1 Introduction 1

2 Why Does Germany Need a Reform of Capital Income Taxation? 5

2.1 The German Tax System of Corporate Taxation 5

2.2 The German Tax Reform 2000 7

2.3 Theoretical and Empirical Arguments for Lower Capital Income Taxation 10

2.4 Germany's Declining Economy and the Increasing Tax Competition in the EU 11

2.5 The Non-Transparent and Complicated German Tax System 16

2.6 Decreasing Revenues From Corporate Taxes 19

2.7 Summary 21

3 The Dual Income Tax 23

3.1 Definition and Main Features of the Dual Income Tax 23

3.2 The Case for a Dual Income Tax 25

3.2.1 The DIT and the Basic Principles of Taxation: Efficiency and Equity 26

3.2.2 Administrative Simplicity 33

3.2.3 Revenue Aspects 34

3.3 The Experience of Nordic Countries 35

3.3.1 Denmark 39

3.3.2 Finland 39

3.3.3 Norway 40

3.3.4 Sweden 42

3.4 Problems Related to the DIT Implementation 45

3.4.1 Difficulties Arising from the Separation of Labor and Capital Income 45

3.4.2 Solutions Applied by the Nordic Countries 45

3.5 Concrete Proposals for Germany 47

3.5.1 Main Features of a DIT System as Proposed by the GCEA (2003) 47

3.5.2 The DIT Proposal of Sinn (2003a) 48

3.6 Summary 51

Appendix - A Reform Proposal for Switzerland 53

4 The Model 55

4.1 Overview of Different CGE Models and Their Characteristics 55

4.2 The Model 59

4.2.1 Business Sector 59

4.2.2 Stylized Analysis of Tax Policy and Effective Marginal Tax Rates 76

4.2.3 Households and General Equilibrium 78

4.2.4 General Macroeconomic Equilibrium 86

4.2.5 Welfare Analysis and the Marginal Excess Burden of Taxes 88

4.2.6 Rest of the World 91

5 Simulation Results 93

5.1 Model Calibration 93

5.1.1Production Technology Parameters 94

5.1.2 Macroeconomic Data 96

2.2 The Marginal Excess Burden 97

5.3 Implementing a DIT as Suggested by the GCEA (2003) 98

5.3.1 Partial Analysis of the Effects of Each Individual Tax Rate Change 100

5.3.2 Steady State Comparisons of the Overall Reform Package 105

5.3.3 Transition Paths 112

5.4 Implementing a DIT as Suggested by Sinn (2003a) 119

5.4.1 Steady State Comparisons 120

5.4.2 Transition Paths 125

5.5 The Two Proposals Compared 129

5.6 Sensitivity Analysis 133

6 Conclusion 137

Appendix A 141

Appendix B 143

Appendix B.1 Hayashi's Proof 143

Appendix B.2 Intertemporal Optimization of Domestic Households 145

Appendix B.3 Walras Law 147

Appendix B.4 Savings Investment Identity 150

Appendix C Functional Forms 153

Appendix C.1 Trend Growth 153

Appendix C.2 Factor Demands 155

Appendix C.3 Adjustment Cost Function 156

Appendix C.4 Agency Cost Function 157

Appendix D Computational Strategy 159

References 161