This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.


This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.

IV. Tax-Transfer Options for the Low-Skilled Labor Problem67

A. Introduction and Summary

171. The empirical evidence presented in Chapters I and III suggested that Germany’s labor market problem is concentrated among the lower-skilled. Those chapters also argued that remolding Germany’s labor market institutions—in the direction of more flexible collective bargaining; a more diversified social insurance system; and a social safety net with stronger re-activation incentives—should be at the top of the reform agenda. But sole reliance on reforming these institutions may prove inadequate if values other than efficiency are also important to policymakers. In this context, economists have traditionally embraced tax-transfer solutions as relatively market-compatible measures (in comparison with direct interventions), as these solutions seek to induce behavior rather than command it.

172. The present chapter discusses the nature and scope of tax-transfer solutions to the low-skilled labor problem, focusing on traditional public finance tools—combining wages with in-work social benefits (combi-wages); wage supplements to boost take-home pay; and wage subsidies to reduce labor cost.68 What are the likely job-creating effects of different tax-transfer schemes? How do tax-transfer schemes rank in terms of fiscal costs? And can tax-transfer solutions help to achieve more efficiently some of society’s equity objectives, in particular “fair incomes” for low-skilled labor (which current German labor market institutions seek to impose directly on labor market outcomes)?

173. Tax-transfer solutions to the low-skilled labor problem have been the focus of much recent debate within and outside Germany:

  • Within Germany, several public authorities and interest groups have come forward with specific tax-transfer schemes. In particular, a preliminary proposal by the “benchmarking working group” within the “Alliance for Jobs” suggested to inter alia subsidize social insurance contributions at lower wage levels to develop a low-wage sector in Germany.

  • At the EU level, the Employment Guidelines for 2000 encourage member states to inter alia “… provide incentives for unemployed or inactive people to seek and take up work…” as well as to “… reduce the fiscal pressure on labor and non-wage labor costs, in particular on relatively unskilled and low-paid labor.”69

  • And a rapidly-expanding body of academic literature analyzes tax-transfer solutions. For example, a widely-publicized book by Phelps (1997) advocates raising earnings of low-wage workers in the United States through wage subsidies.

174. Tax-transfer solutions to the low-skilled labor problem seek to overcome two types of “employment hurdles” at the lower end of the labor market: (i) a worker’s labor cost is “too high” relative to a worker’s productivity; and (ii), a worker’s reservation wage is “too high” relative to a worker’s take-home pay. In case (i), the generic tax-transfer solution is to subsidize labor cost, e.g. through wage subsidies that finance employer-paid social insurance contributions. In case (ii), the tax-transfer system could be employed to boost take-home pay, e.g., through a combi-wage scheme.

175. Tax-transfer solutions may, however, not address the ultimate source of the employment hurdles in the market for low-skilled labor. For example, in an environment where labor demand shifts favor skilled workers, lower-skilled workers’ labor cost may have risen faster than their productivity because increases were tied (proportionally) to labor cost increases of higher-skilled workers. Or, in an environment of high and rising minimum social benefits, lower-skilled workers’ take-home pay may fail to keep pace with increases in reservation wages. Thus, tax-transfer tools may only provide a static solution to a dynamic problem, rooted in institutional labor market arrangements.

176. The employment impact and fiscal cost of different types of tax-transfer solutions depend on the nature and size of the employment hurdles. For example, a subsidy to cut labor cost of employers would not be effective if the binding hurdle is a high reservation wage. Similarly, reduced clawback arrangements for in-work social benefits would not be effective if the binding hurdle is high labor cost. Thus, designing effective tax-transfer solutions may require considerable amounts of information about the employment hurdles afflicting the low-skilled, a type of information that may be difficult to obtain, e.g. in the case of unobservable reservation wages. Not surprisingly, tax-transfer proposals are often first tested out in pilot projects in limited geographic areas to study their effectiveness.

177. Section B introduces a static labor market model for the low-skilled, which will serve as the analytical workhorse of the chapter. Three tax-transfer options debated in Germany can be analyzed with this model: (i) combi-wage proposals that aim at increasing take-home pay of workers receiving means-tested social benefits, i.e. unemployment assistance (Arbeitslosenhilfe) or social assistance (Sozialhilfe); (ii) wage supplements to employees to bolster take-home pay, e.g. by subsidizing social contributions paid by low-skilled employees; and (iii) wage subsidies to employers to reduce labor cost, e.g. by subsidizing social contributions paid by employers of low-skilled workers.

