The state of Hesse has taken on debt itself in order to replace the cash advances of its municipalities. They only have to contribute a personal contribution of 25 euros per capita to the repayment – and promise to operate more solidly in the future.
Rate hikes cost local government millions
On the other hand, one should not ignore the reality that millions of people live in the three countries mentioned, but local politics often no longer takes place because there are no funds for it. The goal of “equal living conditions” mentioned in the Basic Law cannot be achieved in this way. Moreover, failures in local politics are often a reason for growing disenchantment with politics.
>> Read here: “The situation is dramatic” – That’s why there is a risk of additional burdens for the citizens in municipalities
The problem of cash advances is particularly virulent. These are something like a municipal overdraft facility. Because of the very favorable conditions with zero or even negative interest, in the past many municipalities actually used these loans to finance their permanent tasks.
In view of the interest rate turnaround heralded by the ECB last summer, those municipalities that are already literally up to their necks in water are now particularly affected. Of the 28.9 billion euros in municipal cash advances reported by the Federal Statistical Office for the third quarter of 2022, 18.3 billion euros were attributable to NRW and 4.9 billion to Rhineland-Palatinate. Every percentage point increase in interest rates costs the NRW municipalities 183 million euros annually.
Sure, the causes of the financial misery are diverse and often partly to blame for the municipalities: structural change, blatant mistakes by local politicians, insufficient local supervision – but also a questionable distribution of tax money to the individual communities.
Most municipalities are dependent on state funds because their own tax revenues are too low. In 2022, municipal expenditures totaled around 330 billion euros, while their tax revenues amounted to just 130 billion euros. The difference is mostly covered by grants.
The second problem is that this municipal tax revenue is largely shaped by trade tax revenue, and this varies greatly from region to region and is also sensitive to the economy. While some economically strong small towns have an impressive four-digit per capita income, in other places people are satisfied if the per capita income is over the 100 euro mark.
Fiscal equalization in the countries on a vertical level
Balancing these disparities is the task of the federal states, because they are responsible for ensuring that their municipalities are adequately funded. The municipal financial equalization schemes, which are structured somewhat differently depending on the country, serve this purpose. In most cases, however, these systems do not redistribute horizontally, but vertically: the state allocates money to the communities according to flat-rate needs.
Municipalities that themselves take in more money than their calculated needs are consistently allowed to keep almost all of these funds; they just don’t get any grants from the state. For example, the billions in profits made by the vaccine manufacturer Biontech made the city of Mainz rich, but the state and the other municipalities did not participate.
However, the local differences in trade tax revenue are not only responsible for the high disparities between the municipalities; this tax also makes corporate taxation very complicated. Because companies have to consider two different income taxes with different assessment bases. In the case of partnerships, it is not the company but the entrepreneur who is liable for tax. Trade tax can usually be offset against personal income tax.
Corporations have to pay trade and corporation tax plus the solidarity surcharge on retained profits, which adds up to the total burden of 30 percent, which is very high by international standards – and even if the federal government wanted to, it could hardly do anything about it against the votes of the federal states.
>> Read here: These are Germany’s trade tax paradises – an exclusive ranking
It would therefore make sense to link the planned old debt relief to an overdue trade tax reform. In order to waive trade tax shares, the municipalities could be granted a share of the sales tax. The more the distribution key is based on the number of inhabitants, the more disparities would be reduced. Any imbalances could be corrected via municipal financial equalization.
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.
In the middle of last year, Federal Finance Minister Christian Lindner (FDP) stated his conditions for the old debt help for the first time: only cash advances will be paid off, and the beneficiary state must assume half of this municipal burden itself. In addition, a municipal debt brake is to be introduced. A two-thirds majority in the Bundestag and Bundesrat would be required for the necessary amendment to the Basic Law and would therefore require broad political approval.
One can only advise Lindner to add an overdue trade tax reform to this list of conditions. Because without such a reform, the municipal finance problem cannot be solved in the long term, nor can Germany’s corporate taxation be simplified and made more internationally competitive.
Should Lindner manage to do what many of his predecessors failed to do, he would be guaranteed a place in the sparsely populated Olympus of great German finance ministers. Of course, his chances are not really good.
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