The federal tax revenue distribution in Germany

September 18, 2015 by studentnovasbe

Currently there is a controversial domestic issue in Germany, which nobody seems to notice during the international refugee crisis and the depression in Greek. It deals with the distribution of the tax revenues among the German federal states, the so-called Länder. In the German institutional framework equal living conditions in the whole country are guaranteed by its constitution. Therefore the tax revenues among the Länder are aligned by a complex distribution system, which consists of four stages.

Stage 1 – Vertical distribution:

The Constitution allocates the most important taxes (income tax, corporation tax and VAT) to the Federation, the Länder and, to a degree, the municipalities. These taxes are therefore referred to as joint taxes. The Federation receives 42.5 % of the income tax, 50 % of the corporation tax and around 53 % of VAT. The revenue accruing to the Länder is 42.5 % of the income tax, 50 % of the corporation tax and around 45 % of VAT. 15 % of the income tax

and, in 2014, around 2% of VAT go to the municipalities.

	Figure 1:                 Distribution of tax revenue per capita among the German Länder in percent of the federal average per capita in 2013 after stage 1

Stage 2 – Horizontal distribution:

At the second stage, the Länder-share of the joint taxes are distributed. Apart from VAT, the Länder are entitled to the tax revenue which is collected on their territory (principle of local revenue). 75% of VAT is distributed according to the number of inhabitants in the Länder. The rest of the Länder-share of VAT is meant for those federal states, whose tax revenues per capita are lower than the per capita average of all the Länder (see the red line in Figure 1). The amount of the VAT portions depends on the amount by which the per capita tax revenue of a Land falls below the average. Because this step ignores the principle of local revenue and already causes an equalising adjustment before the true equalisation mechanism begins, it is heavely criticized by Länder with high VAT revenues. For example North Rhine-Westphalia is worse off after stage 2 (Figure 2), even though it was not better than the average before (Figure 1).

	Figure 2                  Distribution of tax revenue per capita among the German Länder in percent of the federal average per capita in 2013 after stage 2

Stage 3 – Horizontal financial equalisation:

The starting point for the real equalisation mechanism among the Länder is the sum of its receipts per capita. These consists of: the Länder-share of joint taxes, the individual Länder-taxes and partially (64%) the tax revenues of their municipalities. It is assumed that the financial requirement per inhabitant is the same in all the Länder. The amount of transfers from a rich to a poor Land depends on the amount by which its financial capacity per (fictitious) inhabitant differs from the average. Therefore a linear-progressive skimming-off schedule is used. But there are some exceptions for the city-states and sparsely settled Länder. Their populations are hypothetical increased, because of the assumption of a higher financial requirement per inhabitant. At this point the distribution becomes very elusive, since special needs of certain Länder should be considered actually afterwards in stage 4.

Figure 3                  Financial capacity of the Länder in percent of the federal average in 2013 after stage 3

Stage 4 – Vertical financial equalisation

To complement the financial equalisation there are supplementary grants by the federal goverment for the poorest Länder. There are two different kinds: general grants and grants for special needs. General grants go to Länder whose financial capacity per inhabitant is still less than 99.5 % of average. The difference between the Länder is therefore considerably and clearly reduced. In result there should not be any tax competition between them at all. Grants for special needs (called “solidarity levy”) should compensate eastern Länder and are not tied to a specific purpose. Until 2019 they receive transfers amounting to around 105€ billion to build up the infrastructure, which is still comparatively underdeveloped as a result of the partitioning of Germany. Because the eastern Länder will lose this money after 2019 the discussion about the fairness of the current system is staring again. At present the regulation does not only eliminate competition among the Länder. Furthermore it enlarges the differences in financial capacity among the Länder by pushing poor Länder too far above the average (Figure 4). Therefore the federal government should not extend the solitary grants for eastern Germany. The first three stages of the financial distribution system are already more than sufficient.

by Nils Picker

Figure 4                  Financial capacity of the Länder in percent of the federal average in 2013 after stage 4