Income Tax: Targeted Relief for Middle Class
ResearchZEW Expertise Shows: Even Ten Billion Euros Can Bring Noticeable Relief for Middle-Income Earners
Reducing income tax for low and middle incomes is a key policy goal of the German Federal Government. A new brief ZEW study shows: A relief volume of just 10 billion euros can be sufficient to provide noticeable relief for middle incomes. For a taxable income of 40,000 euros, an annual relief of about 520 euros would be possible – without raising the top and wealth tax rates and without putting other taxpayers at a disadvantage. Alternatively, the same level of relief can be financed in a revenue-neutral way if the top and wealth tax rates were each increased by around three percentage points.
“Anyone who lowers the income tax rates in the lower or middle range automatically provides relief to high earners, as they too pay less tax on the first portions of their income. This spillover effect is precisely what makes many reform proposals expensive. Our approach shows how relief can be concentrated where it is politically desired. The key trick is a targeted jump in the marginal tax curve,” says Professor Holger Stichnoth, head of ZEW’s “Inequality and Distribution Policy” Research Unit.
Targeted jump instead of broad spillover effects
The proposal by ZEW economists focuses on the marginal tax rate. Below a specified target point – 40,000 euros in taxable income in the main variant – the marginal tax rate is reduced. At the target point, it jumps back to the existing income tax schedule. Above this point, the current tax rate remains unchanged. As a result, higher incomes benefit only to the extent that is technically unavoidable. For comparison: a flat-rate tax relief of around 500 euros for all approximately 45 million taxpayers would cost more than 20 billion euros. The targeted variant achieves a similar level of relief at an income of 40,000 euros with only 10 billion euros.
Positive work incentives and transparent methodology
The analysis also shows that the reform could create positive work incentives. Estimates using ZEW microsimulation model EviSTA indicate additional labour supply effects of around 50,000 to 60,000 full-time equivalents. The second-round fiscal effects therefore amount to 1.5 to 2 billion euros per year. The calculations are based on the standard income tax under Section 32a of the German Income Tax Act (EStG), as applicable in 2026 and on data from the 2022 wage and income tax statistics, projected to the year 2026. The solidarity surcharge remains unchanged in the simulations; however, the analysis takes into account that changes to income tax also affect the solidarity surcharge.
