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The German system is decentralized on theexpenditure side—thatis, the states are primarily responsible for delivery of key social services.Equally, the system is highly centralized on the revenue side; the bulk ofrevenues are collected as common taxes with proscribed allocation between theorders of government and subject to federal legislation albeit usuallyrequiring the consent of the Bundesrat representing the states. The allocationof the VAT between orders of government provides the relief-valve for anyemerging vertical fiscal imbalance in the federation. Otherwise, the bulk offederal transfers to states are directed at alleviating the horizontal fiscalimbalance arising out of German unification.

Nonetheless, German states are, at themargin, accountable for the revenues used to finance the provision of publicservices. And this, combined with decentralized provision of public services,albeit with provision for joint decision-making with regard to generalprinciples (Article 91a(2)), conforms to general notions of economicefficiency. Moreover, the significant degree of harmonization in the tax systemand the general commitment to equalization principles mutes the standardcriticisms of decentralized fiscal systems. Thus, for example, the commitmentsto the equalization principle on the revenue side anduniformity-of-living-conditions on the expenditure side ensure a degree ofuniformity in net fiscal benefits (NFBs) across states, alleviating pressuresfor inefficient migration. Centralized tax systems preclude the possibility oftax competition among states.

It needs to be said, however, that theGerman system brings with it some potentially serious flaws. Equalization, forexample, has caused the burden to fall disproportionately on a small sub-set ofstates. As might be expected, this has led to political tension. Moreover, inthe post-unification era, pressure on the western states from proposedinclusion in the interstate equalization scheme has threatened support forpursuing the goal of fiscal equity. In turn, this has resulted in an increasedfederal role in promoting fiscal equity. Yet, this increased federal role hasall but reversed the order of states in terms of fiscal capacity.

The German commitment to equalization anduniformity-of-living-conditions may result in a disincentive for states topursue expansion of their own-revenue sources. Relatively rich states may notpursue economic development potential in view of the equalizationimplications.

Moreover, the willingness of the federalgovernment to bail out near-bankrupt states through federal supplementarygrants might seriously compromise the principle of accountability in statebudgeting.

2. Impacts on Equity

Equity in federal systems is a centralconcern. Equity achieved through the provision of public services is consistentwith the uniformity-of-living-conditions principle. Uniform public servicesconform with the equity objectives of equality of opportunity and economicsecurity, for example. Moreover, the notions of both vertical and fiscal equityare well served by the German arrangements.

It is the emphasis upon the uniformity ofliving conditions principle, the revenue-sharing arrangements and theself-financing nature of the state-to-state equalization that trulydistinguishes the German fiscal arrangements from those in Canada and theUnited States.

3. Equity and Public Services

Important public services such as education,health and social services are provided through the public sector essentiallybecause their provision serves equity objectives. Otherwise, their provisioncould be left to the private sector. Decentralization to the states, as in thecase of Germany, may be efficiency enhancing in that it permits betterreflection of residents’ preferences; equally, the federal government may have an interestin ensuring that some notion of national standards is satisfied. In the Germancase, maintaining some degree of vertical fiscal imbalance has been importantin this process. Equally, the roles of both the federal and state governmentsin ensuring fiscal equity have been clearly enunciated in the Basic Law,resulting in a significant degree of horizontal fiscal equity.

2. Politicalaspects

1. Impact on Stability

The process of intergovernmental relationsand fiscal arrangements has been both a stabilizing influence and a source ofconflict in Germany.

Areas of Consensus

Equivalence of LivingConditions: As noted insection A.4, the achievement of a common standard of living across thefederation has been a goal of the Federal Republic of Germany since itsestablishment. Uniformity became a powerful norm permeating the German systemof governance.

Post-unification, the Constitutional ReformAct of 1994 substituted the term ‘equivalence of living conditions’ for ‘uniformity of livingconditions’.33 It does not appear, however, that the modified constitutionalwording is reflective of a serious diminution of the norm ofuniformity.34 Indeed, the enduring importance of the drive to create a commonstandard of living across the federation cannot be over-estimated. It remains aleading value of the system, and thus affects not only relations amonggovernments, but also sets standards for the equal distribution of wealththroughout the country.

Areas of Dispute

Territorial Reform:

As we have noted, the ability of theLänder to bearsymmetrical constitutional responsibilities has beenquestioned. Given their disparate territorial areas, population sizes, and,since re-unification, levels of economic development, it has been argued thatterritorial reform is necessary if the country is achieve its goal ofequivalence of living conditions. Any territorial reform of Land boundaries hashad important motivations and major implications related to the financialposition resulting from territorial modifications.

There are six specific arguments advancedfor the necessity of territorial reform.35 It has been argued, first, that under the present boundaries, not allLänder can fulfilltheir constitutional functions within the Federal Republic of Germany, and,second, nor can all fulfill the functions expected of them in relation to the European Union. Third, it has been argued thatreorganization is necessary for the orderly economicdevelopment of urban areas which cut across Land boundaries. Fourth, it hasbeen argued that the increased number of Länder post-unification presents amore difficult environment for intergovernmentalcoordination. Fifth, it has been argued that theeconomic disparities among the Länder leave the Länder open to ‘divide and rule’ tactics on the part of the Bund, and, sixth, that thesedisparities place the onus for the realization of thegoal of equivalence of living conditions on the Bund, thereby subverting thefederal nature of the German state.

