In Bed with the Banks? Deciphering the German Capital Gains Tax Puzzle

Recent advances in CPE have highlighted the composition of aggregate demand to understand the politics of institutional continuity and change. More specifically, the growing body of growth models literature asserts the hegemonic dominance of growth-producing social blocs to which competing macroeconomic interests become systematically subordinated (Baccaro and Pontusson 2016; 2019). Yet, the relative political strength of competing producer coalitions, electoral interests, and party politics as an important mediating force might appear much more nuanced and dynamic in nature. The turbulent days of economic policymaking in Germany around Christmas of ‘99 provide an exemplifying case. Only a few days after Chancellor Gerhard Schröder orchestrated a coordinated rescue of insolvent construction giant Holzmann AG, he presented the financial sector with a historic tax cut. Crucially, the reform package involved the surprise abolition of capital gains tax on sales of corporate cross shareholdings, which radically called into question the very foundations of the Deutschland AG industrial model and broke the chains of financialisation in Germany virtually overnight. What explains this deeply contradictory sequence of policy measures? I employ a systematic search of newspaper sources in German and English language to reconstruct the particular sequence of events and triangulate this data drawing on semi-structured interviews with financial and political elite-circle witnesses. I then scrutinize my evidence applying implicit Bayesian process tracing to test three rival hypotheses of regime change: electoral competition, sectoral hegemony, and interest group negotiation. My results show that Schröder used the capital gains tax reform in a quid pro quo to convince banks to bail out Holzmann AG. In turn, saving 30,000 Holzmann jobs allowed him to appease critical left-wing party colleagues and win his re-election as party leader at a national convention only two weeks later. As a direct consequence of this deal, large financial corporations were liberated from the confines of Germany’s domestic credit markets and could now advance the transition towards a capital market-based financial system. This is the first time that such direct quid pro quo between the German government and the financial sector can be proven. My results caution us not to take the political dominance of particular growth-producing social blocs for granted. Instead, we need to carefully analyse diverging interests between cross-sectoral producer coalitions and their relative political power over time and at critical junctures to understand the politics of regime change.