidden investments.^[21] For this reason, it is questionable how effective the tax would then be if its addressees can keep the actual revenue for redistribution low. Still, the recent developments in international tax transparency and information exchange may reduce the risk of capital flight and allow for a more effective taxation of capital.^[22] Nonetheless, those who can afford it, are encouraged to invest in certain assets, such as art, that are easy to hide and difficult to value, which entails higher compliance costs to check for non-disclosure and underreporting, hence, increases the cost-yield ratio of the tax again.^[23] Similarly, the induced investments into these assets are often non-productive and therefore, have a negative impact on the economic growth.^[24]

Furthermore, the impact on the economy can be controversially discussed from other perspectives. On the one hand, it can be argued that the wealth tax could motivate taxpayers to invest their assets as profitably as possible in order to prevent erosion of the substance of their wealth, and by encouraging the economic use of assets, the tax on the presumed rate of return serves the economy as a whole.^[25] On the other hand, a wealth tax induces large distortions with possible welfare costs. First, a wealth tax potentially discourages people from working to create wealth. A wealth tax makes savings and investments more costly, thus promotes immediate consumption, especially in the current context of high inflation.^[26]Second, it disincentivizes entrepreneurship by reducing the capital available to start a business, which becomes even less attractive if business assets are also taxed.^[27] Third, the reintroduction of a wealth tax would undermine investors’ confidence in Germany as a safe and attractive business location.^[28] Taken together, this could harm innovation and thereby potentially affect long-term growth.^[29]

Finally, responses to a tax depend on the framing and are reference-dependent.^[30] Namely, the loss aversion bias induces further distortions.^[31] In general, from the taxpayer’s perspective, the reintroduction of a wealth tax would initially appear as a loss relative to the status quo. However, the reaction to the tax also depends on the taxpayers’ other-regarding preferences.^[32] Here, the tax could be designed to appeal preferences for social fairness.^[33] While at first glance taxpayers might perceive the tax as unfair because others are exempted from it, emphasizing the contribution to a fair distribution of wealth in society and the overall welfare benefits may help policymakers to elicit positive reactions and compliance with the tax.

In conclusion, the framing of the tax can help policymakers to reduce the tax-induced distortions, but due to their substantiality this is a rather weak starting point for the welfare-maximizing design of such a per se salient tax. The reintroduction of a wealth tax in Germany is still associated with high costs due to tax-induced distortions and additional administration and faces comparatively low revenues. Finally, its suitability in terms of the principles of performance and fair distribution is difficult to achieve effectively, and an overall welfare maximization seems unlikely. Hence, Germany should refrain from reintroducing a wealth tax and look for another solution, such as an adjustment of capital income and inheritance taxes, to contribute less costly to a welfare-maximizing regime that addresses the problem of wealth inequality.^[34]

^[1] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 16; Schwarcz, Solidarity and Wealth Tax, 2022, p. 1.

^[2] Vermögenssteuergesetz, see: https://www.gesetze-im-internet.de/vstg_1974/index.html.

^[3] BVerfG, decision of 22.06.1995 - 2 BvL 37/91, see: https://openjur.de/u/178522.html, last visited 6 June 2023.

^[4] German Constitution, see: https://www.gesetze-im-internet.de/gg/art_106.html.

^[5] ARD-Deutschlandtrend, 13.12.2019, see: https://www.tagesschau.de/inland/deutschlandtrend-1897.html, last visited 6 June 2023.

^[6] Comparison of the two approaches in: Jensen (EPRS), Beyond growth. Pathways towards sustainable prosperity in the EU, 2023, p. 97.

^[7] Decision of the SPD Executive Committee, Vermögensbesteuerung. Die Vermögenssteuer wiedereinführen!, 2019, https://www.spd.de/fileadmin/Dokumente/Beschluesse/Parteispitze/20190826_Beschluss_Vermoegensteuer.pdf, last visited 6 June 2023; recently promoted by federal chairwoman of the party Saskia Esken, quoted for example in: Feil, Diskussion über Vermögenssteuer. Reiche starker besteuern – ist das gerechter?, see https://www.zdf.de/nachrichten/politik/vermoegenssteuer-ungleichheit-arm-reich-steuerpolitik-100.html, last vistited 6 June 2023.

^[8] Einführung einer neuen Vermögenssteuer, in: Wir teilen den Wohlstand gerechter, see: https://www.gruene.de/themen/steuern, last visited 6 June 2023.

^[9] Fordert die LINKE auch eine Vermögenssteuer, und wie soll diese ausgestaltet werden?, in: Gerechte Steuern, see: https://www.die-linke.de/themen/steuern/, last visited 6 June 2023.

