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Sunday, September 9, 2012

Problems of the German Income Tax System

The German income tax law is very complicated. While it is almost required of a modern citizen in a western country to complain about their respective tax system, in Germany even the tax agency agrees. The control organization is warning about how the checks on tax declarations are completely insufficient and have a large error rate, endangering tax fairness. And the officials employed at the tax agency are complaining that there are so many changes to the regulations all the time that they just can’t keep up, and even if they do, the law text is written in such a complicated way that even they don’t understand it.

That is pretty bad. So, what’s the problem?


The problem is, simply, that the German tax law has been written, and changed regularly, by people with Good Intentions. Which is why the law as it is is pretty much hell.

There are many dozens of exceptions and special regulations. Almost every single one of those is, if you look at it in isolation, mostly sensible and good. But the combination of many dozens of such regulations make the law as a whole a mess.

The following sections try to explain this phenomenon on the specific example of family and child benefits in the tax code. The same observations hold for other parts of the law, too, though.

Deduction Jungle

In Germany, if you have children, you get money from the state in the form of Kindergeld (Child Money). This is a fixed amount per child (184 EUR for the first and second child each, 190 for the third, and 215 for every further one, per month). This money is not taxed as income, but it is related to the tax deduction called Kinderfreibetrag (Child tax deduction) of 2 184 EUR. If this tax deduction reduces your tax by more than you earned by getting the Kindergeld, that tax deduction is used, but the Kindergeld is added to your total tax debt again. This means this is a tax deduction with a minimum benefit of the Kindergeld.

Parents of young children can get an additional amount of money in the form of Elterngeld (parent money) for the first year. It’s meant to allow one parent to stay out of job and keep watching the child. If the other parent does part of the time, too, the time is extended by two months. The amount paid out with this benefit depends on the normal income, but is at least 300 EUR a month and at most 1 800 EUR a month.

Then, two thirds of the money spent on child care, like kindergarten, nanny, anything, can be deduced from taxes. 30 per cent of the cost of schools can be deduced, too. If the child is an adult but getting an education for a job and not living at home, the parents can deduce another 924 EUR from their taxes. If the child is being raised by a single, that parent can deduce another 1 308 EUR from their taxes.

And if the parents are on welfare (ALG II), the regulations change again. The same if the parents are separated.

Each and every single one of those regulations do seem like a good idea if you look at them in isolation. But combined, they create a very complex situation. And even though it is meant to make it easier for families to have children, the complexity of these regulations in combination with the complexity of the rest of the tax law sadly makes it more or less impossible to know beforehand how much money you will have more if you have a child. Which makes planning for a child much more difficult.

In a Progessive Tax System, Tax Deductions Help Those in Need Less

The next problem is that tax deductions are regressive.

Take the tax deduction for children living in a different household of 924 EUR. The average wage in 2010 was 3 311 EUR a month before taxes. After taxes and mandatory insurance fees, the employee will take home about 2 039 EUR. With that deduction, they will take home 26.55 EUR more a month. I’m not even sure that’s worth the effort to fill out the application forms.

But the German income tax function is linear progressive up to an income of about 50 000 EUR, which means that every single Euro of income more will slightly increase the percentage. If someone takes home 50 % more than the average worker, or about 5 000 EUR a month, they will save 33.06 EUR from this tax deduction. Multiple tax deductions compound together and push the percentage down more and more, so a combination of tax deductions will yield in a greater decrease of tax debt than the sum of single benefits. And even worse, if you earn less than 875 EUR a month, you do not pay any income tax at all, and consequently do not have any advantage from this tax deduction anymore at all.

In a progressive tax system, tax deductions are regressive—they benefit poorer families less than richer families. But especially with child benefits, the purpose would be to support the poor.

Variable Tax Deductions Help Those in Need Less

Take the tax deduction for child care, for example for a nanny. Poor families will have trouble providing the money to actually afford one, while richer families even get money back from the state for doing so. And even if both families somehow afford the same kind of nanny, due to the regressive nature of tax deductions noted in the last section, the rich family even gets more money back for their effort.

Sense—this does not make.


The problems noted in this article are twofold. First, the multitude of regulations are so intransparent that, even if you figure it all out, it’s basically impossible to know beforehand how much money you will have more once you have a child. That makes family planning more difficult than it should be. Second, the kinds of benefits granted so far are mostly in the forms of tax deductions, which actually support families that need them the most less than those families that can afford them better. This is nonsensical.

Luckily, there is a simple solution. Remove all tax deductions. With the money saved this way, increase the Kindergeld. This way, every child will have the same amount of benefit from the state regardless of the income of the family. Additionally, future parents can easily see from that how much money they will have more when they have a child and can plan accordingly.

And this is the major solution to a lot of the income tax law problems. There has been for decades the misguided attempt to use this law as a replacement for benefits. That is wrong. Only a small number of benefits should happen as deductions from the income tax. Anything else should happen as a fixed sum benefit to the recipient.