With increasing inequality in income and wealth, the political debates on the distribution of tax burdens have gained momentum. As the OECD regularly shows with international load comparisons, Germany is the world champion when it comes to taxing labor income. In contrast, asset growth and speculative profits in Germany are highly privileged for tax purposes or not taxed at all. And when it comes to taxing wealth, Germany is more of a low-tax country.
Stefan Bach is a tax expert at DIW Berlin.
(Photo: Florian Schuh / oH)
How inequality should be combated is naturally controversial. While the Union and FDP are primarily focusing on educational policy and economic growth and want to further reduce tax burdens on companies and wealthy private investors in their election programs, the SPD, the Greens and the Left are demanding higher top tax rates on income tax and a wealth tax. The latter is branded as inefficient and hostile to growth from the business-liberal side. The debate is shaped by the postulated trade-off between distributive justice and the efficiency of the tax system – the Equity-Efficiency Trade-Off.
Sebastian Eichfelder is professor for business taxation at Otto von Guericke University Magdeburg.
(Photo: oH)
Tax reform options that combine efficiency and fairness of distribution are criminally neglected in the debate. This applies in particular to the numerous privileges in real estate taxation, as we do in one current post demonstrate. Almost exclusively wealthy strata of the population benefit from these privileges. At the same time, these tax privileges lead to false incentives and distortions in the real estate market.
In contrast to international practice, speculative profits from real estate are only taxed in Germany if the real estate is sold after less than ten years, the so-called speculation period. In the case of owner-occupied properties, this period is effectively reduced to three years. This has particularly dubious effects on rented properties, which in Germany are held almost exclusively by the richest ten percent of the population.
While investors can claim their acquisition and maintenance costs for tax purposes through depreciation and advertising expenses, subsequent capital gains are usually tax-free. In connection with the currently low interest on borrowed capital and the appreciation of real estate, this leads to high and largely tax-free returns. If one assumes, for example, ancillary purchase costs of ten percent, a debt ratio and a building share of the investment of 80 percent each, a debt interest rate and maintenance expenses of one percent each, a long-term increase in the value of the property of 3.5 percent per year, an inflation rate of two percent, one Income tax rate of 45 percent plus 5.5 percent solos and a ratio of purchase price to net rent excluding taxes of 25, the return on equity employed after taxes is 16.4 percent – and only slightly below the return before taxes of 17.8 percent.
The effective tax burden on the return is only about eight percent
The high returns on equity result from the high debt capital ratio, the Leverage effect, and the very low interest rates on borrowed capital. The effective tax burden on the return is only about eight percent. This is mainly due to the depreciation, at least two percent of the investment per year, as well as the tax-free capital gain. If one assumes a ratio of the purchase price to the net rent without rent of over 30, as is quite common today in metropolitan areas, then there would even be a negative tax burden because the tax depreciation would exceed the net rent without taxes. The profitable investment then generates tax losses, the subsequent increase in value is tax-free.
With the really rich with lots of real estate in their portfolio, there is much more: If real estate is invested in a GmbH, the current tax burden on rental income is reduced to 15.8 percent corporation tax and solos – in contrast to the top tax rate of 45 percent for income tax plus solos. Unlike commercial corporations, real estate companies do not pay any trade tax. If the corporation tax rate drops to 10 percent and the solos are abolished, as the Union and FDP are calling for, the burden will be reduced to just 10 percent.
If the Objekt-GmbH is in turn held by a Holding-GmbH, even if the Objekt-GmbH is sold, only 1.5 percent tax will be charged on the profit from the sale, regardless of the holding period. This “share deal” also has the charm that if you sell less than 90 percent of the shares, you can also save the entire real estate transfer tax.
In fact, private real estate companies can be transferred completely tax-free
The property tax in Germany is only a fraction of the burdens that are common in many Western countries, such as the USA, Canada, France or Italy. In the case of inheritance tax, real estate holdings of at least 300 residential units are still considered business assets that are treated with preferential taxation. In fact, such private real estate companies can be transferred completely tax-free if the heirs continue to manage the portfolio. However, if you inherit a small house from your great-aunt or more distant relative, you have to pay 30 percent inheritance tax on the asset above 20,000 euros.
Conclusion: German tax law massively privileges investments in real estate. Highly wealthy invest in real estate accordingly. This aggravates the concentration of wealth and disadvantages employed persons as well as less wealthy classes in the accumulation of wealth and in the competition for the hotly contested real estate portfolios. The liquidity of the real estate market also suffers as a result, since speculative objects are kept away from the market. From a growth perspective, it seems extremely questionable to give tax privileges to investments in existing properties in an industrialized country that is facing considerable challenges in areas such as digitization and decarbonization. Eliminating these tax privileges could generate up to 27 billion euros in additional income annually. This could lower taxes and social security contributions for the middle class or finance future investments. At the same time, it would improve both the equity and the efficiency of the German tax system.