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Empirical Economics

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01.08.2016

Distributional and welfare effects of Germany’s year 2000 tax reform: the context of savings and portfolio choice

Erschienen in: Empirical Economics | Ausgabe 1/2016

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Abstract

This paper empirically investigates distributional and welfare effects of Germany’s year 2000 tax reform in the context of the household savings decision and the allocation of wealth to a portfolio of assets. The reform is simulated in an ex ante behavioural microsimulation approach. Behavioural responses resulting from changes in capital income taxation are estimated in an empirical demand model for household savings and asset allocation, which is applied to German survey data. Significant reductions in tax rates result in income gains for most of the households. Gains are found to be greater for households in higher tax brackets, whereby income inequality increases, in particular in East Germany. Moreover, households increase savings and alter the structure of asset demand as a result of shifts in relative asset prices. As a result, utility losses reduce welfare effects for almost all households, in particular for households with greater savings.

Vorheriger Artikel The role of house price in the US business cycle

Nächster Artikel Dynamics of investment and firm performance: comparative evidence from manufacturing industries

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The reform brought about a total annual tax relief of 32 bn euros, of which about 27 bn euros was related to changes in personal income taxation (Bundesministerium der Finanzen 2004). As a consequence, families, employees, and non-incorporated medium-sized enterprises were meant to benefit most from the reform.

In reflections on the Mirrlees Review, Keuschnigg (2011) stresses the importance of extending existing computational models for meaningful quantification of the gains and costs of reforms to the taxation of capital income.

Domeij and Heathcote (2004) focus on the relevance of household heterogeneity for the welfare implications of cuts to capital income tax rates.

Tuttle and Gauger (2006) find that distributional effects of the former are usually permanent, whereas the latter have rather transitory relevance.

This literature relates to the seminal paper by Feldstein (1976). For a recent analysis, see Poterba and Samwick (2002). For example, Michel and Ahmad (2012) investigate incentives to reallocate assets intertemporally in response to the implementation of a child tax credit in the USA. An analysis for Germany can be found in Lang (1998).

Simultaneously to this reform, the child benefit and child allowance were altered, and a reform of the taxation of old-age pension income was implemented in 2005. These adjustments shall not be considered in this analysis.

This implies that the fiscal budget is unbalanced in the short run through the reform. For the long run, it can be assumed that the fiscal budget is to be balanced, such that the income gains through the reform could be partly (or entirely) drawn back from the households, also see the discussion in Sect. 5. In fact, the major financing elements of the reform were meant to be adjustments of depreciation rules for companies’ assets, which are, however, not considered here (Bundesministerium der Finanzen 2004).

For a consistent treatment of durable consumption, durable goods are treated as investments, following Jalava and Kavonius (2009), and user costs are computed.

In the classical Keynesian framework, savings only depend on current income. The literature motivates the relevance of current income with either liquidity constraints, or myopia, or savings for precautionary motives (e.g. Browning and Lusardi 1996).

Service flows of an asset may involve the return to investment, risk-related attributes, transaction-related characteristics, and other asset-specific services. These are obviously not structural utility parameters, but it shall be assumed that they are invariant to the tax reform.

These two models imply various assumptions on separability of the single decisions. It is assumed that the intertemporal consumption decision and the asset allocation decision are separable from the labour supply decision and that the asset allocation decisions in the two clusters are separable from each other. Separability is tested in Ochmann (2013).

\(p_{ik}\) implies household-specific asset prices. Prices vary over the households by heterogeneity in after-tax rates of return, resulting from heterogeneity in marginal tax rates and in the portfolios.

If income, and thus probably also savings, is concentrated beyond this income threshold (Bach et al. 2009), relevant asset demand responses of the top-income households are missed in this analysis. If these are relevant in size, which the results in Sect. 5.3 suggest, then the true distributional and welfare effects would be greater. The results should thus be interpreted as lower bound results. Note further that while the income distribution is top-coded in the EVS, the distribution of wealth is not. In particular, wealth is observed jointly with income and savings, so that there is no need to estimate or impute the wealth distribution from external data, as it is often the case with microdata on income and consumption.

