Warning to Lindner: Compensation for the cold progression is not suitable as a relief measure

Created: 07/03/2022 06:13

Prof. Achim Truger is a member of the Advisory Council for the Assessment of Overall Economic Development and Professor of State Activities and State Finances at the University of Duisburg-Essen © N. Bruckmann/M.

Litzka/SVR

The cold progression is an issue.

Because with salary increases, the Treasury benefits from higher taxes - while higher taxes and inflation eat up the increase in wages for employees.

Federal Finance Minister Christian Lindner is a thorn in his side.

From next year, the FDP politician wants to improve income tax.

But in view of the budgetary situation and the lack of a relief effect on low-income households, the approach is not convincing, says economics professor Achim Truger in the guest article.

Since the start of the traffic light coalition, there has been hardly any tax policy stimulus from the federal government.

Because the coalition parties were unable to agree on general tax cuts or tax increases given the completely different ideas of the red-green on the one hand and the FDP on the other, the topic was largely left out of the coalition agreement.

But the tax policy debate will soon gain momentum again: FDP Federal Finance Minister Christian Lindner would like to implement tax relief for income tax and justifies this with the compensation for the so-called cold progression.

The cold progression is actually about a serious problem: The income tax rate is progressive, ie the average tax rate increases with increasing income.

This is also desired: strong shoulders carry more than weak ones.

The problem, however, is that the income tax rate refers to nominal income, ie income that is not adjusted for inflation.

As a result, the percentage tax burden increases with nominal income increases even if these only compensate for inflation: the real tax burden increases even though real income has remained constant.

One way to prevent this would be to "put the tariff on wheels", ie adjust it annually for inflation.

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In the reality of the last few decades, however, this was actually not necessary, because the income tax rates were reduced again and again due to tax reforms, so that the cold progression was even overcompensated.

Nevertheless, the legislature decided in 2012 that the federal government must prepare a report every two years on the effects of cold progression, on the basis of which the Bundestag then decides whether there is a compensation and, if so, what kind.

So far, the cold progression has been roughly compensated.

However, inflation has recently picked up extremely sharply.

This will be determined in the next progression report due after the summer break, and then at the latest Christian Lindner will raise corresponding demands for relief.

Cold progression: Bundestag must decide every two years

However, there is by no means a compulsion to compensate for the identified cold progression.

For this, the “tariff on wheels” should have been written directly into the tax law.

Since this did not happen, the Bundestag has to discuss and decide on the desired income tax rate every two years.

So if you want to compensate for the cold progression, you will have to bring good arguments for it.

However, the arguments put forward so far are unconvincing or contradictory.

Firstly, it is often argued that the dismantling of cold progression is necessary so that the state does not get rich from inflation.

It is not at all clear whether the state budget will actually be relieved to such an extent by inflation.

The state now also has higher expenses for many goods and services.

In addition, the higher inflation has already led to a turnaround in interest rates, so that sharply rising interest costs can be expected.

Although the state generally benefits from rising prices through VAT, this does not apply if private consumption weakens due to the higher prices or the looming economic downturn.

Finally, the revenue-increasing effect of cold progression is currently limited by the fact that wages lag far behind inflation, so that full inflation compensation in income tax would cost the state significantly more than it takes in from cold progression.

Cold progression: Tax relief does not fit the budgetary situation

Secondly, the targeted tax cuts do not match the budgetary situation and the fiscal policy challenges.

Complete compensation for the cold progression for 2022 would probably cost at least twelve billion euros a year in the long term.

If you - like Christian Lindner - insist on an unconditional return to the debt brake in 2023 and have therefore already sewn the budget up to scratch, you should not make compliance with the debt brake even more difficult with expensive tax cuts.

This applies all the more in view of the increased financial policy requirements on the expenditure side due to the Ukraine war and the necessary accelerated energy transition.

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Cold progression: The wrong ones would be relieved

Thirdly, the – fiscally expensive – compensation for the cold progression would currently relieve exactly the wrong people.

Contrary to what is often claimed, it is primarily the wealthy who benefit from inflation compensation in income tax: According to calculations by the German Institute for Economic Research, two-thirds of this would benefit the richest 20 percent of private households, and almost half of the relief would even go to the richest ten percent.

The bottom 30 percent in the income distribution, on the other hand, received almost nothing at all because they pay almost no income tax due to a lack of income.

It is precisely the bottom 20 percent of households that are currently suffering the most due to the drastic increase in inflation caused by energy and food prices, despite the federal government's strong relief packages, while the top 10 percent are only slightly burdened net.

So there is definitely a need for further relief.

However, this need exists precisely in the poorest households, which are not reached at all by compensating for the cold progression.

A meaningful, targeted relief would therefore have to look completely different.

Compensating for the cold progression is not suitable as a relief measure: It would be expensive from a fiscal point of view, would make it more difficult to comply with the debt brake and would not reach those people in Germany who are particularly suffering from the high energy prices.

About the person: Prof. Achim Truger is a member of the Advisory Council for the Assessment of Overall Economic Development and Professor of Government Activities and Public Finances at the University of Duisburg-Essen.