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Fiscal Equalization: The Case of German Municipalities

Authors
Disciplines
  • Economics
  • Political Science

Abstract

Fiscal Equalization: The Case of German Municipalities FISCAL EQUALIZATION: THE CASE OF GERMAN MUNICIPALITIES THIESS BUETTNER* AND FÉDÉRIC HOLM-HADULLA** Given increased mobility of capital, many coun-tries face difficulties in taxing corporate in- come. Some observers fear a race to the bottom and wonder whether international economic integration has gone too far. In fact, experience with the finances of local jurisdictions – cities, towns, and municipali- ties – suggests that governments operating under conditions of high mobility are forced to rely more heavily on the taxation of property and land than on personel and corporate income taxes. Although this is true for local governments in most countries, it is not true for Germany. Germany currently has about 12,500 municipal gov- ernments, each of which runs its own budget, employs public servants and raises revenue from various sources. These municipal governments have some tax autonomy in the sense that they decide on the actual tax rate of land tax and of business income tax. But, quite contrary to what might be expected, the rev- enue share of business tax is substantial in this case, and the average statutory tax rate is suprisingly high. Even after the 2008 tax reform it is above 13 percent. While the strong reliance on business taxation seems to contradict conventional wisdom, it is important to emphasize that there are some specific institutions that govern the fiscal policies of local jurisdictions in Germany. Most notably, German municipalities are subject to a system of vertical and horizontal fiscal transfers. Closer inspection reveals that this compre- hensive system of fiscal equalization can partly explain why local governments rely so heavily on business income tax. There are basically two features of municipal finances in Germany that could explain the unusual tax mix and the heavy reliance on business taxes: (1) The fiscal equalization system tends to reduce the marginal cost of using busine

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