Germany’s tax reform debate: Proposed relief plans could widen deficit

As Germany’s federal election campaign gains momentum, tax policy has emerged as a central issue, with major political parties proposing reforms that could significantly impact public finances. Proposals from the CDU, FDP, and AfD advocate for extensive tax relief, primarily benefiting high earners and businesses. However, these measures could increase the national deficit by up to four percentage points of GDP. In contrast, the SPD and Greens aim to ease the tax burden on lower and middle-income groups while increasing levies on high earners and wealth.

Tax Relief vs. Fiscal Sustainability

Germany’s tax system has remained largely unchanged since the major reforms of the 1990s and 2000s. The country has one of the highest tax burdens on earned income among OECD nations, second only to Belgium. Rising social security contributions—particularly for healthcare and pensions—further strain household incomes, while corporate tax rates remain high compared to international competitors.

Although Germany is considered a low-tax country for investment income and wealth, the structure of the tax burden remains a subject of debate. Some experts argue that tax reductions should prioritize earned income and businesses to stimulate economic growth, while moderate tax hikes on high incomes and wealth could contribute to fiscal sustainability.

The VAT Factor

One of the key but often overlooked aspects of tax reform is value-added tax (VAT). While VAT and excise duties in Germany are relatively low compared to other European nations, adjustments in this area could help balance revenue losses from income and corporate tax cuts.

Estimating the Economic Impact

A recent study assessing the revenue and distribution effects of these proposed tax policies for 2025 highlights significant economic trade-offs. While tax cuts could boost growth, their positive impact on revenue would be limited. The study, based on micro-simulation models and economic forecasts, also considers secondary effects such as changes in working hours, consumption, savings, and investment behaviors. However, these projections remain uncertain and serve only as a broad guideline for policymakers.

With fiscal constraints and major policy challenges, including defense spending and investment in infrastructure, the scope for large-scale tax cuts remains limited. Whether Germany moves toward business-friendly tax reductions or progressive taxation will be a defining issue in the upcoming elections.

Source: DIW Berlin
Charts: Source: Simulation analyses by DIW Berlin based on the election programmes of the respective parties.