Tax cuts and direct money transfers to everyone – this is the only way Lindner can control inflation

Inflation wears a Janus face.

Tax cuts and direct money transfers to everyone – this is the only way Lindner can control inflation

Inflation wears a Janus face. She shows society an ugly face. She craves higher taxes. The state, on the other hand, sees a good-natured face. After all, without any political involvement, it coldly ensures increasing tax revenues and less burdensome debt burdens on public budgets.

This is precisely why what a finance minister does is so important. He must resist the alluring temptations of a friendly face. Instead, for the good of the people, he has to expose inflation for what it is: an additional special tax that has not been democratically approved by any parliament.

Tax relief to compensate for the unjustified inflation tax effects is therefore the order of the day. It is precisely this demand that Christian Lindner wants to meet with his relief package of ten billion euros planned for 2023. His thrust is therefore correct. When it comes to weighting, however, question marks remain. Because the current inflation flushes significantly more additional money into the state coffers.

Inflation is an insidious phenomenon for society. It jeopardizes hard-earned income in several ways. First, it devalues ​​the purchasing power of gross wages. You have to pay more for purchases. As a result, many can afford less than before. Accordingly, they demand compensation from employers.

The gross wage should increase at least by so much that it becomes worth what it was before. If gross wages actually rise, however, the tax pitfall of inflation becomes apparent. It can lead to a further erosion of the purchasing power of wages. Because with a higher gross wage you pay more taxes and if you are unlucky, even a lot more.

This is the case when you slip into a higher tax rate. This phenomenon is called cold progression. Cold because the tax increase comes through the back door without any parliamentary justification. It is not knowingly and intentionally declared as a tax. It is an indirect and undesired side effect of inflation. It is therefore only logical that almost all tax experts have always been calling for their abolition.

But at this point at the latest, the face of inflation, which is friendly to the state, becomes a danger for everyone. What is taxpayer's sorrow is Treasury Secretary's joy. Inflation devalues ​​government debt. That, too, automatically and just like that. Here is a numerical example. In 2020, public budget debt in Germany amounted to 2.173 trillion euros.

With a gross domestic product (GDP) of 3.368 trillion euros, this results in a public debt ratio of around 65 percent. If GDP were to increase by ten percent to 3.705 trillion euros in the three years to 2023 solely because of inflation, this would result in a fall in the national debt ratio to 58.7 percent. Without their own savings efforts, the mountain of debt would be cleared away.

The finance minister is given greater leeway – here too, by cold means, without a parliamentary decision. As a gracious benefactor, he could now rain manna from heaven for his subjects – just as the traffic light partners demanded of the liberals. But what looks like a miracle is actually being financed by those who have lent money to the state. In the good faith that we have made careful and risk-free provisions for old age. They now experience how their assets and receivables lose value and thus purchasing power.

So the Minister of Finance is right across the board when he wants to compensate for the burden of the inflation tax for the benefit of the people by eliminating cold progression. But it is also clear that the tax rate adjustments under discussion are not sufficient to do justice to the actual extent of inflation-related wage increases.

In its current July monthly report, the Ministry of Finance assumes an inflation rate of 4.1 percent for 2022 and 2.7 percent next year. It is thus well below the expectations of the German Council of Economic Experts. In March 2022, he had already predicted an increase in consumer prices of 6.1 percent this year and 3.4 percent next year.

Significantly higher rates of inflation and greater compensation for inflation in wages are currently to be expected. Higher tax rates would therefore have to take effect much later than is currently being discussed.

In view of the dynamics of inflation and the delay before it is possible to react politically to their negative tax burdens, Christian Lindner's proposal is expedient to use a "scala mobile", everything that has to do with taxes, to automatically correct pure inflation effects in the future.

This does not only apply to tax rates. The gradual adjustment to inflationary effects would also have to automatically increase the basic tax allowance in line with the inflation rate. And there is just as much to be said for constantly increasing child benefit in line with inflation.

One last point remains important: the finance minister's planned tax package should and can only deal with the direct tax effects of inflation. They need to be corrected and compensated for. That is why inflation tax relief is rightly at the top of the list of priorities.

However, a completely different question remains when it comes to the indirect distributional effects caused by inflation. That inflation is a poor tax that hits the less well off more than the rich remains true. Those who pay no taxes at all because they are not (or no longer) employed and finance their livelihood through their own savings, pension or social benefits suffer particularly badly from inflation.

But neither tax cuts in general nor the finance minister's tax package in particular will help. Direct money transfers to everyone are and remain the simplest, most accurate and therefore fairest measure for general compensation for the consequences of inflation.

You would have to supplement the concept of the finance minister. To finance them, all indirect and therefore socio-politically inaccurate state aid to individual companies, industries, sectors and regions, which is often associated with unwanted side effects, could be dropped. So, of all things, the ugly face of inflation would ultimately ensure a good turnaround. There would be impetus for a better tax system for the benefit of the people.

Thomas Straubhaar is a professor of economics, in particular international economic relations, at the University of Hamburg.

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