'Unfair distribution': Why Germany's tax system needs to change

With national elections scheduled next year, Germany's Green party has some serious work to do if it wants to serve in the next government - not least to coalesce under a new leader and win back its core voter base. 

According to initial reports, the Green’s next campaign plan will likely focus on changes to Germany’s tax code that the party would like to introduce. 

So, before any specific changes to Germany’s tax code are announced, here’s a look at how Germany’s tax code functions currently and why some say it's unfair.

Different tax rates for labour and capital

If you were a full-time employee in Germany earning €45,000 per year in salary, you can expect to pay about 36 percent of your income in taxes and social security contributions.

Of course the exact amount varies a bit from region to region, and also depends whether you are married or have kids - both of which affect your tax class.

READ ALSO: EXPLAINED - What German tax class are you in?

But if you earned that €45,000 on the stock market, your tax burden would drop to around 27 percent. This would be even lower if you had made that money on investment in funds, because part of the income on funds is always made tax exempt.

According to calculations in a report by Focus, the tax rate on €45,000 gained on mixed funds, equity funds, or real estate funds would fall to 23 percent, 19 percent and 10.5 percent respectively.

Finally, if you inherited €45,000 you might not pay any tax at all because there are high allowances for inheritance received from most direct familial relationships.

READ ALSO: Do foreigners in Germany owe tax on money that is inherited from overseas?

What’s the criticism of the German tax code?

Those whose income is primarily made from capital gains might argue that they take risks with their investments, and the reduced tax rates reflect that.

But a common critique of Germany’s current tax code is that it effectively puts a higher tax burden on people in the middle class or with low incomes, whereas the wealthiest people enjoy significant tax breaks.

Earning €45,000 in gains per year requires having assets worth nearly a million euros in most cases – an amount that the vast majority of people living in Germany will never have.

"The consequence is an unfair distribution of the tax burden in favour of taxpayers with high incomes," Clemens Fuest, head of the Munich-based Ifo Institute told Focus.

Critics claim that the unequal taxation of these two types of income - labour and capital - contributes to a rise in the already-rising wealth inequality in Germany.

Closing loopholes could make the tax code more equitable

To be clear, the changes to the tax code that the Greens would like to introduce wouldn’t target people earning €45,000 a year, no matter how they earned it.

Instead, there are loopholes used by real estate companies and super wealthy individuals that if closed could amount to billions of euros more for the German budget each year without adding new taxes.

For example, a current loophole allows even super wealthy individuals to waive taxes on inheritances worth more than €26 million if they cannot pay the tax out of their private assets. In June of this year, BMW heiress and Germany’s richest woman Susanne Klatten reportedly used this exemption to transfer parts of her company property to her three children.

Other loopholes outlined in the party's paper involve exceptions primarily used by real estate companies and investors to evade paying tax on property. Reportedly, closing any of these major loopholes could amount to billions of euros more for the state in tax revenue.

Will it work?

Marcel Fratzscher, President of the German Institute for Economic Research (DIW), endorsed the Greens' initial plans in an initial reaction on LinkedIn, writing: “From an economic and social perspective, these are clever proposals by the Greens”.

However, Ifo chairman Fuest criticised the fact that the party had not set out how they wanted to spend the additional tax income. Investment in battling the construction crisis should be the government's biggest priority, the economist told Focus. 

Of course, how many of these proposals actually make it into the Green’s next election campaign, let alone the German tax code, remains to be seen.

READ ALSO: How much money could taxpayers in Germany save in 2024?