German Länder to control own taxes?

Last year, the Federal
Republic of Germany introduced
the most extensive
constitutional reform since its
birth. The constitutional overhaul, which
Germans call Federalism Reform I, established
a new division of legislative
powers between the federation and its
constituent units, the Länder.
This year, Federalism Reform II is starting
where Federalism Reform I left off. In
its coalition agreement to form the federal
government after the October 2005
elections, the Christian Democrats and
Social Democrats agreed that the first
stage of reform should be followed by a
further step – to adapt financial relations
between the Federation and the Länder
to the new underlying economic conditions
in Germany and elsewhere.
In the first stage of this reform, legislators
in Berlin barely touched on the
constitutional provisions governing state
finances, knowing that to do so would
have made the process an impossible
task. But even now, the challenge is big.
The reform is being handled by a parliamentary
joint commission of the lower
house – the Bundestag – and the upper
house, the Bundesrat. As Christian
Democrat leader Norbert Lammert, the
Speaker of the federal parliament, put it
during the first meeting of the commission
in March 2007, the fiscal reform “is
surely one of the most difficult issues the
federal government and the Länder have
had to tackle since German unification.”
Commission to decide on reform
The joint commission is co-chaired by
Peter Struck, chairman of the Social
Democratic parliamentary group in the
Bundestag, and Christian Democrat
Günther Oettinger, the premier of Baden-
Württemberg. Each house of parliament
forumfed.org
German Länder to control own taxes?
Reform of fiscal federalism “one of the most difficult issues since unification”
BY FELIX KNÜPLING
Felix Knüpling is director, Europe programs, for the Forum of Federations. Formerly, he was
with the German parliament – the Bundestag – for six years and was a senior staffer in the
office of a member of the Bundestag’s foreign affairs committee.
REUTERS/Tobias Schwarz
L
g erman y
OCTOBER | NOVEMBER 2007 Federations
28
Keeping a coalition in line: German Chancellor Angela Merkel moderates a meeting of coalition members with Peter Struck of the Social
Democratic Party, who was named co-chairman of the parliamentary joint commission to reform Germany’s fiscal federalism.
has delegated 16 regular members to the
commission. Four of the Bundestag delegates
are members of the federal
government. Almost all of the Länder
have sent premiers.
The two chambers have agreed on a
group of measures in a resolution that
ties in with approval of the first stage of
the reform. The commission’s mandate
includes the tasks of:
• D eveloping effective mechanisms to
prevent and manage budgetary crises in
the face of Germany’s enormous public
debt, which totals more than 1.5 trillion
euros (more than $2 trillion U.S.).
• D rafting proposals for the modernization
of Federation-Länder financial
relations, particularly in the areas of
growth and employment policy.
• Strengthening the responsibilities of
regional and local authorities, and
ensur ing they have the
necessary financial resources
to carry out their duties.
• M odernizing the administration
and grouping together
of public services with the
aim of enhancing efficiency
and reducing red tape.
• E asing the requirements for
voluntary mergers between
Länder.
Thus far, the commission
discussed financial issues
during a public hearing in
June 2007, with 18 experts it
appointed. A second public
hearing focusing on administrative
issues is planned for
November. The aim is to enact
final legislation in 2008.
More autonomy for the
Länder?
Fiscal law in Germany is predominantly
federal law, and
the Länder are subject to many restrictions
on raising revenues and carrying
out expenditures. The country has a
mi x ed re v enue col l e c t ion and
distribution system. The most important
taxes – the value added tax, and personal
and corporate income taxes – are shared
revenue sources for the Länder and the
federal government. The basis of these
taxes is decided jointly in the Bundestag
and the Bundesrat. But the rates and
basis for other tax sources belonging
exclusively to the Länder, such as inheritance
or automobile taxes, also have to
be passed by both chambers. Experts
estimate that only two per cent of total
Länder revenue is autonomous. This
comes from the beverage tax (beer tax),
entertainment tax, dog tax, and hunting
and fishing tax. The only notable exception
for total tax harmonization is the
local business tax, which each community
and city can set independently
according to its needs.
