Differences in the tax structure between the UK, Germany and Switzerland

Table of Contents

Abbreviations

1. Introduction

2. Background and history of Germany and Switzerland

3. Tax structure in the UK, Germany and Switzerland

4. Trends within and between Germany and Switzerland

5. Similarities and differences within and between the UK, Germany and Switzerland

6. Conclusion

References

Abbreviations

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1. Introduction

This essay provides a short survey of the different tax structures prevailing in the UK, Germany and Switzerland. By doing so, the basic differences and the substantial similarities within and between these three covered countries are presented.

This essay commences by outlining the tax history of Germany and Switzerland. Following, the third section is concerned with the different sources of tax revenue within each above-mentioned country. In the fourth section the focus is channelled to the trends within and between Germany and Switzerland. In this regard, the trends are identified, analysed and finally compared. After outlining the different trends the concentration shifts onto any similarities and differences between and within each country. This essay concludes by summing up the main findings of the different tax structures in the UK, Germany and Switzerland.

2. Background and history of Germany and Switzerland

The development of the German tax system in which social security contributions and the income tax are of paramount importance started mainly in the 19th century.

As the first state in Europe, Germany, which was founded as a federal state in 1871, implemented a series of regulations regarding social security. In 1883 Bismarck, the imperial chancellor, introduced health insurance in Germany in order to alleviate growing pressure from the labour movement. Further, in the following years accident insurance (1884) and pension insurance (1889) were brought into being mainly to reduce civil commotions as well as to encounter socialism (Wikipedia, 2006). As a logical consequence of the changing fiscal system in Germany, the Miquelschen fiscal reform in Prussia in 1891 was carried out to upgrade the German tax system. This reform helped the income tax to obtain its final breakthrough in Germany (Elter, 2006).

The First World War enjoined on Germany high costs. As a result, a general gross sales tax was imposed in 1916 to finance this war. This new tax framed the fundament of today’s purchase tax in Germany.

After the Second World War the allies imposed a high progressive income tax in West Germany. Furthermore, in the time of the formation of the Federal Republic of Germany in 1949, social security taxation was kept and further developed. In fact, in Germany’s basic law the welfare state was constituted^[1] and many social benefits and social charge deductions can be attributed to the two lost world wars.

Especially, during the period of the economic miracle, which is a term for a steep rocket in productivity and per capita income, social benefits were increased by politicians mainly to bribe the electorate to remain in power. Consequently, from 1960 until 2001 overall social benefits increased from 33 billion Euros to 699 billion Euros (Hahlen, 2002).

Additionally, Germany has had to face changes in the demographic structure for many years. One consequence of the ageing population and rising expenditure for health care was the implementation of compulsory nursing care insurance in 1995 and the steady increase in all social security contributions.

After the reunification of Germany in 1990 solidarity tax (a surcharge to income tax and corporate tax of 5.5%) was imposed in order to finance the development of East Germany’s infrastructure.

On the other hand, the EU has increasingly influenced taxation of its member states. Germany, one founder of the EU, adopted for instance, the Sixth Directive (an important VAT directive issued in 1978 by the EC) and the Parent – Subsidiary Directive (PSD) and the Merger Directive (MD) (both passed 1990 by the EC) in order to partly harmonise the VAT and the corporate taxation within the EU (Hamaekers, 2003).

Switzerland is divided into 26 cantons and was formed as a federal state in 1848. Before that time only the cantons had the undisputed power to impose taxes. After the formation of the federal state in 1848 the cantons had to give away the authorisation for custom duties and all other indirect taxes to the central government. However, the cantons kept solely the power to levy people directly. Consequently, all cantons have always had their own tax regulations and levied taxes have varied substantially between the different cantons since that time. After reluctantly releasing a part of their tax authority, cantons tried to compensate their lost source of tax revenue by imposing higher taxes on citizens’ income and property. During that time, direct taxes became the most important source of revenue for all cantons.

