Cold Turkey

German Tax Relief: Two Cups of Coffee

Merkel bei Wahlkampfabschluss
Dispensing Pennies: German Chancellor Merkel will be able to afford two extra cups of coffee per month:
  • Why it matters

    Why it matters

    Germany has one of the world’s highest tax rates on labor. This could hurt growth in future, but there is little appetite for real change.

  • Facts

    Facts

    • Tax relief being considered would amount to €2.4 billion in 2015, or €60.20 per person.
    • Most industrial nations automatically adjust for “bracket creep” that burdens the middle class.
    • Germany’s Finance Ministry plans to issue no new debt in 2015, a first in its post-war history.
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    Audio

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European leaders have repeatedly urged Germany to spend more to revive economic growth in the continent’s largest economy.  Berlin seems ready to finally cut taxes on its long-suffering middle class.

There’s just one problem: a proposal in the works would give Germans a tax break of just €5 ($6.50) a month — the equivalent of one or two cups of coffee.

“This will not turn into a major tax reform discussion,” said Stefan Bach, a tax analyst with the Berlin-based economics institute DIW. “We are just scratching the surface.”

The paltry present to taxpayers would still cost Germany a lot of money: €2.4 billion ($3.1 billion) in 2015 and €2.9 billion in 2016, according to a new estimate from the finance ministry which has been seen by Handelsblatt. That would amount to €60.20 a year for the average taxpayer, according to the ministry’s calculations.

Bottom line: Germany appears unwilling to trim government revenues signficantly to give its taxpayers a serious break.

The stinginess is bad news for Germany’s middle class,  the power behind Europe’s largest economy.

The vast segment of everyday Germans is also one of the most heavily taxed groups in the world, the result of a rigid, unbending tax system that places a much higher burden on lower- and middle-income wagearners than on the wealthy. This growing burden — which is represented by a taxation system that pushes most of those earning just €42,000 into a 40-percent nominal tax bracket — is called the “cold progression” in Germany.

Some in Chancellor Angela Merkel’s Christian Democratic Union Party, the CDU, are trying to come to the aid of taxpayers.

“The groundswell of support is growing by the day,” Carsten Linnemann, a leader of the CDU’s economic wing in parliament, told Handelsblatt. The CDU faction plans to force the issue by proposing a reform for tax relief at the party’s convention in December, and stands a good chance of winning.

But even that plan — which appears to be also supported by Ms. Merkel’s junior coalition partner, the Social Democrats — is being criticized as miniscule.

On the left of the political spectrum, lawmakers want to award more relief by shifting the burden to the wealthy. Those in power on the right, including Ms. Merkel and her finance minister, Wolfgang Schäuble, say it is risky and will jeopardize plans to balance the federal budget next year for the first time in nearly a century.

Mr. Schäuble has proposed tax relief to address the “cold progression” starting in 2019.

“This is not in the first instance about lower taxes. We have to discuss the role of the state.”

Carsten Linnemann, Leader of CDU's economic bloc

Some CDU members don’t want to wait that long. Even if it is small, the tax relief is about fairness and sending a signal that Germany is ready to give some money back to the public after years of austerity, they argue. Low- and middle-income earners bear most of the tax burden, while the rich are getting richer, the left has argued.

“This is not in the first instance about lower taxes. We have to discuss the role of the state,” Mr. Linnemann said.

Wages in Germany are projected to rise sharply – more than 3 percent this year and 4 percent in 2015 – after stalling for much of the decade. With much of Europe still struggling to recover from the financial crisis, Germany’s neighbors are hoping that they, too, might benefit from the higher spending in Europe’s largest economy.

Yet about half of the increased wages will go to the government. That is because Germany has among the world’s highest tax rates on earned income. The Organization of Economic Cooperation and Development, OECD, has put Germany’s tax wedge – the amount of an annual salary paid in income tax and social contributions from both employee and employer – at 49 percent, behind only Belgium among the world’s largest industrial nations and well above the global average of 36 percent.

But unlike in the United States, there is no significant political debate taking place in Germany about actually cutting spending. In Europe in general, social spending tends to be higher than in the United States, and there is no serious talk about curtailing the government’s role in social welfare.

According to German government estimates in March, federal spending is set to rise by 3.3 percent in 2016, 2.9 percent in 2017 and 2.6 percent in 2018.

Straßencafe Unter den Linden im Sommer, Gendarmenmarkt, sidewalk cafe Unter den Linden, Gendarmenmarkt
Germans could have a few more euros to spend at their favorite cafes. Source: DPA

 

The European Commission, OECD and International Monetary Fund have repeatedly criticized Germany’s high level of labor taxes, especially on lower income earners, warning it could be restraining growth.

“Germany has made overall limited progress in improving the efficiency and growth-friendliness of the tax system and to reduce the high tax burden on labor,” the European Commission said in its last report on Germany back in June. “No major measures are foreseen to shift towards more growth-friendly revenue sources.”

The latest calls for tax relief have centered on tackling “cold progression.” For detractors, this amounts to a secret tax increase, and one that is growing every year.

The phenomenon is especially disturbing if wages rise at the same rate or not even kept pace with inflation, which has been the case for much of the past decade. In Germany, this benefit flows into the government’s coffers.

Most other developed countries automatically adjust for at least some of this – if consumer prices rise 2 percent in a given year, the tax brackets are adjusted upwards by the same amount. France, Britain, Spain, Belgium, Portugal, Finland, as well as many non-E.U. countries including the United States have such automatic inflation-adjusted tax brackets. Italy and Greece are among those on Germany’s side.

Matthias Warneke, chief economist at the German Association of Taxpayers, said closing this “fairness gap” is the most urgent problem facing income tax policy today. With tax brackets remaining relatively unchanged since 2007, the problem is getting worse every year. By 2018, the lost money from increased wages and inflation could amount to €1,000 on a salary of €42,000, his group has estimated.

Ending the cold progression is supported by Ms. Merkel’s coalition partner, the Social Democrats. It is also backed by the Bavaria-based Christian Social Union, the CDU’s sister party. Bavarian Finance Minister Markus Söder told Handelsblatt he is pushing for an automatic adjustment of tax brackets to start in 2018. “The cold progression issue would thereby be solved once and for all,” he said.

Yet losing these funds is unpalatable to Mr. Schäuble. At a time when other European countries have struggled to bring their deficits below 3 per cent of economic output since the financial crisis, Germany’s finance minister is standing by his goal of balancing the budget in 2015 – that means issuing no new debt and would mark a first in the country’s post-war history.

The authors are correspondents for Handelsblatt covering financial and economic issues in Germany’s capital. To contact the authors: cermak@handelsblatt.com ; delhaes@handelsblatt.com; hildebrand@handelsblatt.com.

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