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Merkel Set For Battle On Tax Cut Plans

by Ulrika Lomas,, Brussels

08 May 2012

Ahead of a crucial vote in the Bundesrat, Germany’s upper house of parliament, German Chancellor Angela Merkel has warned the federal states not to block the government’s EUR6bn (USD8bn) tax cut plans, aimed at combating fiscal drift in the country’s income tax law.

Fiscal drift (also known as ‘bracket creep’) occurs when the government fails to adjust marginal income tax brackets in line with wage inflation, meaning more taxpayers are dragged into the higher income tax bands and thus suffer a tax increase.

Prepared for battle, Chancellor Merkel defended the coalition’s plans to increase the personal income tax allowance, insisting that the proposals are in accordance with constitutional requirements.

Alluding to provisions enshrined in the country’s basic law, Chancellor Merkel underscored that when the basic cost of living increases, then so too must the personal income tax allowance. The federal states will not able to prevent this correction, the Chancellor added.

Adopted by the German Bundestag, or lower house of parliament, at the beginning of April, the coalition’s tax cut bill provides for a progressive rise in the personal income tax allowance by a total of EUR350, or 4.4%, by 2014, to be achieved in two stages: by EUR126 (rising to EUR8,130) from January 1, 2013, and by a further EUR224 (rising to EUR8,354) from January 1, 2014.

In accordance with the bill, income tax bands in German will also rise by a total of 4.4%.

No adjustments have been made to compensate for fiscal drift as regards annual income above EUR250,000 for individuals or in excess of EUR500,000 for married couples, those currently subject to a 45% rate of income tax or so-called ‘rich tax’.

Under the plans, the black-yellow coalition also intends to in future examine the effects of fiscal drift every two years to determine whether or not similar adjustments are to be made.

Yet the Social Democrats (SPD) and the Green Party have opposed the plans from the outset, and have threatened to veto the proposals in the Bundesrat. Even some federal states led by Chancellor Merkel’s own Christian Democratic Union (CDU) party are now said to also have grave reservations.

The SPD argue simply that there is currently no scope for tax cuts at the present time, either at federal or state level.

While conceding that he would be prepared to enter into talks with the government on the issue, Baden-Württemberg’s Prime Minister Winfried Kretschmann (Green Party) nevertheless underscored that the proposals must first and foremost serve to reduce the fiscal burden on low- and middle-income earners in Germany.

Kretschmann also warned that the initiatives must not lead to a shortfall in revenues, otherwise the plans would have to be financed by, for example, a rise in the top rate of income tax or an increase in other taxes.

Determined to gain support for the plans, and by way of compromise, Chancellor Merkel has indicated that the federal government will assume part of the costs associated with the measures.

The German Bundesrat is due to vote on the coalition’s tax cut bill on May 11.

TAGS: individuals | tax | law | tax rates | Germany | inflation | individual income tax

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