Between a rock and a hard place

By L.G.

LEAVE your heirs €2m ($2.5m) in Germany, and they will pay 19% in taxes on it. Give them a €2m business and they will pay little or nothing. Germans on the left think it is unfair that businesses have such a large exemption from inheritance taxes. But those on the business-friendly right fear that many of Germany’s small- and medium-sized companies would not survive if they were taxed as ordinary inheritances. On December 17th, Germany’s constitutional court sided against business, deciding that the disparate treatment was “disproportionate” and violated the constitution’s protection of equality before the law. The German parliament now has until June 30th 2016 to level the playing field between business and non-business inheritances.

The original law was meant to protect jobs. If a widow or child sells the company for its fixed assets, fires the staff and pockets the proceeds, he or she would pay the full tax. But 85% of a company’s value is exempt from taxation if the inheritor reduces total wages paid by the company by no more than 20% over five years. If the total amount of wages paid out is kept the same or raised over a period of seven years, the entire company value is exempt.

Representatives of the Mittelstand, Germany’s fabled medium-sized and usually family-run businesses, say many would simply go bust if taxed at the full rate. Some companies have already been transferred to heirs in a rush before the December 17th decision, as for example PwC, an auditing and tax-advisory firm, encouraged them to do. The Association of German Industry claims that four out of every ten companies plan a generational handover by 2019.

Proponents of keeping a generous allowance for businesses point out that Germany’s export-oriented companies are in fierce competition with countries that protect businesses similarly. French law is only slightly less generous to business-heirs: a “Dutreil pact” spares 75% of a business from taxation, though in various scenarios the heir will save even more. Italy, where small- and medium-sized companies are the most successful bits of the economy, the law is even more generous. Heirs who keep the business running for five years simply pay a tiny registration tax.

The debate has taken on a predictable left-right division. The economics editor of Der Spiegel, a left-leaning weekly magazine, says there is probably nothing which will damage growth more than letting wealth fall “with no effort into the laps” of heirs. They may not, after all, be the brilliant managers their parents were, while everyone else in Germany must work hard and pay fairly high tax rates. As to the threat that founders might take their companies abroad, this seems hollow: they are usually heavily tied to their hometowns, and would have a hard time replacing specialist workers.

But the politicians are caught in a vice of their own making. Wolfgang Schäuble, the finance minster, wants to spare entrepreneurs from the higher rate. And the grand-coalition government has promised there will be no new taxes. But Mr Schäuble has also promised to balance the budget this year, which will be the first time since 1969 Germany has achieved this. The ruling of the constitutional court, that cash and business inheritances must be treated equally, puts him in a bind of breaking one or the other, as such a reform would require fairly high rates in order to be budget-neutral. The goal of tax reformers everywhere is to broaden the tax-paying base by cutting exemptions, while lowering overall rates. But as is so often the case with fiscal policy, there are no easy choices.