Should Liberal Professionals and Farmers Be Liable to the German Local Business Tax? Theoretical Considerations and Empirical Analysis

Abstract

Taxing local business is a common feature of local public finance in many countries. The German local business tax (Gewerbesteuer) is the main tax revenue source of municipalities in Germany. Liberal professionals, however, have traditionally been exempted from it. In the past, the German Federal Constitutional Court justified this exemption by arguing that their production differed systematically, i.e. in their intensity of capital and labour employment. This paper shows that this claim does not hold true empirically. Furthermore, we analyse the fiscal and distributional effects of a hypothetical inclusion of the liberal professionals in the local business tax. We use a microsimulation model based on official local business tax and personal income tax files. The results indicate that the total revenue effect would be low, because the local business tax can be credited against the personal income tax. On the other hand, today's undesirably unequal distribution of local business tax revenues between municipalities would decrease. We conclude that if a local business tax is levied, all types of enterprise should be liable.