Although Switzerland was not involved in any military conflicts during the 20th century and has always paid attention to conserve its neutral status, it has had to perpetuate its army as a deterrent. As a consequence of the high costs for defence, the central government was forced to impose many indirect as well as some direct taxes (e.g. Military and Civil Service Exemption Tax since 1878, VAT since 1941, Tobacco Tax since 1933 and Beer Tax since 1934).

Especially during the 20th century Switzerland had to keep pace with its neighbours concerning social contributions^[2]. Governments knuckled down on labour movements to improve social security. Hence, the National Insurance Act from 1911 governed the use of accidents as well as health insurance. Additionally, in 1976 unemployment insurance was converted into a statutory insurance (Microsoft Encarta, 2001). Nevertheless, Switzerland has always tried to keep down total contributions and taxes to attract foreign capital and companies (Informationsstelle für Steuerfragen, 2005). Finally, Switzerland’s taxation is also affected by the EU even though it is not a member. For example, in 2005 Switzerland put in place the EU Savings Directive, which is concerned with taxation of cross-border income, into national legislation.

3. Tax structure in the UK, Germany and Switzerland

The total of tax revenue and social security contributions as a percentage of GDP in Germany, Switzerland and the UK vary widely. By comparing the proportion of total tax revenue (including social security) to GDP between these aforementioned countries, it can be ascertained that the UK has the highest percentage with 36%^[3]. In Germany total tax revenue accounts for 34.7% of GDP, whereas in Switzerland the percentage points are the lowest with only 29.2% (OECD, 2006)^[4].

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UK’s overall tax revenue stems from different levied taxes. Taxes on income and profit amount to 36.8% of all tax revenue in 2004. By going into detail, this percentage can be split into taxes on personal income, which account for 28.7% and taxes on corporate income, which are currently 8.1%. Social security contributions from both employers and employees add up to 18.8%, whereas levied taxes on goods and services account for 32%. The lowest revenue in the UK derives from taxes on property, which are 12% of the whole amount of tax revenue.

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In comparison to the UK, the ratio of tax revenue on personal income to total taxation in Germany only amounts to 22.8% and corporate taxes to 4.5%, respectively. A central feature of Germany is its high social security contributions^[5]. Approximately 40.7% of the entire amount of tax revenue stems from social contributions. Tax revenue from property, however, merely accounts for 2.5% and taxes on goods and services for 29.2%.

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The composition of aggregate tax revenue in Switzerland is quite different from Germany. One definite characteristic of Switzerland is its high dependence on direct taxation (Kugler and Lenz).

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In fact, by far the highest tax revenue of the total amount of taxation comprises taxes on personal income with 34.8%. Additionally, tax revenue coming from corporation taxation accounts for 8.6% at the moment. Consequently, about 43.4% of all inland revenue originates from taxes on income and profit^[6]. Contributions to social security springing from employees and employers add up to 24.4%. Nearly the same amount of tax revenue (23.7%) is obtained by taxes on goods and services. The lowest revenue comes from taxes on property, which only amounts to 8.5% of total taxation (OECD, 2006).

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^[1] In Germany there are four different social security contribution rates. Firstly, health insurance of 6% - 7%, secondly, pension insurance of 9.55%, thirdly, unemployment insurance of 3.25% and finally, nursing care insurance of 0.85%. All contributions are deducted monthly from employee total remuneration.

^[2] In contrast to Germany, two different social contributions exist in Switzerland. There are firstly, annual old age and disability contribution of 10.1% and secondly unemployment contribution of 3% of total employee remuneration.

^[3] It should be mentioned that on average, total tax revenues as a percentage of GDP in all OECD countries were 35.9% in 2004.

^[4] All used figures based on the fiscal year 2004.

^[5] The reasons for high security contributions in Germany were already outlined in the “Background” part.

^[6] The reason for high taxes on personal income was outlined in the „Background“ section.