On December 17, 2014, the German tax office suffered a resounding defeat. The German Federal Constitutional Court ruled the inheritance tax unconstitutional and ordered reforms no later than mid-2016. The blanket and almost total exemption for the transfer of business assets went too far for the court.
Additionally, in a dissenting opinion, three of the eight judges noted it is not simply a question of equality in tax reform, but also a matter of equity in the principle of the social state, writing: “It is within the responsibility – and not subject to mere discretion – for lawmakers to compensate for inequalities that would otherwise become even more permanent.”
Naturally, German Federal Minister of Finance Wolfgang Schäuble feels vindicated. He wanted to take the misgivings of the Constitutional Court’s first senate into account but, at the same time, change as little as possible. He presented the cornerstones for this reform in February.
Criticisms of the reform are justified, but for completely different reasons: it is half-hearted and misses the goal of uniform taxation.
The proposed new law limits tax exemptions to €20 million, or $21.8 million, per company bequest while a means test would decide whether an exemption was appropriate in the case of larger inheritances. Half the heir’s private assets would be considered in this test, since it’s not unreasonable for an heir pay a portion of the tax with private assets.
Politicians, particularly those in Bavaria and Baden-Württemberg, the German states with a large number of family firms, and small- and medium-sized associations were up in arms about the proposal and swore many businesses would go bankrupt if the exemption limit weren’t set much higher.
Certainly, criticisms of the reform are justified, but for completely different reasons: it is half-hearted, misses the goal of uniform taxation and continues to create incentives to designate private assets as company assets.
For a long time, prominent voices have advocated for higher taxes on inheritances. Not all those voices can be labeled as leftist. John Stuart Mill, the most important pioneer of liberalism, believed inheritances should go to the state, arguing that unlike the person making the bequest, the heirs contributed nothing to the wealth creation. Additionally, Mr. Mill argued wealth endangers a free society when fewer and fewer members accumulate larger and larger fortunes through inheritance.
Stefan Homburg, a conservative German economist, argued some time ago for classifying inheritance as a form of income tax so that it would taxed at the same rate as income from employment.
Even if politicians don’t have the goal of raising the amount of inheritance tax collected – which currently stands at €5.5 billion, or $5.98 billion, annually – it doesn’t mean everything must remain as it is. The unquestioned principle in finance of a “broad base, low rate approach to taxation” holds true not only for income tax, but also for inheritance tax. Thus, all inherited assets should be subject to the same low tax rate, all heirs granted high tax allowances and generous deferment and extension rules in company transfers be created.
As finance minister of a grand coalition, Mr. Schäuble could have taken the opportunity to initiate reforms, but apparently he shies away from a conflict with Bavaria and Baden-Württemberg, which see themselves as lobbyists for the family-owned businesses in their regions.
Mr. Schäuble’s desire to avoid confrontation may be because that while the federal government is responsible for the inheritance tax, the states collect it from areas where wealth in concentrated, such as Bavaria, Baden-Württemberg, Hesse, and Hamburg. Bavaria alone generates 16 times more inheritance tax income than the five East German states combined.
In coming decades, Germany will become a republic of heirs. Estimates on how much is inherited annually range from €60 billion to €360 billion. The richest Germans already own about one-third of the nation’s total wealth. Meanwhile, half of the children of parents who die are likely to come away empty-handed. The gulf between rich and poor in German is growing larger.
A property or wealth tax could offset this trend, but the administrative costs are very high because all items of property would have to be assessed every year to be on constitutionally solid ground. The far better path to wealth redistribution would be a modern inheritance tax: simple, low and just.
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