^[10] Congdon et al., Policy and Choice. Public finance through the lens of behavioral economics, 2011, p. 177

^[11] Decision of the SPD Executive Committee, Vermögensbesteuerung. Die Vermögenssteuer wiedereinführen!, 2019, https://www.spd.de/fileadmin/Dokumente/Beschluesse/Parteispitze/20190826_Beschluss_Vermoegensteuer.pdf, last visited 6 June; Bach/Thiemann, Hohes Aufkommenspotential bei Wiedererhebung der Vermögenssteuer, 2016, p. 84.

^[12] Bach et al., Aufkommens- und Verteilungswirkungen einer Wiedererhebung der Vermögenssteuer in Deutschland, 2016, p. 56.

^[13] Wissenschaftlicher Beirat beim Bundesministerium der Finanzen, Besteuerung von Vermögen, 2013, p.57; OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 17.

^[14] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, pp. 18 f.

^[15] Decision of the SPD Executive Committee, Vermögensbesteuerung. Die Vermögenssteuer wiedereinführen!, 2019, https://www.spd.de/fileadmin/Dokumente/Beschluesse/Parteispitze/20190826_Beschluss_Vermoegensteuer.pdf, last visited 6 June 2023.

^[16] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, pp. 64; Mosemann, Eine kritische Betrachtung der Vermögenssteuer in Deutschland, 2017, p. 25.

^[17] Mosemann, Eine kritische Betrachtung der Vermögenssteuer in Deutschland, 2017, p. 24; Warnecke, Zehn Argumente gegen die Vermögenssteuer, 2012, p. 2.

^[18] Chetty et al., Salience and Taxation: Theory and Evidence, 2009, p. 35.

^[19] Finkelstein, E-ZTAX: Tax salience and tax rates, 2007, pp. 976 f.; Congdon et al., Policy and Choice: Public finance through the lens of behavioral economics, 2011, p. 180.

^[20] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 68.

^[21] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 66; Krenek/Schratzenstaller, A European Net Wealth Tax, 2018, p. 6; Durán-Cabré et al., Behavioural Responses to the Reintroduction of Wealth Taxes. Evidence from Spain, 2019, p. 28 f.

^[22] OECD Tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 67.

^[23] OECD tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, pp. 17, 67 f.

^[24] Schwarcz, Solidarity and Wealth Tax, 2022, p. 6.

^[25] Schwarcz, Solidarity and Wealth Tax, 2022, p. 6; Wieland, Rechtliche Rahmenbedingungen für eine Wiedereinführung der Vermögenssteuer,2003, p. 24; also Mosemann, Eine kritische Betrachtung der Vermögenssteuer in Deutschland, 2017, p. 11.

^[26] Schwarcz, Solidarity and Wealth Tax, 2022, p. 6.

^[27] OECD tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 63.

^[28] Lindner, Eine Vermögenssteuer kann Deutschland sich nicht leisten, 2022, see: https://www.bundesfinanzministerium.de/Content/DE/Standardartikel/Presse/Namensartikel/2022/2022-11-11-lindner-zur-vermoegensteuer.html, last vistied on 6 June 2023, with reference to the effects of already a one-time wealth levy in: Wissenschaftlicher Beirat beim Bundesministerium der Finanzen, Sollte wegen der Corona-Krise eine einmalige Vermögensabgabe erhoben werden?, 2021, p. 4.

^[29] Enache, Analyzing Recent Tax Trends Among EU Countries, 2022, see: https://taxfoundation.org/eu-tax-trends-eu-tax-reforms/, last visited 6 June 2023.

^[30] Congdon et al., Policy and Choice: Public finance through the lens of behavioral economics, 2011, p. 182.

^[31] Khaneman et al., Anomalies. The Endowment Effect, Loss Aversion and Status Quo Bias, 1991. pp. 197 f.; Congdon et al., Policy and Choice: Public finance through the lens of Behavioral Economics, 2011, p. 182.

^[32] Dhami, The Foundations of Behavioral Economic Analysis, 2016, pp. 398 ff.; Congdon et al., Policy and Choice: Public finance through the lens of behavioral economics, 2011, pp. 182 f.

^[33] Considered as an important factor by Chirvi/Schneider, Preferences for Wealth Taxation - Design, Framing and the Role of Partisanship, 2020, p. 27.

^[34] OECD tax Policy Studies, The Role and Design of Net Wealth Taxes in the OECD, 2018, p. 70; also Bach/Thiemann, Hohes Aufkommenspotential bei Wiedererhebung der Vermögenssteuer, DIW 4/2016, p. 88.