Tax return: Digitalization instead of beer coasters

Professor Rudolf Mellinghoff and Professor Deborah Schanz were members of two independent expert committees appointed by the German Ministry of Finance to simplify tax law. Schanz is Professor of Taxation and Accounting at LMU, while Mellinghoff heads the Center for the Digitalization of Tax Law at LMU. In our interview, they identify the major flaws in current tax law and explain how these issues can be overcome.

People often say that the German taxation system is unnecessarily complicated and lags behind when it comes to digitalization. Are these criticisms fair?

Rudolf Mellinghoff: German tax law is indeed very complicated. You can see this in the proliferation of subsections in German laws. If you think a certain tax law has 99 paragraphs, you’d be mistaken. These paragraphs are subdivided into letters a, b, c, d, and so forth, and are correspondingly unwieldy. And regarding the digitalization of financial administration, here’s a telling example: the German states each have their own data centers. When you submit a tax declaration digitally in Baden-Württemberg, for example, the authorities there cannot transmit it online to their counterparts in, say, Rheinland-Pfalz. Rather, the declaration is printed out and mailed across the Rhine, where it is scanned for further digital processing. This state of affairs is untenable. Just imagine, there are local governments today still working with software that does not recognize the @ sign. If we don’t promptly change many things, soon we’ll have completely outdated systems that are unfit for purpose.

Prof. Schanz, you primarily analyzed corporate tax law in the reports for the Ministry of Finance. Do you share Prof. Mellinghoff’s assessment?

Deborah Schanz: Yes, absolutely. Corporate tax law has grown so complex and convoluted that in meetings with company representatives, they often tell us that you cannot sign a tax return in good conscience anymore. Nobody can be really sure they’ve got all the details correct, no matter how hard they try. That’s a clear sign that something’s awry.

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The two committees you were part of have proposed simplifications and improvements spanning around 200 pages. Could you share some particularly salient examples from these comprehensive documents?

Deborah Schanz: A vivid example, I think, are the exemption procedures for cross-border payments. If a company uses a software license from an American company, say, the licensee is actually supposed to retain and pay a withholding tax. However, a company can often obtain an exemption from this obligation. But every single foreign licensor has to arrange this exemption for each individual contract themselves, which can result in hundreds of thousands or even millions of applications. This is something you can streamline. We can make sure that such assessments take place once only and not a million times over. There’s great scope for simplification here.

Prof. Mellinghoff, the phrase “once only” also appears in the report focused on digitalization, to which you contributed. What does it mean in this context?

Rudolf Mellinghoff: The core idea is that data known to the state, because it has been submitted to some authority or other, should be accessible to all other authorities. When filling out their returns, taxpayers can sometimes see that prepopulated sections contain data which the state already possesses. We need to introduce something like this across the board. The will is there and the relevant ministries are working on it, but we’re lacking an integrated strategy.

Could you give an example of an effective measure to simplify tax law that could be implemented at little cost and effort?

Rudolf Mellinghoff: The committee on which I served was very keen that an ordinary employee who has no extra sources of income on top of their salary should not necessarily have to deal with the tax office at all. And the same goes for a retiree whose only source of income are pensions or other retirement benefits. To this end, we want to introduce flat rates. For employees we recommend a so-called working day flat rate (Arbeitstagepauschale), while for retirees and pensioners we envisage a withholding tax like the one we have for payroll tax. This means that tax is deducted at source when paying out the pension.

Prof. Schanz, when it comes to corporation tax in particular, the argument is often made that a taxation system has to be complicated to be fair. Is the German tax system fair at least, for all its complexity?

Deborah Schanz: Individual justice (Einzelfallgerechtigkeit) is an important aspiration. But in reality there are many areas where an ignorance penalty applies. That is to say, companies with excellent advisors come away better than companies lacking the knowledge to apply the rules optimally. And that is unfair.

The committee you were on called for a massive repeal of rules for combating fraud, particularly in cross-border tax law. Doesn’t that just open the doors to the shrewd and unscrupulous and make fools of the honest?

Deborah Schanz: On the contrary. We think that repealing anti-fraud rules will not make fraud any more likely. We’ve proposed this measure because the background conditions have changed a lot. A global minimum tax was introduced. Whereas there used to be states that facilitated zero rates, a new worldwide system has ensured that everybody pays taxes of at least 15 percent on profits. This has transformed the competitive situation quite significantly. Many regulations that were previously on the books to ensure minimum taxation have been made redundant.

You also make proposals that would probably be rather unpopular to implement. For example, you want to abolish the option of claiming tax relief on tradesmen invoices. Why?

Rudolf Mellinghoff: This was introduced into tax law only in 2011, so it’s a relatively recent provision. But there have already been numerous assessments, and not one of them has been able to demonstrate that it achieves its intended effect – namely, of reducing undeclared work. And yet this provision is the largest subsidy in income tax law, with a volume of over three billion euros. If we eliminated this subsidy, then we could unburden citizens in other areas. Moreover, the application of this provision is extremely complicated, because it overlaps with extraordinary expenses and income-related expenses. This is another argument for abolishing it completely.

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The reports you helped draft are each hundreds of pages long. How long would it take to implement your proposals?

Rudolf Mellinghoff: That depends very much on the particular proposal in question. There are individual measures that could be implemented within a few months: depreciation options, pooled items, and similar provisions for, say, tradesmen. But there are other provisions that would need to be analyzed more carefully, and that can take years.

Deborah Schanz: I agree that some things could be done within a few months. And it’s been heartening to see how politicians and ministries at state and federal levels have engaged intensively with our proposals. Of course, there are also other areas that are more complex and where it will certainly not be possible to implement changes in what’s left of this parliament. But after all, reports are also about starting conversations.

For years now, we’ve heard people make the case that the laws should be so simple that a tax return would fit on a beer coaster. Is that plausible?

Rudolf Mellinghoff: No. I don’t think there will be, or can be, a tax return on a beer coaster. But what can be achieved if we have good digitalization is tax returns at the push of a button. If the authorities have sufficient data at their disposal, then employees and pensioners would only have to check whether the prepopulated information is correct.

Deborah Schanz: I agree that the question has become obsolete. What we need today is a place offering comprehensive access to data and corresponding interfaces and digital communication capabilities. Then we could bin the beer coasters.

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