In 2000, the German tax system underwent a major reform featuring a dramatic reduction in taxes on business (from a corporate income tax rate of 40% to 25%, and the elimination altogether of a 53% tax on investment profits), as well as a scheduled reduction in the top income tax rate to 42% by 2005 from 56% in the 1980's, and 53% in 2000. In 2003 the corporate income tax rate of 25% applied to both retained and distributed earnings. A one-year surcharge totaling 6% was added because of serious flood damage in 2002, bringing the effective rate to26.5%. A non-resident corporation, whose headquarters and management are outside of Germany, does not have to pay the surcharge. The government intends to reduce the profits tax rate back to 25% for resident companies in 2004. Capital gains except for those derived from the sale of shares of both foreign and domestic corporations, which are tax-exempt, are taxed at the same rate as other income. Business activities are also subject to municipal trade taxes of 12% to 20.5%.
In 2003 the progressive schedule of income tax rates was in a process of transition. The 0%, tax-free base was scheduled to increase from €7,235 in 2002 to €7,427 in 2003 to €7,665 in2005. The range of the other tax brackets was scheduled to fall from 19.9% to 48.5% in 2002, to 17% to 47% in 2003, and then to 15% to 42% in 2005. On the other hand, the threshold for the highest tax rate was scheduled to decrease from €55,008 in 2002 to €52,293 in 2003 to €52,152 in 2005. Rates and exemptions depend on the number of children, age, and marital status of taxpayer. 8% to 9% of income taxes due is a Church tax. Non-church goers, and members of the Orthodox or Anglican Churches are exempt from paying any Church tax. Other direct taxes include an inheritance and gift tax, a net worth tax, and a 2% real estate transfer tax.
The main indirect tax in Germany is a value-added tax (VAT) introduced in 1968 with a standard rate of 10%. By 2003, the standard rate had risen to 16%. A reduced rate of 7% applies to some basic foodstuffs, water supplies, medical care and dentistry, medical equipment for disabled persons, books, newspapers and periodicals, some shows, social housing, agricultural inputs, social services, and some transportation. Items exempt from the VAT include admissions to cultural events, building land, supplies for new buildings, TV licenses, telephones and faxes, basic medical and dental care, the use of sports facilities and some waste disposal services.