Reforming Family Taxation in Germany – Labor Supply versus Insurance Effects

The present paper quantifies the economic consequences of eliminating the system of income splitting in Germany. We apply a dynamic simulation model with overlapping generations where single and married agents decide on labor supply and homework under income and life-span risk. We compute welfare changes across households and isolate aggregate efficiency effects of a move towards either individual taxation or family splitting. In terms of economic efficiency a switch towards individual taxation performs better than family taxation, due to reduced labor market distortions and improved insurance provision. The efficiency increases even further when individual taxation is combined with a child-splitting factor. Since such a reform also has very favorable distributional consequences, it should be seriously considered in the political debate.