Income tax autonomy of German states: Reform options and consequences

Abstract

The paper considers the introduction of a surtax on the federal income tax as a means to provide German states with more taxing autonomy. Simulations indicate that even a modest reform would result in strong disparities either in tax revenues or in tax rates across states. Given this background it seems likely that a reform would partially compensate differences in the taxing power by means of adjustments in the revenue sharing and fiscal equalization systems. This would, however, lead to problematic incentives for the states' tax policies. Although horizontal competition would exert a downward pressure on the tax rates, the incentives provided by the horizontal fiscal equalization system and the vertical revenue sharing might well result in excessive taxation.