Christoph Trautvetter ■ Elucidating the missing half – the tax rate of a typical millionaire in Germany
We’re pleased to share this blog post written by Christoph Trautvetter & Julia Jirmann from Netzwerk Steuer Gerechtigkeit.
Every year, just before the rich and powerful meet in Davos to discuss politics, Oxfam publishes a report that shows that the rich have become richer. Ten years since the first of these studies the situation hasn’t changed. Indeed Oxfam just published another report showing that the richest 1 percent have captured more than half of the wealth created since 2012 and that in the crisis years since 2020, billionaire wealth has grown at 2.7 billion US-dollars per day.
With these shocking numbers, Oxfam calls on governments to “tax the super-rich now”. One of the central elements to achieve this is taxing the companies they own. The Tax Justice Network has done a remarkable job showing how corporate tax rates have raced to the bottom over the last two decades and how huge corporations damage public budgets around the world by shifting profits. And this awareness-raising work has not been without impact. EU countries are now at work on implementing EU-wide public country-by-country reporting. Together with many other countries they are also set to implement the global minimum tax negotiated by the OECD and the UN has just embarked on the long journey towards a more inclusive global tax architecture. But corporate tax is just half the story (and a minimum tax of 15% about half of that half).
Once corporate profits are taxed, they become capital income and in many countries the owners are supposed to pay personal income tax on them. Just like corporate tax rates, personal income tax rates for the rich have been cut dramatically over recent decades from around 50 percent to 60 percent in the 80s and to about 30-40 percent nowadays. But with a corporate minimum tax of 15 percent and many gaps in the taxation of capital income, the super-rich often end up paying lower tax rates than a normal worker.
But – with a few exceptions –taxes on capital income are notably absent from the global tax justice debate. The main reason for that is that they are very diverse and country-specific. That’s why Oxfam’s Commitment to Reducing Inequality Index only looks at corporate tax and personal income tax on labour and why TJN has focussed on corporate tax so far. We believe that taxing the super-rich requires national debates around the taxation of capital and capital income that lay the ground for international minimum standards in the future. And for those debates we need simple illustrations of the diverse tax rules.
To illustrate the gaps and privileges of capital taxation in Germany we have therefore assembled the portfolio of a typical multi-millionaire, calculated their tax rate and compared it to the tax rate of an average working family. The result is clear and striking: With a combined tax and social contribution rate of 24 percent they pay a little over half the 43 percent due from the average couple. And that’s the rate after accounting for the corporate tax their company pays and before including any special trickery or outright tax evasion that rich people often use.
The concrete calculations are the following:
- Assets and income: Our typical millionaire has total assets of €23 million. They work in the family business and receive a salary of €200,000.
- In addition, they have inherited shares in the company, for which they receive a profit share of €600,000 in 2022 which they save in family holding company
- They also own 40 rental apartments in Berlin worth €8 million euros, from which they receive around €200,000 in rental income, which they also save in the family holding company.
- The assets saved in the family holding are invested in equity funds. These generate an average return after costs of 6 percent
- In addition, they still own a 4 percent interest federal bond since childhood.
Beyond that they have sold an apartment this year which they owned from their student days for a profit of €300,000.
- In total, their income amounts to €1,645,000 in 2022.
- Their assets have also grown by a further €1 million due to increases in the value of his shares in the company and the real estate
- Income tax is only payable on income from employment of €200,000. Because their spouse has no earned income the couple benefits greatly from German spousal splitting (i.e. the couple’s income is added together to calculate the tax rate and then halved). After taking into account all allowances and deductions (e.g. costs of private schooling and donations) as well as the application of the spousal splitting, the taxable income for the couple is €136,504. The top tax rate of 42 percent only applies to a small portion of the salary (the part that exceeds 117,914 euros) and the wealth tax threshold above which a tax rate of 45 percent applies is not reached at all. The effective tax rate of their salary is 16.18 percent.
