There is an often overlooked gap in the debate about public finances: the German state ended the past year with a deficit of a good 100 billion euros. The deficit ratio was 2.6 percent, which means that Germany has complied with the three percent limit of the European treaties for the first time since the corona outbreak at the beginning of 2020.
It is hardly known that it was only the federal government that was in the red, while the federal states, municipalities and social security funds achieved billions in surpluses. If you combine the federal government and social security funds on the one hand and the federal states and local authorities on the other, a deficit of 113 billion euros is offset by a surplus of a good eleven billion euros on the one hand – poor federal government, rich federal states.
The federal government financed the major tasks of the past year. With a lot of money the energy supply of the fourth largest economy in the world had to be secured, the Bundeswehr had to be made more defensive and at least the needy had to be shielded from the financial consequences of the energy price explosion. In addition, it was necessary to take care of one million refugees from Ukraine and to finance the consequences of the – hopefully – last wave of corona.
One could argue that dealing with such shocks is the task of the central government, while the subordinate levels merely represent executive administrative units. This is the case in centrally organized states such as France.
But the German state has a federalist structure. Each of the 16 federal states insists on its uniqueness and independence, and each state chancellery emphasizes its own importance. However, paying for this autonomy is decidedly unpopular in all 16 countries.
Exchange power for money
For this reason, the federal states in the Bundesrat made active use of the possibilities for influencing central policy areas provided for in the Basic Law. Last but not least, this related to questions of the financial constitution and thus taxes. Any change in tax law that does not affect pure federal taxes such as tobacco tax requires a majority in the Bundestag and Bundesrat. The Chamber of the Federal States had to pay dearly for such approvals.
So it came about that since the last federalism reform in 2009, the federal states gradually negotiated shares of the tax revenue with the federal government and, in return, the federal government gained influence over more and more federal state responsibilities. In the meantime, not only the expansion of day care centers is co-financed by the federal government, but also their operation.
The result: since 2020, the states have been entitled to a larger share of tax revenue than the federal government. In the past year, the federal states received almost 43 percent of the taxes collected, the federal government 38 percent, the municipalities 15 percent and the EU a good four percent.
In 2000, the federal share was about five percentage points higher, while the shares of the states and municipalities were correspondingly lower. At the same time, the spread of mixed financing and a “tangle of interconnected negotiation arenas” mean that “everyone is responsible for everything and nobody is responsible for anything,” as CDU veteran Wolfgang Schäuble once put it. The consequences are a confusion of competences and growing bureaucracy.
The German economy is now undeniably facing major challenges that will cost the state a lot of money. The marked aging of the population that will soon begin will be a stress test for social insurance, for which no convincing concept has yet been identified.
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Expenditure, especially for pension and long-term care insurance, will rise significantly due to demographic changes, while the income base of social insurance and the tax authorities will shrink due to falling employment.
The decarbonization of the economy must be driven primarily through privately financed investments. Nevertheless, it is the task of the state to adapt and modernize the energy infrastructure so that it can cope with the new requirements.
Location disadvantage Germany
Likewise, the digitization of administration can only progress if the federal government provides uniform framework conditions for an infrastructure and develops standards that then have to be implemented locally by the federal states and municipalities.
In addition, Germany is falling further and further behind in location rankings due to high corporate taxes and deteriorating infrastructure. In his house’s annual economic report, even Economics Minister Robert Habeck considers a new “supply policy” to be necessary in order to strengthen the location.
All of these are tasks for which the federal government is primarily responsible. In fact, today more than every third euro from the federal budget flows into the area of social security, in particular into the co-financing of the statutory pension insurance.
Prof. Bert Rürup is President of the Handelsblatt Research Institute (HRI) and Chief Economist of the Handelsblatt. For many years he was a member and chairman of the German Council of Economic Experts and an adviser to several federal and foreign governments. More about his work and his team at research.handelsblatt.com.
The majority of the expenditures of the federal states and municipalities, on the other hand, are personnel expenses, which are often caused by federal laws. For these two levels together, the national accounts for 2022 show employee compensation of 240 billion euros – for the federal government it is only a good 40 billion.
There is no doubt that the police and judiciary, the maintenance of clinics, schools and day-care centers and other public services are labour-intensive. But it is also a growing bureaucracy that ties up a lot of resources. Representatives of the new political economy, such as the US economist William A. Niskanen, see one reason for this in economic incentives. According to this approach, the management of authorities endeavors to expand their own competences and budgets, with the result that the number of employees increases.
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A presumably more important reason for an increase in bureaucracy is impractical laws. In fact, laws are still being created as in the early years of the Federal Republic, without lessons having been learned from seven decades of management research and three decades of digitization.
The ministry responsible writes a draft that is passed around the cabinet. Change requests are often put together in overnight meetings within days or within hours without assessing the consequences for feasibility.
The proven administration expert Volker Brühl therefore recently demanded in the “Handelsblatt” that all laws should be “digitizable”. All the data that authorities need for their services should be recorded in a standardized way in a central database – without a doubt a mammoth project.
It is undisputed that the federal government’s financial requirements will increase significantly in the coming years. If tax increases are to be avoided for good reason, there is little choice but to distribute the existing income differently – through financial equalization between and within the levels of government.
A strong and efficient federal state not only needs sufficient income, enough skilled workers and usable technology, it also needs modern regulations and laws as well as clear and practical responsibilities.
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