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 loop-holes. Within the top of the distribution, the gain in net incomes is spread widely, but is not negative under plausible assumptions on reporting adjustments.