EUROPEAN BUSINESS SCHOOL
International University Schloss Reichartshausen

Thesis

To obtain the academic degree
Bachelor of Science

Increase in the Value Added Tax to Finance Social Benefits

Name: Benjamin Hein

Submission Date: 26th of April 2007

Table of Contents

List of Abbreviations IV
List of Figures V
List of Tables VI

1 Introduction ... 1
1.1 Problem Definition and Objectives  ... 1
1.2 Course of the Investigation  ... 2

2 The Swedish Model  ... 4
2.1 Differences and Similarities with Germany  ... 4
2.2 A Role Model for Germany?  ... 7

3 Basics of the Value Added Tax and the Social System in Germany ...  9
3.1 The Value Added Tax  ... 9
3.2 The Social System  ... 11
3.2.1 The Principles  ... 11
3.2.2 The Five Branches ... 12

4 Literature Review  ... 15
4.1 Differences in Economic Models  ... 15
4.2 Labor Market Results of Different Models  ... 16

5 Economic Discussion  ... 21
5.1 Refinancing Possibilities ... 21
5.2 Illustration of the So-Called "Versicherungsfremde Leistungen"  ... 22
5.3 Reasons for the Claim to Refinance  ... 24
5.4 Discussion of the Effects  ... 25
5.4.1 Decrease of the Contribution to the Social Security System  ... 26
5.4.2 Increase in the Value Added Tax  ... 29
5.4.3 Combination of the Effects ...  31
5.4.3.1 Description of the Combined Effects  ... 31
5.4.3.2 Overcompensating Effects  ... 33
5.5 The Winners and Losers of the Refinancing ...  34
5.5.1 Evaluation of Different Social-Groups ...  35
5.5.2 Evaluation of Different Income-Groups  ... 37
5.6 Discussion of the Reduced Rate of the Value Added Tax  ... 41
5.7 Further Reform Ideas  ... 43

6 Conclusion  ... 46
6.1 Summarization of the results  ... 46
6.2 Derivation of recommended actions ...  46

References  ... 48

1 Introduction

1.1 Problem Definition and Objectives

Although the number of people unemployed in Germany has fallen several consecutive months, the unemployment rate is still at a high level. The continuing unemployment has resulted in a process of selection on the German labor market with a high level of long-term unemployed people. Economists, researchers, and politicians have made numerous propositions to improve this situation. A regular recurring request is to decrease the amount of the non-wage costs, which consist mainly of the contributions to the social insurance (Kaltenborn, Koch, Kress, Walwei, Zika, 2003, p. 673).

High non-wage costs increase the price of labor and therefore force companies to shed jobs, as these jobs have become unprofitable.¹ This creates a vicious circle, because if jobs are cut down, the number of people paying social insurance contributions is decreasing which leads to an increase in the price of the contribution for the remaining insured persons, because fewer people have to pay the same amount. Hence, this leads to more job shedding, because again jobs become unprofitable.

One proposition often made to decrease the non-wage costs is to copy the "Swedish Model". According to the propositions makers, Sweden shows, that higher indirect taxes and lower contributions to the social security system lead to a lower unemployment rate and a better economic well-being.

The aim of this thesis is to describe the Swedish Model and show if it can be used as a role model for Germany in order to decrease the unemployment rate. In special a refinancing of the benefits that do not correspond to the aim of an insurance, the so-called "versicherungsfremde Leistungen" (VFL), is evaluated. Thereby an increase in the value added tax (VAT) and a simultaneous decrease of the contribution rate in the unemployment insurance is discussed. The additional taxes raised shall be used to finance the VFL in the unemployment insurance and thus make the lower contribution rates possible.

Whereas most papers discussing a change in the financing of the social system rely on the results of different models, hardly any paper explains the effects that would occur on the labor market theoretically. This gap shall be closed with this thesis. After describing the effects suggestion to improve the employment situation shall be given.

1.2 Course of the Investigation

Chapter 2.1 starts with an overall description of the Swedish Model. Thereby, differences and similarities between the Swedish and German social system are stated briefly. Chapter 2.2 evaluates the question if the Swedish social system could be a role model for Germany to improve the labor market situation.

Chapter 3.1 explains the basics of the VAT in Germany. Thereby especially the functioning and the different rates shall be explained. In chapter 3.2 the social system in Germany is presented. Special emphasis is put on the unemployment insurance, as this insurance will be the focus of the refinancing evaluations.

Chapter 4 contains the literature review of this thesis. Whereas the first part discusses the differences of models used to estimate the labor market effects of a refinancing of the social system, the second part evaluates the results of several models.

In chapter 5, firstly the possibilities for a refinancing of the social system in Germany shall be discussed. Secondly, the economic effects of a refinancing of the VFL are evaluated. After that a discussion about the winners and losers of such a reform follows. Fourthly, the abolishment of the reduced VAT rate is evaluated and similarities to a reform of the VFL are pointed out. Finally, more comprehensive models to improve the situation on the German labor market shall be discussed briefly.

The thesis ends with chapter 6, which consist of a summarization of the results and the derivation of recommended actions.

2 The Swedish Model

2.1 Differences and Similarities with Germany

From a neo-classic perspective Sweden does everything what leads to weakness in growth and reduced competitiveness: taxes are high, social benefits are generous, public expenditure is extensive, the public sector is big and inefficient, and there exists a substantial dismissal protection (Becker, 2006, p. 7). Nevertheless, the percentage of people employed is high namely 78% and the unemployment rate of 4.8% is low (Konjunkturinstitutet - National Institute of Economic Research, 2007).² Furthermore, the amount of long-term unemployed people is substantial lower than in most other European countries (Becker, 2006, p. 2).

In general the Swedish social system works similar to the German one. Analog to Germany the main part of the revenue of the social system is raised by contributions. However, in contrast to Germany the contributions are paid by employers and self-employed people (Försäkringskassan, 2005a; Försäkringskassan, 2005b; Schwedisches Institut, 2004; Regeringskansliet, Ministry of Health and Social Affairs 2005; Försäkringskassan 2007). Five categories of insurances are financed wholly or in part by means of general social insurance contributions: parental insurance, sickness insurance, work injury insurance, old-age pension and survivor′s pension (Försäkringskassan, 2005a, p.10). 

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1 As the wages are negotiated either by the unions (collective wage agreements) or by the employees themselves, the non-wage costs are the only point the state can influence the total wage costs. As the effect of a wage alteration will be the same whether a private person or a union has negotiated it, in the following no distinction between union-negotiated and self-negotiated wages will be made.

2 In Germany the employment rate is 69% and the unemployment rate is 9.8% (Statistisches Bundesamt, 2007).