Relief for low earners: What we know so far about Germany's tax shake-up

Germany is set to reform the tax system next year, with the aim of putting money in the wallets of lower earners.

Now if you feel like you've been hearing about this for weeks or even months without any concrete details, you're absolutely right.

The coalition government – made up of the conservative Christian Democrats, Bavarian sister party the CSU and junior partner, the centre-left Social Democrats (SPD) – is struggling to reach an agreement.

However, plenty of ideas are on the table. Here's a guide to what you can expect in the upcoming tax reform.

Who will pay less tax?

People in Germany who earn between €2,500 and €3,000 gross per month will pay less tax to the Finanzamt under the overhaul that is scheduled to come into force on January 1st 2027. 

The change will likely result in a tax break of €100 to €200 per year for low earners, according to calculations by economist Stefan Bach of the German Institute for Economic Research (DIW).

For middle-income earners, the savings could amount to as much as €400 per year. Bach says this is because of progressive taxation: those who earn less pay a lower percentage in taxes – and therefore receive a smaller tax break.

As The Local has reported, around half of all people in Germany are classed as middle, low or very low earners. Middle-income earners take home up to €3,724 gross per month, while low and very low earners receive no more than €3,381.

Data from the government also shows that around one in five people in Germany (20 percent) earn less than €1,538 per month. This group includes millions of pensioners.

READ ALSO: How does your salary stack up against Germany's top earners?

As you'd imagine, the government is going to take a major hit from this. Economist Bach estimates the reforms could create a tax revenue shortfall of €20 to €30 billion per year.

This money will have to be recouped elsewhere – and the coalition is bickering over where savings can be made. 

Could high earners pay more tax?

The Social Democrats want to target higher earners by taxing them more heavily. 

The standard top tax rate (Spitzensteuersatz) of 42 percent applies to single people with taxable annual income above €69,879. The SPD has floated the idea of raising it to 49 percent.

"We don’t just have the 'rich tax' (Reichensteuer), we also have the top tax rate, which needs to be discussed," said SPD Bundestag leader Matthias Miersch recently.

But the CDU and CSU do not want any changes to the standard top tax rate.

Earlier this month, Chancellor Friedrich Merz told broadcaster ARD there would be no increase. He said: "We have a tax burden on skilled workers and on the middle class through income tax that is too high.

"And I will not discuss any further increases with the SPD."

Another proposal centres on raising the 'rich tax'.

The Reichensteuer applies to single people with an annual income of €277,826 or more and is currently set at 45 percent.

Some CDU/CSU lawmakers have proposed raising it to 47.5 percent, starting at an annual taxable income of €210,000.

It’s an idea the chancellor is generally open to but experts say the effect would be limited because very few people earn enough to pay it.

"If you were to raise the tax rate by one percentage point, you’d have just €1 billion in additional revenue," said Bach. 

READ ALSO: How does Germany's highest income tax rate compare to other countries?

Are changes to inheritance tax on the horizon?

The government would be able to generate revenue by reforming inheritance tax (Erbschaftsteuer) laws. 

At the moment, extensive exemptions are in place. Business assets are fully or largely exempt from inheritance tax if heirs continue to operate the company for a specified period and meet certain requirements regarding payroll.

The aim of this regulation is to ensure that as many firms as possible continue to operate and that jobs are secured. But it comes at a price, with the government missing out on billions in revenue.

The SPD is therefore proposing to exempt only family-owned businesses valued at up to €5 million.

A reform could bring an additional €4 to 6 billion per year into state coffers, according to ifo economist Andreas Peichl.

The CDU/CSU, however, is cautious, warning that it could weaken Germany as a business location.

Furthermore, it would be the states – rather than the federal government – that benefit from the additional inheritance tax revenue.

READ ALSO: Will Germany's inheritance tax law see a serious shake-up this year?

Could we see higher VAT on everyday products?

A proposal to raise the standard value added tax (VAT) rate from 19 to 21 percent is also on the table. 

However, the idea hasn't received a lot of support so far. 

SPD parliamentary group leader Matthias Miersch stressed that it places a disproportionate burden on lower-income earners in particular.

CSU leader Markus Söder also believes a higher VAT rate is not a good signal in times of rising prices.

Financially, however, an increase could help offset lost government revenue. According to economists, it could result in an additional €15 billion a year.

What happens next?

The coalition still needs to reach a final agreement before the law goes through the Bundestag and Bundesrat. 

Ministers are aiming to pass the reforms by the Bundestag summer recess which begins on July 13th.