Kohl May Pay A High Price If Tax Reform Fizzles

Chancellor Helmut Kohl's plans for a German supply-side revolution are running into political headwinds. Last Spring, Kohl floated a raft of proposals for tax cuts and an overhaul of Germany's featherbedded welfare system. They were designed to boost his political appeal and give a lift to a lackluster economy. Instead, business confidence is sinking, and the opposition Social Democratic Party (SPD) is now pulling ahead of him in the polls.

At first glance, Kohl's tax plan seems to be on track. A government commission, due to report by the end of January, will recommend slicing top corporate and personal tax rates from 53% to less than 40%. But Germans' overall tax burden will drop only $18 billion, half of what Kohl originally promised. Finance Minister Theodor Waigel isn't helping Kohl's cause either. He insists that Germany needs a tax hike if it wants to slash its budget deficit and qualify for Europe's single currency. He wants to increase value-added taxes by two percentage points to meet that target.

Waigel's math may add up, but his politics don't. Surveys show growing skepticism about Kohl's pledges to ease Germany's tax pain. Voters now believe the tax reform drive will end up costing them money.

Talk of raising VAT, says Karl Heinz Dake, president of the German Taxpayers Assn., "[is] making tax reform psychologically unacceptable."

DIGGING IN. Kohl's flagging efforts are starting to alarm business leaders. Retailers facing flat sales are pleading that the only way to pump up the domestic economy is to cut VAT, not increase it. Meanwhile, German companies fear Kohl will renege on promises to abolish certain business levies, particularly those that tax capital, not profits. Because many of those revenues go directly to state governments, Kohl has little hope of pushing them through the Bundesrat (upper house), which is made up of state representatives and controlled by the opposition.

Meanwhile, interest groups across the political spectrum are digging in to fight for their cherished tax benefits. Supply siders in the Kohl camp hoped to eliminate the reams of tax breaks enshrined in Germany's byzantine tax code, which fills more than 2,000 pages. Voluntary church levies, union dues, and life insurance premiums, for instance, are all deductible. Their original plan was to sweep all these away and trade them in for big, politically appealing tax-bill cuts for everyone. But advisers are now telling Kohl it's too risky to dump tax deductions the voters love, such as those for travel to and from work.

Kohl's backsliding is now roiling his own Christian Democratic Union (CDU) party. Christian Wulff, CDU chief in the Lower Saxony state parliament, is demanding that Waigel be fired if he continues to torpedo Kohl's visionary plans. "We need a completely new tax law, not a few tiny changes here and there," says Wulff. And the CDU's turmoil has given life to a new opposition challenger, the populist premier of Lower Saxony, Gerhard Schruder.

Even if Kohl gets tax reform back on track, it could collide with his efforts to reform Germany's generous state pension system. Welfare reformers want tax incentives to encourage savings in private pension schemes. But budget hawks want to tax savings such as life insurance. "One hand doesn't know what the other is doing," complains Adrian Ottnard, a tax specialist at IWG Bonn, an economic think tank.

Kohl needs to boost investment and create hundreds of thousands of new jobs if he is to cut Germany's record 10.8% unemployment rate. That means using his consummate political skills to get tax reform back on the rails.

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