German cabinet approves 10 billion euro income tax reform targeting lower and middle earners

Cabinet approval and rollout schedule

On Wednesday, the German federal cabinet approved draft legislation for an income tax reform designed to lower burdens on low- and middle-income households and families with children. The package implements an agreement reached by coalition leaders in early July, scheduling initial tax changes to take effect on 1 January 2027 before reaching full implementation in 2028. Finance Minister Lars Klingbeil was unable to attend the cabinet meeting in Berlin in person due to a mechanical issue with a government aircraft door in Greenville, North Carolina, following a G20 finance ministers meeting. The draft law now moves to the Bundestag and Bundesrat for legislative debate and final parliamentary approval.

Adjustments to allowances and brackets

The legislation expands the tax-free basic allowance in two stages to protect the subsistence minimum, increasing it from the current 12,348 euros to 12,564 euros in 2027 and 12,900 euros in 2028. The entry threshold for the 42 percent top tax rate will rise slightly from 69,879 euros to 70,600 euros, flattening the rate progression for middle incomes earning between 17,800 euros and 70,600 euros. Monthly child benefits will increase from 259 euros per child to 267 euros in 2027 and 272 euros in 2028, alongside an expansion of the child tax allowance to 10,236 euros. Additionally, the standard employee deductible allowance will rise from 1,230 euros to 1,430 euros per year.

Financing mechanisms and high-income taxes

The reform aims to deliver ten billion euros in annual gross relief by 2028, though net federal tax revenue losses are projected at 5.6 billion euros compared to 2026 due to targeted revenue measures. To fund the reductions, the government lowered the threshold for the 45 percent wealth tax rate from 277,826 euros to 250,000 euros of taxable income. Incomes exceeding 280,000 euros will face a newly created 47 percent super-rich tax tier. Furthermore, the tax deductibility rate for craftsman services drops from 20 percent to 15 percent, while the maximum hourly wage for tax-free Sunday and holiday bonuses increases from 50 to 75 euros.

Political responses and coalition friction

Klingbeil defended the package before departing the United States, pointing out that a family with two children could retain more than 600 euros annually by 2028 under the proposed rules.

Families with children can have more than 600 euros a year more in their pocket from 2028 with our reform than today. No one should talk that down.

Employer associations rejected the plan, with employer president Rainer Dulger stating that Germany has no time for tax policy sleight of hand and requires genuine relief. Tensions also surfaced between coalition partners following a critical letter from the CDU-led Economy Ministry under Katherina Reiche, which questioned the economic impact of the package. Klingbeil criticized the timing and format of the letter, stating that opposition within the government is improper and challenging the Union to propose alternate financing for any expanded tax relief.