According to sources within Merkel's centre-right coalition on Wednesday, her conservative Christian Democrats and the pro-business FDP plan to announce next month their intention to lower the burden on taxpayers by up to €10 billion ($14 billion).
The business daily the Financial Times Deutschland reported earlier that Merkel had agreed to the tax cuts as a concession to the new leader of the Free Democrats, Economy Minister Philipp Rösler. The FDP has long pushed for lower taxes and is currently wallowing at all-time lows in opinion polls.
The cuts will reportedly be targeted to help the middle class and small to mid-sized businesses known as the Mittelstand and could take effect just before the 2013 election.
However, there could be pressure from Merkel's conservatives to put budgetary consolidations ahead of cuts aimed to help boost the flagging FDP's fortunes.
And any tax cuts would require the approval of the upper house of parliament, the Bundesrat, where the centre-right coalition no longer has a majority. It would therefore need the support of the centre-left opposition to push tax code changes through, but the FTD reported that members of the Social Democrats had already expressed scepticism for lowering taxes.