A Tax Reform as Lackluster as the Government Behind It

Germany urgently needs tax reforms because taxes are too high. The majority of experts in the country agree on this. This is not about minor details, but about the entire architecture of the country’s fiscal system. The best example for this is Germany’s top rate of income tax.

Germany has a progressive tax system that places a higher burden on higher incomes than on lower ones. The top rate is supposed to be paid by top earners, who can afford to contribute more because of their higher incomes. At least, that is the theory behind it. But because tax brackets have not been adjusted to reflect income growth for many years, the top rate now also affects average earners.

At the same time, the German state is reporting record tax revenues but remains chronically short of money, even though, at the start of this governing coalition, it also treated itself to €1tn ($1.17tn) in “special funds”, the largest debt package since the end of the Second World War.

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Tax Relief Was Promised

Citizens, however, have been promised relief. The current government agreed to tax cuts in its coalition agreement and definitively ruled out tax increases. In practice, the government is doing exactly the opposite. Federal Finance Minister Lars Klingbeil of the SPD presented a draft bill for tax reform to the federal cabinet shortly before the parliamentary summer recess.

Specifically, Klingbeil’s draft provides for relief for low and middle incomes. A higher basic tax-free allowance and a flatter tax rate mean lower taxes, while a higher employee lump-sum allowance makes it possible to deduct more work-related expenses directly. The effect is barely noticeable overall, as lower incomes in Germany are already taxed at very low rates.

Families will receive relief, according to the minister, through an increase in child benefit to €272 ($318) by 2028. This relief is offset by the fact that spouses without an income of their own will no longer be covered by health insurance free of charge, which will cost at least €240 ($281) per month.

Tax Increases Are Coming

Top earners will face a higher burden. They will pay 45% tax on taxable income above €250,000 ($293,000) and 47% above €280,000 ($328,000). These are serious tax increases. Further de facto tax increases include a reduction in the tax bonus for tradespeople, an increase in the flat-rate tax on mini-jobs and the abolition of some tax breaks. The overall package is said to provide around €3bn ($3.5bn) in relief in 2027 and €10bn ($11.7bn) from 2028.

It is easy to see that the entire tax reform, together with plans such as the healthcare reform, is nothing more than a shell game. A little is put into one pocket and slightly more is taken out of the other. Friedrich Merz also generously promised €10bn ($11.7bn) in relief for taxpayers but failed to mention that inflation alone will already eat up that amount. The other burdens described as measures to finance the relief have not even been taken into account.

Alice Weidel simply has to reap the rewards, as the coalition parties are effectively doing the opposition’s work for them. Photo: Michael Kappeler/dpa /picture alliance via Getty Images

Discussion After the Draft Was Presented

Immediately after the draft bill was presented, a major debate broke out, including within the coalition. Calls for changes came from all sides, including from within the governing parties themselves. This means that the draft was poorly prepared and had clearly not been communicated at all within the two parties, the SPD and CDU. The expectation was apparently that parliamentarians would simply wave it through. This is not the first time such communicative amateurism has been seen in the Merz cabinet. If this draft were put to a vote in Parliament today, not only would the opposition formally tear it apart during the legislative process. It is possible that no reform would materialize at all.

The governing parties are currently doing the opposition’s work for it. Alice Weidel of the AfD, the opposition leader in the German Bundestag, only has to reap the rewards. Moreover, within the draft itself, one measure after another supposedly described as relief for citizens is turning out to be a cleverly concealed tax increase.

Deception and Trickery

It only recently became public that the finance minister had hidden a provision in the draft that would abolish tax allowances for employee discounts. Experts are even describing this as a hidden pay cut. Fiscal drag, the very phenomenon that causes more and more taxpayers to move towards the top tax rate, is not addressed by the reform at all.

After the country already went deeply into debt last year with its special fund, a further €210bn ($246bn) in new debt is to be taken on in the coming budget, which, in addition to the hidden tax increases, will place an even greater burden on citizens.

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Social Democrats Cannot Handle Money

It somehow fits the pattern. Social Democrats have a reputation for being unable to handle money, and they themselves firmly believe that citizens’ money belongs to the state. This is currently evident in the federal finance minister’s greed. In the present crisis, this is making an already tense situation worse. Corporate insolvencies are rising, while unemployment has long since exceeded the three million mark. Every year, 300,000 higher-earning, productive workers leave the country. Germany does not have much room for maneuver left.

A lack of budgetary discipline caused by the government’s uncontrolled, ideologically driven spending policy, combined with the increasingly severe tax squeeze on businesses and households, forms a deadly cocktail for the economy. No growth can be expected in Germany either this year or next. Citizens and businesses are groaning under a level of government spending that has long exceeded what is bearable. High energy costs and crushing bureaucracy compound the problem. Lars Klingbeil’s cabinet draft for tax reform is now discouraging even the last of the country’s motivated people.

Cuts Are Necessary

Getting the economy moving again urgently requires a drastic reduction in income tax and, above all, a change in how the burden is distributed. Top earners should pay the top rate of tax. That is right, although there can still be debate about where that rate should begin. Certainly not at the income level of a tradesperson or skilled worker. A reduction in wage and income taxes would, on the one hand, provide the urgently needed boost to purchasing power and therefore domestic consumption. For partnerships, income tax also serves as the form of business taxation. Businesses are in even greater need of relief so that they can invest. Only then can the economy get moving again.

The same applies to corporation tax. A reduction has been agreed, but it comes far too late and is nowhere near sufficient in scale. Energy is also taxed too heavily. With energy prices already high, the state takes a disproportionately large share in taxes, thereby further increasing the burden on both households and businesses. Yet indirect taxes are not even considered in the cabinet draft.

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Germany’s Tax Reform Falls Flat

If Germany is serious about tax reform, it needs the equivalent of a fast downhill run in skiing. It needs to go steeply downhill and at a brisk pace because Germany’s sputtering economy can tolerate neither hesitation nor delay, let alone a half-hearted little reform.

The minister’s uninspired and hopeless draft appears so unambitious that one might think Klingbeil is already certain that, after the end of the summer recess, or at the latest after the state elections in Saxony-Anhalt and Mecklenburg-Western Pomerania on 6 September, he will no longer hold ministerial office at all.

The latest polls predict disastrous results for the coalition parties, the CDU and SPD, in both states. In Saxony-Anhalt, there is even a risk that the SPD will fail to enter the state parliament altogether. This federal government has long since reached the end of the road. It simply has not realized it yet.