Exactly 27 years ago today on October 3, 1990 the German Democratic Republic, also called East Germany, joined the Federal Republic of Germany, known as West Germany, to form one nation. Realizing this project has always been a challenge and still remains one. 40 years of socialism had left traces, there were two German countries that had developed apart. Economic strength in the East reached only a third of that in the West, the difference in standards of living was clearly noticeable. This incline in prosperity within a reunified country was not acceptable, the development of equivalent living conditions became anchored as a goal in the German Constitution.
Out of this commitment, the federal financial equalization system arose. The idea was to ensure appropriate levels of funding among federal states through a multistage process, where tax revenues are distributed partially to the national government and to all federal state governments. Each of the latter receives their share in proportion to the number of state inhabitants and contribution to total tax revenues. “Financial equalization” takes place in the following step: Poor states receive adjustment payments from wealthier ones, financed through an additional tax called “Solidaritätszuschlag”. On top of this assistance among federal governments, the national government provides supplementary grants. The objective of such transfers was to help target states, particularly those in former East Germany, implement policies and adjust their economic strength or at least avoid a further diverge.
These regulations constituting the federal financial equalization system will expire by the end of 2019 and have long been subject to debates, most recently during the German federal elections less than 2 weeks ago. Every major party took up on the topic within their election program. Although there are different suggestions on how to execute an abolition of the tax, all agree on the fact that there shall not be any adjustment payments in the long run. There are many reasons for such unambiguous rejection of the current system. Over 25 years after the fall of the Berlin Wall, much has already been achieved. The level of infrastructure in East Germany is high and often even better than in the West. In 2013, the states of Bavaria and Hesse mutually filed in legal action against the government, claiming the equalisation scheme to be unfair and discouraging economic performance after being donors ever since the regulations came into effect in 1991. There was further criticized that the system has drifted off the initial idea of helping Eastern states, since equalization is also applied on states in Western Germany that are poorer compared to the economically strongest regions. In fact, out of all 16 federal states, there are currently more states receiving payments than there are of those paying. This is even more problematic against the background that for years, the tax brings in more money than is actually spent on its purpose to increase living conditions, indicating an inefficient allocation of resources.
German “cash cow states” Bavaria, Hesse & Baden-Wurttemberg providing transfers to the rest. Each bucket represents another receiving federal state. The quote at the bottom says: “The financial equalizer is back”
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