Top Tax Progression and Capital Taxation in Germany

This paper analyzes the effect of the introduction of a flat tax schedule on capital income on the progressivity of the German personal income tax, with a particular focus on top income groups. The reform-induced change in net incomes is proposed as a measure for progressivity changes at the top. Changes in vertical and horizontal equity are analyzed and broken down by reform component. The analysis is based on a micro-level panel dataset of income tax returns between 2001 and 2006 that is particularly representative for the top of the income distribution. The panel structure is used to construct a permanent reform effect that is less prone to annual volatility in income composition. The reform is found to be regressive. It is shown that the reform included substantial loopholes. Within the top of the distribution, the gain in net incomes is spread widely, but is not negative under plausible assumptions on reporting adjustments.