Hidden Tax Increases - the Extra Tax Burden of the Bracket Creep and the Expected Impact of Income Tax Rates "on Wheels" on Tax Reliefs

Tasks

This research project quantifies the bracket creep, evaluates it from an economic perspective, and examines income tax rates "on wheels" (steadily inflation-adjusted rates) as a political reform option.

Methods

We examine to what extent bracket creep gave rise to extra income tax revenues in Germany between 2010 and 2016. Using different income levels and household characteristics, we run simulations to quantify bracket creep and its expected growth in the years until 2030. In our simultations different assumptions are used regarding the long-term development of inflation, employment and real wages.

Bracket creep is also evaluated from a (political-)economic perspective with a focus on social justice.

Tax rates "on wheels" is examined as a reform option. We simulate the tax relief for different income groups, the loss of tax revenues and how the reform influences the economy by using multipliers.

Data and other sources

Statistische Landesämter (Statistical Offices of the German States), 
Statistisches Bundesamt (Federal Statistical Office)

Results

The project results were presented by Clemens Fuest at a press conference in Berlin on 27.10.2016.

• Bracket creep is weakening the distribution effects of the taxation system and leading to a rise in the tax ratio that is beyond democratic control. The elimination of bracket creep is therefore advisable.
• The public debate mostly focuses on bracket creep in the narrower sense of the term, which only takes into account the effect of rising prices. This bracket creep in the narrow sense of the term alone led to additional tax revenues of 33.5 billion euros from 2011 to 2016. If the effect of rising real wages (bracket creep in the larger sense of the term) is also taken into consideration, the additional tax revenues during this period total 70.1 billion euros.
• The impact of the burden caused by bracket creep is not equally distributed among income tax payers. Income tax payers in the low and medium income tax brackets are particularly negatively affected by bracket creep.
• Bracket creep in the narrower sense of the term will lead to an increase in income tax revenues of a total of 314.9 billion euros during the period of 2017 to 2030. If the tax ratio is to be kept constant, or if bracket creep is considered in the wider sense of the term, cumulative “hidden” additional tax revenues will be as high as 433.6 billion euros.
• A “rolling rate” is proposed whereby a tax rate parameter and creep areas are coupled with inflation and growth in real income (bracket creep in the broader sense), in order to keep the tax ratio constant ceteris paribus.
• State revenues continue to grow even with a “rolling rate”: even if bracket creep in the wider sense is taken into account, public income continues to rise in line with growth in price levels and real wages.

Publications

Dorn, Florian, Clemens Fuest, Björn Kauder, Luisa Lorenz, Martin Mosler and Potrafke. Niklas,"Die Kalte Progression – Verteilungswirkungen eines Einkommensteuertarifs auf Rädern", ifo Schnelldienst 70 (03), 2017, 28–39 | PDF Download

Dorn, Florian, Clemens Fuest, Björn Kauder, Luisa Lorenz, Martin Mosler and Niklas Potrafke,"Steuererhöhungen durch die Hintertür – fiskalische Aufkommenswirkungen der Kalten Progression", ifo Schnelldienst 70 (02), 2017, 51–58 | PDF Download

Fuest, Clemens, Björn Kauder, Luisa Lorenz, Martin Mosler, Niklas Potrafke and Florian Dorn,Heimliche Steuererhöhungen – Belastungswirkungen der Kalten Progression und Entlastungswirkungen eines Einkommensteuertarifs auf Rädern, ifo Forschungsberichte 76, ifo Institut, 2016 | PDF Download