Taxation in Germany and Switzerland – Comparitive Study

Authored By: Shreyas B. T

We have seen in the previous posts on how taxes are collected in India by the three levels of government, the Center collecting the vast majority of the taxes and mechanisms (with the specifics of the latest/ 14th FC’s recommendations) of the Center sharing part of those taxes with the States and most importantly the lacunae in the very principles and formulae around it.

 Let’s now see what and how is it done in some of the European Federal Democracies:

Germany: Germany’s constitution (which is called The Basic Law), divides the authority predominantly between the Federal (Center) and the Lander (State) governments. Just like the Indian Constitution, Germany’s Basic Law also clearly defines which layer of the government collects which tax.

The table below provides a view of some of the most important German taxes and their collection authorities. VAT and Income Tax are the largest by far, and it can be clearly seen that those are called and treated as “Shared” revenues.

Taxation Powers in Germany
Federal Energy, Insurance Tax, Tobacco
Landers (States) Inheritance Tax, Transactions Taxes (Real Property Transfer Tax)
Local Authorities Real Property Tax, Trade Tax, Local Excise Tax
Shared Income Tax, Corporate Tax, VAT, Solidarity Surcharge

These taxes are then shared with the other layers of governments to carry out public spending to deliver policies falling in areas of their respective responsibilities. A high-level split of the shared taxes between the Federal, Lander (State) and Local Authority buckets are:

Vertical Distribution
  VAT Income Tax Corporate Tax
Federal 52.00% 42.50% 50.00%
Lander (State) 45.50% 42.50% 50.00%
Local Authority 2.50% 15.00%

 A key factor to note here is that every Lander (State) eventually receives 42.5% of Income Tax revenues that are collected for the income of its inhabitants (income earned from either inside or outside of its territory). Likewise, even the Corporate Tax is distributed to the Landers (States) where the corporate operates based on the respective share of the wages in the total.

Such arrangements ensure a rightful share of the Income Tax and Corporation Tax reach the Landers and fairly compensate the Landers for the resources it would have spent on providing the living conditions for the people; and an operational ecosystem and infrastructure for the corporates.

 The Landers’ share of VAT however follows a rather uncreative arrangement (like in the Indian context, where more populous yet poorer States eat into the less populous yet financially disciplined States’ contribution) – where a State’s population gets an approximate weight of 75% and the rest 25% weight is earmarked for the financial “backwardness” of the States having lower than the per capita average of all States.

 There are a few more Financial Equalisation arrangements applied (like the Supplementary Federal Grants from the Federal’s kitty) to ensure harmonization to provide a near equal living conditions across the country.

Impact of Financial Equalisation and Supplementary Federal Grants
Without

Financial Equalisation

After

Financial Equalisation

After Financial Equalisation

+

Supplementary Federal Grants

70.00% 91.00% 97.50%
80.00% 93.50% 98.00%
90.00% 96.00% 98.50%
100.00% 100.00% Not Required to be compensated further
110.00% 104.00% Not Required to be compensated further
120.00% 106.50% Not Required to be compensated further
130.00% 109.00% Not Required to be compensated further
All numbers represent Financial Capacity per inhabitant in a Lander as a % of the average financial capacity per inhabitant across the Federation

 Although such arrangements of grants might sound like penalizing the rich and/ or financially disciplined Landers for their good work to compensate the poorer and/ or less financially disciplined Landers, a positive correlation can be seen between a German State’s population and its financial strength (unlike the Indian scenario). This factor greatly avoids chances of unfair compensation for poor performance/ discipline.

Also, another key difference is that the supplementary grants are usually time bound and not perpetual (like the East German State gets 105 bio Euros till 2019 to build up infrastructure which was comparatively underdeveloped as a result of partitioning of Germany), which indirectly encourages the recipients of such grants not to take it for granted and instead to work towards improving their financial health.

 Switzerland: The Swiss Republic that has a population of just about 8.5 million (just for comparison, the population of Bengaluru city alone is about the same), considers itself a heterogeneous country – because of its multi-lingual* and multi-confessional** nature!

