Germany – An Overview of Fiscal Arrangements

Germany – An Overview of Fiscal Arrangements Germany – An Overview of Fiscal Arrangements by Roger Wilkins The Federal Republic of Germany (FRG) consists of 16 states, or Länder. Its federal parliament consists of two houses: the Bundestag, to which the ministers are responsible, and the Bundesrat, which has regional representation. The Bundesrat consists of members of the governments of the Länder (ministers, permanent secretaries and heads of government) and plays a central role in the relations between the two main orders of government in Germany. The federal government generally has legislative authority while the Länder and the Communes are generally responsible for the implementation and administration of policies. In accordance with this principle of shared responsibilities, the Länder administer roughly 75% of federal laws, including the collection of the main taxes (value-added tax and corporate and personal income taxes). Federal authority is exclusive over foreign affairs, defence, citizenship, immigration, currency, and air transport, in particular. The Länder have jurisdiction over culture, health, education, public security and regional development. The Communes are assigned responsibility for various local public services, local health care delivery centres, school buildings, housing and roads. Spending Federal spending power is overseen by the Bundesrat, which must approve by an absolute majority of votes any use of the federal spending power that affects the Länder. The general breakdown of public spending by order of government in 1995 was: Länder 38 %; Federal government 35 %; Communes 27 %. Taxation Germany has a highly developed system of intergovernmental financial relations. Apart from the sharing of tax revenue, it includes a three-part equalization system – sharing of VAT, horizontal equalization, additional transfer payments – and a series of shared-cost programs. Taken together, the three components of the equalization system seek to achieve uniformity of living conditions for Germans throughout the Federation by equalizing the financial capacities of the Länder. The proceeds of personal income tax (PIT) are shared by the Communes (15%), the federal government and the Länder (42.5% each). Corporate tax is shared equally between the federal government and the Länder. Revenue from the value-added tax (VAT) is also shared between the federal government and the Länder. A federal law, requiring the approval of the Bundesrat, determines the rules of sharing. These shared taxes are collected by the Länder on behalf of the Federation, which returns their shares to them according to rules of sharing set out in the Constitution (Basic Law) and in federal legislation. The federal government sets, collects and remits the proceeds of two taxes: customs duties, which it remits to the European Union, and duties on beer, which it pays in full to the Länder. CHART 2 The federal government alone sets and collects excise taxes. The Länder alone set and collect taxes on gambling and gaming, estate taxes, taxes on real estate transactions, and the tax on motor vehicles. The Communes derive part of their revenue from property taxes. Intergovernmental financial relations Sharing of the VAT The sharing of VAT revenue is one of the main instruments available to the Federation to balance the “current revenue” with the “necessary expenditures” of the two orders of government. Currently, 2.2% of VAT proceeds are paid to the Communes and 5.63% is earmarked for the federal government as compensation for improving its pension plan. Of the remaining 92.17%, the federal government receives 50.25% and the remaining 49.75% goes to the Länder. Three quarters, at least, of the share of the Länder is redistributed among them according to their demographic weight. Equalization Component 1: Sharing of the VAT The portion remitted to the Länder that is subject to the rules of equalization, namely 25% of their share, is paid to the less affluent Länder to raise their per capita income to 92% of the national average. If the objective is achieved with less than the 25% stipulated for this purpose, the remainder is redistributed to all the Länder based on their share of the population. At this stage, only the revenue from the sharing of PIT, corporate income tax and the local business tax is considered in the calculations. DIAGRAM 1 Component 2: Länderfinanzausgleich (LFA) The LFA, or horizontal financial equalization, is a mechanism for equalizing the financial capacities of the Länder and is funded entirely by them. It consists of four distinct processes, the first two of which involve calculating the financial capacity and demographics of each Land. The third process involves the application of an equalization index, and the fourth involves collection of contributions from Länder in a surplus position and payment to Länder in a deficit position. Component 3: Bundesergänzungszuweisungen (BEZ) The BEZ, or additional transfer payments, are the third component of the German equalization system. Some BEZ were created following reunification with the GDR and, accordingly, meet the special needs of the new Länder that are much less affluent than those of West Germany. The federal government covers the cost of these programs, some DM26.1 billion in 2000. CHART 3 Other transfer programs The federal government and the Länder have developed a number of shared cost programs, in particular to improve institutions of higher education and develop the regional economies (federal share: 50%), to support agriculture and its infrastructure (federal share: 60%) and to preserve the shoreline (federal share: 70%). Dispute settlement mechanisms Although the Basic Law grants the Bundesrat a right of review on any federal draft legislation designed to amend the Constitution or affect the finance or administrative jurisdiction of the Länder, at times the two houses can fail to agree on the scope of this right, one arguing that it is entitled to oppose a bill while the other maintains that the bill lies outside its province. In such cases, the parties may ask the Constitutional Court to settle the dispute. In addition, it often happens that the two houses fail to reach a compromise on bills that require the approval of the Bundesrat and the Bundestag, i.e. bills affecting the Länder. In such cases, either house may call on the Mediation Committee. This committee consists of a representative of the government from each Land (member of the Bundesrat) and of 16 deputies of the Bundestag, in proportion to the seats held by each party, for a total of 32 members. It is chaired alternately by a member of each house. Furthermore, there are a large number of intergovernmental councils that coordinate the various policies of the three orders of government. While these councils have only an advisory role, their views are generally taken into account when formulating policy. The most important are the Financial Planning Council and the Economic Policy Council (consisting respectively of the federal minister of finance and those of the Länder as well as representatives of the Communes). Source This material is an abridged and amended transcription of: Commission on Fiscal Imbalance, “Germany”, in Intergovernmental Fiscal Arrangements: Germany, Australia, Belgium, Spain, United States, Switzerland, Background Paper for the International Symposium on Fiscal Imbalance, 13-14 September 2001, Bibliothèque nationale du Québec, Quebec, pp. 3-13.