Municipal Finances and Municipal Financial Equalisation in Germany

Jens Bullerjahn, Michael Thöne

GIZ/ December 2020/ Report, GIZ (publ.) p.p. BMZ

Abstract
The German municipal finances and the municipal fiscal equalisations form the outermost branches of a financing system which, in federal Germany, links and binds together the three state levels of federal government, Länder and municipalities. The levels are linked via many mechanisms in the fulfilment of state tasks and their financing, not least via a joint tax system in which all three participate. Nevertheless, in this dense network, which characterizes the cooperative federalism of the German type, two regulatory circuits can be clearly distinguished. The regulatory circuit at the upper level is constituted by the Federal-Länder fiscal equalisation system, which links the central state with the 16 Länder ― three city states and 13 territorial states. This system and its changes were examined by the authors of the present study in 2018 in a first GIZ study with regard to its suitability for providing impetus and instruments for the work of the development cooperation partners.1With the same focus on impulses for development cooperation, the present study examines the second regulatory circuit of the federal and decentralised financing system in Germany, the financing of the 11,000 independent municipalities and community associations in and through the 13 territorial states. In principle, German mechanisms and instruments of public finance are not directly presented as functional and worthy of imitation in this report either. The German municipal financing system has been shaped by developments and political needs over the past 150 years. Many instruments are, first and foremost, answers to concrete questions that have been raised in individual German Länder or throughout Germany. Hardly any of these questions can be answered in the same way in a partner country of development cooperation today. Accordingly, we do not present the components of municipal finances as “solutions”, but as the results of political processes in which, at best, the efficient decentralised fulfilment of public tasks and their financing are sought. This process approach provides a number of starting points for international cooperation and for the adaptation of solutions. The study talks about the public finances of municipalities but does not start with money. Revenues serve tasks. Whoever talks about municipal finances has to start with the distribution of tasks and their financing. Important principles of the municipal system must already be implemented when public tasks are being carried out: Subsidiarity, connexity, equivalence, solidarity, equivalence of living conditions and loyalty to the alliance. These principles resonate in municipal finances.  The first pillar of the municipal finances are their own tax revenues, such as property and trade tax, rates and contributions. We discuss their origin, development and future in detail. The main focus is placed on the interplay between municipal autonomy and integration, which is expressed in the fact that each municipality determines the tax rates of its own property and trade tax itself, while the federal government and the Länder decide on these in their legislation. At the same time, it has long been clear that the traditional municipal taxes are not sufficient to ensure adequate funding everywhere. This is why municipalities have long been involved in the important joint taxes, income tax and VAT. For many municipalities, this second pillar, their participation in the German tax association, has now become their true basic funding. Finally, the third pillar of municipal financing in Germany is the municipal financial equalisation scheme in the 13 territorial states. Even the differentiated and adaptable municipal tax system offers only few municipalities funding that allows them to fulfil their legal obligations and fulfil their democratic self-government. For this purpose, municipal financial equalisation is needed. It is these financial and equalisation instruments with which the intention to think municipal services from the perspective of the task and not from the perspective of money can be redeemed. In the beginning, there is always the “vertical financial equalization” between the state and the entirety of its municipalities. Here, the financial portion is taken from the tax revenues of a Land state, and used later for distribution to the individual municipalities. This distribution of funds determines the political scope of both levels: The gains of one level are the losses of the other. Because of that, vertical financial equalisation is often very controversial. Since the Federal states act as legislators, the legal protection of the local level by the constitutional courts is of particular importance. The pinnacle and conclusion of municipal financing in Germany is the horizontal municipal financial equalisation in each territorial state. In some countries, so-called “abundance allocations” are actually used to redistribute funds from rich to poor. In all countries, however, the transfer system is primarily designed as a vertical compensation with a horizontal effect: From the very start, allocations are Benefits for development cooperation made on the basis of municipal revenue power. The relatively poor municipalities receive a lot, the relatively rich receive little or no allocations at all. This means that the final horizontal financial equalisation is the final decisive phase in German municipal financing. At this point it is decided whether the municipalities have sufficient funds to fulfil their tasks adequately and evenly. If these mechanisms and the underlying principles of German local politics and local financing can be used as suggestions or examples in development policy - in what-ever intention and complexity - this short study will serve its purpose. In our view, the issues of decentralisation of political and administrative structures, the establishment and expansion of infrastructure, the economy, education, the welfare state and the rule of law on the basis of growing, stable public revenues are more acute than ever in developing countries.