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How Should Local Governments Tax Local Business? Lessons from an International Comparison and a Microsimulation Analysis for Germany

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How Should Local Governments Tax Local Business? Lessons from an International Comparison and a Microsimulation Analysis for Germany A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Fossen, Frank M.; Bach, Stefan Working Paper How should local governments tax local business? Lessons from an international comparison and a microsimulation analysis for Germany DIW Discussion Papers, No. 717 Provided in Cooperation with: German Institute for Economic Research (DIW Berlin) Suggested Citation: Fossen, Frank M.; Bach, Stefan (2007) : How should local governments tax local business? Lessons from an international comparison and a microsimulation analysis for Germany, DIW Discussion Papers, No. 717, Deutsches Institut für Wirtschaftsforschung (DIW), Berlin This Version is available at: http://hdl.handle.net/10419/27241 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu Discussion Papers Frank M. Fossen Stefan Bach How Should Local Governments Tax Local Business? Lessons from an International Comparison and a Microsimulation Analysis for Germany Berlin, August 2007 Opinions expressed in this paper are those of the author and do not necessarily reflect views of the institute. IMPRESSUM © DIW Berlin, 2007 DIW Berlin German Institute for Economic Research Mohrenstr. 58 10117 Berlin Tel. +49 (30) 897 89-0 Fax +49 (30) 897 89-200 http://www.diw.de ISSN print edition 1433-0210 ISSN electronic edition 1619-4535 Available for free downloading from the DIW Berlin website. Discussion Papers 717 Frank M. Fossen* Stefan Bach** How Should Local Governments Tax Local Business? Lessons from an International Comparison and a Microsimulation Analysis for Germany1 Berlin, August 23rd, 2007 * Corresponding Author. DIW Berlin, Department Public Economics, e-mail: [email protected] ** DIW Berlin, Department Public Economics, e-mail: [email protected] 1 Acknowledgement: We would like to thank Viktor Steiner, Michael Broer, Nadja Dwenger and Pio Baake for valuable comments. The usual disclaimer applies. Discussion Papers 717 Abstract Abstract The local business tax as the main revenue source of local governments in Germany has been under extensive debate for decades. Proposals for reform range from a broad tax base in the sense of an origin-based value-added tax to a pure profit tax that could be implemented as a surcharge on corporation and personal income tax. Local business taxation systems in OECD countries actually represent the whole spectrum between these two extremes. We use a newly developed microsimulation model for the business sector in Germany to analyse the fiscal and distributional effects of the general reform options identified, including the extension of the local business tax to liberal professionals. We also analyse the effects of the actual German business tax reform 2008 with respect to local business tax revenues. JEL classification: H71, H25, C8 Keywords: Local business tax, microsimulation, local taxation, tax reform 1 Discussion Papers 717 1 Introduction 1 Introduction Local business taxation has been a constant source of discomfort and critique among policy makers, taxpayers and academics for a long time not only in Germany but apparently in many countries. Economists have pointed out that local business taxes are often rather a product of piecemeal legislation enacted over decades and do not follow clear guidelines of local taxa- tion such as fiscal equivalence and the benefits principle (see e.g. Studenski (1940) and Testa and Oakland (1996) referring to the USA or Maiterth and Zwick (2006) referring to Ger- many). In Germany, the local business tax is the main source of revenues for local govern- ments and imposes a considerable burden on enterprises. As the tax largely depends on busi- ness profits, municipalities are faced with highly volatile tax revenues. Politicians, interest groups and economists have proposed various options for reform ranging from a pure profit tax to an origin-based value-added tax. The literature weighting the arguments is extensive.2 In spite of the dimension and importance of the debate, empirical information on the fiscal and distributional impact of different local business taxation systems based on micro data is scarce. Case studies and showcase calculations have dominated simulation studies of business taxation (e.g. Devereux et al. 2002, Spengel 2003). One reason is that detailed and representa- tive individual firm and tax file data was hardly available, especially about small and medium sized enterprises (SME).3 In Germany, fortunately the Research Data Centre of the statistical offices has made tax statistics increasingly accessible recently. Another reason for the scarce empirical literature is that the behaviour of firms is hard to model as it has many dimensions – financing, investment, hiring, incorporation, entry and exit decisions all interact. This may explain why the field of microsimulation first covered the household sector, where the main economic decisions, labour force participation and work intensity, are more easily modelled, and is only slowly expanding into the business sector as researchers are gaining more experi- ence with microsimulation and computational power is growing at the same time. Maiterth and Zwick (2006) used a microsimulation model to assess the impact of two reform options for the German local business tax on 253 example municipalities which were selected from 2 Examples for the German discussion are Döring and Feld (2005), Petersen et al. (2005), Vesper (2004), Fuest and Huber (2003), Maiterth (2003), Junkernheinrich (2003), Zwick et al. (2003), Jarass and Obermaier (2003), Bach and Versper (2002), Scherf (2002), and Zimmermann (2002). 3 Data on large corporations has been used for research more often as they are obliged to publish financial statements. 2 Discussion Papers 717 2 Local Business Taxation in International Comparison the total of almost 14,000 municipalities in Germany. While this analysis reveals interesting trends, it is not representative. In this paper, we describe our newly developed microsimulation model BizTax which is based on a representative sample of official individual local business tax and income tax files for 2001.4 For the first time in Germany, the fiscal and distributional effects of reform options for the local business tax can be quantified in detail on the basis of micro data. In the section following this introduction, we describe the institutional background in Ger- many and summarise the discussion around the local business tax. Based on an international comparison of local business taxes in OECD countries, we identify basic models of local business taxation. These models are discussed in the light of public finance theory. This leads to the definition of five fundamental tax reform options for the German local business tax. In the third section, we describe the data and the microsimulation model BizTax that we use to quantify the effects of these reform options. Section 4 presents the simulation results. The microsimulation model allows a precise analysis of the fiscal and distributional effects of the reform scenarios by industry, legal form, and by firm size in terms of profit and number of employees. Additionally we are able to analyse the impact of the reform on different regional categories. For each of the various reform options, we investigate how its implementation would redistribute local business tax revenues between cores of agglomeration, surrounding areas and rural areas, between western and eastern Germany, and between municipalities with high, medium and low local tax revenues per capita. The last section provides a short sum- mary and conclusion. 2 Local Business Taxation in International Comparison 2.1 German local business tax (“Gewerbesteuer”) under discussion The German local business tax (“Gewerbesteuer”) has been under extensive debate for dec- ades. Having its origins in the 19th century “taxe professionelle”-tradition, it has been as- signed to the local layer of German fiscal federalism since the 1930s. To this day, the local business tax is the main tax source of local governments in Germany (OECD 2006). Origi- nally, it rested on the pillars “profit before interests” (with adjustments), “capital” and “pay- 4 The data is available at the Research Data Centre of the statistical offices, http://www.forschungsdatenzentrum.de. 3 Discussion Papers 717 2 Local Business Taxation in International Comparison roll”. The idea was to tax a broader base of local value-added. However, over the last decades several reforms washed out the
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