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New Plan Would Rejigger Controversial German State Financing

Dominik Butzmann/laif
  • Why it matters

    Why it matters

    The finance ministry is considering radically reorganizing the financial relationship between the federal states and the government to reduce debt and control spending more closely.

  • Facts

    Facts

    • Under Germany’s state finance redistribution law, wealthier federal states pay to finance the deficits of weaker states.
    • A solidarity tax in Germany was created following reunification to channel money to East Germany but the finance minister’s plans may integrate this tax into income tax after 2019.
    • The finance minister intends to make it cheaper for the federal states to take on credit but he seeks greater control over the federal states’ spending.
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    Audio

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Controversial new plans at Germany’s finance ministry would radically reallocate the way tax income is distributed between the country’s states and central government.

The plans by Wolfgang Schäuble, the finance minister from the centrist-right Christian Democratic Union, together with Olaf Scholz, a Social Democrat and Hamburg’s mayor, would introduce one of the most far-reaching financial reforms in Germany in recent years.

Mr. Schäuble’s plans foresee rearranging the way tax revenue is redistributed among federal states.

He also plans to replace the solidarity tax, a surcharge that was designed to pay for the reconstruction of East Germany following reunification, into a new, higher federal income tax.

And Mr. Schäuble seeks to develop a new system of bonds to pay for the debt, according to a confidential finance ministry working paper seen by Handelsblatt.

But implementing these ideas will not be easy: Mr. Schäubles plans are likely to meet opposition from state premiers who will need to pass the reform in parliament.

To sweeten the proposal, Mr. Schäuble is offering money in the form of shared bonds. The federal government would centralize the way debts are managed and issue bonds, which would enable German states to sell new debt at a lower cost.

Mr. Schäuble is also considering taking on the cost of the housing allowance for low-income taypayers. For other social benefits paid for by states, restricted legislative powers are being considered, apparently along the lines of, “whoever pays the bill calls the shots.”

There are some strings attached. The finance minister is calling for a bigger proportion of sales tax to be paid to the central government. And he wants greater control over the financial business of the federal states, a controversial demand among state premiers.

But Mr. Schäuble is confident about his plan to fundamentally rebuild the financial structures between the states, which could be the most important project in this legislative period.

The plan also encompasses the redistribution of social security contributions, the issuing of bonds between the central government and the federal states, and the establishment of a fund for prior debts.

The solidarity tax was developed to support East German states and even out the financial situation following reunification.

In the future, if the plans are passed, this tax would be integrated into income tax, corporate income tax and capital returns tax. This would give the federal states access to some half of the income from this tax which has so far gone to the coffers of the central government.

Income from this solidarity tax would partly be used to cut cold progression, or bracket creep. And the remainder would support some of the federal states which currently have the highest debts. There are limitations on the amount of debt allowed and the federal states cannot take on new credit after 2020. For some it is unclear how this will be possible.

Some of Germany’s federal states are in significant debt while others are wealthy. Currently each year, this is reorganized under the state finance redistribution law.

Mr. Schäuble’s plan is welcomed support from poorer states such as North Rhine Westphalia. Norbert Walter-Borjans, the state finance minister and a social democrat, said he did not mind how the tax was reorganized, “so long as it is used to support economically backward areas whether they are in the east or the west.” He is concerned about his state and the industrial Ruhr area in western Germany.

The finance minister of wealthier Bavaria has a different view. Markus Söder argues that states which who are in debt such as North Rhine Westphalia or Berlin should get their act together. “They should introduce reforms and save money,” he said.

Further, Mr. Söder believes that the state finance redistribution law endangers federalism. “Bavaria pays some 60 percent of this equalization,” he said. “We can’t go on like this.”

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