*There are four official national languages, German (65%), French (20%), Italian (8%), Romansch (1%); other languages count for about 6 % of the population.

**Religion is divided into 47% Roman Catholic, 41% Protestant; 12% belong to other religions or have no declared religious affiliation.

 Without delving a lot (into the rightful importance the Swiss have attached to diversity despite these seemingly small numbers when compared to the Indian scene) given the context here is “Taxation”, this very presence of diversity has prompted the Swiss to create a highly decentralized system for themselves to be able to best address the diverse needs of the diverse 8.5 million population! The idea of decentralization clearly reflects in the way taxation and public expenditure powers and leeway the various levels of governments possess. Let’s see more on this in the following sections.

 The table below provides a view of some of the most important taxes and their collection authorities:

Taxation Powers in Switzerland
Federal Income Tax, Corporate Tax, VAT
Cantons (States) Income Tax, Wealth Tax, Corporate Tax
Communes (Municipality) Income Tax, Wealth Tax, Corporate Tax

As can be seen from the above table, Income, Wealth and Corporate Tax collection span across multiple levels of government. The split is achieved by a moderate taxation at each level so that no single government exhausts the entire tax capacity – and more importantly, the assessment of priority is first to the Cantons, then to the communes and lastly to the Confederation.

Even the Cantons and Communes’ share of the Income Tax is entirely paid in the canton and the communes of residence; and any income obtained in other jurisdictions is assessed in the jurisdiction of residence according to the rules of the jurisdiction of residence (and not the rule of the jurisdiction where the income has been gained).

A similar treatment is given to Corporate Tax as well – when corporate business takes place in several jurisdictions, the yields of the profit and capital taxes are distributed between those jurisdictions according to financially measurable components of the activity (for example turnover, the volume of sales, total insurance premiums for insurance companies).

 A more granular split of the revenues that the three levels of government have a final handle on is as shown below:

  Confederation

(Center)

Cantons

(States)

Communes

(Local Corporations)

Taxes on Income and Wealth 30.19% 39.58% 30.23%
Consumption or expenditure

taxes

92.68% 7.06% 0.26%
Fiscal Monopolies, Licences 25.04% 62.75% 12.21%
Revenues from public property 47.41% 24.87% 27.73%
Revenue-sharing 0.11% 75.95% 23.94%
Grants-in-aid 0.11% 72.17% 27.72%
Indemnities and sales 10.65% 41.91% 47.44%
Total 33% 40% 27%

 The cantons and the communes enjoy a similar autonomy with the public expenditures as well, thereby being able to spend on focussed local situations.

Respective shares of public expenditures
  Split between 3 layers of Government Split within budget of a Government layer
Function Confederation Cantons Communes Confederation Cantons Communes
Administration 18% 38% 44% 3% 5% 9%
Public Order 7% 67% 26% 1% 8% 5%
National Defense 90% 5% 5% 11% 1% 1%
Foreign Affairs 100% 0% 0% 4% 0% 0%
Education 12% 53% 35% 7% 24% 23%
Culture & Sports 13% 31% 56% 1% 2% 5%
Health 1% 56% 43% 0% 16% 18%
Social Affairs 44% 37% 19% 27% 19% 14%
Transportation 51% 32% 17% 18% 9% 7%
Environment 12% 24% 63% 1% 2% 9%
Economy 52% 40% 8% 10% 6% 2%
Finance 51% 27% 22% 15% 7% 8%
Total 33% 40% 27% 100% 100% 100%

 It can be seen that the Swiss Cantons and the Communes have a direct handle on 2/3rd of the total revenues and expenditure to achieve public policy delivery.

 Conclusion: Study on the above two advanced countries is just an example to illustrate the importance of decentralized policy delivery and hence the importance of flexibility with revenue generation (taxation) and public expenditure.

Unless India takes a leaf out of such example models, localized policy delivery will be elusive eternally and hence ineffective and less relevant policy delivery will continue until that time!

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