Reform of Financial Relations between the Federal Government and the Länder: a Fair Compromise or Setting New False Incentives?

On 14 October 2016, and after lengthy negotiations, the heads of the Germany’s federal government and its Länder agreed to a new regulation of federal financial relations as of 2020. A new redistribution system will replace the current Länder fiscal equalisation scheme. What does the agreement mean for the federal government and the Länder? According to Edith Sitzmann, Minister of Finance for Baden-Württemberg, the negotiations were worthwhile and led to a fair compromise. Thanks to the elimination of the Länder fiscal equalisation scheme in the narrower sense of the term, arguments in the future will revolve less around which is the donor state and which is the recipient state, which, in turn, will be good for the cohesion of Germany. The new fiscal equalisation scheme will also continue to preserve the requisite balance between direct responsibility and independence on the part of the Länder on the one hand, and support for weaker Länder on the other. Should the package agreed become applicable law, Stefan Korioth, University of Munich, does not think that it will guarantee a balanced fiscal distribution between the federal government and all Länder. In his view, the agreement is not convincing conceptually or in terms of the transparency of financial flows called for on all sides. It could cause serious collateral damages in the federal system overall and is to be seen, on the whole, as a federal disaster; especially for the Länder, which have unnecessarily agreed to diminish their status and relinquish power in return for more money from the federal government. Thomas Lenk and Philipp Glinka, University of Leipzig, primarily see the deal as an extension of the federal government’s competences in terms of the tasks performed, which will strengthen the federal government’s position at the expense of the Länder. This applies to the fields of tax administration, digitalisation and federal highway management. Moreover, the federal government’s rights in mixed financing and investments in municipal education infrastructure have been expanded. The far-reaching task of the Länder in offering each other mutual financial support within the Länder fiscal equalisation scheme, their greater collective dependence on the federal government and rising income inequality between the Länder signifies an effective departure from longstanding and well-established guiding principles. For Friedrich Heinemann, ZEW Mannheim and University of Heidelberg, a fiscal equalisation reform was called for that granted the Länder greater freedom on the income side, avoided a new, far-reaching shift in burden onto the federal government and provided incentives to examine Länder territorial reform with greater openness. The new direction set by the compromise between the federal government and the Länder, however, does not even begin to satisfy these demands. By contrast, Joachim Wieland, German University for Administrative Sciences Speyer, sees the reform of fiscal relations as an opportunity for the federal government. The new regulation promises less complexity, fewer solidarity requirements and litigious tendencies at the price of strengthening the role of the federal government. For Martin Junkernheinrich, Technical University of Kaiserslautern, the consensus reached can be considered a success for the moment. However, delight at this achievement has overshadowed the need for further central reforms. The absence of proposals to reduce high and starkly contrasting levels of old debt between the Länder; along with the lack of any consideration of municipal fiscal problems, are particularly dissatisfactory. Ultimately, reinforcing the redistributive function of federal government, as well as the competence gain in terms of policy tasks, is not part of an overall federal policy perspective.