178. Section C briefly reviews the characteristics of selected tax-transfer solutions to the low-skilled labor problem in Germany and selected other industrial countries. This overview illustrates the wide-ranging array of tax-transfer solutions applied in practice. The last section, D, describes and analyzes selected tax-transfer solutions currently debated in Germany, highlighting the possibly high fiscal cost of schemes that aim at subsidizing social contributions of the low-skilled.

179. The main conclusion of the chapter is that tax-transfer solutions to the low-skilled labor problem are likely to work best as part of a comprehensive strategy that also addresses the institutional sources of the employment hurdle problems underlying the low-skilled labor problem. When considering the likely high fiscal cost of extensive tax-transfer schemes, it should be borne in mind that these schemes also serve to make the fiscal cost of meeting society’s equity objectives more transparent. The alternative approach, achieving these objectives directly through the collective bargaining process and the social insurance system, may, at first sight, involve lower fiscal cost. However, as exemplified by Germany’s experience since the 1970s, a malfunctioning labor market can have adverse fiscal spillover effects over time and crimp the overall functioning of the economy. Tax-transfer solutions could also be integrated in a longer-term strategy of social insurance reform. For example, tapered social contributions at the lower end of the wage distribution could be designed as a first step toward establishing a multipillar social insurance system, where the future public pillar provides a basic package of social benefits in line with lower social contribution rates.

B. The Analytics of Tax-Transfer Options

180. The left-hand panel of Figure IV-1 illustrates the operation of a stylized tax-transfer system at the lower end of the labor market: W is the worker’s gross wage; the worker’s net labor income (also equal to take-home pay above a certain level of labor income) is defined as gross wage minus employee-paid social contributions;70 and the worker’s labor cost is defined as gross wage plus employer-paid social contributions. Non-insurance social benefits (social assistance, unemployment assistance) introduce a minimum standard of living L, where the level of L depends on the family situation of the worker. Figure IV-1 is drawn to indicate that the impact of additional work effort on take-home pay at low income levels is almost completely off-set by clawback of social benefits (welfare trap).71

Figure IV-1.
Figure IV-1.

A Stylized Labor Market for Low-Skilled Labor

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004

181. The right-hand panel of Figure IV-1 depicts labor supply and demand in the stylized low-skilled labor market, where N denotes low-skilled employment. Labor supply (LS) is drawn as quite inelastic at low levels of gross wage, reflecting the combination of high reservation wages and the operation of social benefit clawback rules. As soon as wage income rises beyond the eligibility range for non-insurance social benefits, take-home income becomes more sensitive to work effort, and, as a consequence, labor supply becomes more elastic as well. The labor demand schedule (LD) is conventional and slopes downward. The equilibrium in the low-skilled labor market illustrates a situation of a binding wage floor due to collective bargaining institutions, which could arise from a minimum wage law or (as is more likely to be the case in Germany) from solidaristic wage bargaining that raises low-skilled wages in line with those of higher-skilled workers. This is not a required ingredient of the framework; in some examples below, the assumption of a binding wage floor is relaxed.

182. In this framework, there are three tax-transfer options available to increase low-skilled employment, depending on whether they aim to shift labor demand or labor supply, and, in the latter case, on how labor supply will be targeted. The first option is referred to as the “combi-wage option.” It aims at improving labor supply incentives by reducing the clawback rate of non-insurance social benefits. This option is illustrated in Figure IV-2. A combi-wage reform, illustrated by the bold dashed line, could alter two parameters. First, the reform could provide for a larger basic exemption. Second, the clawback rate in the second segment could be lowered. As a result, labor supply could become more elastic and be shifted to the right, leading to an increase in equilibrium employment, where it is now assumed that collective bargaining institutions permit the gross wage to be set at the intersection of labor demand and supply. Even though the gross wage decreases, take-home pay in equilibrium increases, and this motivates a higher amount of labor supply.

Figure IV-2.
Figure IV-2.

