Wolfgang Schäuble achieved several international tax policy successes durign his recently ended eight-year tenure as Germany’s finance minister. Massive tax avoidance leaks like the Panama Papers and Luxleaks boosted his quest to tackle corporate tax fraud with his European counterparts, who in turn won over other G20 nations in the fight. Together, they pressed ahead with the so-called BEPS project, which aims to make corporate tax avoidance more difficult by closing various loopholes.
However, such international cooperation between finance ministers has become more difficult since Donald Trump entered the White House nearly a year ago. The only piece of legislation the US president enacted in 2017 is a tax reform. Mr. Trump loudly praises it as the biggest tax cut of all time — and it's one that benefits corporations above all. While it’s natural to take Mr. Trump's self-congratulatory superlatives with a pinch of salt, there’s no denying that his Tax Cuts and Jobs Act is the largest overhaul of the US tax system in decades. And it will have an impact far beyond America.
The global effects became apparent even before the controversial reform came into force. Unsurprisingly, Peter Altmaier, Germany’s interim finance minister who took over after Mr. Schäuble stepped down in September, and his European counterparts reacted nervously to the plans and sent an unusually strongly worded letter to Washington.
Addressing corporate tax avoidance simply through tougher rules will no longer be enough.
The worst-case scenario they feared has not materialized: There won’t be an import tax in the US. But nonetheless, economists agree: The massive reduction in corporation tax from 35 to 21 percent, along with the better ways to write off investments, are a mermaid’s call to many German companies, and they may very well heed it.
Above all, the tax overhaul by the world’s biggest economy will spur global competition. China was among the first countries to respond by announcing a new measure: If a foreign corporation invests its profits in China, it will not have to pay taxes under certain conditions. The gift, worth billions of dollars, even applies retroactively for 2017. Under these circumstances, international fiscal cooperation will become more difficult in the future, while geographical competition will increase instead.
Whoever takes over permanently from Mr. Schäuble as finance minister — when Germany finally has a new government — will not need to fundamentally change Germany’s current strategy, but rather complement it. This means that efforts to fight tax avoidance should not be abandoned lightly. After all, there is still plenty to do within the European Union. In addition, the US is still a partner for the EU. Mr. Trump’s tax reform includes rules that make it harder for American corporations to shift profits to tax havens. And if it matches Washington’s interests, US Treasury Secretary Steven Mnuchin will support the BEPS project.
Nevertheless, one thing is clear: Addressing corporate tax avoidance simply through tougher rules will no longer be enough. In addition to the regulatory stick, Germany’s next finance minister will also need to give away carrots to improve the country’s competitiveness. At 28.2 percent, the effective tax burden for companies is relatively high in Germany — but not terribly high. Until now, the US has been a rather high-tax country. The effective tax burden for corporations was around 36.5 percent in California, including local taxes. After the reform, it will be around 22 or 23 percent, depending on the state.
The tax cut in the US and the reaction in China are no reason to panic about a race to the bottom. Especially since a decision to invest somewhere never depends solely on the tax rate. Other locational factors such as a modern infrastructure or well-trained professionals are equally crucial. Here, too, Germany has some catching up to do, but then so does America. And many investors suspect that it won't only be the US’s mountain of debt that will grow as a result of the gigantic tax cut granted to corporations and the wealthy — so will inequality and social tensions.
So far, however, it does not seem that these risks are weighted higher than the benefits of the tax reform. Therefore, there is good reason to streamline Germany’s tax system as well.
Many have long criticized the complicated juxtaposition of corporate tax and business tax. Cities and local councils fended off Mr. Schäuble’s attempts at reform. But with a nudge from abroad, the upcoming federal government should risk a fresh start. Better depreciation rules and the reduction of the solidarity surcharge spring to mind. Time is running out.
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