Brief analysis 11: German income tax reform backlog

"The German economy is growing at a snail's pace. Last year, gross domestic product increased by 0.6% and growth is only expected to be slightly higher in 2020. Austria is also affected by this, as around 30 percent of its exports go to Germany. At the same time, Germany has been running massive budget surpluses for years, which amounted to around 50 billion last year. At the same time, there is a considerable backlog of reforms to German income tax," says Tobias Thomas, Director of the economic research institute EcoAustria. Germany, for example, has not carried out a major reform of wage and income tax for more than 5,000 days. In Austria, on the other hand, the current government program provides for a reduction in the first three levels of income tax from 25 to 20, 35 to 30 and 42 to 40 percent respectively.

In Germany, the tax burden on private households has risen steadily since 2010, despite regular adjustments to the basic tax-free allowance and the other tax brackets. The reason for this is cold progression, which is not fully compensated for. In 2010, income tax revenue in Germany accounted for 7% of GDP; in 2018, it was already 9% of GDP. This increase is associated with a significant reduction in private households' ability to consume. "If the burden of wage and income tax were to correspond to the average for the years 1999 to 2010, private households would have more than EUR 55 billion extra available for consumption this year. This would have a considerable impact on growth and employment," says Thomas. Calculations by the economic research institute EcoAustria show that the partial abolition of the solidarity surcharge on wage and income tax alone would increase value added and employment by 0.3 percent and 0.25 percent respectively in the medium term with a volume of EUR 10 billion. A complete abolition of the solidarity surcharge would even be associated with a 0.45% increase in value added and a 0.35% increase in employment in the medium term.

"Particularly in light of the current weak economic development, especially in Germany, and the economic and social challenges, e.g. in connection with climate policy and structural change, a tax reform that promotes growth and employment would be advisable," explains Thomas. The planned reform of income tax in Austria is therefore a step in the right direction. In addition, Germany shows that the regular rate adjustment there is not sufficient to fully compensate for cold progression. According to a brief analysis published today by EcoAustria, the creeping additional burden on households can only be completely prevented by adjusting the tax rate annually in line with average wage development.