Schwidetzky: Musings on a German Tax Conference

Walter D. Schwidetzky shares his interesting "Musings on a German Tax Conference" on http://taxprof.typepad.com/:

"I have recently returned from a German tax conference on the value added tax (19% in Germany). Some musings:

A big issue for the value added tax in Europe is people gaming the system. As there is not a uniform value added tax in Europe, people will often buy a product in a country with a lower value added tax and then bring it into the country where they live. With higher end items like cars, this has mostly been stopped, but for other items it is a common problem, especially for people living near borders.
German maximum income tax rates are high by US standards, in the low 40%’s for income above around 60,000 Euros (around $81,000 depending on exchange rates). Germans may, however, effectively deduct payments for medical insurance and mandatory pension contributions. As a consequence, the net effective rate of income tax in the US and Germany, especially for middle class families, may not be that different once medical insurance and pension contributions are taken into account. Most Germans do not think their tax rates are too high, at least judging by the comments of people at the conference (who are mostly high earners). However, Germany significantly lowered its income tax rates in 2000, and its economy has done significantly better since then, providing some possible evidence of a move from the right side of the Laffer curve to more in the middle. While Germany’s unemployment rate has come down as a result of the recent boom in exports, it remains stubbornly high, around 8%, 15% in the former East Germany. At the same time, Germany has a shortage of skilled workers. I have been told that most of Germany’s unemployed have few skills and often a limited capacity to develop them. I should add that many Germans feel that the reunification has created many of Germany’s economic problems, which have been tough to solve. The unemployment rate in the former West Germany is comparable to that of the U.S.

Most Americans have a somewhat romanticized view of universal health care. While few Germans would support moving away from universal health care, most would agree that their system is badly in need of repair. There is a bewildering array of some 300 health insurance companies, mostly private, though some at least have a state association. A minimum amount of health insurance is required. Most who can afford it buy upgraded private insurance to get better care and better service. If you have the standard insurance, and you want to see a doctor, you don’t make an appointment; you just show up and wait until the doctor sees you. Might be an hour, might be half of a day. An American friend of mine gave birth to her third child in Germany. Initially she was put in a room with 7 other women, which freaked her out as she was used to US standards. She and her husband paid extra for a semi-private room. (A digression: When she and her husband asked for a circumcision, the doctor responded: ”Half or whole?” Not a question they wanted to answer incorrectly…). Many young German hospital doctors by the hour make the same as the janitorial staff. As a consequence, large numbers of young doctors are leaving Germany for better paying jobs in the US, Switzerland, and England. I would rather be sick with good insurance in the US than in Germany, but if I was poor, I would rather be sick in Germany where at least I would get treatment.

Most Germans probably also have a greater sense of social obligation to those less fortunate than most Americans. Most Germans trust their government more than most Americans trust theirs. Governmental paternalism is much more accepted in Germany than the US. The reach of this would surprise many Americans, however. For example, free speech is not allowed nearly to the same extent in Germany as it is in the US. Also, Moslem women who want to teach school are not allowed to wear head scarves (which has the effect of preventing many from entering the teaching profession). Germans commonly feel that the scarf subjugates women and also feel that teachers’ religious views should not be obvious to students. These considerations trump religious freedom issues. The Church of Scientology is at risk of being outlawed in Germany, something that could not happen in the US. (I might add that there is some hypocrisy here. In Bavaria it is common to see crosses on the walls in courts and schools.) Last I checked, if you change abodes in Germany, you are required to register with the police. Name changes are generally not allowed.

Many of my liberal colleagues probably would prefer the German system to the US system. Having lived in Germany and experienced German paternalism first hand, I am more hesitant, but I don’t doubt the US and Germany could learn from each other. As Prof. Ted Seto pointed out in a recent posting on TaxProf, the US needs to pay more attention to how other countries do things. There is plenty we could learn."

The world (Tax) is Flat

There is an interesting editorial in the Wall Street Journal, The World is Flat:

"Sooner or later it had to happen: The mainstream press is finally discovering the flat-tax movement that has been sweeping Europe. It must be painful to credit an idea associated with the likes of Milton Friedman and Steve Forbes, but reality can't be ignored forever.

