Opinion

US tax reform and implications for the German coalition agreement

Major recent reform of US tax laws represents a serious challenge to Germany, highlighting several weaknesses in the country's economy. The formation of Germany's coalition government represents an opportunity to discuss its own tax changes, which could remedy current problems and stimulate a sustainable domestic boom.

By: and Date: February 7, 2018 Topic: Global economy and trade

A version of this article is published by Caixin and Manager Magazin.

caixin logo

Manager Magazin logo

In the wake of the recent passing of major reforms to US tax laws, the European Union and Germany urgently need to discuss the implications of the new measures for their own tax system.

Beyond the income tax changes, the reform reduces the tax burden on corporate profits and, importantly, puts in place a 100% expensing rule for capital investments. As a result, the US will likely become more attractive as a place to invest and do business.

A first indication of the tax reform’s effects has been Apple’s recent announcement to plan a new “campus” in the US and accelerate investments. Moreover, the tax reform will increase the deficit of the United States in a pro-cyclical way, which may further increase the current account deficit of the US.

The European Union’s first and most immediate concern with these reforms should be that of tax competition. Here we are touching upon a politically very sensitive topic; popular opinion is certainly very concerned by tax competition and the perceived shift of tax revenues away from corporate taxes to labour taxes.

One widespread political concern in Europe is that the Trump administration’s move will accelerate the race to the bottom on corporate tax rates and increase pressure in Europe to follow suit – with consequences for the financing of the relatively large European welfare state. This concern is particularly pronounced in France, which has a relatively high corporate tax rate. France has been strongly pushing the policy debate on achieving a more harmonised European corporate tax setting that would prevent a further race to the bottom in tax rates.

A second important consideration relates to the impact of the US tax reform on current accounts. To start with, the US current account deficit could, at least initially, increase due to the increased fiscal deficit. Moreover, the gain in the relative attractiveness for investment in the US – as compared to Europe and Germany – could pull corporate investments away from Europe towards the US.

A combination of tax exemptions for domestic investment and a number of supply-side reforms would trigger a new and sustainable domestic boom in Germany

The latter point should be of particular concern to the incoming German government. Germany currently has the largest current account surplus in the world, amounting to around 8% of GDP. From the beginning of monetary union – when Germany’s current account surplus was in slight deficit – through to the present, the move towards greater surplus has primarily been driven by increasing savings and falling investments in the German corporate sector. In particular the low corporate investment in Germany has led to a stagnation of the German capital stock. Germany’s capital production intensity has fallen relative to that of the United States.

On a political level, Germany has been singled out by the US president for its large bilateral trade surplus with the US. While the bilateral trade measure is not an economically useful measure, it does influence political perceptions in the US. But also organisations such as the IMF have been pointing to the fact that Germany’s current account surplus reflects an excess in corporate savings, relative to a weakness in corporate investment, which is undermining prospects for growth in Germany and is ultimately not in Germany’s interest.

In these circumstances, it would be useful for the German policy establishment to have a serious conversation on German corporate tax reform. The coalition agreement puts a strong focus on reducing tax competition in the European Union by suggesting a collaboration with France on a common consolidated tax base and minimum tax rates. Neither Germany nor France wants to engage in a race to the bottom on corporate tax revenue, as they want to preserve a strong social model and a relatively large government sector.

Still, this approach does not provide an answer to the strategic challenge posed by the US tax reform and its impact on investment in Germany. The German debate should add a focus on depreciation allowances for capital investment, and for research and innovation investment. Such a tax reform would provide strong incentives for the German companies that currently hold large amounts of cash to invest in Germany.

Rather than holding their savings in short-term assets with relatively low returns outside of Germany, a combination of tax exemptions for domestic investment and a number of supply-side reforms would trigger a new and sustainable domestic boom in Germany. This policy would not only be good in bringing down Germany’s current account surplus, it would also be helpful in further boosting salaries in Germany that have suffered partly from the weak development in German capital stock.

The new government should address the challenge posed by US corporate tax reform head on. A sensible response would be to incentivise corporate investments while cooperating with France on the tax base and the tax rates.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article Download PDF More on this topic
 

Book/Special report

European governance

Instruments of a strategic foreign economic policy

Study for the German Federal Foreign Office produced by Bruegel, the Kiel Institute for the World Economy and DIW Berlin.

By: Katrin Kamin, Kerstin Bernoth, Jacqueline Dombrowski, Gabriel Felbermayr, Marcel Fratzscher, Mia Hoffmann, Sebastian Horn, Karsten Neuhoff, Niclas Poitiers, Malte Rieth, Alexander Sandkamp, Pauline Weil, Guntram B. Wolff and Georg Zachmann Topic: European governance Date: November 12, 2021
Read article More on this topic More by this author
 

Blog Post

What to make of the EU-US deal on steel and aluminium?

While deeply disappointing that the surprise deal maintains aluminium and steel tariffs against the EU beyond a modest quota, it alleviates a major irritant in transatlantic relations and contains interesting and innovative features relating to climate policy and to dispute settlement under WTO rules.

By: Uri Dadush Topic: Global economy and trade Date: November 4, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

Opinion

European governance

The inconsistency in global strategic relations

All of this talk on strategic retrenchment and autonomy is the language of escalation, not of appeasement and collaboration.

By: Maria Demertzis Topic: European governance, Global economy and trade Date: October 13, 2021
Read article Download PDF More by this author
 

Policy Contribution

Inclusive growth

Do robots dream of paying taxes?

The digital transition should be managed – and taxed – alongside other societal transitions, but any tax on companies that replace employees with automated systems should be targeted and carefully designed to not stifle innovation.

By: Rebecca Christie Topic: Digital economy and innovation, Inclusive growth Date: October 5, 2021
Read article More on this topic
 

Blog Post

German elections: seizing the moral and economic opportunity of global health security

The new German government should play its part in global health security and preparedness.

By: Amanda Glassman and Guntram B. Wolff Topic: Global economy and trade Date: September 24, 2021
Read article More on this topic More by this author
 

Blog Post

Germany’s foreign economic policy: four essential steps

Germany and the EU need to develop a strong and proactive agenda to manage foreign economic relations, which are essential for German and European prosperity.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: September 23, 2021
Read article
 

Opinion

Relaunching transatlantic cooperation with a carbon border adjustment mechanism

The best way for the EU and the US to jointly introduce carbon border adjustment would be to form a ‘climate club’.

By: Simone Tagliapietra and Guntram B. Wolff Topic: Global economy and trade, Green economy Date: June 11, 2021
Read article More by this author
 

Podcast

Podcast

A transatlantic climate alliance

When Joe Biden visits Europe for the first time as US president, he should begin forging a transatlantic green deal.

By: The Sound of Economics Topic: Global economy and trade, Green economy Date: June 11, 2021
Read article Download PDF More on this topic More by this author
 

External Publication

The Value of Money, Controversial Economic Cultures in Europe: Italy and Germany

A discussion of Italian and German macro-economic cultures and performances.

By: Francesco Papadia Topic: Macroeconomic policy Date: June 10, 2021
Read article More on this topic More by this author
 

Blog Post

Inflation!? Germany, the euro area and the European Central Bank

There is concern in Germany about rising prices, but expectations and wage data show no sign of excess pressures; German inflation should exceed 2% to support euro-area rebalancing but is unlikely to do so on sustained basis.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: June 9, 2021
Load more posts