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When Higher Gross Wages Lead to Lower Net Pay

Summary:
The grand coalition needs to introduce sweeping reforms of Germany’s taxation, social insurance and transfer system, according to Andreas Peichl, Director of the ifo Center for Macroeconomics and Surveys. “We have a completely absurd system in Germany,” notes Peichl. “The net income of single parents with children and a gross income of between 1,700 euros and 2,350 euros drops with every additional euro that they earn. In other words, higher gross wages lead to lower net wages and the marginal burden is above 100 percent. This urgently needs to be changed by Germany’s next government. These figures stem from the interaction between a loss of welfare benefits, social insurance contributions and income taxes. There is no

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The grand coalition needs to introduce sweeping reforms of Germany’s taxation, social insurance and transfer system, according to Andreas Peichl, Director of the ifo Center for Macroeconomics and Surveys.

“We have a completely absurd system in Germany,” notes Peichl. “The net income of single parents with children and a gross income of between 1,700 euros and 2,350 euros drops with every additional euro that they earn. In other words, higher gross wages lead to lower net wages and the marginal burden is above 100 percent. This urgently needs to be changed by Germany’s next government. These figures stem from the interaction between a loss of welfare benefits, social insurance contributions and income taxes. There is no incentive at all to take on any additional work. And this is also highly dubious from a distributional perspective policy point of view,” adds Peichl.

This policy has been a problem for years, warns Peichl in a recent study jointly conducted with the Institute for Employment Research (IAB) on the interaction between individual benefits of the taxation, contributions and transfer system. A potential solution would be to limit the marginal tax rate on additional income to 70 or 80 percent for lower earners. “But to achieve this, the various ministries and institutions would have to agree on a coordinated policy. And that is a major stumbling block,” explains Peichl. This is shown by the fact that this has been a well-known fact for decades. The ifo Institute published detailed studies highlighting this problem 40 years ago. “Nothing has changed since and it is high time that politicians addressed this issue,” says Peichl.

Publication (in German)

  1. Bruckmeier, Kerstin, Jannek Mühlhan and Andreas Peichl, "Mehr Arbeitsanreize für einkommensschwache Familien schaffen", ifo Schnelldienst 71 (03), 2018, 25–28 | Details | PDF Download

Clemens Fuest
Clemens Fuest took over from Hans Werner Sinn as chairman of the IFO Institute in April 2016. He is professor at the Faculty of Economics of the University of Munich.

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