Germany Considers Split Tax Reform

by Ulrika Lomas, Tax-News.com, Brussels

23 April 2010

Following months of political wrangling within the German coalition as to a precise timeframe for implementation of further tax cuts, a solution may now be at hand, as the government is reportedly considering whether or not to split the agreed tax reform into two parts: simplifying the country’s existing tax system in 2011, and introducing tax cuts in 2012.

According to the proposal, a law simplifying the tax system could enter into force from January 1, 2011, as a first step, with tax reductions following shortly afterwards in 2012, the volume of which could then be determined in spring 2011.

Although the country’s coalition leaders have not yet formally discussed the proposal, Chancellor Angela Merkel is reportedly open to the suggestion, provided that both the Free Democratic Party (FDP) leader Guido Westerwelle and the Christian Social Union (CSU) leader Horst Seehofer are also in agreement.

Yet any consensus from the FDP may well prove difficult to achieve given the recent – and somewhat outspoken – remarks from Germany’s Finance Minister Wolfgang Schäuble. Despite clear attempts by the FDP to compromise on its tax cut plans, Schäuble has pointedly dismissed the watered-down proposals as simply unrealistic.

Schäuble has insisted that resolving the financial problems of the country’s municipalities – as stipulated in the coalition agreement – remains of paramount importance and must therefore be given absolute priority. Alluding to the “financial reservation” contained in the agreement, the Finance Minister also pointed out that public opinion increasingly believes that reducing the country’s debt should be a matter of top priority for the government.

As a result of these comments, however, the Liberals are now threatening to veto any spending plans proposed by CDU-led ministries if Schäuble continues to oppose the party’s tax plans.

Warning Schäuble not to overstep the mark, Hessen’s Chairman Jörg-Uwe Hahn (FDP) emphasized that an experienced and wise government minister should not expect too much from his partner, and reiterated that the party’s latest plans for tax reform mark the end of negotiations, and not the beginning.

Under the proposals, the FDP aims to reduce the burden on taxpayers by around EUR16bn by 2012 at the very latest. This figure pales into insignificance when compared to the EUR34bn in tax cuts pledged during its election campaign, and even when compared to the EUR24bn negotiated as part of the coalition agreement.

Determined to replace the existing system of linear income tax rates with a graduated system, the FDP has also compromised on the number of tax rates. As part of its election promise, the party pledged to introduce a graduated system with three income tax rates (10%, 25% and 35%). According to the revised plans, however, the linear system will be replaced by a graduated system comprising five income tax rates (14%, 25%, 35%, 42% and 45%).

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