This text was also published in German in ZEIT ONLINE on May 26 as part of the op-ed column “Fratzschers Verteilungsfragen“
Going by what political parties say, it would seem that the tax system in Germany is unjust. In the federal election campaign, each is trumping the next: promising tax relief to voters or demanding higher taxes on the wealthy. Last year’s high fiscal surplus of almost 24 billion euros has whetted appetites. In the upcoming months the election campaign is likely to become more and more of a tax campaign. Is there a good reason for this? What do people’s tax burdens really look like?
The German tax system is based on the principle of capability. People with high earned and capital incomes should convert a higher proportion of their income into government tax revenues. In general, taxes should be progressive. This means the tax rate should rise as income rises.
But how progressive is Germany’s tax system really? A study conducted by Stefan Bach, my colleague at the German Institute for Economic Research (DIW Berlin), and co-authors from the Cologne Institute for Economic Research and Freie Universität Berlin, has an answer. It shows the percentage of total household income that goes to taxes and social security contributions. In the graph, the lowest-income households appear at the left and those with the highest at the far right.
A “Whale in a Bathtub”
They nicknamed the graph “Whale in a Bathtub.” The bathtub is the sum of German households’ indirect and direct taxes and the whale, their contributions. What it illustrates is surprising to many: the German tax system is clearly much less progressive than widely assumed.
Here, however, it is important to differentiate between direct taxes (income and corporate taxes) and indirect taxes (value-added tax, insurance tax, energy taxes, taxes on tobacco, alcohol and betting, property taxes, motor vehicle tax and other taxes). Social security contributions (divided into the proportion that employees must pay and that of employers) are not taxes. After all, people receive an insurance benefit, that is, a claim against the state.
Indirect taxes are anything but progressive
The graph clearly shows that income and corporate taxes are highly progressive. The wealthiest half of all households account for almost the entirety of direct taxes paid. Some politicians are attacking the system’s progressive character and demanding lower income tax rates. However, almost all of their proposals would primarily provide relief for higher-earning households.
The parties’ proposals virtually ignore indirect taxes. Yet of the two types of taxes, precisely they are the opposite of progressive. People with low incomes pay a significantly higher proportion of their income toward indirect taxes than those with high incomes. For example, a household that belongs to the 10 percent of the population with the lowest income pays over 20 percent of its income to the state in the form of indirect taxes. And a household that belongs to the top 10 percent pays just below eight percent of its income in indirect taxes.
This is not particularly surprising. After all, people with low incomes can hardly save anything and use almost all of their income to cover their basic needs. A value-added tax of 19 percent applies to most goods and services in Germany, with exceptions such as groceries. That means these households allocate a significant proportion of their income to indirect taxes. The consumption rate of people with high incomes is much lower, as is the proportion they allocate to indirect taxes.
In the overall picture, indirect taxes are just as important as direct taxes. The German government has annual revenues of just under 380 billion euros from income and corporate taxes and 330 billion euros from indirect taxes.
However, these two types of tax are unequally distributed among income groups. The richest 10 percent account for almost 60 percent of total income taxes paid but only 20 percent of all indirect taxes. The lower 50 percent of the income distribution make up four percent of total income taxes paid but are responsible for 36 percent of all indirect tax revenues.
In Germany, total contributions to government revenue are not consistently progressive. People at the lower end of the income distribution have only a slightly lower tax burden than people at the upper end. The tax system in Germany is actually degressive until the 20th percentile of the income distribution. At that point the tax burden plateaus at almost 18 percent until the average income, where it slowly begins to rise.
Low earners pay proportionally higher taxes
For households with relatively high incomes, the overall tax burden is lower than commonly perceived. For example, households in the highest percentile (90th and upward) pay almost 25 percent of their income in taxes. This is only slightly more than the 20 percent that households in the lowest percentile (the 10th percentile) pay in taxes on average.
Indeed, the German tax system is not consistently progressive; nor is it highly progressive for people with high incomes. Only the people in the upper five percent of high-income households (95th percentile and upward) are subject to a tax burden that rises sharply upon entering the next tax bracket.
On the other hand, social welfare contributions – such as statutory pension, health and nursing care insurance – are almost consistently progressive (at least until the 85th percentile, where the legal contribution limit takes effect). It is important to differentiate between social contributions and taxes because people obtain direct claims against the state through social contributions. For example, the statutory pension fund’s equivalence principle ensures that each euro paid into the fund yields the same pension entitlement, regardless of household income. This is not true of statutory health and nursing care insurance to the same extent. More specifically, in terms of their distribution, social welfare contributions have a trickle-down effect.
Factoring in indirect taxes the German tax system is, overall, anything but highly progressive. In particular, people in the lower quarter of the income distribution are subject to degressive taxation. For them, lower income goes hand in hand with proportionally higher taxes.
Indirect taxes need a progressive structure
Changing income tax rates will not relieve the tax burden on people with low incomes, as they pay little or no tax to begin with. A more productive approach would be to lower the value-added tax or other indirect taxes such as the EEG surcharge. Reducing their relatively high social welfare contributions would relieve middle-income households, while people with high incomes would benefit most from lower income and corporate taxes.
There is no convincing evidence that the tax system is unjust for the majority of Germans – with the key exception of the 25 percent who are low earners. Their tax burden is relatively high. None of the political parties are comfortable with this message, for it is difficult to reconcile with the client politics many of them practice.