The Combi-Wage Option

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004

183. The second tax-transfer option, wage supplements, also affects take-home pay and labor supply, but through a different channel and it is not tied to receiving non-insurance social benefits. Wage supplements for employees will translate a given gross wage into a higher net wage. Most wage supplement proposals are designed in a regressive fashion, so that lower wages are subsidized at a relatively higher rate, and subsidies taper off to zero beyond the low-wage range. A cut of employee-paid social security contributions is equivalent to a wage supplement. However, there could be significant sensitivities when it comes to the choice between direct wage supplements versus a measure that would alter the basic design of the social insurance system. In terms of the take-home schedule, such a wage subsidy would be reflected in altering the net income line as depicted in Figure IV-3. This leads to a kinked new labor supply curve.

Figure IV-3.
Figure IV-3.

The Wage Supplement Option

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004

184. The third tax-transfer option, wage subsidies, focuses on employers’ labor cost. Like employee wage supplements, these proposals are typically regressive, and are economically equivalent to a corresponding reduction in employer-paid social contributions. Given the particularly high levels of employers’ social contributions in much of Europe, most of the proposals in this area involve reducing or subsidizing employer-paid social contributions. Figure IV-4 illustrates a regressive cut in employers’ social contributions. Labor cost is reduced by making the bottom section of gross wages entirely exempt from contributions, and then gradually raising employers’ contributions back to old levels. The resulting change in labor cost is indicated by the bold dashed line. The effect on the labor demand schedule is also illustrated in Figure IV-4 assuming that wages are entirely within the range that is exempt from contributions. The labor market has a binding wage floor, and the LD shift resulting from the policy has a clearly positive impact on employment.

Figure IV-4.
Figure IV-4.

The Wage Subsidy Option

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004

185. To evaluate or rank tax-transfer options requires an efficiency criterion. An ideal yardstick would assess the option’s effect on the overall distortions caused by the tax-transfer system, taking due account of society’s preferences regarding distributional goals. This exercise would amount to generating a desired income distribution while maximizing allocative efficiency. While some general-equilibrium simulations attempt to evaluate tax-transfer options along these lines, an exercise of this type would be well beyond the scope of this chapter. A more hands-on (and widely popular) criterion is to estimate the fiscal cost of creating additional low-skilled-jobs. As explained in more detail in Boxes IV-1 and IV-2, the fiscal costs of creating additional jobs depend on the sizes of the labor demand and supply elasticities and the “pick-up” and “replacement effects” of a proposed tax-transfer scheme.

Labor Market Elasticities and the Fiscal Cost of Tax-Transfer Options

Box Figures A, B, and C below illustrate that the same increase in employment will entail a lower required wage supplement or subsidy (and thus lower fiscal costs) if labor demand or supply are more elastic. For example, indicating the supplement amount by a bold vertical line, and comparing Box Figures A and B reveals that, for the same increase in employment, the required supplement is smaller in Box Figure B since labor demand is more elastic. Box Figure C illustrates that this result does not depend on whether a wage supplement or subsidy is granted. Here, the elasticities are the same as in Box Figure B but labor demand is shifted instead. The amount of the required subsidy is equivalent to the amount of the supplement. Formally, for a small change in a subsidy (ds) and labor demand and supply elasticities η and e, respectively, employment growth (dlnN) will change by:


Pick-Up and Replacement Effects of Tax-Transfer Options

Given the size of the subsidy and the desired employment effect, the cost of a policy depends critically on how well targeted it is. The gray box in Box Figure (a) illustrates the cost of an entirely untargeted wage subsidy. The bigger, left-hand part of that box represents the amount of subsidies paid for workers that were already employed previously, an effect that is called the “pick-up effect.” Conversely, Box Figure (b) illustrates a perfectly targeted policy where only previously unemployed workers are subsidized. This assumes that firms do not lay off previously employed workers and replace them with previously unemployed workers, in order to benefit from their lower labor cost. Realistically, this will happen to some extent even under well-targeted schemes, an effect that is called the “replacement effect.” Box Figure (c) shows the worst possible case, where firms hire all previously unemployed workers (entire gray box) and then lay off previously employed workers to adjust labor demand (left-hand part of gray box). Realistically, any targeted policy will have replacement effects to some extent.


