Labour and employment law 2026: The reform package for economic recovery and employment
The governing coalition of the CDU/CSU and the SPD aims to generate growth, protect jobs and strengthen social cohesion in Germany. On 2 July 2026, the administration's coalition committee announced a comprehensive reform package which also provides for a number of far-reaching changes to labour and employment law, addressing areas of reform that were previously considered difficult to implement politically. The "Programme for Economic Recovery and Employment" includes changes to protection against unfair dismissal, the rules for fixed-term contracts, works constitution law, codetermination and income tax law. The following article outlines the key employment law initiatives, explains the legal background and assesses the reform proposals from the perspective of companies and corporate groups.
Reforming the law on fixed-term contracts: greater flexibility for employers
For years, the law on fixed-term contracts has been seen as an obstacle to flexible staffing decisions. Under the current section 14 (2) German Part-Time and Fixed-Term Employment Act ("TzBfG") , a fixed-term contract which is not based on objective grounds is limited to a maximum of two years and can be extended up to three times within that period; rehiring by the same employer is not permissible ("prohibition of prior employment"). At the same time, section 14 (4) TzBfG requires fixed-term employment contracts to be in writing ("wet ink") – with the consequence that any breach renders the contract invalid: a formal obstacle which results in numerous disputes in practice.
For employees hired up until 31 December 2030, it would be possible to offer fixed-term contracts without objective grounds for a maximum duration of 48 months, renewable up to six times. The prohibition of prior employment and the requirement for fixed-term contracts to be in writing would also be abolished on 1 January 2027.
The reform brings welcome changes from an employer's perspective. Doubling the maximum duration from two to four years and allowing fixed-term contracts to be extended six times give companies much more flexibility – particularly in times of economic uncertainty. Lifting the prohibition of prior employment for new hires until the end of 2030 also removes a legal obstacle that had already been restricted by the German Federal Constitutional Court in 2018 (decision of 6 June 2018, 1 BvL 7/14, 1 BvR 1375/14). However, the fact that these measures are temporary should be viewed critically. As things stand at present, anyone hired after 31 December 2030 will be subject to the old legislation once again. It is therefore a temporary measure which does not provide any lasting flexibility in the medium to long term. The abolition of the written form requirement is a logical step and takes account of the digitalisation of the working world.
For international corporate groups, particularly those with matrix structures involving managers based abroad with disciplinary authority and signatory powers, this change represents a helpful step towards standardisation, as in many countries fixed-term employment contracts currently do not have to be in writing.
Protection against unfair dismissal for high earners: new rules on severance payments
General protection against unfair dismissal under the German Act against Unfair Dismissal ("KSchG") applies to all employees after a six-month period in organisations which, as a rule, employ more than ten people, regardless of their level of income. Unlike many other countries, unfair dismissal proceedings in Germany are not about getting a severance payment if there are not sufficient grounds for dismissal. The labour court will rule that the dismissal is invalid if there are not sufficient grounds for dismissal under German law on protection against unfair dismissal. As a result, the employment relationship continued and continues to exist throughout the entire period (including the duration of the court proceedings, which may span several levels of jurisdiction), with all its rights and obligations – including all claims to remuneration. However, under section 14 (2) in conjunction with sections 9, 10 KSchG , the employment relationship for certain positions (managing directors, operations managers, etc.) can be terminated by the labour court during ongoing proceedings for protection against dismissal, in return for a severance payment and without further justification. Depending on age and length of service, the severance payment can amount to a maximum of 18 months' salary (section 10 KSchG). Currently, German law does not provide for any special provisions for high earners (only under the law on financial regulation section 25a (5a) German Banking Act (KWG) provides for a special provision for risk-bearers, which also allows for termination without cause in accordance with sections 9, 10 KSchG ).
For "high earners", a scheme modelled on the risk-bearing arrangements in the financial sector is to be introduced with effect from 1 January 2027 which will allow for the termination of employment with the option of a severance payment for annual incomes exceeding 1.75 times the contribution assessment ceiling for the statutory pension insurance scheme (currently EUR 101,400). It remains to be seen what the details will be.
The income threshold, currently EUR 177,450 gross per annum, applies to a relatively small number of employees. Nonetheless, the proposed reform of protection against unfair dismissal is of paramount importance. This model represents a significant change for the high earners concerned. Instead of the labour courts protecting employment, there will be financial compensation in the form of a severance payment. This takes the pressure off companies wishing to fill management positions more flexibly and reduces the risk of protracted proceedings relating to protection against unfair dismissal. Another key factor will be whether this provision only applies to new contracts or also to existing employees.
