Tax coffers, ready to burst

The well-known Berlin-based neoliberal think tank Initiative Neue Soziale Marktwirtschaft (Initiative New Social Market Economy) organised a discussion on the topic of ‘just tax policy and full tax coffers – why tax reliefs are justified’ on the 12th of July 2017. The Federal Minister of Finance, Dr. Wolfgang Schäuble (Christian Democrats/CDU), debated with one of the top three German economists, president of the ifo-Institut in Munich, Professor Dr. Clemens Fuest. The background of the discussion regarded German tax coffers, which are ‘ready to burst’, and vivid debates on how this money should be spent.

Electoral campaigning and the political question of redistribution

In his speech, Dr. Wolfgang Schäuble generally rejected all forms of Keynesianism and emphasised his commitment to financial austerity, including austerity within the European context. From his arguments, it became clear that his (and his party’s) most important constituency for the upcoming federal elections on 24th of September are the middle and high-income classes. For example, Professor Fuest stated that he does not consider the concept of the so called Baukindergeld (financial subsidies for parents buying a house or an apartment regardless of income), that the Christian Democrats favour, to be the right tool to help lower income groups.

On the other hand, Schäuble said that income derived from investments (a.o. shares) should be taxed in the same way as income from employment. (At the moment, tax on income from investment in Germany is only 25 percent.) Besides the Baukindergeld this is also one of the initiatives the Christian Democrats plan to implement in the event that they form the new government.

Rising inequality?

After the seminar, an informal discussion among certain participants took place where it was argued that inequality within Germany is not significantly rising. This is quite remarkable, given a situation where institutions like the IMF and OECD are pointing to growing inequality in OECD-countries as a serious problem that needs to be addressed. One of the most important indicators for income distribution is the Gini index (here after taxes and transfers). In the IMF paper, it is mentioned that the income Gini index in Germany increased over 30 percentage points in recent years, while at the same time the popularity for more redistribution measures increased by 70 percentage points between the late 1990’s and the late 2000’s. The OECD study also confirms an increase in the Gini income index for Germany from 1985 to 2013, increasing by approximately 20 percentage points.

Source: OECD: http://stats.oecd.org/Index.aspx?DataSetCode=IDD

A central study that is frequently cited to show that inequality in Germany is not significantly rising, is a report from 2014, written by the German government-funded Sachverständigenrat zur Begutachtung der wirtschaftlichen Gesamtentwicklung (German Council of Economic Experts). This report challenges the myth of rising inequality, using OECD data as basis for its claim that: “In international comparison, the temporal development of income inequality in Germany is inconspicuous. As in almost all OECD countries, inequality of income over the past two decades has increased in the long-term comparison…” This underlines the point of view of the authors that rising inequality is not problematic, partly due to the fact that in most OECD inequality is on the rise too. This judgement was confirmed in the report for 2015/2016.

The report states further that “The improvement of the labor market situation since the mid-2000s – following the reforms of Agenda 2010 – was accompanied by stable distribution results. For example, a comprehensive analysis of the aggregate distributions of income and wealth in Germany provides an inconspicuous picture for the past ten years”. Moreover, the report maintains that: “since the mid-2000s, the development of the middle class income share has been as inconspicuous as the development of the Gini coefficients for the equivalence-weighted household and net household incomes”. To bring this point home, the report is referring to a paper by Grabka et al., 2015. Surprisingly, the paper by Grabka, et al. proves that Germany witnessed a sharp rise in inequality of disposable household income until the mid-2000s and that since then disposable household incomes are stagnating at a high level.

Summarising, this means, that it is widely acknowledged that a steep rise in income equality in Germany has taken place from 2000 until 2005 (see the chart above). However, the Sachverständigenrat puts emphasis on the fact that there is no significant increase in inequality of disposable household income starting from 2005, and that most OECD countries witnessed a steep increase in inequality too. Therefore, the Sachverständigenrat comes to the conclusion that German development can be regarded as inconspicuous. In contrast, the Grabka, et al. study, the Sachverständigenrat referred to in order to prove its own evaluation of the situation, is assessing the situation quite differently. Grabka, et al. underline the fact that inequality among disposable household income rose sharply until 2005 and to this day remain on a high level compared to past decades.

Moreover, the Sachverständigenrat is referring to the fact that income inequality is on the rise in the last decades in other OECD countries too, which makes Germany’s rising inequality appear as in line with the overall development of advanced economies. Nevertheless, the fact that inequality is rising in overall terms can hardly be used as an argument to ignore the phenomenon of inequality.

What does this mean for fiscal and distributional policies?

When it comes to the question of who (lower, middle, or upper classes) should receive the money from bursting tax coffers, it is certainly relevant whether one believes income quality exists in a society, and if income inequality is actually a problem. Probably, strong support by the Sachverständigenrat for the argument that the level of income inequality is not problematic, would subsequently lead policy-makers –  those who base their reasoning solely on that source –  that a redistribution to lower income classes should not be a priority.

In contrast, taking into account the assessment made by Grabka et al. politicians would possibly arrive at a different conclusion, namely that income inequality is a serious issue that needs to be addressed by improving the disposable incomes of the 40 percent bottom income groups.

Besides the assessment of income distribution another important indicator of is the concentration of wealth. In most countries of the world wealth concentration is much higher than income concentration. The German case illustrates this well, where 10 percent of the top earners are representing 25 percent of overall disposable income, while at the same time owning 60 percent of household net wealth in 2012. In an integrated view wealth concentration and income inequality at high levels can make a stronger case for policy-makers to take measures to address inequality.

Outlook

Conservatives often hold that governments should generally not engage in income or wealth distribution because this disincentives people from working hard, which will eventually harm economic growth and innovation. Left-leaning people are usually arguing in favour of redistribution to lower income classes, holding that extrinsic motivation (money) is not the most important motivation for people to work hard and that more resources channeled to the poor would result in more consumption and thus strengthen the economy.

Finally, governments around the globe have to confront the discussion if inequality is rising (or if it is at historically high levels), and if this poses a problem for the well-being societies. There has been a growth of populist political movements[1] that are in some contexts replacing established parties and gaining substantial electoral support from politically disenchanted citizens. This is partly because of these voters’ deteriorated economic situations, and indicates that high inequality (or rising inequality), may create severe tensions within society, putting social peace and cohesion at risk. Policy-makers therefore bear a special responsibility to closely monitor this development and to take appropriate actions.

 

[1] Examples for right-wing populist parties in Europe: Alternative für Deutschland (AfD), Front Nationale (FN), Swedish Democrats (SD), Law and Justice (PiS), UK Independence Party (UKIP),

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Klemens Witte
Klemens Witte, Research Associate at the DOC, is specifically interested in economic questions, international relations, and policy-making. He holds a Masters in Political Science and Intercultural Communication (Martin-Luther-University Halle-Wittenberg), a second Masters in Baltic Sea Studies (Södertörns University College/Stockholm), and a postgraduate LL.M. in International Economic Law (Southwest-University for Political Science and Law/Chongqing and Martin-Luther-University Halle-Wittenberg). Klemens Witte has gained international experience in universities in Kazan, Moscow, Kaliningrad, Minsk, and Beijing. He has further work experience within the fields of internationalization and education as a desk officer with Swedish government ministries and as a lecturer from the Moscow State Institute of International Relations. He speaks German, English, Swedish, Russian, and Chinese.