(a) Untargeted

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004


(b) Targeted

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004


(c) Targeted with replacement

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A004

C. Tax-Transfer Tools in Germany and Selected Industrial Countries

186. Section B’s framework is first used to survey tax-transfer tools in use in Germany and other industrial countries. Germany already has a considerable number of tax-transfer programs to spur low-skilled employment (Table IV-1).72 However, all the wage subsidy programs presently in place are in the nature of “jumpstarting solutions.” These programs provide temporary and targeted incentives to spur employment opportunities of workers with particularly unfavorable labor market characteristics (e.g., the long-term unemployed; handicapped workers; or workers in depressed regions). These programs also typically involve relatively large wage subsidies to cut labor costs significantly. Hence, these solutions are mainly motivated by an attempt to “buy time,” so that subsidized workers can raise their productivity to a level that obviates the subsidy, e.g. by improving their marketable skills while employed, or by allowing employers to overcome possible misperceptions about the productivity of workers.

Table IV-1.

Selected Tax-Transfer Tools in Germany

article image
Sources: Buslei et al. (1999); and Ministry of Labor.

187. The targeted nature of jumpstarting solutions largely avoids pick up effects. Moreover, the measures usually entail provisions to curb replacement effects. Partly reflecting this, most of the programs listed in Table IV-1 have relatively small numbers of participants, with the notable exception of the special program for eastern Germany (structural adjustment measures east). In 1997, the number of workers enrolled in wage-subsidy programs, with a total of about 246,000 workers, represented about 20 percent of participants of active labor market policy programs. The rather small scale of the wage subsidy measures may also in part be due to financing restrictions as amounts available for these measures are typically subject to ceilings. The conditions of programs were at times made more restrictive as demand for the schemes was growing beyond funds.

188. A tax-transfer policy issue that has recently been the focus of much attention are the so-called “DM 630 jobs” (see Box IV-3 for details). The number of DM 630 jobs appears to have increased significantly, with about 10 percent of the labor force holding a DM 630 job as their sole source of (official) labor income in 1997. The work incentives at the DM 630 limit are low, since for wages exceeding DM 630 the entire income becomes subject to social contributions, implying a marginal tax rate far in excess of some 12,000 percent for the first additional 1 DM earned at an income of DM 630. One implication of this discontinuity is that very few jobs exist in the DM 630 to about DM 1,400 range.

DM 630 Jobs

System before April 1999; Jobs with monthly gross wage earnings of up to DM 620 (western Germany) or DM 530 (eastern Germany) and requiring less than 15 hours work per week were exempt from both the employers’ and the employees’ component pf social contributions. Employees were exempt from income tax, but employers have to pay a flat tax of 20 percent of gross income. This covered both additional jobs (held besides a main job) and cases where the small-time job provided the sole source of labor income.

System since April 1999: The cut-off income was fixed at DM 630 for all of Germany and will be kept at that level in the future. Employers’ flat income tax was removed, but instead employers have to pay social contributions of 22 percent (so that the total labor costs at the DM 630 level remains practically unchanged). The difference is that now the employee is earning claims against the social insurance system.

The number of jobs under the DM 630 regime has increased rapidly during the 1990’s, from an estimated 3.8 million in 1991 to an estimated 5.6 million in 1997. About 75 percent of these jobs provide the sole source of labor income for the employee. At the same time, roughly three quarters of the jobs are held by married women, students, or senior citizens, persons who are likely to receive nonlabor incomes from other sources as well. The majority of DM 630 jobs is located in sectors such as private household services, retail services, or resteraunts.

189. Table IV-2 provides an overview of selected tax-transfer schemes used in other industrial countries. These programs vary considerably by type, scale and conditionality—but it appears that countries seem to focus on a certain type of policy. The most extensive combi-wage schemes are found in the United States and the United Kingdom, which in turn do not have particularly substantial wage subsidy schemes in place. The latter are found on a larger scale in several continental European economies, particularly in France and the Netherlands, where they represent key policy instruments.

Table IV-2.

Tax-Transfer Schemes in Selected OECD Countries

article image
Source: Mainly Buslei et al. (1999), OECD (1996), and Klös (1999).

A year (“1994”) indicates the time that the description of the program refers to. A range (“1989-1993” or “Since 1996”) indicates the overall tenure of the program.

