The state financial equalization system was reformed with effect from 2020. Numerous details changed in the process, but the essential properties and problems of the complex system remained the same. It is therefore by no means surprising that Bavaria, as a paying country, has a renewed constitutional complaint threatens. The financial equalization of the federal states is certainly economically questionable in many respects, but is it also unconstitutional?
The state financial equalization system is a non-transparent system for distributing funds between the federal states. The starting point is the tax power of the countries. It is based on the tax revenue accruing to the federal states based on local revenue (state taxes, shares of income tax and corporation tax). In addition, there are the state shares in the sales tax, which are calculated in the first step according to the number of inhabitants.
Figure 1 shows the resulting tax capacity before fiscal equalization in euros per inhabitant. The large differences in countries’ tax capacity are due to post-income taxes. The sales tax shares increase the tax power of all countries by the same per capita amount, which already significantly reduces the relative tax power differences.
Three instruments for one goal
This is followed by a comprehensive equalization of financial power among the federal states. Three instruments are used for this purpose: (1) surcharges and deductions for sales tax, (2) general supplementary federal allocations and (3) supplementary federal allocations for under-proportional municipal tax capacity.
Further supplementary allocations serve to fund questionable special needs (BEZ for the costs of political leadership, costs of structural unemployment, under-proportional research funding). They are not considered here because they do not depend on financial strength.
In Figure 1, the income after equalization of financial strength does not show an even approximation of the financial strength of the relatively poor and rich federal states. The ranking of the countries is not even preserved, but is completely jumbled up. Bayern slipped from 2nd to 10th place, while Berlin, on the other hand, improved from 5th to 1st place.
Before fiscal equalization, the income per inhabitant in Berlin is 4,518 euros and in Bavaria 5,019 euros. In fiscal equalization, Bavaria loses 740 euros per inhabitant, while Berlin gains 1,409 euros. According to this, the Berlin income per inhabitant of 5,927 euros exceeds the Bavarian income of 4,279 euros by 38.5 percent. Against this background, a constitutional complaint almost appears as self-defense.
However, the massive redistribution is perfectly fine by the standards of the Financial Equalization Act. The financial power equalization is not based on the relative per capita tax power of the states, but on the relationship between the financial power and the equalization index. In addition to the tax capacity of the federal states, the financial power indicator (FMZ) also includes 75 percent of the tax capacity of the municipalities. In principle, the Equalization Indicator (AMZ) corresponds to the average financial strength indicator per capita, but is not based on actual residents but on weighted residents.
The significant increases in financial power in the eastern German federal states in Figure 1 are not surprising, because they are based on the low tax power of these states and their municipalities. In contrast, the city-states benefit primarily from the weighting of their inhabitants with 135 percent. This reduces their relative per capita financial strength (FMZ/AMZ) enormously, which explains the high financial equalization gains in Bremen and Berlin and the low burden on Hamburg.
The city-state privilege is economically controversial for good reasons, but has so far withstood all constitutional attacks. As long as the weighting of the residents is tolerated as a general measure of a larger per capita financial requirement, swapped rankings in relation to the per capita income are not relevant for the assessment. Reversing ranks measured against the legally relevant FMZ-AMZ ratio can, however, violate the constitutional ban on over-levelling.
Over leveling not excluded
Figure 2 illustrates the Financial Power Equalization (FKA) based on the standards of the Financial Equalization Act. The countries are sorted here according to the relationship between the financial strength index and the compensation index. As a result of the city-state ranking, Bremen is now the poorest federal state. Berlin and Hamburg also slipped down significantly in the ranking of financial strength.
The financial power equalization causes a strong leveling of the relative financial power positions. The surcharges and deductions for sales tax compensate for the AMZ-FMZ differences by 63 percent. The remaining financial strength gaps are almost completely closed by general federal supplementary grants (a BEZ) with a compensation rate of 80 percent. From an economic point of view, the degree of leveling achieved up to that point was far exaggerated, but the ranking of the countries’ financial power has not yet shifted.
This is changing with the federal supplementary grants for under-proportional municipal taxpayers, which have been paid additionally since 2020. There is no apparent systematic reason for these allocations, because the municipal tax capacity is already taken into account in the financial capacity index. Rather, the extra allocations distort the equalization of financial power and they also produce over-leveling effects that are constitutionally objectionable.
Figure 2 shows that recipients of municipal tax credits (g BEZ) are overtaking countries that previously ranked ahead of them in terms of financial weight. Even within the recipient group, shifts in ranking occur. After financial equalization, four of the six recipient countries even achieve a FMZ-AMZ ratio of over 100 percent, which amounts to an unjustified overcompensation of their financial power gaps. As a result, the municipal tax allocations violate the constitutional ban on over-levelling.
From an economic point of view, it is also extremely high limit loads are responsible. If the wage tax revenue of a recipient country increases, the state budget records a minus (!) of around 30 to 35 percent of the additional revenue. The speedy abolition of municipal tax allocations therefore appears necessary from both an economic and a constitutional point of view. The federal government could compensate for the loss of the states in the context of sales tax distribution and thus support a sensible, albeit small, reform.
Conclusion
A far-reaching reorganization of the financial equalization of the federal states via Karlsruhe is not to be expected. Appropriate proposals have so far always been ignored. Even the paying countries agreed to the last reform and only focused on the distribution gains that they could achieve in the short term at the expense of the federal government. Unfortunately, it can be assumed that the financial equalization of the federal states will also survive the renewed attack from Bavaria unchanged.