All other income of the millionaire is capital income (1.45 million euros). The effective tax rate on this is 21.88 percent. These can be broken down as follows:
- The profits of the family business are taxed with corporate income tax (Körperschaftsteuer), local business tax (Gewerbesteuer) and solidarity surcharge. This amount leads to an average tax rate of around 30 percent. If the company profits are distributed to the owner’s private account, personal income tax is due. If, however, he does not distribute the profits to his private account, but to a GmbH (limited liability company) that acts as a family holding company, no taxes are due. Thanks to the prohibition of deduction for part of the operating costs, 1.2 percent tax is effectively due.
- Just like the shares in the family business, the real estate does not belong directly to our millionaire, but to a subsidiary of the family holding company. This company benefits from a tax privilege: it is effectively exempt from local business tax as long as it does not engage in any “harmful” commercial activities. Thus, after deduction of costs, the rental income is taxed only through corporate income tax and the solidarity surcharge, i.e. together at 15.83 percent. In addition to the standard costs for administration, depreciation and interest payments can also be considered as costs from a tax perspective. There are various ways to artificially increase the costs. To simplify, we assume that our multimillionaire artificially increases his costs by €50,000 euros. As a result, the real estate is effectively taxed at 12.31 percent.
- With the total of €5 million retained in the family holding company (including compounded interest), our millionaire invests in the stock market. With an annual return after costs of 6 percent, this results in capital gains of €300,000. The family holding company invests in an equity fund. Twenty percent of the income is taxed. Including the 15 percent tax at the level of the fund and the corporate tax at the level of the distributing company, the effective taxation is 43.4 percent. However, if our millionaire had distributed the original invested profits directly instead of saving them in the family holding company, he would have had less money left to invest. Taking this lower level of investment assets and the resulting income as a basis, the effective tax rate for retained investment income is 32.01 percent.
- The federal bonds from their childhood worth €500,000 earn interest at 4 percent. They pay capital gains tax and solidarity surcharge on the interest income, i.e. 26.5 percent. Should these bonds ever expire, they can give the remaining assets to their company as a shareholder loan at the same interest rate and continue to benefit from low-taxed interest income.
- They sells the apartment from their student days with a capital gain of 300,000 euros. The profit remains completely tax-free, as the purchase was made 10 years ago.
- The increase in the value of their assets is not taxed because it is not realized (i.e. when the assets are sold).
Overall result: As the following table shows, a tax rate of 21.8 percent is therefore due overall. If the millionaire distributes the income saved in the family holding company, the tax rate rises to 35.75 percent.
|Income and tax type||Income||Taxable income
||Tax||Nominal tax rate||Effective tax rate||Tax gap, tax privileges, optimisation options|
|Salary family business||€200,000||€136,504||€32,372||23.71%||16.18%||School fees, donations, household-related, spousal splitting, etc.|
|Profit family business||€600,000||€600,000||€187,200||31.20%||31.20%||Retained earnings, further structuring options not taken into account (eg privately used company assets, private leasing of real estate, shareholder loans, profit shifting)|
|Rental income||€250,000||€175,000||€27,703||15.83%||12.31%||Repeated depreciation, local business tax exemption|
|Stock investment||€300,000||€221,250||€96,023||43.40%||32.01%||Compounded interest benefit of retained and reinvested earning, further structuring options of the Investment Tax Act not taken into account|
|Federal bonds||€20,000||€20,000||€5,250||26.25%||26.25%||Flat rate withholding tax|
|Inherited apartment in private property||€300,000||€0||€0||0%||0%||Capital gains exemption after a 10-year period|
The calculation includes only taxes and no social security contributions. If social security contributions are added, the tax and contribution ratio is only 24 percent and thus only about half of what a couple with a German average gross income of €110,000 pays. This is due to the fact that his social contributions are only due on his income from non-independent employment. Capital income is not subject to contributions. In addition there are income thresholds above which additional income is no longer subject.