190. The French case is the subject of considerable attention because of its scale and because this program likely to be expanded in the future. After first measures toward a subsidy to cut employer-paid social contributions were put in place in mid-1993, the policy was re-designed and expanded in 1996. The ristourne dégressive has by now become a key element—in terms of funding and in terms of employment effects—of the overall labor market policy strategy. Following the changes in early 1998, employers receive a social contribution refund for all SMIC (minimum wage) employees that amounts to 18.2 percentage points at the SMIC, in effect reducing employers’ social contributions from about 40 percent to 22 percent and reducing labor costs at the SMIC level by about 12.6 percent. The size of the refund decreases in steps and reaches zero at 1.3 times SMIC. It is estimated that about 5 million jobs (about 25 percent of employment) benefit from this policy, and the overall budgetary cost in 1998 is somewhat above F 40 billion (0.5 percent of GDP). The ristourne regime is currently being redesigned in conjunction with the introduction of the 35-hour workweek initiative. The base eligible for rebates would be increased to 1.8 times the SMIC, likely extending the number of workers covered by the new regime to about 9 million, but also increasing fiscal cost by some F 25 billion (0.3 percent of GDP).

D. Tax-Transfer Proposals for Germany

191. The present discussion in Germany focuses on significant expansions of tax-transfer solutions to address the low-skilled labor problem. Several proposals have been put forward covering the full range of possible instruments (Table IV-3). Two broad groups can be identified. The first group comprises programs that seek to subsidize social contribution rates at the lower end of the labor market (usually both employer- and employee-paid contributions). The second group comprises combi-wage proposals that seek to increase incentives to supply labor by recipients of social or unemployment assistance.

Table IV-3.

Selected Tax-Transfer Proposals for Germany

article image
Source: Mainly Busiei et al. (1999) and information from the Federal Ministry of Labor.

Monthly gross wage. When based on hourly wages, 38 hours per week are assumed. For Ministry of Health and Employers’ Association proposals, based on 1998 social assistance levels for Western Germany in Boss (1999). These figures correspond to the level of assistance plus the maximum overall exemption amount, taking into account the initial exemption and the amount inherent in offset rates < 100 percent.

192. The fiscal cost of programs can be approached in different ways. First, there is a gross component, captured by simply adding up all additional fiscal costs that arise for the recipients under the policy. At the same time, however, the policies also create jobs and increase take-home income. This implies a potential to reduce gross fiscal costs through lower unemployment benefit payments and additional social insurance contributions, as well as indirect tax revenues from the higher consumption that stems from the increase in take-home income. The balance of all of this, the net cost, thus takes into account the overall effects of the policy (Table IV-4). The net fiscal costs put an additional burden on the budget, which could result in increased borrowing or the need to raise higher revenues through taxation. The resulting general equilibrium effects can further alter the fiscal impact of the policy.73

Table IV-4.

Fiscal Costs of Selected Tax-Transfer Proposals for Germany

article image

See table IV-3 for a description of the plans.

Cost ranges cover different assumptions about labor supply and demand elasticities and about savings generated elsewhere in the tax-transfer system (higher income tax and VAT revenues, e.g.).

193. The fiscal cost estimates suggest that most of the tax-transfer proposals are expensive in fiscal terms. As a reference point for the figures in the table, consider that the annual gross income at the cutoff-wage, for, say, the Friedrich-Ebert-Foundation proposal (DM 3,000 per month) is DM 36,000, and that the average annual gross income in the manufacturing sector is DM 49,000 (western Germany). The wage subsidy programs are expected to generate substantial increases in employment, but the costs—according to the available studies—are likely to be high. Typically these studies use estimates for labor demand elasticities to gauge, together with the percentage change in labor costs due to the subsidy, the increase in labor demand. The actual employment effect will also have to take the labor supply response into account. The costs of the measure are found by multiplying the subsidy amount by the number of workers (or hours worked) presently in these wage categories, together with those that are newly drawn into employment. The degree of precision varies across studies. Buslei at al. (1999), probably the most ambitious study in the table, estimate low-wage labor demand elasticities for jobs/hours worked and men/women, and use these elasticities, together with a distribution of current employment across categories of hourly wages, and the subsidy amount for each individual wage category, to estimate labor demand effects by wage category. The labor supply response is modeled in a very detailed fashion, incorporating an accurate model of the entire present tax and benefit system (to translate wages in take-home income) and taking into account the household type.

