The economic impact of "cold progression" and fiscal options to reduce tax burden

The progressive income tax rate in Germany implicates that tax payers with high incomes pay disproportionately higher income taxes – the economically more productive individuals are supposed to be more involved in financing public tasks than the less productive. Over time however, a growth in nominal income leads taxpayers to higher tax rates and increases aver-age tax burden. For taxpayers whose nominal income growth only compensates for inflation, real income remains constant while their purchasing power declines as a result of the higher tax burden. This effect is called ‘cold progression’.

Using a microsimulation model, we estimated the aggregate income tax revenue for the period 2010-2012 that would be attributed to ‘cold progression’. Furthermore we developed a reform of the tax rate that would redistribute the estimated revenue linked to "cold progression" to taxpayers, and we suggested ways of annually adjusting the tax rate to inflation in order to avoid future effects of ‘cold progression’.

The report is published as IAW-Kurzbericht 1/2008 [PDF: 3,3 MB].