In times of a downturn, tax estimates are awkward appointments for every finance minister. In advance, finance and economics ministers must agree on an economic forecast, on the basis of which the independent “Tax Estimates Working Group” then forecasts the expected tax revenue for the coming years. It is usually the case that when the economy picks up, this income rises sharply and when the economy goes down it develops much weaker and falls short of expectations.
The German economy is now at the beginning of a recession that will last at least three quarters, not only according to the current forecast by the Handelsblatt Research Institute (HRI). A sluggish recovery is not likely to follow until next spring.
Germany will not reach the pre-corona level in the foreseeable future, and the German economy will lack five years of growth. Therefore, Federal Finance Minister Christian Lindner (FDP) and his country colleagues should actually look forward to October 27, the day the tax estimate is announced.
Actually – because this recession is different. The order books in industry are well filled, the labor market has been swept empty, and finding craftsmen is still a game of chance in many places. In addition, restaurants and inner cities are still well frequented.
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So far there has been no sign of a collapse in domestic demand, as is usually the case in recessions. However, the expensive energy drives up production costs, reduces purchasing power and thus slows down real economic growth.
Nominal GDP increased
The fact is that taxes mostly relate to nominal assessment bases, i.e. sales or income. That is why the tax estimators look less at real economic growth than at the development of nominal gross domestic product (GDP) – and this is increasing significantly in view of the strong price increases.
According to the HRI forecast, the nominal total economic output should increase by at least 8.5 percent this year and by at least four percent next year – to significantly more than four trillion euros.
Although the HRI recently revised its economic forecast for the real economy significantly downwards, nominal GDP in 2023 is likely to be around two percent higher than estimated three months ago. Overall economic output will therefore be around 80 billion euros higher next year.
This additional economic output in the form of higher income and sales is largely taxed. It is therefore not surprising that tax receipts up to the end of August alone were 12.8 percent higher than in the same period last year. For comparison: the last tax estimate in spring only predicted an increase in income of 7.4 percent for the year as a whole, despite significantly better economic expectations.
Revenue from the single tax with the highest revenue, sales tax, rose by 18 percent in the first eight months of this year alone. The second largest individual tax, the wage tax, increased by ten percent.
Despite the noticeably weaker economy and tax relief such as the tank discount and the retrospective increase in the basic tax-free allowance, the state will take in significantly more money this year and next than previously calculated. Because one percent additional economic output – regardless of whether it is real or due to inflation – leads to additional tax revenue of ten billion euros, even with an unchanged tax rate of almost 24 percent.
The state is a crisis winner
Of course, government spending is also increasing. The state now has to pay interest on new bonds again, and the energy costs for the buildings used are also increasing significantly.
State employees will receive 2.8 percent higher pay from December. In addition, collective bargaining for employees at the federal and local governments is due at the beginning of 2023, the result of which will then usually be transferred to civil servants.
However, a full compensation for the increase in the price level, which is likely to amount to around 20 percent within three years, seems unlikely. These real income losses for public employees increase the state’s financial leeway.
In the first eight months of this year, federal spending even fell by 1.1 percent compared to the same period last year. Higher personnel and interest expenses as well as rising material expenses were offset by significantly lower investment expenditure.
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The planned strong increase in armaments investments is still a long time coming. While tax revenue rose sharply, not least because of the rapidly rising inflation, expenditure was within the expected range – so the Treasury has so far been a big winner of the crisis.
Four proposals for the state
Inflation requires a gigantic redistribution program. With its aid programs, the state gives back a part of its inflation gains to the citizens – just not to all citizens who have been deprived by inflation. The current inflation rate therefore says little about the extent to which the purchasing power of individuals will be reduced.
This makes it difficult for the government to design targeted aid programs. This is probably one of the reasons why they are more likely to resort to haphazard, large-scale and therefore necessarily very expensive aid such as the tank discount or the reduction in VAT on gas.
Now the government’s remaining inflationary gains are uncertain – while the energy price crisis may last for months, if not years. The federal government would therefore be well advised to focus on four key goals.
The aim should be to ensure security of supply with energy, if necessary through nationalization, as in the case of Uniper.
The state should strengthen incentives to save energy. To do this, the price signals of the market must be able to take effect. It goes without saying that needy households must be protected and supported, but affordable basic needs cannot be guaranteed for all households.
It is no less important to protect companies from liquidity bottlenecks. The IW Köln therefore proposes deferring all tax advance payments for the fourth quarter of 2022 and the first quarter of 2023.
In addition, there is much to be said for expanding the loss offset options. The associated loss of income would be considerable, but predominantly of a temporary nature.
Inflation gains used in this way would always be well invested. Additional energy would be saved, the state would tend to spend less money on aid programs, and many entrepreneurs’ fear of not making it through the winter would be alleviated.
However, the government must be aware that inflation only relieves the national budget temporarily and cannot be a sustainably productive source of financing. The vast majority of the country’s inhabitants will have to learn and accept that this crisis will make them much poorer and that it will take a long time to make up for these losses.
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Communicating this bitter truth would be the task of the Federal Chancellor. No country in the world can absorb a country’s permanent loss of prosperity.
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