This "severance pay solution" ultimately reflects the reality in companies and in the courts. Hardly any unfair dismissal case ends without a settlement involving severance pay. However, there is still no sign of any further structural reform of protection against unfair dismissal.
Tax benefits for severance payments and for taking up new employment promptly
Under current law, severance payments are, in principle, taxable; though, under the "one-fifth rule" (section 34 German Income Tax Act (EStG)), they are subject to preferential tax treatment if they constitute extraordinary income. German tax law does not currently provide any direct tax incentive to encourage people to seek new employment quickly.
To make a swift transition from one job to the next more attractive, severance payments will be tax privileged if the individual takes up new employment promptly. The tax benefit will be greater the sooner a person takes up new employment.
The idea is conceptually appealing. Anyone who finds work again quickly after exiting should be rewarded for it in tax terms. This reduces the costs to the social security system and boosts the deployment of skilled workers. This will be tricky to implement, particularly with regard to how the term "promptly" is defined and what happens if the new job does not work out. One positive aspect is that it works well in conjunction with the severance pay scheme for high earners. Anyone who, on the basis of their income, falls under the new rule regarding termination will, in return, also benefit from tax relief – provided they find a new job quickly. Combining these two measures could significantly speed up the reemployment rate of senior staff.
In the event of future restructuring and staff reduction measures, care will be taken not only to offer attractive severance packages, but also to provide outplacement and transition support, with a view to helping employees find new employment quickly, retaining the tax benefit and thereby also easing the burden on social security funds.
Incapacity for work: changes to sick leave and requirement to obtain a certificate of incapacity for work
The system for obtaining a sick note by telephone was introduced in 2023 to ease the burden on doctors' offices and reduce the administrative burden on employees with minor illnesses. Under current legislation, employers are already entitled to request a certificate of incapacity for work from the very first day – section 5 (1), third sentence, German Act on Continued Payment of Remuneration (EFZG) expressly provides for this possibility. Certificates of incapacity for work issued over the phone were a pragmatic measure designed to tackle the strain on doctors' practices.
The practice of issuing sick notes over the phone is to be abolished, and issuing false certificates of incapacity for work will be subject to harsher penalties under section 278 German Criminal Code (StGB) . A requirement to submit a certificate of incapacity for work from the first day of illness will be introduced, as well as a "guaranteed appointment with a specialist" as part of implementing the law on general practitioners. In addition, a statutory heart attack prevention scheme is being introduced.
The high level of sick leave in Germany and the associated costs for companies and health insurance providers, undoubtedly need to be addressed at a political level; in this respect, the reform sends a clear signal. Nevertheless, the abolition of sick notes issued by telephone, coupled with the statutory requirement to submit a certificate of incapacity for work from the first day of illness, raises a number of questions: Capacity bottlenecks in the outpatient care system are well documented, and employers already have the option to require a certificate of incapacity for work from the very first day under section 5(1), third sentence, EFZG. Against this background, the need to tighten the law further to cover all employment relationships does not appear entirely convincing. As the SPD toned down the announcement made in the coalition document just a few hours after it was published, it remains to be seen whether the planned change will actually be implemented. By contrast, the tougher criminal penalties for issuing false sick notes under section 278 StGB are appropriate and consistent with legal doctrine.
Important for HR departments: employers can continue to deviate from the provisions of section 5 EFZG in favour of their employees. This means employers can continue to require that a certificate of incapacity for work be submitted at a point in time after the first day of illness. It therefore remains possible to include such employer-friendly provisions in works agreements, collective agreements or internal policies.
Automotive, chemicals, steel and mechanical engineering: planned special provisions for key industries
The industries mentioned are under considerable pressure to transform. The automotive industry is struggling with the rise of electric vehicles and phasing out of traditional powertrain components; the chemical and steel industries are suffering from high energy costs and international competition; and the mechanical engineering sector is facing a decline in orders. Structural changes in these sectors are affecting hundreds of thousands of jobs and are the subject of intense collective bargaining negotiations.
The German Federal Government plans to ask the parties to collective bargaining agreements in the industries particularly affected by the current crisis to propose, following sector-specific consultations, specific measures by mid-October 2026 that will enhance the competitiveness and resilience of the respective sector. This applies in particular to the automotive and chemical industries, as well as to the steel and mechanical engineering sectors. The parties to collective bargaining agreements will be asked to engage in dialogue with one another to propose specific areas of regulation in which provisions deviating from existing legislation – for example, in the field of labour and employment law (e.g. regarding fixed-term contracts on objective grounds or health and safety at work) or company law (e.g. reporting or due diligence obligations) – may be agreed upon by the parties to the collective bargaining agreement.
