• The ‘Financial Constitution’
  
  • Tax Legislation
  • Shared Taxes and Fiscal Equalisation

The ‘Financial Constitution’

Tax Legislation

The financial procedures and arrangements of German federalism give rise to what might be called a ‘federalism by negotiation’. This is mainly due to the fact that most (though not all) Federal Acts relating to the distribution of financial resources require the consent of the Bundesrat, thus giving it a strong bargaining power. In terms of autonomous powers to raise taxes, the functions of the Länder essentially boil down to the ruling of Art. 105/2a of the Basic Law, which gives them the ‘power to legislate on local excise taxes as long and insofar as they are not identical with taxes imposed by federal legislation’. In practice this power is inconsequential. In the field of concurrent federal legislation on taxes, though, the Bundesrat has a strong say as all ‘federal laws relating to taxes the receipts from which accrue wholly or in part to the Länder’ or to the local government level require its consent (Art. 105/3), while Art. 106 defines in detail which tax revenues accrue to the Federation and/or the Länder (including local government).

Shared Taxes and Fiscal Equalisation

The German ‘financial constitution’, which determines the tax revenues which accrue to, and are equalised between, the different levels of government has the following five main characteristics:

§ The basic (theoretical) rule is that the federation and the Länder ‘shall be autonomous and independent of each other in their budget management’, but that they shall on the other hand ‘have due regard ... to the requirements of overall economic equilibrium’ (Art. 109/1-2 of the Basic Law).

§ Inland revenue is divided between the federation, the Länder and local authorities according to a mixed system of both separate and shared taxes: Shared taxes are by far the most important, and of them, income and corporation taxes (amounting to approx. 45% of all inland revenue) are shared half and half between the federation and the Länder (in the case of income tax after deduction of 15% for local government bodies). Most important for the working of the federal system is the role of the shared value-added tax (VAT). VAT revenue is currently (since 1995) divided between the federation and the Länder in the ratio of 56:44%. This ratio is, however, not constitutionally fixed (as are income and corporation tax) but is adjusted in the light of changing financial needs approximately every two years by a Federal Act requiring Bundesrat consent (Art. 106).

§ This adjustment mechanism is all the more necessary as Federal Acts giving financial grants to individuals or corporations (Geldleistungsgesetze) are by no means necessarily financed at the cost of the federation alone. On the contrary, their costs have frequently to be met predominantly by the Länder, so that the financial effects of new legislation of this kind has to be ironed out via VAT share adjustments. Though the bulk of such legislation requires the Bundesrat's consent, this is not the case if the proportion of the costs falling on the Länder is one quarter or less of the costs of the entire Act. [ This rule has engendered much criticism in debates on the reform of the federal system, as discussed further in Uwe Leonardy, ‘German Federalism Towards 2000: To Be Reformed of Deformed?’, in C. Jeffery (ed), Recasting German Federalism , op.cit.]

§ In addition, there exists a highly intricate system of financial equalisation (Finanzausgleich) which seeks to adjust financial allocations between federation and Länder and between the Länder themselves and to distribute the burdens imposed by constitutional duties. [ As detailed and discussed in Hans Mackenstein & Charlie Jeffery, ‘Financial Equalization in the 1990s: On the Road Back to Karlsruhe?’, in C. Jeffery (ed), Recasting German Federalism , op.cit.]

§ ‘Joint Task’ arrangements added to the financial constitution in 1969, which legalised the co-financing of Länder responsibilities by the federation, were meant to have an additional effect of financial adjustment. They have since, however, fallen subject to considerable criticism both because of the problem of over-‘entangling’ federation and Länder in policy-making (Politikverflechtung) [ See Hartmut Klatt, ‘Centralizing Trends in Western German Federalism, 1949-89’, in C. Jeffery (ed), Recasting German Federalism , op.cit.] and, even more so, because they tend to give the federation the power of the ‘golden leash’ which can allow it to divide and rule by (selectively) offering co-financing of Länder initiatives (Arts. 91a-b and 104a).

In these various ways, the Basic Law attempts to iron out the numerous social, economic and territorial imbalances which are inherent in any federal system, not least the German one - especially since the addition of the financially extremely weak five eastern Länder to the federal structure following unification in 1990. The securing of ‘equivalent’ or ‘uniform’ living conditions throughout the country (as required in Arts. 72 and 106 of the Basic Law), one of the paramount and traditional tasks of German federalism, has been made all the more visible and urgent by that event.