Germany should consider patent box, reject minimum tax, expert panel concludes

By Dominika Langenmayr, Professor of Economics at Catholic University of Eichstaett-Ingolstadt

The German Council of Economic Experts, the so-called council of “economic wise (wo)men,” once a year produces a report with recommendations for the German government.

It came out on 7 November. I will summarize (and comment on) the chapter on tax policy below:

• The first part is on the US Tax Cuts and Jobs Act. The council expect a positive effect on economic growth in the US, and, via exports, on Germany. Long-term effects depend on what the US will do to finance the tax cuts in the long run.
• The next part is on tax competition. Based on the observation that besides the US, also Belgium, France, and Italy lowered their corporate tax rates, they suggest that Germany makes some small adjustments to the effective tax burden on firms (abolishing the solidarity surcharge, lowering the tax rate by about 0.8%).
• They also suggest that Germany introduce a patent box (with nexus approach), despite citing the empirical evidence that it doesn’t increase R&D and doesn’t increase tax revenues. It is surprising how the council reaches the conclusion that introducing the patent box is a good idea, given that they summarize the empirical evidence very well.
• The next interesting part is on taxation of the digital economy. The panel finds the EU Commission proposal to define a “digital permanent establishment” imperfect, citing the view of Johannes Becker of the University of Münster that the concept is inconsistent with the principles of international taxation. The council also stresses that value creation by users would imply a tax liability for the users. The proposed temporary digital services tax is also seen negatively; they stress that the US may interpret it as a unilateral tariff, against which it would retaliate. It would also cause double taxation and is difficult to collect. They propose to strengthen the general anti-avoidance rules (CFC and transfer pricing rules). Here, I disagree: without redefining permanent establishments, CFC rules, etc., digital economy firms will not pay significantly more tax in Europe.
• Next, they talk about potential tax harmonization in Europe. They like a coordinated introduction of destination-based cash flow taxes in principle, but anticipate too much political resistance (due to redistribution of tax revenue and effects on exchange rates and price levels).
• They argue against a CCCTB and minimum taxation. Minimum taxation would make beneficial tax competition impossible, while not hindering harmful tax competition, which they state is mostly carried out via the tax base. I’m not a fan of minimum taxation, but I do not really see where the distinction between “good competition in rates” and “bad competition in bases” comes from.
• The last part is on tax incentives to promote private investment. Here, they suggest eliminating the solidarity surcharge (additional burden of 5.5% of the tax burden). In addition, they suggest an allowance for corporate equity (as they have been suggesting since 2012).
• There is a dissenting opinion by economist Peter Bofinger (University of Würzburg), who disagrees on several points. He sees no need for Germany to lower taxes due to increased tax competition. He stresses also that other things (besides taxes) matter for location decisions; that the US will (due to the deficit) be forced to raise taxes again; and that effective tax rates in Germany are not very high when you look at implicit tax rates (i.e., when ignoring received dividends in the denominator). He also likes minimum taxation.

So much for a short overview! The whole chapter has 46 pages, so I’ve obviously shortened and simplified it a lot. If you read German, read the whole thing! If not, an English translation will become available soon. You will find it here.