International Tax & Trade Policy Implications
This election will be different from the German elections of recent years, as it will take place in the middle of a fragmenting world. Unlike German elections of the recent past, however, this election will take place in the middle of a fragmenting world.
Russia’s invasion of Ukraine continues to put pressure on Europe’s eastern border while newly elected President Trump is once again threatening Europe with a trade war from the West. France, Germany’s closest European ally is also facing a political crisis, which puts the EU’s ability to adapt into question. This is not to mention that the German economy faces major challenges such as a demographic shift in the labor force, energy insecurity, geopolitical pressures on its export-driven model, and weakening growth forecasts.
Consequently, the outcome of the German election will have major implications far beyond its borders, especially in matters of
taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
, and trade policy. This makes it important to identify key policy decisions, such as the future of Pillar Two, that the next German government will need to make in the broader European and transatlantic context.Germany’s Electoral Tax Debate Remains Domestic
In a campaign where immigration policy is a central theme, tax policy is not far behind. The tax reform ideas offered by parties across the political spectrum are vague at times, but they promise to boost economic growth. The ideas are predictable and range from redistributing the income to increasing private investment to adjusting that much-discussed Debt Brake. Without outlining every detail, suffice it to say that parties understand how consequential tax policies can be for voters’ standard of living.
Beyond Germany, each party has outlined certain European and international tax policy ideas in their manifestos, like broadening the EU’s Emission’s Trading System, implementing an EU digital levy if Pillar One fails, or supporting a globally coordinated minimum tax on billionaires. Candidates have rarely discussed how tax policies (and trade policies, by extension) within Europe, or the external retaliation against them, can impact German citizens. The impact of international disputes, such as those over the Carbon Border Adjustment Mechanism or Pillar Two, is not discussed in party manifestos or campaign speeches. The negative economic effects of potential retaliation for German voters could be far greater than most of the domestic reforms that are regularly debated.
Policymakers at the EU level will need to decide whether the current tax and trading policies, which are intended to establish European standards and simultaneously change the policies of third countries, will do more harm than good. The EU’s Directive implementing OECD’s Pillar Two Model Rules, the Undertaxed Profits Rule (UTPR), and CBAM, are examples of EU sanctions on foreign firms, which could invite retaliatory actions, rather than EU inspired changes to their domestic policies. The “Brussels Effect” is not as effective as it once was. On his first day as president, President Trump issued multiple executive orders that targeted “discriminatory international tax” (read digital services taxes and UTPR) and trade practices. He also threatened the EU once again with tariffs. The orders give US federal agency until mid-March or the beginning of April to provide the president retaliation alternatives that could be used against Germany and the EU. How the EU would respond to a tax and trade war is still uncertain.
Related to Pillar Two, an international agreement at the Organisation for Co-operation and Economic Development (OECD) on Pillar One looks unlikely. EU leaders have threatened to push forward with digital services tax (or reattempt a EU-level digital levie) if Pillar One negotiation fails. This would likely add fuel to the fire of an EU-US tax and trade war.
Prominent German political figures have made vague statements about working with the US during the election campaign but have yet to release nuanced plans. These plans could become more complex due to the fact that tax and trade policies in the EU are divided between Brussels and national capitals such as Berlin. The OECD and United Nations also make decisions at an international level. The German government has a limited time to finalize its response plans, given the potential economic impact of a dispute with US on German citizens. The EU can avoid retaliatory actions by negotiating safe harbours or similar measures. However, this will reduce the amount of revenue that European governments receive. There is a scenario where the EU enforces UTPR but faces retaliatory actions from its major trading partner. Moreover, European firms may become less competitive as a result of the high costs associated with Pillar Two compliance. Similarly, European governments might receive less revenue that they expected. Then, one might wonder what Pillar Two has accomplished.
The new German government will have to decide whether it wants to continue supporting Pillar Two despite possible retaliation or if they want a system overhaul. German leadership on the question of a unified EU position will be paramount.
A Focus on Competitiveness
Beyond external retaliatory risks, the next German government’s position on the future of Pillar Two will be highly impactful within the EU’s domestic competitiveness agenda. The European Commission has recently launched a strategy called “Competitiveness Compasses” that outlines steps to make the EU economically competitive in comparison with the US and China. The strategy focuses on simplifying regulations, removing inefficient tax policies and removing overlapping ones. In EU jargon, this is called “decluttering.”
Pillar Two, in addition to the EU’s Anti-Tax Avoidance Directive (ATAD) and domestic controlled foreign corporation (CFC) rules, is the main policy in question. Germany has already begun to change its CFC rules based on Pillar Two. If the next German government believes that Pillar Two does not achieve the tax fairness goals initially envisioned, but rather makes European firms less competitive than they were before, then they could push to include Pillar Two in the decluttering initiative. This would be a particularly powerful position given that Germany was a strong supporter of the Pillar Two project at its inception.
Germany’s Voice in the EU
The next German government will have powerful contacts in both the European Commission (President Ursula von der Leyen) and European Parliament (Manfred Weber is the leader of the largest group), in addition to Germany’s impactful voice in the Council of the EU. While EU policymakers must consider the economic impacts of EU policies on the whole EU, it certainly doesn’t hurt to have compatriots in key positions.
Ultimately, there will be many consequential tax and trade policy decisions made at the EU level over the next two years. The impact of Pillar Two, CBAM and digital services taxes could be significant for German citizens. The next German government should be prepared to help make those tough choices.
Note
: This blog post is the first of four in a series focused on the impacts of tax policy and the 2025 German federal election.
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