It seemed strange when Federal Finance Minister Christian Lindner (FDP) presented the new tax estimate last week. After that, the tax revenue should not only be noticeably higher than estimated six months ago.
They are even said to be well above the estimates from November 2019, when most Germans were just as unfamiliar with corona viruses as they were with the names of Ukrainian cities and regions, around which a bitter war has been raging for almost three months.
While the tax estimators in November 2019 expected income of 875 billion euros for 2022, these experts are now assuming almost 890 billion euros in revenue this year.
But caution is advised. The corona recession and the energy price shock have by no means left their mark on public budgets. If there was hope of an upswing in autumn 2019, stagflation is a threat today.
And because most taxes are based on nominal values, i.e. sales, profits or income measured in euros, inflation drives up tax revenue even when the economy is stagnating in real terms.
Lindner is in a dilemma
A common measure of the Treasury’s appetite is the tax rate, i.e. the relationship between tax revenue and gross domestic product. Since the tax system is slightly progressive due to the high importance of wage and income tax, this rate increases steadily over time without legal changes.
If you compare the tax ratios estimated in autumn 2019 with those currently forecast, you can almost see a precision landing: This year, the tax ratio of 23.42 percent is likely to be only 0.09 points higher than the estimate before the outbreak of the pandemic. In the coming year, this rate should be 0.22 points and in 2024 0.05 points lower than expected in 2019 – so there is no sign of real additional income!
But that’s exactly what Lindner needs to get out of the dilemma he’s in: On the one hand, he wants to comply with the debt brake enshrined in the Basic Law from next year. On the other hand, the federal government is required not to collect any additional income from “cold progression”, i.e. additional income from income tax due to inflation. To do this, the tax rate would have to be shifted accordingly.
Lindner: “The cold progression can become an issue”
Lindner’s problems are aggravated by the fact that government spending is increasing as a result of inflation. It doesn’t matter whether it’s spending on buildings, tanks, company cars, energy or pencils, many things are also becoming more expensive for the state.
In addition, social benefits such as basic security or housing benefit, which are in euros in the law, must be promptly adjusted to the rising price level in order to guarantee the subsistence level of the recipient at all times. Ultimately, the Russian war of aggression will permanently require additional government spending on armaments and the conversion of energy infrastructure.
Funding future charges
This raises the question of financing. As with most political decisions, there are also distributional issues. The debt brake is intended to limit new government borrowing to 0.35 percent of gross domestic product and prevent interest and repayments from being shifted into the future, which is considered to be unreasonably high.
The debt brake may only be suspended in the event of extraordinary events, which undoubtedly include the pandemic, provided that a reduction path is adopted for the additional debt.
In this way, future taxpayers will be involved in financing these extraordinary burdens – and the greater the burden, the more so.
The independent Advisory Board of the Stability Council therefore rightly warns that it contradicts “the intention of the debt brake to use the (…) exception clause to finance or pre-finance measures that are not directly related to the crisis”. Successors to Finance Minister Lindner must therefore be accountable for his decisions.
Progressive wage and income tax means that tax revenue develops more dynamically than nominal economic output. Since 2012, the government has been obliged to report regularly to the Bundestag on the effect of cold progression in the tax scale.
Prof. Bert Rürup is President of the Handelsblatt Research Institute (HRI) and Chief Economist of the Handelsblatt. For many years he was a member and chairman of the German Council of Economic Experts and an adviser to several federal and foreign governments. You can find out more about the work of Professor Rürup and his team at research.handelsblatt.com.
Estimates by the German Economic Institute (IW) assume that a ten percent increase in inflation via the cold progression will generate around 25 billion euros in additional income per year for the tax authorities – additional income that comes mainly from high and higher earners.
For the current year, the government has retrospectively increased the basic income tax allowance, the employee allowance and the commuter allowance. This leads to annual revenue shortfalls of a good four billion euros.
In addition, further relief such as the temporary energy tax reduction, the “energy flat rate” and the “nine euro ticket” are on the way to parliament, which of course do not affect income tax.
Nevertheless, the Federal Minister of Finance emphasizes that the government is giving the additional income from the cold progression back to the citizens with this relief package – and conceals the fact that the beneficiaries are a different group of taxpayers.
Elimination of traditional subsidies and tax breaks
The coalition agreement does not regulate how to deal with cold progression. It is therefore uncertain whether the government will adjust the tax rate fully to the inflation surge from 2023 or at least keep part of the inflationary gains. According to the FDP, this would be tantamount to a tax increase – which is excluded in the coalition agreement.
This is how the Handelsblatt reports on taxes:
Faced with this dilemma, it might be time to recall a worthwhile, albeit politically arduous, endeavor: phasing out legacy subsidies and tax breaks. The last relevant attempt dates back to September 2003, when the Prime Ministers of Hesse and North Rhine-Westphalia presented the “Koch-Steinbrück List”.
It said: “A comprehensive and consistent reduction in subsidies is necessary in order to reduce the general government deficit and thus make an important contribution to achieving a path of financial stability again.”
Although a reduction in subsidies is often called for, concrete individual cases show “that the organized resistance of the groups and associations concerned repeatedly succeeds in preserving their own advantages at the expense of the general public”. New subsidies must therefore be limited and degressive, i.e. gradually reduced, from the outset.
Two decades later there is nothing to add. Subsidies for certain companies or groups of people are always associated with an increased tax burden for the general public. There are macroeconomic costs when the state favors certain sectors and thus inevitably burdens others.
Ultimately, subsidies usually slow down the growth forces of an economy. However, additional growth would be the best medicine for public finances to recover. A first step, at least symbolic, would be if the impact on trend growth of each new law were estimated econometrically.
Of course, there can be good reasons to also pass laws that weaken growth. Only these reasons should be presented openly and debated in Parliament.
More: Christian Lindner – The Sorcerer’s Apprentice and the Mountain of Debt