Germany’s fiscal federalism is also
marked by a very complex financial
equalization system aimed at providing
comparable standards of living for people
in the entire country, as the German
Constitution requires. After distributing
revenues to the Länder, a system of transfer
payments kicks in, bringing the fiscal
capacity of each Land to 97.5 per cent of
the average. Critics contend that because
the degree of fiscal equalization between
the states is extremely high, the richer
states are discouraged from increasing
their efficiency because most of the gains
would be transferred to the poorer states.
It is also a disincentive for the poorer
states to improve efficiency as that would
decrease the amount of transfers they
received.
The lack of Land autonomy on the revenue
side and the strong restriction on
the spending side which requires the
Länder to provide a minimum quality of
public services have led the Länder to
rely on transfers from the federal government
and to use borrowing as the
instrument of choice to finance any
spending shortfalls. This has contributed
to the enormous debt the country has
amassed.
The politics of fiscal reform
Some of the wealthier and more economically
powerful Länder, ruled by
Christian Democratic-led governments,
are demanding more autonomy over the
raising of income taxes. They prefer to
raise their own tax rates on the share of
income tax they are entitled to. Obviously,
remodelling the revenue system in this
fashion would encourage competition.
This approach is largely supported by
Christian Democrat politicians in the
Bundestag and in the richer Länder, and
by the Free Democrats.
However, the poorer
Länder, especially in East
Germany, whose economic
capacity is about two-thirds
of the average, are very
reluctant to introduce more
competition. As well, many
Social Democrats remain
skeptical, referring to the
s t ructural di f ferences
be twe en the L änd e r .
“Competition requires that
the federation, the Länder
and the communities are in
the same position to fulfill
their duties,” Berlin mayor
Klaus Wowereit of the Social
Democrats said during a
Bundestag debate on March
8, 2007. The premiers of the
six Länder in the former East
Germany accordingly made
it clear they do not want to
introduce changes to the
equalization system. Part of the equalization
system is the Solidarity Pact II ,
negotiated in 2001. Under the terms of
the pact, the East German Länder will
receive special federal grants totalling 159
billion Euros until 2019, on a yearly
declining scale, to enable them to cope
with the challenges of unification.
Applying a “debt brake”
One proposal to deal with the debt crisis
is to introduce a “debt brake,” or a halt to
[please turn to page 31] forumfed.org
The beer tax is one of the few independent sources of revenue for the
German regional governments. Drinking this beer is Guenther
Oettinger, Baden Wuerttemberg’s Christian Democratic Premier and
co-chairman of the parliamentary joint commission to reform
Germany’s fiscal federalism.
REUTERS/Alexandra Beier
OCTOBER | NOVEMBER 2007 Federations
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forumfed.org
OCTOBER | NOVEMBER 2007 Federations
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united states [from page 27] Flores (1997), the Court declared this law
unconstitutional. According to the Court,
Congress’s powers under the Fourteenth
Amendment did not extend to the “intrusion
at every level of government,
displacing laws and prohibiting official
actions of almost every description and
regardless of subject matter.” It was the
Court’s responsibility to determine
whether Congress had overstepped its
bounds. This seemed to promise a continuing
judicial scrutiny of congressional
legislation affecting the states. However,
the Court has since retreated from a confrontation
with Congress, and its rulings
show considerable deference to congressional
judgment.
Accused of commandeering
In other cases, the Supreme Court ruled
against the federal government when it
dictated specific behaviours to state
governments.
For example, the court found that part
of a law dealing with radioactive waste
was unconstitutional. The provision
required a state that had failed to provide
for the disposal of low-level radioactive
waste to take possession of the waste and
become liable for damages associated
with it. Justice Sandra Day O’Connor
held that the Constitution simply does
not give Congress the authority to require
the states to regulate.
“Where a federal interest is sufficiently
strong to cause Congress to legislate, it
must do so directly; it may not conscript
state governments as its agents,” she held.
