politicians' positions

The Price of Tax Reform

Merkel cologne carnival scholz_effect
Chancellor Angela Merkel winning friends in Cologne in the western part of Germany.
  • Why it matters

    Why it matters

    If Chancellor Angela Merkel changes the tax system, and drops the solidarity tax designed to support east Germany following reunification, the move will come at a political cost.

  • Facts

    Facts

    • Ms. Merkel seeks a slow phase out of the solidarity tax, which generates about €15 billion, or $18.2 billion annually, starting in 2020 and running through 2030.
    • She is willing to bargain with political foes such as Bavarian Minister-President Horst Seehofer and the Christian Social Union on issues such as inheritance and state and federal tax reforms to achieve her goals with the solidarity tax.
    • Slashing the tax complicates Germany’s efforts to maintain a balanced budget, dubbed Black Zero.
  • Audio

    Audio

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Tired of the recurring debate over the solidarity tax enacted in 1995 to help fund the huge costs of reunification and economic development in the former East Germany, Chancellor Angela Merkel of the center-right Christian Democratic Union is taking steps to finally bring the so-called Soli tax to an end.

The actions by Ms. Merkel, who grew up in the former East Germany, bring her tax policies into alignment with the CDU’s economic wing, which has been unhappy about Soli for years, while also solidifying the ties between business and the party.

Above all, it’s a concession to the perpetually aggrieved Christian Social Union, the sister party of the CDU in the state of Bavaria, and its chairman, Horst Seehofer, who has torpedoed every attempt to reach an agreement on Soli, not to mention a faltering federal and state financial reform and inheritance tax reform.

By giving Mr. Seehofer the Soli, Ms. Merkel can demand concessions from him in other areas. Opposition to ending the Soli by the center-left Social Democratic Party, Ms. Merkel’s current coalition partner in government, only strengthens the chancellor’s position.

Ms. Merkel’s proposal isn’t really saying, “That’s it, it’s over.” As a realist, she doesn’t want to endanger the success of the balanced federal budget that has been credited to the CDU. The tax, with the €15 billion, or $18.2 billion, in revenues it brings in each year, would start being wound down in 2020 and would continue until 2030.

The liberal Free Democratic Party, the German Taxpayers Federation and the CDU’s economic council complain that pace is much too slow, which could mean Ms. Merkel will fail in her goal to end the Soli debate once and for all.

How much is a promise worth if it cannot be fulfilled until long after the next federal elections? 

Regardless, the CDU has firmly committed itself to tax relief for the elections in 2017, in line with Ms. Merkel’s initiative. This reduces maneuvering room for developing serious income tax relief proposals for taxpayers after a long period of budget consolidation. The last such reform, hammered out in a coalition of the social democrats and the Green party, was a long time ago, coinciding with the arrival of the new millennium.

Too many Germans still believe in the promise made by former Chancellor Helmut Kohl that the solidarity tax was only meant to make up for a temporary shortfall in federal finances and would quickly end.

Debate over “cold progression” – which occurs when inflation drives wages into a higher tax bracket – only distracts from the fact that even the normal progression is tangibly gnawing away on wage increases. At any rate, the CDU won’t be able to credibly use the campaign claim of “tax relief for the middle” while ending the Soli tax at the same time.

Ms. Merkel still has a tactical advantage. SPD Chairman Sigmar Gabriel, who is flirting with reorienting his party toward the “working middle classes,” will be unable to promise lower taxes either.

But Mr. Gabriel can campaign by accusing Ms. Merkel of providing tax relief primarily to the wealthy, since the highest incomes benefit disproportionately from the dismantling of the Soli than from a general lowering of the income tax. This gives the SPD a motive to block the dismantling of the Soli and preserve it as a campaign issue.

It will be interesting to see if Ms. Merkel and Mr. Seehofer can push their plans through the grand coalition with the SPD.

Not only have they upset the SPD with their proposal, but they also duped the finance minister, Wolfgang Schäuble, of Ms. Merkel’s CDU party, who had hoped to integrate the Soli into the income tax rate. The majority of Soli revenues would have gone to the federal states and municipalities in 2020. All of the states except Bavaria saw this as an important component in reaching agreement in the stalled federal and state financial reform negotiations, which was the advantage of Mr. Schäuble’s proposal.

The disadvantage apparently carries more weight more for Ms. Merkel.

Too many Germans, especially CDU voters, still believe in the promise made by former Chancellor Helmut Kohl that the Soli was only meant to make up for a temporary shortfall in federal finances and would quickly end. But the fact is, 20 years later the federal government still provides special funding for the eastern states, such as pension subsidies, while efforts to develop the east have led to investment delays in poorer western states.

There also was an unforeseen financial crisis that drove the mountain of debt to new heights. And 10 years ago, the government decided it would no longer bankroll expenditures on credit.

None of this is much help in formulating a politically attractive message for retaining the Soli. Neither is noting that combining the income tax and Soli under the heading of income tax isn’t really a tax increase.

This is why it remains quite possible the SPD will swing over to the path Ms. Merkel is taking.

For their doing that, the chancellor then would likely be forced to meet the SPD more than half way on the inheritance tax reform and Mr. Seehofer in reforms of the financial transfers between states.

 

The author can be reached at riedel@handelsblatt.com

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