ZEW Tax Proposal Provides Greater Relief for Middle-Income Earners

At the beginning of the week, ZEW Mannheim published a proposal for income tax relief. In the meantime, plans by Federal Finance Minister Lars Klingbeil have also been announced. Professor Holger Stichnoth, head of the “Inequality and Distribution Policy” Research Group and author of the proposal, explains the proposed tax schedule:

“With the same fiscal volume, tax relief for middle-income earners could be designed more effectively than in the Klingbeil models that have been published. In particular, taxable incomes of 40,000 and 50,000 euros could benefit from greater relief through what we refer to as a “ZEW jump” in the tax schedule.

For a taxable income of 40,000 euros, our proposal, which is optimised for this target point, achieves the same relief as the Klingbeil models, but without any additional burden on higher incomes. At 50,000 euros, the relief is even higher. If we allow the same counter financing at the upper end as in the Klingbeil plans, our tax schedule significantly exceeds the tax relief provided by the Klingbeil models at all points considered – for example, at 40,000 euros, the relief is around 1,170 euros instead of 790 euros. For a taxable income of 50,000 euros, the ZEW model even achieves close to 800 euros more per year with the same overall volume.

However, this more targeted relief comes at a price. Because the basic allowance and the initial tax rate remain unchanged, the ZEW jump in the tax schedule has the effect of concentrating the relief on incomes in the middle range and slightly above, while lower incomes receive hardly any relief. By contrast, the Klingbeil models have a broader impact because they raise the basic allowance and reduce the tax rate throughout. In addition, the ZEW model creates a jump in the marginal tax rate curve rather than a smooth, linearly progressive scale.

As a result, the key finding is that none of the models is “better” than the other but that the same budget can generate more relief for middle-income earners if the tax structure is tailored more closely to this income range. The decision is therefore a political trade-off: If a given relief volume is to be distributed as broadly as possible, this tends to favour the Klingbeil approach. If the aim is to provide efficient relief for middle-income earners in particular and limit wasteful distribution, our ZEW simulation shows that a targeted jump rate can achieve more.

We reconstructed the Klingbeil models on the basis of publicly reported information. The relief amounts for each income level are matched almost exactly, while our net volume estimates are close to the reported orders of magnitude.”