Putting `Fear Of The Taxman' Into The Germans

It was hardly the kind of publicity Merrill Lynch & Co. wanted. At midday on June 8, about 300 German tax police and district attorneys raided the brokerage house's five German offices, as well as the homes of 60 Merrill Lynch financial consultants. Investigators were hunting for evidence that clients had evaded taxes, allegedly with the help of Merrill Lynch employees. The firm denies encouraging tax evasion. A spokeswoman adds that Merrill Lynch has been a "good corporate citizen" and that it will "cooperate fully with the German authorities."

The raids are part of a crackdown on what German authorities fear is an epidemic of tax evasion. The stakes are huge, especially in a time of high deficits. The tax collectors' labor union, for instance, figures bilking could be costing federal, state, and local governments well over $70 billion in lost revenues each year. Finance Ministry officials in Bonn counter that the figure is "exaggerated," but decline to make estimates of their own. Still, the government wants its raids to have an impact. Says one banker: "They are very public displays intended to put, if not the fear of God, at least the fear of the taxman, into the Germans."

What's abundantly clear is that the temptation for German taxpayers to fiddle as they file has grown substantially. Since Jan. 1, Bonn has been levying a 7.5% "solidarity surcharge" to finance unification costs. Coming on top of the usual income taxes, that translates to an effective 57% top rate for the affluent.

An even stronger stimulus to bilking is a 35% withholding tax on interest payments in Germany. Implemented at the start of 1993 to ferret out underreported income, the withholding tax has struck panic into the hearts of savers, who think they should pay no tax on income generated from aftertax savings. Months ahead of its imposition, Germans scrambled to move cash to tax havens such as neighboring Luxembourg, which offers banking secrecy and pays interest and dividends without withholding taxes. In 1992-93, more than $200 billion fled the country.

The odd thing is that a German saver has to be pretty well off before withholding takes effect. Because of generous exemptions, a couple earning 5% on $170,000 or less in savings would owe no tax. "In reality, most savers are not liable to the tax," says one Frankfurt banker. "But we still had lines out the door of customers wanting to move money out of the country."

As a result of the stampede, the Luxembourg branches of German banks--which follow Luxembourg rules on withholding--now manage more than $90 billion in German-mark-denominated mutual funds, as well as traditional deposit accounts. The flight capital, though deposited abroad, usually gets invested in German government bonds and corporate securities. "The money coming into Luxembourg from Germany goes right back the same day," explains Lucien Thiel, general manager of the Luxembourg banking association.

DENIED WRONGDOING. Moving money abroad is legal. But the huge traffic lays German banks open to accusations that they encourage tax evasion. Although the banks routinely warn customers to report any foreign income to German tax authorities, this prudence hasn't protected them from raids like Merrill Lynch's "high noon," as the German magazine Focus dubbed it. Early last year, tax police hit two German branches of Dresdner Bank. This spring they also descended on the domestic asset-management subsidiaries of Munich-based Bayerische Hypotheken und Wechsel-Bank. Dresdner challenged the legality of the raids, but was overruled by the Constitutional Court. All the banks deny any wrongdoing. None has been formally charged.

The raids have rattled a few hundred German taxpayers into coming clean. By owning up, they escape penalties--though they do have to pay the back taxes. That doesn't solve the underlying problem. Five years ago, Germany suggested imposing a 15% withholding tax throughout the European Union, but was quickly shot down by Luxembourg, Britain, and others. "It's a purely German affair," sniffs Luxembourg's Thiel.

The tax collectors' union argues that to ensure compliance, western Germany alone needs an additional 28,000 tax collectors to join the current 110,000. But the one remedy most likely to persuade Germans to be honest--radically cutting tax rates--remains a distant prospect.



High tax rates of up to 57% on income and recent impositions, such as 35% withholding levies


Unrestricted transfers of capital to nearby tax havens such as Luxembourg


Government loses tax revenues estimated at more than $70 billion a year


Before it's here, it's on the Bloomberg Terminal.