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Fiscal Incentive Effects of the German Equalization System

  • Sven Jari Stehn
  • Annalisa Fedelino

Does reliance on transfers weaken fiscal discipline and encourage pro-cyclical fiscal policies in recipient subnational governments? Using fiscal reaction functions for a panel of the German Länder, this paper finds a positive answer to both questions. Net-recipient states (Länder, benefiting from the transfer system) have not reduced primary expenditure significantly in response to rising deficits, but have instead relied on vertical transfers from the federal government to ensure debt sustainability. Moreover, they have pursued pro-cyclical policies, particularly by raising expenditures in good times. Net-contributing Länder (paying into the transfer system), in contrast, have ensured fiscal sustainability through spending adjustments; they have also been less pro-cyclical. Panel vector auto-regressions confirm these findings.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/124.

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Length: 29
Date of creation: 01 Jun 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/124
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  10. Thiess Buettner, 2007. "Equalization Transfers and Dynamic Fiscal Adjustment: Results for German Municipalities and a US-German Comparison," Working Papers 2007-07, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
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