At a recent speaking event I made a bit of a controversial statement that I’ve received some flak for. During my speech, I told the audience that “The average American would pay less taxes in Germany than the USA”. Standing by my point, I’d like to take a moment to analyze the tax structure of the two countries. I’d like to note that I’m only taking into consideration the taxes that come out of your paycheck, not including healthcare, pension, etc.
First, let’s examine income taxes in the USA:
Federal Income tax in the United States ranges anywhere from 10% to 35% depending on your income. The tax brackets are as follows: $0 – $8,500 (10%), $8,500 – $34,500 (15%), $34,500 – $83,600 (25%), $83,600 – $174,500 (28%), $174,000 – $379,150 (33%) and $379,150+ (35%). The tax is a progressive tax, meaning that every dollar you make up to $8,500 is taxed at 10%, the next $26,000 is taxed at 15% so on and so forth. This leads to the signature stair-step look that I’ll discuss later. In addition to the Federal Income tax, Americans also pay a 1.45% gross income tax for Medicare and a 4.20% gross income tax on Social Security (though you are not taxed on any income over the Social Security Wage Base of $106,800). Finally, most states have an income tax that is deducted each payday from net income. Some states have a progressive state tax, while my home state of Illinois has a flat tax of 5% (Note: I will be using this number for future calculations).
Now let’s examine income taxes in Germany:
Germany’s tax structure is a bit different. No income tax is charged on the basic allowance, which is €8,004 for unmarried persons and €16,008 for jointly assessed married couples. Beyond this threshold, the marginal tax rate increases linearly from 14% to 24% for a taxable income of €13,469 (€26,938 for married couples). In the subsequent interval up to a taxable income of €52,881 (€105,762 for married couples), the marginal tax rate increases linearly from 24% to 42%. The last change to the occurs at a taxable income of €250,730 (€501,460 for married couples) when the marginal tax rate jumps from 42% to 45%. (Note: numbers may be different due to the exchange rate)
Having trouble picturing all that in your head? Take a look at the following graph.
This graph shows the marginal tax rates in both the USA and Germany. The USA is represented by the blue line, Germany by the red. It should be noted that, in this graph, tax rates for personal income tax, social security tax and medicare tax have all been added together. Looking at this graph, it appears the USA has marginally lower tax rates than Germany, given that Germany’s tax bracket skyrockets from 24% to 42% between $19,530 and $76,677. What is more important, however, is to take a look at the EFFECTIVE income tax rates, shown here in the light blue and red lines. Because Germans do not pay tax on any income up to €8,004, it slightly reduces the effective tax rate. This combined with the fact that the taxes increase linearly for the first two tax brackets, gives Germany an effective tax rate lower than that of the USA up to a point. This point, depending on the exchange rate, is around $107,500.
Below is a better look at the effective tax rates in the USA and Germany.
To put this into perspective, the median family income in the USA is currently right around $40,500. If you are an American that makes $40,500 per year, you would pay a combined total of $8,538.25 in Federal, Social Security and Medicare taxes along with $1,598.09 for state tax in the state of Illinois. This would leave you with a net income of $30,363.66 for an effective tax rate of 25.03%. The same person in Germany would pay nothing on their first €8,004 (~$11,605) earned, and would pay a total of $7,230.93 on their total income, keeping the remaining $33,269.07, an effective tax rate of 17.85%.
Let’s recap: someone making an average American salary of $40,500 would pay an effective tax rate of 25.03% in the USA and 17.85%.
Just food for thought.