Note that applying the LWR from six waves between 2002 and 2007 is consistent with an ex ante evaluation of the tax reform that took place between 1998 and 2005, because the LWR data are only used to estimate the interest rate elasticity of compound savings in the first model. This elasticity is used to derive the savings demand effects of the reform. However, the reform is simulated only on the 1998 wave of the EVS data.

Given that microdata are not available for every year, an ex ante analysis appears preferable. For an ex post analysis, additional assumptions on the development of asset demand during the last reform year (2005) and the latest year for which microdata are available (2008) would be needed.

For a survey on behavioural microsimulation models in the context of public redistribution policies, see Bourguignon and Spadaro (2006).

For a study of effects of tax reforms on asset prices and other markets in a general equilibrium framework, see inter alia Hall (1996).

As Hicksian demand functions are first derivatives of the cost function, integration over the interval of a price change yields differences in costs of reaching the same indifference curve at two distinct price vectors (see Deaton and Muellbauer 1980, pp. 184–186).

Alternatively, social utility weights could vary over the households, and inequality aversion could be introduced. This would put a higher weight on households with relatively lower income and a lower weight on households with relatively higher income. The results in Sect. 5 indicate that such weighting would reduce the aggregate welfare effects of the reform, as welfare effects increase by income and they are even slightly negative in the lower income deciles. The results found for the utilitarian welfare function shall be compared to welfare effects for an income-weighted welfare function in future research.

This decrease in the after-tax savings price corresponds to an increase in the rate of the return of about 0.20 % points, e.g. from 5.0 to 5.2 %. The prices computed here for the asset clusters are composite price indices, generated as weighted averages over the prices of the underlying single assets, where the weights are sample-average portfolio shares of asset holdings, which are assumed exogenous to the decision of allocating savings. By a composition effect, the decrease in the price for savings is stronger here than the decrease in the price for housing assets.

First-round distributional effects turn out to be structurally very similar to second-round effects for this reform. Demand responses reduce income gains only marginally on average. On the one hand, households substitute assets that became relatively more expensive through the reform for relatively cheaper assets. On the other hand, a strong income effect dominates the substitution effect for some relatively more expensive assets, or it adds to it in the case of stocks. The compound effect over all assets slightly reduces aggregate capital income for an average household. First-round distributional effects can be found in Ochmann (2010).

If demand responses are neglected, budget effects are positive for 69 % of all households in the population. They are negative for 8 %, and some 23 % are unaffected by immediate budget effects. Households are unaffected by the reform, before behavioural response, if their pre-reform taxable income is below the tax-exempt allowance and no other changes apply. If other changes, related to the broadening of the tax base or to the effect of “bracket creep”, apply in addition households may actually lose from the reform.

Maiterth and Müller (2009) further qualify this result in the context of tax equity, applying a measure for the distribution of the tax burden, and find that increasing income inequality does not necessarily allow the conclusion that the reform increased tax inequity.

Note that this increase in asset prices is related to the average price differential over all single assets. The decrease in the price for savings of 0.20 % is offset by increases in prices for other assets here.

Haan and Steiner (2005) find that labour supply effects let the income gains increase on average by an additional 126 euros in annual net household income, compared to 725 euros without labour supply effects (an additional 0.5 %-points of pre-reform income). Haan (2007) moreover finds that welfare effects are on average 34 % (153 euros in annual equivalent income) lower than income gains (449 euros) if labour supply effects are accounted for.

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Titel: Distributional and welfare effects of Germany’s year 2000 tax reform: the context of savings and portfolio choice
Publikationsdatum: 01.08.2016
Erschienen in: Empirical Economics / Ausgabe 1/2016
Print ISSN: 0377-7332
Elektronische ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-015-1003-2

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