Despite the strength of these arguments,however, the prospects for territorial reorganization are not bright. Whilesuch reorganization has been a matter of debate forthe entire life of the Federal Republic of Germany, only the 1951 amalgamationof three small south-western Länder, into the new Land of Baden-Württemberg, has been successfullyimplemented.36 Two expert commissions, in 1955 and 1973, recommended territorialreorganization, but the governments involved proved both unwilling and unableto carry through with reforms. In 1990, the extreme political time pressuresassociated with the re-unification process meant that another opportunity for reorganization was lost; the eastern Länder were simply admitted to theFRG on the basis of the Land boundaries that had existed in East Germany priorto 1952. Finally, an attempted 1996 merger of Berlin with Brandenburg failedwhen the voters of the latter rejected it in areferendum.

Reform of the Fiscal TransferSystem: As noted, whiletransitional financial arrangements were made in the wake of unification, andsubsequent long-term adjustments made in the financial equalization system,differences in size, population, and level of economicdevelopment among the Länder continue to generate disagreementsamong them and between them and the federal government. One issue is the levelof equalization payments.

The second stage of theequalization process, the award of supplementaryfederal allocations, now ensures income equalization at a level of 99.5 percentof the Länderaverage.37 However, as expenditure needs are not taken into account, therecipient Länder remainunsatisfied. The poorest Länder therefore continue to press the Bund for selective financialsupport. Meanwhile, the payee Länder feel that they are penalised for their effective economic andfinancial management; they believe they are being forced to subsidiseLänder that have notmade the hard choices necessary to improve their own positions. While cuts tothe target level of equalization have been suggested, territorialreorganization may be the only long-term solution. In the absence of suchreorganization, payee Länder may resort to constitutionallitigation in an attempt to decrease their financial obligations to the poorer Länder.

A second issue is that of ‘unfunded mandates’. As we have noted above, theLänder, asadministrators of federal policy, often end up footing the bill for costs incurred as a result of federal legislation. Proposalsto remedy this situation have focused on the need for constitutional revisionswhich would provide that the order of government which legislates costs shouldbe legally required to cover those costs, rather than shifting them to anotherorder of government.38 Such revision may bepossible, given the history of constitutional amendment in Germany, but it willassuredly not be easy.

A third financial issue relates to the‘jointtasks’. TheLänder have regarded this as the area most open to abuse by the Bund.Both the difficulties, noted above, of the use of the ‘golden leash’ by the Bund, and ofdecision-making on the basis of the lowest common denominator, seem to occurmost frequently in relation to the joint tasks. Whilefurther adjustment of the VAT allocation ratio, in favour of the Länder, may decrease somewhat thefinancial influence of the Bund, it is unlikely that this would be sufficientto remedy the difficulty entirely. The disparities in size and population ofthe Länder pose astructural difficulty which tinkering cannot cure; i.e., the smaller and poorerLänder will never beable to afford to provide the same levels of services in regard to thejoint-task policy areas without special assistancefrom the Bund. Unfortunately, the long-term resolution of these difficultiesdepends upon territorial reorganization.

Ability to Adapt to Changes

Despite the areas of dispute noted in theprevious section, the fact remains that the Federal Republic of Germany hasproven itself remarkably adaptable over its first fifty years. Adjustments inthe federal balance have been accomplished via constitutional amendment,intergovernmental relations, and judicial review. All three processes haveproved relatively flexible. Partial revisions of the constitution have beencommon, with the major amendments having included the strengthening of theBund’s legislative andfinancial roles in the late 1960s, the reunification of Germany in 1990, andthe post-unification reforms of 1994.

Intergovernmental relations in Germany havealso proven a relatively successful method of adjustment in the federation. TheGerman pattern of intergovernmental relations follows the ‘executive federalism’ model common to parliamentaryfederations. However, in Germany the intensive network of relationships, at theGesamstaat, Bundesstaat, and‘third’ levels,provide for systematic coordination among orders ofgovernment. This tightly interlocked relationship appears to offer a lessconflictual model of executive federalism than is found in some otherparliamentary federations.

This system of interlocked relationships hasbeen criticized, however, for being an impediment to adaptation. Aninstitutional culture which puts a premium on consensus can mean the indefinitepostponement of difficult policy choices. This is the so-called ‘joint-decision trap’, identified by Fritz Scharpf, inwhich both policy decisions and changes to the rules via which such decisionsare made are blocked by an institutional culture which prescribes unanimousagreement for virtually all major decisions. Finding the most effective balancebetween cooperation among orders of government and maintenance of eachorder’s ability to actautonomously and flexibly in response to policy challenges has become a majorissue within the German federation, although it is a problem not unknown toother federations.

Judicial review has been an important methodof adaptation to changing circumstances, in part due to German societal normswhich prescribe that political life take place with significant reference to alegal framework. The Federal Constitutional Court’s balanced approach tojurisdictional disputes has meant that both orders of government have been ableto use the Court to seek adjustments in the federation.

While the fiscal transfer system was showingsome strain in the 1980s, overall it may be observed that prior toreunification it had proven a flexible instrument in the West German context.With special transitional provisions and adjustmentsin the allocation of VAT revenues, the system has survived re-unification.However, the enduring disparities in economic development between the formerWest- and East-German Länder, and the consequent high levels of transfers, are severelystraining the inter-Länder solidarity on which the system depends. Whether the widersystem of intergovernmental relations will be sufficiently flexible to effect the necessary changes which wouldpreserve the principles of the present system while adapting its details to thenew economic realities is an open question.

2. Transparency andAccountability Considerations

As noted in section A.5, the highlyintegrated German system of fiscal federalism exhibits a degree of complexitywhich is inimical to transparency and accountability.

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