The €23 billion package of tax cuts is aimed at supporting household budgets already hit by inflation. This will be done mainly by increasing income tax thresholds, which in turn will reduce fiscal drag. Fiscal drag happens when higher inflation leads to higher wages and bumps people up to the next tax bracket.
However, the higher inflation quickly eats up any extra income earned by workers, despite their wages seeing a hike. This is also known as cold progression.
Germany’s tax move is expected to be worth about €430 for every adult with a job in Germany and will be carried out over the next couple of years in three stages.
The first stage will be to hike the tax-free allowance to €12,336 by 2026. This will also take into account a backdated rise of €180 to €11,784 in 2024.
The second stage is likely to be implemented in January next year, with the tax-free allowance threshold inching up by another €300 to €12,084. The third stage is expected to see the highest taxpayer rate threshold hiked to €69,798 in 2026.
The German finance minister, Christian Lindner, has highlighted that this decision is only fair, in order to tweak the tax system to reflect the burden of inflation on citizens at the moment. This is due to the country’s tax system not automatically being adjusted for inflation, as it is in other countries like Canada, the US and Switzerland.
Lindner’s tax generosity sees backlash
Although Lindner, a member of the Free Democratic Party, may see a lot of support from cash-strapped households for his tax cut announcement, this has also led to a considerable backlash from his other two coalition government parties, the Greens and the Social Democrat party.
This is mainly due to Germany potentially looking at a budget hole of between €20 billion to €25 billion, if not more, for the next year’s budget, with Lindner being especially hawkish and imposing restrictions on debt levels for most ministries apart from defence.
In this case, cutting taxes and further eroding away government revenue could be seen as further exacerbating the budget issue.
Katharina Beck, a lawmaker from the Greens party told Welt newspaper, as reported by Bloomberg, “There is a budget gap of €25 billion, which is also causing us difficulties with defence and infrastructure investments. To bring general tax cuts into the double-digit billion range into play in this context is dubious.”
Lindner has also been criticised for failing to take his fellow coalition parties’ suggestions and concerns sufficiently into account when making these major decisions, as well as delegating debt-cutting measures far more to other ministries than to the finance ministry.
Germany has already come under considerable scrutiny by organisations such as the International Monetary Fund which has advised the country to pause its debt brake and ramp up public investment.
