Germany in tax competition [Deutschland im steuerwettbewerb]

The paper offers theoretical and empirical evaluations of the 1997 German tax reform from the viewpoint of international tax competition. Has Germany done the right thing to improve its competitive position? To answer this question the paper distinguishes between investment whose return is taxed according to the source principle (direct investment) and investment whose return is taxed according to the residence principle (normal investment with an international connection through financial investment). Although the reform is of the tax-cut-cumbase broadening type which induces a lengthening of depreciation periods, it reduces the cost of capital for the first type of investment. The second type of investment which is empirically the more important one, is discriminated by the reform, since, in a situation of accelerated depreciation, even the tax cuts themselves increase the cost of capital. While both types of investment are adversely affected by the reform, it is worth noting that the reform is unambiguously welfare improving from a national point of view, since in either case it narrows the gap between the social return and the social opportunity cost of investment. The paper substantiates its theoretical findings with detailed empirical cost-of-capital calculations.