194. Three factors contribute to the high fiscal cost of the proposed wage subsidy schemes. Firstly, a low labor demand elasticity will imply that the overall cost leads to fewer new jobs, implying high cost on a per-job-created basis. Secondly, an inelastic labor supply response will translate a given labor demand effect in wage increases rather than new employment, reducing the number of jobs created. Thirdly, the untargeted approach leads to very high overall cost stemming from recipients that were already employed to start with.

195. Turning to the proposed combi-wage schemes, the small labor supply effects reported in Table IV-4 illustrate that these measures are unlikely to have strong employment effects. In additional simulation exercises, Buslei et al. (1999) also found that combi-wage proposals have only small significant positive effects on labor supply.

196. While significant insights can be gained from these exercises, attention needs also to be given to important factors that cannot be addressed specifically within the framework of this chapter. First, to the extent that tax-transfer schemes increase low-skill gross wages, these policies tend to narrow the wage differential with high-skill jobs, thus discouraging training. The practical relevance of this concern, however, seems to be limited. Second, the administrative cost of the different policies could be rather different, depending on the extent to which they rely on simple changes in existing parameters of the transfer system (a very simple combi-wage) as opposed to introducing new parameters (such as a targeted, regressive wage subsidy).

197. The illustrative analysis of this section suggests that an approach that tackles the low-skilled labor problem exclusively through tax-transfer solutions may have limited success in terms of additional employment creation and carry a hefty fiscal price tag. Nevertheless, well-designed tax-transfer solutions can constitute a valuable part of a more comprehensive strategy that also addresses the institutional sources of the employment hurdle problems. In evaluating the high fiscal cost of comprehensive tax-transfer schemes, one could argue that tax-transfer schemes represent a transparent approach to bring out the cost of meeting society’s equity objectives as regards labor incomes. The alternative approach, achieving these objectives directly through the collective bargaining process and the social insurance system, may at first sight involve lower fiscal cost burdens. But, as exemplified by Germany’s experience since the 1970s, a malfunctioning labor market has also considerable adverse fiscal spillover effects over time. Moreover, tax-transfer solutions aimed at reducing social contribution rates at the lower end of the labor market could be integrated in a longer-term strategy of institutional reforms that seeks to remold social insurance institutions. For example, tapered social contributions at the lower end of the wage distribution could be used as a first step toward establishing a multi-pillar social insurance system, where the (future) public pillar would provide a basic package of social benefits in line with lower social contribution rates.


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Prepared by Stefan Hubrich.


For example, this chapter does not discuss reducing the rate of VAT on labor-intensive services not exposed to cross-border competition, a proposal by the EU Commission. Germany and several other EU countries have voiced strong reservations against this proposal noting the administrative complexities of such a scheme, the likely difficulty of containing pressures for VAT preferences, and adverse budgetary implications.


Quotes from points 4 and 14, respectively, of the annex to the EU Council’s Employment Guidelines for 2000.


In the German context, the income tax burden at lower income levels is likely to be small. For example, since the beginning of 1999 monthly gross incomes are subject to income tax beginning at DM 1,080 (single) and at DM 3,900 (family with three children and non-working spouse), respectively, and the personal income tax reforms to be phased in during 2000-02 will lead to further upward adjustments in these amounts.


See Thimann (1995) for a quantitative analysis of Germany’s welfare trap.


The table omits a few tax-transfer programs that are outside the framework of section B, such as income tax credits for hiring private service employees or the new government’s program for reducing youth unemployment. The latter targets 100,000 unemployed youth with lower qualifications—at an overall cost of DM 2 billion. The table also omits the exemption limits for earning additional income for recipients of social assistance (DM 269 per month) and unemployment assistance (DM 315 per month). The special case of the DM 630 jobs is discussed below.


Some studies using a general-equilibrium framework find that cuts in social contributions could be self-financing (negative net costs). For example, Van Rijckeghem (1997) arrives at this conclusion when considering the long-run effects of a cut in employers’ social contributions that is targeted towards the low-skilled. The result comes about via a broadening of the tax base and lower outlays in unemployment benefits, but appears to rely on a rather elastic labor supply, together with the realistic (for France) assumption that the low-skilled segment of the labor market is subject to a binding minimum-wage constraint.

Germany: Selected Issues and Statistical Appendix
Author: International Monetary Fund