Bringing Down the Other Berlin Wall: Germany's Repeal of the Corporate Capital Gains Tax

Faced with pressure from increased global competition and capital mobility, Germany's government made a surprise announcement in December 1999 that it would repeal the longstanding capital gains tax on sales of corporate crossholdings. The repeal was hailed as a revolutionary step toward breaking up Germany's complex web of cross-ownership. When the changes become effective in 2002, Germany will move from having one of the most punitive taxes on corporate capital gains to having the smallest among major industrial countries. This paper uses Germany as a natural experiment to provide evidence on the extent to which taxes present a barrier to the efficient acquisition and divestiture of stakes in other firms. In particular, we examine the stock market response by German firms to the announcement that capital gains taxes on intercompany holdings would be eliminated. We find a positive association between a firm's abnormal stock returns and the extent of its crossholdings, consistent with taxes acting as a barrier to efficient allocation of ownership and investment. However, the reaction is limited to the largest banks and insurers and their extensive minority holdings in industrial firms, suggesting that taxes are not the binding constraint preventing most firms from divesting their crossholdings.