Incentives to work, reduction of bureaucracy and digitalisation ̶ effects on income tax of the German growth initiative

Simplifying tax law

German tax law is to become simpler and more manageable. A specially convened commission of experts called “Citizen-centred income tax” will submit proposals in July 2024 for revising the German income tax return. The German government is examining these proposals and, if the outcome is positive, plans to implement them in a bill in 2024. It remains to be seen what kind of proposals the commission will submit and whether they will be soon introduced. Simplifying the complex German income tax law by reducing bureaucracy and increasing digitalisation is to be welcomed.

Avoiding “cold progression”

To avoid additionally burdening taxpayers due to inflation, the federal government is planning to amend the tax rate benchmarks for 2025 and 2026. “Cold progression” refers to the situation in which a salary increase is absorbed by inflation on the one hand, while still resulting in higher taxation on the other. This leaves the taxpayer with less purchasing power despite the increase in salary. Reducing cold progression, which the federal government has been working on since 2023, will continue in the coming years.

Rewarding overtime and flexibility

The federal government is planning the following measures to make more flexible working models possible and to compensate for overtime appropriately:

1. Allowances for overtime in excess of the collectively agreed full-time working hours are to be exempted from tax and contributions. In the case of collectively agreed working hours, full-time work is deemed to be a working week of at least 34 hours. For working hours that are not collectively agreed or stipulated, 40 hours is considered full-time. 
2. Premiums for extending working hours are to be tax privileged. 

Strengthening women in work

Moving the tax class combination III/V to the factor method of tax class IV is intended to strengthen women in employment. Applying tax class combination III/V leads to a higher tax deduction for the spouse in tax class V than it does if they are in tax class IV. This often affects women, who more often work part-time, leaving them with an even lower monthly income after class V tax has been deducted. The reform is intended to ensure that the tax-reducing effect of the splitting method is already taken into consideration when monthly income tax is deducted. This avoids the higher taxation of tax class V. Implementation is planned for 2030, but faster introduction is currently being reviewed. The latest draft law for 2024 already contains the implementation.

This change to the tax class model is intended to incentivise women in particular to expand their work.

Tax benefits for starting to work in Germany

To make Germany more attractive to foreign skilled workers, the federal government is planning tax incentives for starting to work in Germany.
The federal government are currently discussing making 30, 20 and 10 percent of the foreign skilled worker’s gross wage tax exempt in the first three years. A lower and upper limit for the gross wage will be defined for this exemption. The rule will be assessed after five years.

Germany would like to introduce a kind of special tax regime, as in other countries. How it will actually be implemented and for how long remain to be seen. We’ll keep you posted on the developments.