The approach is ambivalent. On the one hand, it is right to involve the parties to such collective bargaining agreements, who are best placed to understand the specific characteristics of the sector. On the other hand, the Federal Government is delegating responsibility for specific solutions to third parties to a considerable extent.
AI and employee participation: reform of works constitution law announced
Section 87 (1) no. 6 German Works Constitution Act (BetrVG) grants the works council – contrary to the wording of the Act – an enforceable right of codetermination regarding the introduction and use of technical devices that are objectively suitable for monitoring employees' behaviour or performance, in accordance with the highly controversial case law of the German Federal Labour Court (Introduction of AI in the company – Involvement of the works council). In practice, this right of codetermination regularly leads to significant delays in the roll-out of software updates, new IT systems and, in particular, AI applications – even if they do not primarily have a monitoring function. In some cases, companies refrain entirely from (further) digitalisation due to employee participation rights and protracted negotiations with the works council.
To support businesses in implementing AI in their day-to-day operations and to safeguard jobs in the context of digital transformation, the Federal Government intends to ensure that software and its updates, as well as upgrades to technical equipment, can be introduced more easily and quickly, in accordance with the works council's codetermination rights. The social partners are asked to draw up proposals on how cooperation can be facilitated and expedited through appropriate provisions, for example in works constitution law.
The reform package does not yet contain any specific proposal to amend section 87 (1) no. 6 BetrVG. The government does indeed wish to ensure that software and its updates, and upgrades to technical equipment can be introduced more easily, and has asked the social partners to put forward appropriate proposals. This, however, is a tentative signal. The question of how the right to codetermination can remain workable in the context of rapidly rolling out AI is one of the most pressing challenges currently facing works constitution law. Furthermore, by international standards, German codetermination rights regarding the introduction of technical equipment are significantly more extensive than elsewhere. This represents a significant locational disadvantage for companies operating internationally, as identical systems can be implemented in other jurisdictions without comparable delays. However, no specific legislative measures – such as simplifying framework works agreements, introducing trial periods or fast-tracking conciliation proceedings for IT updates – are proposed.
Whilst delegating the matter to the social partners may lead to sector-specific solutions, it carries the risk that binding regulations will not be introduced for years to come. Given the speed at which IT and AI systems are being adopted by businesses, and in light of international competitive pressure, there is a clear need for much swifter legislative action.
Shelf SE: changes to employee codetermination planned
The Societas Europaea (SE) is a European company form in which employee codetermination on the supervisory board is established by an agreement with the employees' representatives when the SE is incorporated. The economic activation of shelf SEs can therefore "freeze" a situation in which there is no codetermination.
The most recent case law of the CJEU and the German Federal Labour Court (CJEU, judgment of 18 October 2022, Case C-677/20; BAG, decision of 23 March 2023, 1 ABR 43/18, see our article Is the guarantee of a seat for trade unions on the supervisory board of an SE in line with EU law?) has approved the use of the SE as being in line with EU law, even if it results in a situation where codetermination rights are effectively frozen. The government now wants to close this loophole. The aim is to put an end to the possibility of "circumventing" German codetermination rights by setting up shelf SEs. This should be viewed critically, as the SE structure represents a legitimate option under European law which enables high-growth companies to establish an internationally competitive governance structure.
As the SE is based on European law, a purely national solution will probably only be possible by tightening the so-called "abuse clause" (section 43 German SE Participation Act (SEBG)). Under this provision, the SE must not be misused to deprive employees of their participation rights or to deny them such rights. An abuse is presumed to have taken place if, within one year of the SE's formation, structural changes occur which result in employees being denied or deprived of their participation rights. There is therefore a need for affected companies to review their existing SE structures or related plans to assess their long-term viability. It is important to document the objectives and purposes of establishing or acquiring a shelf SE to be able to refute any allegation of deliberately denying participation rights.
Reducing red tape: fewer company officers and more personal responsibility
Under German law, there are a number of company officers who must be appointed by law: data protection officers (GDPR and BDSG), safety officers (section 22 SGB VII), waste management officers (section 59 KrWG), immission control officers (section 53 BImSchG), radiation protection officers (section 70 StrlSchG), dangerous goods officers and others. For SMEs, the requirement to appoint and train these individuals entails a considerable organisational effort and a financial burden. Furthermore, those appointed to such posts generally also have special protection against unfair dismissal.
