2019 Opinion issued by the Federal Performance Commissioner – Reduction of the solidarity surcharge

Jun 04, 2019

Symbolbild - Solidaritätszuschlag

0 Executive Summary
0.1
In its coalition agreement for the 19th legislative term, the government coalition agreed on relieving low and middle income earners from the solidarity surcharge as from 2021. This would result in annual revenue shortfalls of approximately €10 billion. Apart from this relief, the federal government plans to continue levying the solidarity surcharge beyond the financial planning period (2023). In his capacity as Federal Performance Commissioner, the President of the German SAI has decided to study this draft law and advise the federal government on the legal and budgetary risks associated with implementing this plan.

0.2
The solidarity surcharge is an income and corporation tax surcharge pursuant to Art. 106 para. 1 item 6 of the Basic law (German Constitution). The tax was introduced in 1995 to support the federal government, which was then in a difficult budget situation, in financing redevelopment programmes in Eastern Germany. Ever since that time, the surcharge has been levied, which makes up 25 years. Surcharges are intended to cover specific temporary funding requirements. The federal government alone benefits from the solidarity surcharge collected. In the period from 1995 to 2018, budget revenue collected from the surcharge amounted to a total of €311.7 billion.

0.3
In a public technical discussion in June 2018, the parliamentary Finance Committee debated on two parliamentary group initiatives that had the aim of abolishing the solidarity surcharge. The majority of the experts were of the opinion that the solidarity surcharge lacked legitimacy after the expiry of the Solidarity Pact II on 31 December 2019. The experts made the point for abolishing the surcharge by that time.

0.4
The prevailing opinion in technical journals is also that the surcharge is no adequate means for permanent financing. Technical authors state that the surcharge is to be abolished once the conditions for its adoption no longer apply. According to them, this is the case, for example, when the federal government has a healthy budget.

Overall, the Federal Performance Commissioner concludes that partial instead of full abolition of the surcharge as proposed by the federal government is subject to high constitutional risks. A judicial review of the solidarity surcharge by the Federal Constitutional Court seems likely to occur. There is also the risk that the federal government is sentenced to refund billions of taxes such as in the case of the nuclear fuel tax.

0.5
One key principle of budgetary and financial planning is that of prudence. In line with that principle, all expected budgetary burdens need to be estimated in the budget or cushioned by means of budgetary buffers. Neither the current financial plan running up to 2022 nor the benchmark decision adopted by the federal government on the new financial plan sufficiently address the budgetary risks likely to emerge as from the financial year 2020. So far the federal government has ignored any potential constitutional problems likely to emerge when removing the surcharge in part only as proposed in the coalition agreement.

0.6
Shifting the solidarity surcharge to other budget sections not serving reunification purposes does not seem acceptable from the constitutional law point of view. The federal government may not impose income tax surcharges for an indefinite period of time. The German Constitution does not provide for such practice.

0.7
However, since no adequate budgetary provisions have been made, abolishing the solidarity surcharge in full as from 2020 seems to be a rather difficult exercise. In the light of fiscal constraints, such as compliance with the debt rule, it may be reasonable to gradually cut down the surcharge over the new financial planning period until 2023. Any additional revenue losses beyond those catered for by current planning reserves could be made up by both cutting expenditure and generating other revenue. The federal government might

  • review the need for the various grants given to state and local governments; and
  • reduce extensive tax expenditures and other subsidy-like tax relief schemes.
  • reshape the income tax rate to set off the revenue shortfalls.


0.8
The new fiscal equalisation scheme to become effective from 2020 is based on a healthy condition of the German system of public finances which means that there are no major and new federal expenditure needs. 25 years after its implementation, the solidarity surcharge is no longer an inherent part of the tax system. The Federal Performance Commissioner recommends abolishing the surcharge for constitutional reasons promptly and fully, that is at the latest by the end of the new financial planning period in 2023.

Symbolbild - Solidaritätszuschlag

Bonn, 4 June 2019

Abolish solidarity surcharge promptly and fully

 

In his capacity as Federal Performance Commissioner, the President of the German SAI has issued an opinion assessing the legal and financial aspects of the government coalition’s intention to reduce the solidarity surcharge.

“The federal government should abolish the solidarity surcharge promptly and fully”, recommends Kay Scheller, President of the German SAI, in his Federal Performance Commissioner function. “To cushion this up, the federal government should provide for a budgetary buffer in the new 2019 to 2023 financial plan.”

The government coalition intends to relieve low and middle incomes from the solidarity surcharge as from 2021. Apart from this relief, the federal government plans to continue levying the solidarity surcharge beyond the financial planning period (2023) as it stands.

“This approach bears major risks of constitutional and financial nature”, says Kay Scheller. “There is no longer any basis for the solidarity surcharge as from year-end 2019. There is also the risk that the federal government is sentenced to refund billions of taxes such as in the case of the nuclear fuel tax.” According to Kay Scheller, this would blow a big hole in federal financial planning.

The Federal Performance Commissioner holds that it would be possible to have completely abolished the surcharge by the end of the new financial planning period in 2023 and still adhere to the debt rule requirements. “This is how reasonable and pro-active budgetary and financial planning would look like”, said Kay Scheller.

In the opinion issued, the Federal Performance Commissioner provides advice on how to cater for revenue shortfalls in current financial planning. This includes a review of federal grants provided to fund state and local government tasks and various tax benefits. To avoid one-time revenue losses, another option is to reshape the income tax rate. If the federal government intends to stick to the low tax / high tax dichotomy as stated in the coalition agreement, the solidarity surcharge adopted to finance the German reunification is the wrong instrument.

Background:

The solidarity surcharge is an additional fee resulting in tax revenues that flow to the federal budget. In 1995, in the face of the difficult budget situation, the surcharge was implemented to finance the redevelopment of Eastern Germany. The funding provided mainly by the Solidarity Pact II is to expire at year-end 2019. The federal government does not intend to continue providing special funds to Eastern Germany. Furthermore, the federal budget situation has significantly improved since 1995. Thus, the surcharge does no longer have sound constitutional grounds. Surcharges are intended to cover temporary special financial needs only.

© 2019 Bundesrechnungshof