Mrs Merkel told reporters after an agreement was reached among her Christian Democrats and their coalition partners that the tax cuts would come in two steps starting in January 2013 and ease the burden on lower and middle income Germans.
The legislation must still be approved by parliament.
The news agency dapd reported that Mrs Merkel said her government wanted to "thank citizens for the many burdens they have borne in the international financial crisis".
Germany expects a tax take of 16.2 billion euro (£13.9 billion) this year, higher than previously forecast.
© 2011 Press Association