Once this level of protection has been achieved, other company officers whose appointment is not based on EU requirements are to be abolished. Compliance with substantive requirements will be shifted more to the company's realm of responsibility, accompanied by heavy penalties for breaches.
The reform follows a sound regulatory approach. Bureaucratic structures will be scaled back in favour of greater corporate autonomy, without reducing the substantive level of protection. The model with increased penalties for breaches focuses on results rather than structural oversight – a regulatory approach that affords companies greater operational flexibility while providing effective incentives for compliance. In practice, this means: companies gain considerable organisational flexibility, but must ensure that internal compliance structures adequately take over the role previously performed by the designated officers. Employers and their legal advisors should assess at an early stage which roles will be phased out and which internal processes will replace them.
Income tax 2027: tax relief for employees and higher taxes for high earners
Income tax places a disproportionately heavy burden on middle-income earners in particular, as the progressive tax scale applies even to comparatively low incomes. Although the gradual increase in the tax burden resulting from pay rises that do not translate into a real gain in purchasing power has been partially offset in recent years, there has not been a structural reform of tax rates.
The coalition intends to reduce the income tax burden on citizens with effect from 1 January 2027. The aim is to achieve this tax relief by increasing the basic tax allowance, increasing the child allowance, increasing child benefit, increasing the flat-rate allowance for employees, and flattening the second tax bracket, which will be accompanied by a shift in the threshold for the top tax rate. The focus is on those with low and middle incomes.
According to the paper published by the administration's coalition committee, once the measures come into full effect from 2028, a working family with two children and total taxable income of EUR 60,000 could see their tax burden reduced by more than EUR 600 a year compared to today. The total value of the tax relief provided by the reform amounts to approximately 10 billion euros per year. The plan is to finance this primarily through a change to the "wealth tax". A tax rate of 45 % would apply to taxable income of EUR 250,000 or more, and a rate of 47 % to taxable income of EUR 280,000 or more.
The overall package is plausible in terms of distributional policy. Low and middle-income earners stand to benefit from the tax reform, while families with children will see a disproportionately large reduction in their tax burden thanks to the child benefit and the child tax allowance. However, the higher marginal tax rate in the upper income bracket carries the risk that highly qualified specialists and executives may move to countries with more favourable tax regimes. In an already fierce international competition for talent, this could create a significant locational disadvantage that runs completely counter to efforts to attract qualified staff to Germany. The flat-rate tax on "mini-jobs" would also increase from two to five % – another counterproductive development that places a greater burden on mini-job workers and may lead to rethinking this employment model.
Reducing red tape and digitalisation: what lies ahead for companies?
Another of the coalition partners' objectives is to cut red tape. Reporting and documentation requirements will be abolished across the board. The coalition mentions a "brake on reporting obligations". The aim is to review all documentation requirements across the ministries and abolish one in four of these requirements within 12 months.
It remains to be seen whether this will happen. Legislation such as the recently enacted German Act on Compliance with Collective Bargaining Agreements, which has just introduced new and comprehensive information and documentation requirements contradicts this.
Digitalisation is also to be driven forward as part of this process. In this context, an 8 % reduction in staff is to be implemented within federal authorities and the indirect federal administration.
In short: the 2026 reform package shows a willingness to embrace change – but the work has only just begun
The German government’s reform package is a remarkable step – both in its scope and its willingness to tackle the fundamental structures of employment law. The measures address the right issues:
- greater flexibility for fixed-term contracts,
- less protection against unfair dismissal for high earners,
- incentives for seeking new employment promptly.
However, questions regarding AI codetermination, in particular, remain unanswered. The reform package does not yet contain any specific legislative measures to relax section 87 (1) no. 6 BetrVG. Multinational corporations rolling out AI systems across their organisations continue to face a system of employee codetermination that is more extensive than in the rest of Europe. Framework works agreements remain the key instrument for shaping working conditions. The details of the tax relief available for severance payments have yet to be finalised; plans for staff reductions should therefore be closely monitored as the legislative process unfolds.
Overall, the positive effects of the reform package outweigh the negative ones for multinational corporations. Whether the hoped-for growth momentum actually materialises, however, will depend to a large extent on how the outstanding regulatory issues are addressed in legislation. Those practising employment law would be well advised to follow the legislative process closely and to start preparing their clients for the forthcoming changes now.
