German Tax and Transfer System Impeding Income Increases for Low-Wage Earners

Increases in income among low-wage earners in Germany are more heavily taxed than that of top earners. This is due to the combination of a number of factors in the tax, contribution and transfer system. This is the result of a recent study carried out by the Centre for European Economic Research (ZEW), Mannheim, on behalf of the Bertelsmann Stiftung.

The study determines the effective marginal tax rate (EMTR) for six different types of households.  The EMTR is the percentage of an additional euro’s worth of earnings that is unavailable to an individual due to social security payments or income taxes, or because it is offset by reduced welfare entitlements, such as housing and child benefits. At an effective marginal tax rate of 60 per cent, a household is left with 40 cents for every extra euro earned.

ZEW researchers have found that high earners are able to keep a considerably higher percentage of every additional euro they earn than low-wage earners. The effective marginal tax rate for many income groups does not increase progressively, but rather decreases as income goes up. For example, a single household with a gross annual income of 17,000 euros has to hand over the entirety of every additional euro earned, while a household with a yearly income of 75,000 euros gets to keep 56 cents. The situation is similar in the case of single parents. The marginal tax rate for single-parent households only drops to 44 per cent with a yearly income of 41,000 euros or higher. By comparison, the marginal tax rate for an annual income of 23,800 euros is 60 per cent.

When it comes to trying to combat this sharp increase in the tax burden for lower income groups, debating the “middle-class bulge” is limited in its usefulness, since such debates divert attention away from many of the larger problems affecting the system as a whole. Simply eliminating the middle-class bulge would primarily serve to further benefit high income households and lead to high losses in government tax revenue.Instead, the authors of the study suggest creating a more optimal balance between income tax, social contributions and transfer payments within the system as a whole in order to create employment incentives for low-wage earners. Harmonising the various transfer payments, such as child supplement, housing benefit and long-term unemployment benefit would be a first step in the right direction. Combined with a constant transfer withdrawal rate of 60 per cent, this could have a positive impact on employment and lead to a reduction in income inequality.