Examining the law reforming the German revenue sharing system

In February the Federal Ministry of Finance introduced draft legislation for the reform of the German revenue sharing system necessitated by a Constitutional Court decision. The draft contains parameters for the revenue system and criteria for revenue sharing. The parameters relate to the vertical revenue sharing between the federal government and the Länder as well as the horizontal distribution of revenue sharing. In the meantime, Länder governments have evaluated the draft. In this article, the Ifo Institute in collaboration with Prof. Bernd Huber, Munich University, and Dr. Karl Lichtblau, Cologne Institute for Business Research, present details of the legislation and analyse it on the basis of fiscal economics. The results are that with regard to vertical tax allocation, the proposed legislation is based too mechanically on a coverage ratio method and thus contains moral hazards. Accordingly, one level of government - especially the federal level - can expand its tasks and thus also its spending and by means of higher shares of the value added tax can achieve a nearly complete refinancing. For the horizontal redistribution elements, the draft legislation takes into consideration the arguments against the present revenue sharing system put forward by experts on public finance. Accordingly, the Länder could keep greater portions of additional revenue and the empirically demonstrated moral hazard elements of the revenue sharing system could be reduced. With regard to taking possible extra revenue needs into consideration, additional regulations should be added to the draft legislation that would regulate the concrete determination of cost differences between the Länder.