Merz coalition proposes tax relief and pension reform in Germany

Chancellor Friedrich Merz’s coalition government on Tuesday proposed a package of reforms aimed at reviving Germany’s stagnant economy. The plan includes tax relief for lower-income families and changes to the state pension system that would raise the retirement age to 68 by 2035.

Germany’s economy contracted in 2023 and again in early 2024. High energy costs and weak export demand have held back growth. The reforms target two drags: household purchasing power and the long-term solvency of the pension system.

The tax component lifts the basic allowance and reduces the entry rate of income tax. For a family with two children earning €60,000 a year, the coalition estimates an annual saving of roughly €1,200. The pension side limits annual benefit increases to wage growth minus 0.3 percentage points. Together the measures are meant to boost demand today while slowing the rise in contribution rates later.

The package lands in a fractured political environment. Merz’s three-way alliance with the Greens and the Free Democrats holds a slim majority in the Bundestag. The far-right Alternative for Germany and the Left Party have already vowed to block the pension changes. The Greens want more climate investment alongside the tax cuts, a demand that could delay passage.

The fiscal arithmetic is tight. The government pegs the net cost at €15 billion in the first year, to be partly offset by higher carbon-pricing revenue. Finance ministry officials said they will present a supplementary budget if growth undershoots the 0.8% forecast.

The euro has weakened 4% against the dollar this quarter. Bundesbank President Joachim Nagel welcomed the reform direction. He warned that implementation will determine the effect. “The plan looks sensible on paper. History shows structural reforms in this country often get watered down in committee,” he said in a statement.

The pension changes are the most politically fraught. Raising the retirement age to 68 would require a constitutional amendment, which needs a two-thirds majority. The coalition lacks that on its own. It would need support from either the far right or the center-left opposition. Both have signaled they will not give it without steep concessions.

Merz’s approval rating has fallen to 29%, the lowest for any chancellor since polling data became widely available. The reforms are his bid to reverse that slide and revive a German economy that has become the laggard of the euro area.

The Bundestag is scheduled to begin committee hearings in mid-July. A final vote is expected before the summer recess in September. Merz needs to hold his coalition together until then. Every defection raises the odds of a snap election, an outcome that would delay the reforms indefinitely.