By Erik Kirschbaum
BERLIN (Reuters) - Chancellor Angela Merkel's center-right coalition has suffered a humiliating defeat by the center-left opposition when lawmakers threw out a plan to cut income taxes by 6 billion euros.
Rejection of the plan, which had been seen as an election-year gift to voters, showed the waning strength of Merkel's coalition nine months before the poll, analysts said.
Despite promises of cutting taxes when it took power in 2009, internal dissent within the center-right government at first blocked the initiative and later it was stymied by the opposition.
"This government hasn't accomplished a thing when it comes to tax reform in the last three years and it doesn't look like they'll get anything done in the next year either," said Gero Neugebauer, political scientist at Berlin's Free University.
"They got off on the wrong foot and never got it right. It shows how weak they really are," he added.
The setback came just before midnight on Wednesday when the center-left opposition Social Democrats (SPD) and Greens used their veto powers in the Bundesrat, the upper house of parliament representing the federal states, to block the plan.
The SPD and Greens argued there was no scope for tax cuts, especially because they would reduce revenues to states and towns. They said they would have backed tax cuts for ordinary earners if the coalition had raised taxes on higher incomes.
A parliamentary mediation committee, made up of members of both the upper house and the lower house Bundestag spent five hours on Wednesday evening exploring scope for an agreement. But it failed because the SPD and Greens stuck to their guns.
In a further sign of its weakness, the coalition saw a tax deal with Switzerland blocked by the mediation committee. It would have required Swiss banks to levy a punitive charge on an estimated 150 billion Swiss francs ($160 billion) in undeclared funds stashed away by Germans in Swiss accounts [ID:nL5E8NCH6H]
"The coalition didn't use the chance when it had a majority in 2009 and 2010," said Gerd Langguth, a political scientist at Bonn University. "They wasted time."
Merkel's center-right coalition had a majority in the upper house when it took office in 2009 but Merkel hesitated when the idea of tax cuts was first aired and the coalition lost its upper house majority in 2010.
The coalition was widely criticized at the start in 2009 for cutting taxes for hotel operators, with the Free Democrat (FDP) junior coalition partners plunging in opinion polls after that to around 3 percent from 14.6 percent in 2009.
The FDP had hoped this 6-billion euro tax cut would help to restore some of its lost credibility with voters but the coalition itself was long divided about the tax cut plans.
The Christian Social Union (CSU), the Bavarian sister party to Merkel's Christian Democrats (CDU), had long resisted tax cuts. The public wrangling lasted months and earned Merkel's government the nickname "chaos coalition" in the media.
The coalition agreed to cut income taxes by 2 billion euros in 2013 and another 4 billion euros in 2014.
Finance Minister Wolfgang Schaeuble had hoped the tax cuts would have leveled out the effects of "cold progression", also known as "bracket creep".
These terms describe what happens when tax thresholds are not adjusted for inflation. Workers getting pay rises sometimes see net pay actually fall because they have entered a higher tax bracket.
Thanks to the "bracket creep" in the tax code, the treasury takes in three billion euros in extra revenues each year.
Merkel will seek a third term next September. Her conservatives are well ahead of opposition parties in opinion polls but her allies the FDP may fail to get back into parliament, making a 'grand coalition' with the SPD possible.
(Editing by Gareth Jones and Stephen Nisbet)