Germany’s Government Finally Has a Reform Package. Now Comes the Hard Part.

Germany’s governing coalition has unveiled a broad package of tax, pension, labor and administrative reforms intended to revive Europe’s largest economy after months of internal disagreement and growing pressure on Chancellor Friedrich Merz.

The 34-point program combines approximately €10 billion in annual income-tax relief, major changes to the pension system, stricter rules governing sick leave, more flexible employment contracts, reduced reporting requirements for businesses and new measures intended to accelerate housing, infrastructure and strategic industrial investment. The government says it wants the principal legislation adopted by the end of this year.

The announcement is both an economic program and a political test for Merz’s coalition of the centre-right CDU/CSU and centre-left Social Democrats.

Germany’s economy is forecast to grow by only around 0.5 per cent in 2026, following years of stagnation and recession. German manufacturers are facing high energy costs, increased competition from China and the United States, slow approval procedures and growing concern over labor shortages and the long-term cost of pensions and healthcare. The coalition is also under pressure after months of public infighting, while the far-right Alternative for Germany has overtaken or matched the governing conservatives in several national polls.

What the government is proposing

€10 billion in income tax relief

The coalition plans to reduce taxes primarily for low- and middle-income households.

A family earning approximately €60,000 per year could receive more than €600 in annual relief. The program would be financed partly by increasing Germany’s top income tax rate from 45 to 47 per cent for the highest earners.

That compromise reflects the composition of the government itself. Merz’s conservatives wanted lower taxes and more business flexibility, while the Social Democrats demanded that the cost not be shifted onto lower-income households or public services.

The result is therefore not a traditionally conservative tax-cutting program. It redistributes part of the tax burden upward while attempting to increase disposable income for households more likely to spend the additional money.

A gradual increase in the retirement age

The most politically difficult part of the package concerns pensions.

The government wants the statutory retirement age to rise gradually in line with increases in life expectancy. It is also proposing a stronger capital market component inspired partly by Sweden’s pension model, under which investment returns would supplement the traditional pay-as-you-go system.

Germany’s existing system relies heavily on current workers financing current retirees. As the population ages and the proportion of working age residents declines, either contributions must rise, benefits must fall, the government must provide more tax revenue or people must remain in employment longer.

Merz has argued that postponing the question will only make the eventual adjustment more painful. But raising the retirement age is particularly contentious for people in physically demanding occupations, who may not realistically be able to continue working for as long as office-based employees.

Sick notes required from the first day

The reforms would also require employees to obtain medical certification from the first day of illness, replacing the general system under which workers can usually remain home for several days before providing a doctor’s note.

The government argues that Germany’s high sickness-absence rate has become a competitive disadvantage and that tighter verification is needed to prevent abuse. Employers have broadly welcomed greater control over short-term absences.

Medical professionals and labor representatives have warned that the change could create a different problem: people with minor illnesses may flood doctors’ offices simply to obtain paperwork, consuming appointments without improving public health.

It could also encourage sick employees to attend work rather than seek certification, potentially increasing workplace transmission.

More flexibility for employers

Businesses would receive more freedom to use fixed-term contracts, while some restrictions on the dismissal of highly paid employees would be loosened.

The coalition also wants to expand tax advantages for holiday work and permit longer Sunday opening hours in some sectors. Supporters argue that Germany’s labor rules have become too rigid for start-ups, technology companies and businesses trying to respond quickly to changing demand.

Trade unions say that flexibility for companies can easily become insecurity for workers. They have objected particularly to the combination of easier short-term hiring, stricter sickness controls and changes that could weaken employment protections.

Cutting bureaucracy and the size of government

Federal ministries would be required to reduce staffing by approximately 8 per cent, with digitization expected to replace some administrative functions.

The government also wants to reduce corporate reporting obligations, simplify approval processes and bring some German data-protection requirements down to the minimum required under European Union law.

For years, German companies have complained that permits, reporting requirements and fragmented administrative systems delay investment. The coalition says infrastructure approvals and electricity-grid projects should move significantly faster.

The difficulty is that “cutting bureaucracy” remains a popular political promise but is often harder to implement than announce. Germany’s federal structure divides authority among the national government, 16 states, municipalities and multiple regulatory bodies. Removing one requirement at the federal level does not necessarily eliminate delays elsewhere.

Housing, industry and competition with China

The package would establish a federal body to support affordable housing construction and make mortgage financing easier.

It also proposes additional support for strategic sectors including artificial intelligence, semiconductors and clean technology, alongside stronger European trade protections against unfairly subsidized imports. Germany wants the EU to make greater use of anti-dumping rules and is considering tighter conditions involving technology transfers connected to investments from outside the bloc.

This reflects a significant change in Germany’s economic thinking.

For decades, the country’s model depended on inexpensive Russian energy, strong exports to China and security guarantees largely provided through the United States and NATO. All three assumptions have weakened. The government is now trying to protect German industrial capacity while simultaneously funding defense, the energy transition and an aging welfare state.

What the opposition and critics say

The far-right Alternative for Germany, currently the country’s largest opposition force, dismissed the package as insufficient and ineffective. But its response should be understood within its broader strategy: the AfD benefits politically from portraying Germany’s established parties and institutions as incapable of reform, and it is seeking to convert economic dissatisfaction into support for a more nationalist and anti-EU program.

That does not mean every criticism of the package is extremist or partisan.

Labor unions argue that the employment measures shift too much risk onto workers. Medical professionals question whether first-day sick notes are practical. Some employers support the deregulation but object to the higher top tax rate and say the government has not reduced spending sufficiently. Economists broadly welcomed the package as a meaningful beginning but warned that many of the benefits will take years to emerge.

There is also disagreement over whether the program is large enough to reverse Germany’s economic trajectory.

Economists cited by Reuters estimated that, if fully implemented, the reforms could lift Germany’s underlying annual growth rate from approximately 0.4 to 0.7 per cent. That would be an improvement, but not a dramatic economic transformation.

The criticism from the center is therefore different from the AfD’s blanket rejection. The question is not necessarily whether Germany requires reform, but whether these measures are coherent, adequately funded and politically durable enough to deliver it.

Why Merz is acting now

Merz entered office promising lower bureaucracy, stronger growth and a more competitive German economy. One year later, much of the public sees a coalition defined by internal disputes and incomplete promises.

The reform package is intended to demonstrate that the CDU/CSU and SPD can still govern together despite their ideological differences.

It also arrives before Germany’s summer parliamentary recess and amid a series of state elections that could further strengthen the AfD. The government needs to show visible progress before voters conclude that only the political extremes are capable of forcing change.

But announcing agreement is not the same as implementing it.

Each major component will create its own constituency of opposition: workers concerned about employment protections, older voters worried about pensions, doctors facing additional administrative demand, wealthy taxpayers facing a higher rate, ministries resisting staffing cuts and regional governments defending their own regulatory authority.

The coalition has produced a reform program. It has not yet proved that it can turn that program into law.

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