The court followed with a ruling striking
down provisions of a handgun law
that commanded state and local lawenforcement
officers to conduct
background checks on prospective handgun
purchasers. The justices held that
conscripting state officers to carry out a
federal program violated the states’
sovereignty.
But despite the publicity generated by
these rulings, they had little impact on
American federalism. For one thing,
Congress has only rarely relied on commandeering
state officials to achieve its
ends. For another, as the court noted in
New York v. United States, Congress could
still regulate directly and to pre-empt
contrary state regulations. Or Congress
could establish grant programs that
would induce states to adopt the policies
it favored as a condition for receiving federal
funds.
States invoke immunity against
lawsuits
The Supreme Court has given a mixed
message when it comes to whether
Congress can enact laws allowing state
governments to be sued without their
consent. The Court struck down seven
federal statutes in the 1990s in which
Congress had authorized persons to sue
the states. In one case, then Chief Justice
Rehnquist wrote that “each State is a sovereign
entity in our federal system” and
that “it is inherent in the nature of sovereignty
not to be amenable to suit without
its consent.”
However, the justices have since ruled
that Nevada employees could sue their
employers in federal court for violation
of the Family and Medical Leave Act.
And in subsequent rulings the Court has
continued its deference to Congress,
upholding a federal law that guarantees
that disabled persons can sue states in
federal court. And in a Virginia case the
justices ruled that the Bankruptcy Clause
of the Constitution gives Congress the
authority to take away the immunity that
usually protects states from private suits.
Judges divided
The Supreme Court’s federalism initiatives
in the 1990s have proved less
revolutionary than most commentators
had predicted. In part, this may reflect
the divisions among the justices. Many
of the Court’s federalism rulings have
been 5-to-4 decisions, and efforts to pursue
a more fundamental break with
existing judicial doctrine might have
splintered the Court majority. In part,
however, it may reflect a lack of judicial
commitment to federalism itself. Some
commentators have suggested that the
Court’s rulings reveal less a principled
attachment to federalism than a desire to
enhance judicial power at the expense of
Congress. Certain decisions support
such an interpretation. Whatever the
case, the recent replacement of two
strong advocates of federalism – Chief
Justice Rehnquist and Justice O’Connor –
suggests that the final word on the
question respecting the extent of the
powers actually granted to the federal
government has yet to be written.
german y [from page 29] a l l bor rowing . Anothe r i s the
introduction of an “early warning system”
to avoid unhappy budgetary surprises.
But such moves would only help to prevent
future indebtedness. Legislators still
need to deal with the current debt of the
Länder and the federation. Günther
Oettinger, co-chair of the commission,
proposed the introduction of a special
solidarity fund to assist the Länder in
reducing the debt. Some Länder argue
there first must be agreement about how
to avoid accumulating even more debt in
the future before considering how to deal
with the accumulated debt.
However, the Länder – especially the
poorer ones in the east – obviously will
face a huge challenge if a debt brake is
introduced. Currently, they have had
only two ways of balancing their budgets:
cutting expenditures, or borrowing more
money, thereby increasing their total
debt. But cutting expenditures is not a
viable option because most expenditures
are prescribed by federal law. And if a
debt brake is introduced, they will not be
able to borrow money any more.
It seems like a no-win situation, but
Hans-Peter Schneider, executive director
of the Institute of Federalism in Hannover,
argues that the East German Länder
might be interested in receiving more fiscal
responsibility because they know that
this will be their salvation. “The Länder
need greater fiscal autonomy,” Schneider
said. “First, they should have the competency
to legislate on those taxes which
are attributed to them. Second, they
should be empowered to (place a) surcharge
on shared revenues to finance
specific tasks for a restricted period of
time. Finally, they should be able to deal
more flexibly in administering federal
laws and to deviate from federal standards,
which often are very costly for the
Länder.” In general, he argued that
Germany’s form of federalism needs to
be shifted more from an administrative
one to a creative, constructive model.
Federalism Reform II will not be completed
until 2008 at the earliest. The
grand coalition needs to be able to compromise
with the Länder to reach
agreement on legislation and get it
passed in Berlin. When it is, it will represent
more than a major step in the
development of German federalism.