ending Bracket Creep A Surprise Tax Giveaway

Germany's finance minister surprised the country by announcing a tax cut on Thursday, ending more than a year of wrangling. But the tax relief is small, and won't affect the country's determination to balance the budget.
You're welcome! Wolfgang Schäuble made the surprise tax announcement on Thursday.

Wolfgang Schäuble, Germany's finance minister, is always good for a surprise. Rising tax revenue is helping him keep the surprises coming.

The last time the ministry reviewed its overflowing tax coffers in November, Mr. Schäuble presented an unexpected investment program. The plan went part of the way to easing international criticism of Germany's determination to reduce spending despite the ongoing European economic crisis – though the criticism has continued.

On Thursday afternoon, Mr. Schäuble took another surprise step, announcing there was room in the federal budget to provide relief for German taxpayers from next year. The Berlin government now wants to end bracket creep, or "cold progression" as it is known in Germany, from the beginning of 2016.

"I propose that we now solve the problem of bracket creep," Mr. Schäuble said Thursday as he presented the results of a semi-annual tax appraisal, explaining that there would be financial scope for this from next year.

The olive branch comes as the government's fiscal coffers are practically overflowing. An independent tax panel that advises the Finance Ministry revised upwards its estimates for tax revenue by €38 billion between now and 2019. The federal government will get about €16 billion of these funds, and states will take in an additional €17 billion.

Germany's middle class is one of the most heavily taxed groups in the world, the result of a rigid, unbending tax system that places a higher burden on lower- and middle-income wage earners than on the wealthy. This burden is growing as a result of bracket creep, which has helped push most of those earning just €42,000 into a 40-percent nominal tax bracket.

I propose that we now solve the problem of bracket creep. Wolfgang Schäuble, German Finance Minister

Lawmakers from Chancellor Angela Merkel’s Christian Democrats, the CDU, and from the minority partner Social Democratic Party, or SPD, had been calling for months for the abolition of bracket creep. But there has long been resistance from Mr. Schäuble, who repeatedly said that his first priority is to keep the federal budget balanced.

With tax revenues continuing to rise and low interest rates reducing the government's costs in paying down the debt, it seems Mr. Schäuble has now found a bit more room to spend. He apparently reached an agreement very quickly with Ms. Merkel and with economy minister Sigmar Gabriel, the leader of the SPD, on the proposal. Policymakers from the two parties were also quick to praise the plan.

Sources at the Finance Ministry said that the ministry would now calculate exactly who would get how much relief on what income.

Government sources reported that the aim was to deal with an endlessly recurring topic once and for all. Lawmakers from the CDU and the SPD had recently sought to outdo each other with increasingly loud calls to cut bracket creep, though the federal government had not signed off on a plan.

Mr. Schäuble appeared optimistic that the project would be implemented this time. "In times when inflation is low, it's simpler with regard to the budget," he said.

In plain terms, what this means for the German public is that they will only get a small amount of relief: Mr. Schäuble expects an inflation rate of 1.5 percent for 2014 and 2015 together. The income tax brackets will be adjusted by this percentage, preventing people from falling into a higher bracket if they get a wage increase of that amount.

In total, this is expected to reduce the budgets of the German government, federal states and municipal authorities by €1.5 billion each year. A review will be carried out every two years in future to measure the effect of "cold progression" and make adjustments.

Mr. Gabriel praised the fact that this will strengthen purchasing power: "The economic upturn in Germany must reach the workers."

The timing of the reduction in bracket creep is favorable from the point of view of fiscal policymakers.. Annual inflation in Germany is currently only 0.4 percent, which means that "cold progression" is barely measurable; Mr. Schäuble's ministry reported that it was zero for 2014.

Critics argue that the government should have been bolder. The "cold progression" it plans to end arises when income increases only by as much as inflation. Taxpayers will still move up into a higher tax bracket if their salary increase is above the average for inflation. The average worker is expected to earn 3 percent or more this year as a strong economy has pushed unions to ask employers for more money.

Some economists had called for taxpayers to be granted retroactive relief from the accumulated charges of the last few years. Mr. Schäuble's plan does not include this.

Based on his current proposal, Mr. Schäuble estimated that inflation for 2014 and 2015 together will come to 1.5 percent. And it's by exactly this percentage that the income tax rate will be adjusted above the basic tax-free allowance.

Such tax relief of €1.5 billion works out at very little for the individual. Even in an unsuccessful bill previously submitted by the coalition that had intended to cut bracket creep by €3 billion, the relief that would have been provided for taxpayers on medium incomes was equivalent to the price of one cup of coffee per month.

Some economists had therefore called in the past for taxpayers to be granted retroactive relief from the accumulated charges of the last few years. Mr. Schäuble's plan does not include this.

Still, with the so-called grand coalition of Ms. Merkel and Mr. Gabriel at odds over many issues at the moment, Mr. Schäuble's announcement has at any rate acted as a major peace offering.

"We will remain true to our line: firstly a balanced budget, then additional investment and then a reduction in bracket creep," said Ralph Brinkhaus, deputy leader of the CDU/CSU parliamentary group. He pointed out, however, that it was clear that money can only be spent once. "There is now no longer any scope for any further spending requests."

Carsten Schneider, deputy leader of the SPD parliamentary group, also welcomed Mr. Schäuble's announcement "that a reduction in bracket creep will now finally be implemented." He noted this had always been a concern of the SPD.

"This is a good sign from Berlin," said Bavaria's finance minister Markus Söder of Ms. Merkel's sister party, the Christian Social Union. "The abolition of bracket creep is a question of price fairness. If it goes ahead in 2016, even better."

However, the tax cut still has to be approved in the Bundesrat, the upper house of the German parliament, that includes representatives of the federal states, which are not as financially strong as the federal government. The states and the municipal authorities will together have to absorb 57.5 percent of the tax losses.

The federal states are far from in a mood to spend. They unanimously rejected a separate offer from Mr. Schäuble of €7 billion per year for a broad reform of a long-running inter-state fiscal adjustment, saying that it was too low.

Mr. Schäuble is aware he has a problem with the states on his hands. "The government knows that it also needs to help the weaker states," he said of the ongoing talks.


Donata Riedel covers politics and finance for Handelsblatt in Berlin. Axel Schrinner is an editor covering economics and taxes for Handelsblatt in Düsseldorf. To contact the author: [email protected] and [email protected]