The latest news is that the government of Greece is contemplating a 25% flat-rate income tax to take effect in 2006, replacing a multiple-tier tax structure with rates of 40% or more. The Finance Minister insists that such a flat-tax reform is necessary to reduce a spiraling budget deficit, and that any lost revenue will be recouped "via an overall increase in income."

By our count, this brings to 11 the number of nations with a single-rate, postcard tax system. More dominoes are expected to fall in the next few years: Bulgaria, Croatia and Hungary are also preparing to feed their thousands of pages of tax code into the shredder in favor of lower, flatter rates. A flat-tax proposal was debated as part of Poland's recent election campaign. And one of the countries that started it all, Estonia, plans to lower its rate one more time, to 20% from 24%, which was down from the initial flat rate of 26%. Lithuania hopes to go to 24% from 33%.

As shown in the nearby table, most of the world's flat-tax nations today are the former Iron Curtain nations, which for 50 years attempted to create a workers' paradise through command-and-control economic systems. Many of these nations have swung full circle in the opposite, free-enterprise direction. Daniel Mitchell, chief economist at the Heritage Foundation, notes that Greece's decision would make it the first non-former communist European nation to adopt the flat tax. East Europe is exporting its economic system westward after all, but not in the way Nikita Khrushchev ever could have imagined.

In response, even Old Europe has had to consider tax reform, lest its economies become increasingly uncompetitive. Rather than catching the flat-tax wave, France, Germany and Italy have been attempting to stop it by outlawing tax competition through international entities, such as the OECD, the European Union and United Nations.

But in the meantime, Germany has decided it can't wait and has announced plans to cut its corporate tax rate to 19% from 25%. During last month's election campaign, the opposition party's candidate for finance minister, Paul Kirchhof, championed a 25% flat tax "so that workers don't need 12 Saturdays but 10 minutes to complete their taxes." Some analysts blame the proposal for the opposition's late collapse in the polls, as incumbent Gerhard Schröder's party fanned fears about the flat tax. But the fact that it was debated at all shows that even Germans realize they are under competitive tax pressure.

And what of the United States? The postcard flat-tax concept was virtually invented on these shores, originally by Mr. Friedman. Americans devised the economically optimal tax system and much of the world seems ready to embrace it -- just not us.

Back in the 1980s, a few Democrats (Bill Bradley, Dick Gephardt) entertained a tax reform of flatter rates and fewer deductions. But nowadays the political left derides the concept as some sinister plot to let Rolls Royce and yacht owners slash their tax bills. Their ideological blinders prevent them from learning the lesson that the new political class in Russia, Estonia and now Greece accept as a 21st-century economic reality: The best way to get more taxes out of rich people is to generate more rich people, and then give them more incentive to report their income by keeping tax rates low.

Russia, for example, has reported that it now gets more tax revenues from the rich from its 13% flat tax than from its pre-existing Swiss cheese tax code with massive evasion and 50%-plus tax rates. Russia's revenues with the flat tax grew in real terms by 28% in 2001, 21% in 2002, and 31% in 2003, according to a recent analysis by the Hoover Institution. If the U.S. had that kind of revenue growth, our politicians would be wringing their hands over what to do with budget surpluses.

Last year the Internal Revenue code achieved a new Olympic record for complexity, with nine million words -- 12 times the length of the King James Bible. High tax rates and mindless tax complexity are an economic ball and chain. We hope President Bush's tax reform commission will cut through the class-warfare blather later this month and endorse a simple, broad-based, single-rate tax system."

The WSJ published a table showing the flat tax rates in these eleven countries. I have added below the 2004 GDP growth rates in these countries, which usually exceeds the worldwide growth rate of major industrialized countries:

Flat Tax Rates and GDP Growth Rates
Country Flat Tax Rate GDP Growth Rate
Estonia 24% 4.8%
Georgia 12% 5.5%
Greece 25% 4.0%
Hong Kong 16% 2.9%
Latvia 25% 6.8%
Lithuania 33% 7.1%
Romania 16% 4.5%
Russia 13% 7.3%
Serbia 14% 2.0%
Slovakia 19% 3.9%
Ukraine 13% 8.2%
October 8, 2005 in News | Permalink