MATRIZ DE CONECTIVIDAD

Tax revenues usually account for 70-75% of the länder’s total revenues. The other main sources of revenues include current and capital transfers from the federal budget and various other own revenues, such as fees. The länder are responsible for the collection of both federal and state taxes, which fall into four categories:

„ Shared taxes, which are apportioned among federal, state and municipal governments, according to various pre-determined percentage allocations (notably income and sales taxes).

„ Taxes allocated solely to the federal government (notably duties on mineral oil and tobacco).

„ Taxes allocated entirely to the länder (notably motor vehicle and inheritance taxes).

„ Taxes allocated solely to municipalities.

In 2009, shared taxes (for which rates are centrally set) represented the largest portion of the tax system, accounting for c.70% of the total. The länder’s own taxes represented a low c.3% of total tax revenues in 2009 and, on our projections, are unlikely to change over the course of the years ahead. Instead, the council of German tax surveyors (Arbeitskreis Steuerschätzung) expects their weight to decline to c.2.25% in 2010.

Shared revenues are distributed between the levels of government and among the länder through a four-stage sequence of vertical and horizontal apportionment and equalisation, which can be summarised as follows:

„ Vertical apportionment or distribution. Rates for all shared taxes and their apportionment among the different levels of government are largely pre-determined or decided centrally. For income taxes, the shares allocated to the various levels of government are laid down in the constitution. The apportionment of sales taxes is subject to federal legislation and has varied over the past few years as part of a negotiation between the central and state governments on the overall mix of burden sharing.

„ Horizontal distribution of länder share of revenues. In part, this is related to population and/or shares of revenue actually collected in each state, but there is also an element of redistribution (or equalisation) of VAT revenues, which increases the tax revenue received by the states that are weaker economically.

Practical constraints on fiscal flexibility

Taxes account for about three quarters of länder revenues

Shared taxes account for c.70% of all tax revenues

„ Financial equalisation. This is a horizontal redistribution in which richer länder contribute funds and weaker länder receive funds in order to reduce (but not eliminate) imbalances in the financial resources available per inhabitant.

„ Supplementary federal grants. There is a further stage of vertical equalisation in which the federal government makes additional grants to poorer länder. These may be general grants, designed to further reduce the extent to which a state’s financial capacity per inhabitant falls short of the national average, or special grants, designed to compensate poorer länder for special burdens. For example, Eastern länder and the city-state of Berlin still receive special supplementary grants to assist in building up their comparatively under-developed infrastructure.

Following the apportionment of taxes and taking into consideration the use of federal funds to make payments to the EU and the vertical equalisation payments to the länder, the federal and länder governments end up with largely comparable shares of tax revenues from which to fund their expenditures. Tax estimates published in May 2010 indicate that c.43% (2009: 44%) of the taxes should be available to the federal government and c.39.5% (2009: 39.5%) to the länder, in aggregate. In our view, due to this split, länder generally have a rather limited short-term flexibility with regard to their revenues.

The extent to which the cumulative stages of equalisation achieve convergence in the financial resources available to individual states is illustrated below. The advantage of länder with above-average financial capacity is reduced by the horizontal redistribution, eg, a state that starts with a capacity of 130% of the average will find that reduced to 109%. For all länder with capacity of less than 99.5% of the average, the process lifts them towards the average. For example, for a state that starts with 80% of the average capacity, horizontal equalisation is designed to increase it to 93.5%, and general supplementary grants increase it further to 98% (Figure 188).

Figure 186: Tax type (€bn) (lhs) and distribution of revenues after apportionment and vertical equalisation payments (€bn) (rhs)

0 50 100 150 200 250 300 350 400 450

Shared Taxes Purely

federal*

Purely Länder Municipalities

2005 2006 2007 2008 2009 (f) 0 50 100 150 200 250 300

Federal Laender Municipalities EU

2005 2006 2007 2008 2009 (f)

Note: Based on May 2010 tax estimates. Source: German Ministry of Finance, Arbeitskreis Steuerschätzung, Barclays Capital Largely equal division of taxes

between federal and länder governments

Figure 187: Effect of financial equalisation on financial capacity per inhabitant (as % of the average financial capacity per inhabitant)

Financial capacity per inhabitant before Financial Equalisation Financial capacity per inhabitant after Financial Equalisation

among the länder

Financial capacity per inhabitant after Financial Equalisation among the länder and

general supplementary grants

70 91 97.5 80 95 98 90 98 98.5 100 100 110 104.5 120 106.5 130 109 Source: German Ministry of Finance

Notwithstanding the redistribution of revenues according to the German Financial Equalisation Scheme, the diversity in economic resources across German länder is strongly reflected in substantial divergences with respect to the individual public finances. This becomes particularly evident when comparing public sector expenditure of east (c. 20% of GDP) and west German (10%) länder.

The German Financial Equalisation Scheme is geared toward achieving a convergence in the financial resources available to the states. Specifically, it seeks to reduce the differentials in financial strength, defined with respect to total revenues per capita available to regional governments. It does not take into account the differing expenditure needs that can go along with varying starting levels in terms of regional living standards. The scheme was never designed to ensure equality in terms of public finances. This is underpinned by the continuing divergence in public finance and debt indicators. Still, the scheme is generally understood to be a major source of credit protection for the regional governments of the economically weaker parts of the country, although rating agencies take differing views as to just how much support this entails). The flipside to this, however, has been to limit the potential upside revenue for stronger economic regions, which, in turn, has limited their incentive to optimise revenue generation. The amendments introduced in 2005 leave the system continuing to provide a large part of the redistribution and, hence, credit support of the existing scheme, although there has been a shift in the balance towards limiting the redistributive effect and increasing the incentive to optimise revenues.