How Bracket Creep Creates Hidden Tax Increases: Evidence from Germany

A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Dorn, Florian et al. Article How Bracket Creep Creates Hidden Tax Increases: Evidence from Germany ifo DICE Report Provided in Cooperation with: Ifo Institute – Leibniz Institute for Economic Research at the University of Munich Suggested Citation: Dorn, Florian et al. (2017) : How Bracket Creep Creates Hidden Tax Increases: Evidence from Germany, ifo DICE Report, ISSN 2511-7823, ifo Institut - Leibniz- Institut für Wirtschaftsforschung an der Universität München, München, Vol. 15, Iss. 4, pp. 34-39 This Version is available at: http://hdl.handle.net/10419/181259 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu REFORM MODEL REFORM MODEL Florian Dorn, Clemens Fuest, Bracket Creep in the Broader Sense of the Term level and/or developments in income. If both compo- be adjusted to price developments from an economic Björn Kauder, Luisa Lorenz, Martin Mosler nents of the bracket creep, namely the effect of infla- point of view, since only income increases that exceed and Niklas Potrafke Another aspect of the bracket creep remains largely tion and of real income growth, were to be taken into inflation indicate a higher real ability-to-pay on the ignored by the public debate – namely the so-called account, the threshold figures and components of the part of taxpayers. Even if tax rate parameters (and the How Bracket Creep Creates bracket creep in the broader sense of the term. This tariff formula would have to be regularly multiplied potential amounts of tax deductible, if applicable) are Hidden Tax Increases: second aspect of the bracket creep arises from growth with a nominal gross income growth factor.3 updated in line with price developments, increases in 1 in real income, in addition to or possibly even in the This article begins by presenting the reform real income are still coupled with an increase in the tax Evidence from Germany absence of an increase in the overall price level. This options of a “rolling” income tax rate as a tax rate burden. extended interpretation of bracket creep earned the indexation that automatically eliminates the bracket Due to the (aggregate) real increases in productiv- Florian Dorn* state additional tax revenues of 52.1 billion euros from creep. It also quantifies how the bracket creep burden ity forecast, a corresponding tax revenue elasticity 2011 to 2015, i.e. 23.9 billion euros more than the purely was distributed across the various income groups which is greater than one can still be expected to lead inflation-related increase in bracket creep over the between 2010 and 2018, and who has borne the great- to an increase in the tax rate as measured by the same period. Since revisions of the income tax rate est tax burdens due to bracket creep. national income. This implies that the state itself BRACKET CREEP CREATES COVERT TAX RATE during the period from 2016 to 2018 only aimed to com- absorbs a growing share of private income even if the INCREASES pensate for the inflation-related increase, bracket ELIMINATING BRACKET CREEP BY INDEXING tax rate is indexed to inflation. There is nevertheless no creep in the broader sense of the term looks set to rise THE TAX RATE direct economic justification for the related inherent In recent years Germany has seen a significant increase in the future (Dorn et al. 2017b). mechanism of an automatic increase in the tax rate. In in its tax revenues, mainly thanks to income tax reve- An increase in the tax burden borne by individual Since the present income tax rate based on nominal terms of the current German income tax rate with its Clemens Fuest* nues which have risen steadily as a share of total tax taxpayers is desirable if the latter earn relatively high figures does not take bracket creep into account, there different brackets, it is rather a question of citizens revenues (cf. for example, Breuer 2016; Dorn et al. incomes compared to other taxpayers. The bracket seems to be a need for reform. One solution to the slipping into higher tax brackets, which reduces the 2017b, p. 56). Although the favourable situation in the creep in the broader sense of the term, however, occurs bracket creep problem advocated by many econo- social distribution effect of the tax burden. This, in labour market at present is largely responsible for this if the level of real incomes rises in an economy; even if mists is an indexation of the tax rate. In this context it turn, deviates from the distribution effects of the taxa- fiscal growth, ‘hidden’ tax increases due to the bracket individual taxpayers do not earn higher incomes com- seems sensible to monitor two variables: inflation or tion system originally intended by the legislator (and creep also play a key role in this development. It is pared to the economy as a whole. In this case the state nominal income, depending on whether the bracket hence the electorate). Lower and middle-income earn- important to distinguish between tax revenues gener- absorbs an increasingly large share of private revenues creep in the narrower or broader sense of the term is ers in particular face a steadily growing burden in Ger- ated by bracket creep in the narrow and in the broader due to the progressive tax rate, i.e. a tax revenue elas- under consideration. many due to bracket creep and will contribute a grow- sense of the term. ticity which is greater than one. In the case of real eco- ing share of tax revenues as a result. There is no explicit nomic growth, a growing number of revenue earners Automatic Adjustment to Price Developments – democratic legitimation of this automatic change in Björn Kauder* Bracket Creep in the Narrow Sense of the Term “slip” into higher tax rate brackets, which, in turn, Eliminating Bracket Creep in the Narrow Sense of tax burden distribution. weakens the redistribution effect of the income tax. the Term If incomes rise with inflation, gross real income remains Germany’s tax wedge, which is already one of the larg- Automatic Adjustment Based on Nominal Income constant. The progressive income tax rate based on est of all OECD countries, rises as a result which pushes If the income tax rate is indexed to the general price Developments – Eliminating Bracket Creep in the nominal figures nevertheless leads to an increase in the up the tax rate over time even without inflation (cf. level, it is possible to avoid tax increases due to purely Broader Sense of the Term individual tax burden, and thus lowers the real net Dorn et al. 2016, Dorn et al. 2017b). The state demands nominal changes in income that would otherwise arise incomes earned by citizens. This phenomenon is the a higher percentage of additionally earned income in in the case of constant and/or even falling real wages. If developments in nominal income, i.e. the sum of so-called bracket creep in the narrow sense of the term. taxes than it did of the previously prevailing income This means that real purchasing power losses gener- inflation-related and real income growth, are taken Although the German government has to report to the level. It is precisely this increase in the contributions ated by the tax system can be circumvented. This would into account in measuring taxation instead of inflation, parliament on the state of bracket creep every two burden that forms the “second part” of the bracket eliminate an inflation-related bracket creep in the nar- the bracket creep in the broader sense of the term will Luisa Lorenz* years, this does not involve any legal obligation to creep. However, the relative tax burden on society, and row sense of the term. Such an automatic annual also be eliminated, and a tax rate increase will be adjust the taxation rate accordingly. It remains at the by extension the tax rate, should not rise over time due adjustment of the income tax rate to price develop- avoided should real income rise. A progressive tax bur- discretion of the federal government in question to to a mechanism inherent in the tax rate, but should ments is already legally binding in many countries den in this instance only takes effect in the case of dif- carry out tax rate revisions. After the revision in 2010 rather remain constant ceteris paribus, especially with- including Belgium, Britain, Canada, the Netherlands, ferent income increases between taxpaying entities, there was no significant tax rate adjustment to com- out a specific democratic vote on it. Switzerland and the United States of America. In most but no longer in the case of general real increases in pensate for the bracket creep until 2015, but merely of these countries the amounts of tax deductible items, wages and income.

Load more