Politics & Policy

Germany’S Art Laffer

Meet Paul Kirchhof, a pro-growth tax reformer who's as good as they come.

With a month to go before the general election and polls showing some erosion of support, Christian Democratic Union (CDU) leader Angela Merkel decided to add the Arthur Laffer of Germany to her campaign. Paul Kirchhof, 62, a University of Heidelberg professor and a former constitutional court judge, became the instant star of the team.

In Germany, the name Kirchhof, like Laffer, is synonymous with pro-growth tax reform. It began when Kirchhof was still sitting on the Federal Constitutional Court, the nation’s highest court. From 1987 to 1999, he made a series of decisions mandating changes in tax policy. After leaving the bench, he developed what’s been dubbed the “Kirchhof model” — a flat-tax plan that he’s popularized in numerous newspaper op-eds.

Kirchhof would replace Germany’s steeply progressive income tax with a flat-rate tax of no more than 25 percent and at the same time eliminate myriad tax loopholes and fiscal subsidies — an astonishing 163 taxpayer subsidies, to be exact. The new flat tax would extend to all manner of income, including individual, corporate, and interest income, thereby curtailing the separate tax treatment of corporate and partnership earnings.

His plan would provide a basic allowance of €8,000 for every household member, including minors, plus an additional €2,000 allowance to offset wage earners’ working expenses. The tax would be phased in, applying to only 60 percent of the first €5,000 in taxable income and 80 percent of the next €5,000 up to €18,000, wherein the 25 percent flat tax would fully apply.

In answer to questions at a Berlin news conference announcing her new team, Merkel wouldn’t promise Kitchhof a cabinet seat in a new government, however. Neither did she endorse his flat-tax plan. Instead, she remained committed to her previous pledges to raise Germany’s value-added tax from 16 percent to 18 percent and to trim the top marginal income-tax rate by just 3 percentage points from 42 percent to 39 percent.

Clearly, while Kitchhof’s inclusion in the campaign doesn’t signal Merkel’s conversion to supply-side economics, her decision does bring Germany a step closer to pro-growth tax reform. The Frankfurter Allgemeine Zeitung, commenting on her decision, called Kitchhof a “ray of hope,” adding that “with this man, [the Christian Democratic Union/Christian Social Union alliance] is generating renewed interest in its financial policies.” And as Lower Saxony Prime Minister Christian Wulff put it: “In a few years, we will have the Kirchhof model.”

Although it’s unclear what, if any, role Kirchhof would play in a Merkel government, one thing’s certain: He’s no pushover. During his tenure on Federal Constitutional Court, for instance, Kirchhof penned a landmark decision reserving Germany’s right to reject any European Union (EU) directive that breached its own constitutional law. The thunderous 1993 ruling, aimed squarely at the European Court in Luxembourg, is still the closest any EU member state has ever come to rejecting the primacy of EU law.

Whatever the fate of Kirchhof and his flat tax, the London Telegraph said that Merkel’s “choice of such a contentious figure to shape economic policy shows how quickly Germany’s ideological landscape is changing as the free-market revolution sweeps across from eastern Europe.”

A flat-tax tide is sweeping across the former East bloc. Estonia became the first European nation to institute a flat-rate income tax in 1994 (initially at 26% and later cut to 24%). Eight other countries have since joined the flat-tax club — Georgia (12%), Latvia (25%), Lithuania (33%), Romania (16%), Russia (13%), Serbia (14%), Slovak Republic (19%), and Ukraine (13%) — and Hungary is considering the flat tax, too.

Germany surely needs a pro-growth fiscal catalyst. Since the leftist Social Democrat Gerhard Schroeder became chancellor in the fall of 1998, GDP has expanded at an average annual rate of 1.9 percent (in nominal terms on a year-to-year basis, seasonally adjusted). That’s roughly half the 3.7 percent GDP growth rate scored under conservative Christian Democratic Chancellor Helmut Kohl in the post-unification period.

More significant, without the benefit of government spending or exports of goods and services, Germany’s nominal domestic private-sector GDP, seasonally adjusted, actually averaged a 0.9 percent annual decline under Schroeder compared with an average annual gain of 2.9 percent during Kohl’s post-unification tenure.

Similarly, in the 2005 first quarter, while total nominal GDP was up 1.5 percent from a year earlier, the domestic private economy had actually shrunk by 2.6 percent from a year before. Personal disposable income growth, meanwhile, has been sluggish at best, averaging 2.3 percent since the fall of 1998 on a year-to-year basis versus a rate of 3.4 percent in 1992-98. In the first quarter of this year, income grew by a mere 0.8 percent from a year earlier.

Merkel’s to be applauded for adding as insightful a tax reformer as Paul Kirchhof to her campaign. Yet Germany would be infinitely better off if she’d take matters a step further and heed his flat-tax ideas.

– William P. Kucewicz is editor of GeoInvestor.com and a former editorial board member of the Wall Street Journal.


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