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Germans who choose to work beyond the retirement age will be able to earn up to €2,000 a month tax-free, as part of chancellor Friedrich Merz’s push to tackle labour shortages and revive Europe’s largest economy.

The government estimates that the measure will cost €890mn a year from the moment it takes effect, on January 1, according to draft legislation seen by the Financial Times. The so-called active pension plan, a Merz campaign pledge, is expected to be approved by his coalition with the Social Democrats on Wednesday.

Merz’s coalition is seeking to mitigate the impact of Germany’s ageing workforce as the economy grapples with a shortage of skilled labour after three years of stagnation. The initiative is one structural change delivered by the coalition, as part of a broader “autumn of reforms” promised by the chancellor.

“The German labour market is facing structural challenges as a result of demographic change. The baby boomers will gradually retire in the coming years, while fewer young people are entering the workforce. This is leading to a shortage of skilled workers in many industries,” the draft bill reads.

Working after retirement is allowed in Germany, as in much of Europe, but Berlin wants to make it more appealing with tax breaks.

Other countries incentivising post-retirement work include Greece, with some success. Since Athens allowed working pensioners to retain their full pensions and subject their additional income to a reduced 10 per cent tax rate, the number of working retirees went from 35,000 in 2023 to more than 250,000 as of September, according to the Greek labour ministry.

Germany faces some of Europe’s steepest demographic challenges, with 4.8mn workers — 9 per cent of the labour force — set to retire by 2035, putting pressure on its welfare state and economy.

In addition to a shrinking workforce, Germany has the shortest average working hours of any OECD economy, according to the Paris-based organisation. Meanwhile, the share of part-time workers has more than doubled to 30 per cent of the labour force since the early 1990s, mainly driven by women.

The tax incentive will also help “retain experience and knowledge in companies for longer” and lead to an “overall increase in the employment rate and contribute to economic growth and higher government revenues”, the draft bill says.

Employees and employers will pay social contributions on these salaries, offering a lift to the strained finances of Germany’s health and pension systems.

The estimate of €890mn in tax revenue shortfall per year seems to be at the low end of what economists expect, implying that the government may not anticipate a big number of recipients.

The IW Institute estimates that the measure’s annual costs could be closer to €1.4bn, with some 340,000 workers entitled to use the tax incentive.

The finance ministry declined to comment on the estimates.

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Others also note that the government is keeping existing incentives put in place to encourage workers to retire as early as the age of 63. Germany’s statutory retirement age is 67.

The number of recipients from the new measures should rise over time, Holger Schmieding, chief economist at Berenberg Bank, said, with additional positive effects on growth and social contributions “more than offsetting the costs within two to three years”.

“It is also a sign that society appreciates the contribution of older people who decide to stay on and contribute,” Schmieding said, adding: “A bit of a positive psychological effect over time.”

Additional reporting from Eleni Varvitsioti in Athens and Olaf Storbeck in Frankfurt