A closer look at German federalism

Federalism in Germany has been increasingly at the focus of political debate in recent years. Criticism is directed at the increasing interlinkage of spending and revenue-intake competencies of the federal and Länder governments as well as a financial system that leaves the Länder little scope for their own initiatives in improving their financial situation. The Ifo Institute, with the collaboration of Prof. Bernd Huber of the University of Munich, has conducted a comprehensive examination of this problem. The study concludes that German federalism is in need of strengthening. The scope of action of the Länder should be increased to do more justice to the preferences of the Länder population. At the same time, however, the goal of a uniform standard of living throughout Germany must be kept in mind. In concrete terms, the Ifo Institute proposes that the Länder be granted the right to levy taxes in the form of surcharges and deductions on income tax and corporate income tax. An empirical analysis also determined that the Länder fiscal equalisation tends to have a negative impact on growth in the Länder because of the strong tapping of additional tax revenue. For this reason, fiscal equalisation should be reformed in a way that the negative incentives from high marginal tapping can be reduced. At the same time, all Länder must continue to receive sufficient financing, and additional reconstruction aid for the new Länder must not be called into question. The Ifo Institute also proposes that mixed financing schemes (joint tasks, financial aid, and cash benefit laws) be reduced. A regional differentiation in the pay scale for government employees also seems to be advisable.