The Short-Term Fiscal Effects of the Preferential Treatment for Non-Incorporations' Retained Earnings

Abstract

With the 2008 reform of business taxation (Unternehmensteuerreform 2008) a preferential treatment of retained earnings for non-incorporated companies was introduced: Earnings may be retained at a preferential tax rate (29.8%) and will be subjected to supplementary tax (26.4%) when they will be withdrawn in the future. By now, studies on this topic have been based on case studies. Our article is based on microdata of the German Income Tax Statistics 2002 and provides a general empirical analysis of the new regulation's fiscal effects. Unlike studies before, we do not only consider marginal tax rates but also take into account that retained earnings may reduce progressive income tax for other earnings. Moreover we consider that taxpayers may retain earnings without having to pay supplementary taxes on these earnings if they are withdrawn within two years. On the individual level, beneficiaries of the preferential treatment are mainly taxpayers with high income. For instance, those with an annual income of at least 750,000 Euro reduce their tax burden by approximately 10% (unmarried, withdrawal before retention of 100,000 Euro). By contrast, taxpayers with an annual income of less than 22,087 Euro do not benefit from the reform at all. On the macroeconomic level, the fiscal effects of the reform are considerable: Depending on the scenario, we estimate a shortfall in receipts of 3.4 bn, 5.0 bn Euro and 7.5 bn Euro (theoretical upper limit).