Fiscal Equalization Scheme Research Articles

The Dynamic Response of Municipal Budgets to Revenue Shocks

We study the fiscal and tax response to intergovernmental grants, exploiting quasi-experimental variation within Germany's fiscal equalization scheme triggered by census revisions of population counts. Municipal budgets do not adjust instantly. Instead, spending and investments adapt within five years to revenue gains, while the adjustment to losses is more rapid. Yet the long-run response is symmetric. The tax response is particularly slow, stretching over more than a decade. Well-known empirical anomalies such as the so-called flypaper effect may thus reflect a short-run phenomenon, while long-run fiscal behavior appears more consistent with standard theories of fiscal federalism. (JEL E62, H71, H72, H77, R51)

Skimming the achieved? Quantifying the fiscal incentives of the German fiscal equalization scheme and its reforms since 1970

Marginal rates of contribution (MRC), i.e., the rates at which additional revenues are skimmed via larger contributions or lower transfer receipts, quantify the incentives of a fiscal equalization scheme. This paper is the first to calculate marginal rates of contribution for the Laender (states) in the German fiscal equalization scheme for each of the 51 years since its establishment in 1970 and over five major reforms, taking into account all relevant revenues. Our results show that MRC have been at a consistently high level. Until 2019 the scheme induced an almost full skimming of additional tax revenues of recipient states. With the system’s latest reform in 2020, MRC increased further. Recipient states now face an over-skimming of additional tax revenues and, thus, massive fiscal disincentives to maintain their own tax base. While these findings have been widely expected, comprehensive evidence has been missing so far.

Skimming the Achieved? - Quantifying the Fiscal Incentives of the German Fiscal Equalization Scheme and its Reforms Since 1970

Skimming the Achieved? - Quantifying the Fiscal Incentives of the German Fiscal Equalization Scheme and its Reforms Since 1970

Tiebout sorting with progressive income taxation and a fiscal equalization scheme

This paper develops a model of Tiebout sorting with decentrally determined progressive income taxation and a built-in fiscal equalization scheme that redistributes money from richer to poorer regions. Both aspects are central to policy makers: the progressivity for equity reasons and the fiscal equalization to prevent an underprovision of the publicly provided good and to limit the degree of segregation of households according to income. The model is calibrated to the metropolitan area of Zurich (Switzerland), and policy evaluations reveal that a progressive tax scheme as the basis for decentrally determined tax rates causes strong segregating forces that can only to some extent be compensated by the fiscal equalization scheme.

The Dynamic Response of Municipal Budgets to Revenue Shocks

We study the fiscal and tax response to intergovernmental grants, exploiting quasi-experimental variation within Germany's fiscal equalization scheme triggered by Census revisions of official population counts. Municipal budgets do not adjust instantly. Instead, spending and investments adapt within five years to revenue gains, while adjustment to revenue losses is more rapid. Yet, the long-run response is symmetric. The tax response is particularly slow, stretching over more than a decade. Well-known empirical anomalies in public finance such as the flypaper effect are thus primarily a short-run phenomenon, while long-run fiscal behavior appears more consistent with standard theories of fiscal federalism.

The Dynamic Response of Municipal Budgets to Revenue Shocks

We study the fiscal and tax response to intergovernmental grants, exploiting quasi-experimental variation within Germany's fiscal equalization scheme triggered by Census revisions of official population counts. Municipal budgets do not adjust instantly. Instead, spending and investments adapt within five years to revenue gains, while adjustment to revenue losses is more rapid. Yet, the long-run response is symmetric. The tax response is particularly slow, stretching over more than a decade. Well-known empirical anomalies in public finance such as the flypaper effect are thus primarily a short-run phenomenon, while long-run fiscal behavior appears more consistent with standard theories of fiscal federalism.

How to improve the quality of life in peripheral and lagging regions by policy measures? Examining the effects of two different policies in Germany

AbstractPeripheral regions commonly appear to be less attractive to live in and policymakers all over the world are applying various measures to make them more attractive. This paper analyzes the effects of two very different measures: The German municipal fiscal equalization scheme and the German structural funds for economically weak areas (GRW). It focusses on the impact on perceived quality of life, measured through interregional migration between German labor market regions. Using a spatial vector autoregressive panel model, we find evidence that equalization transfers have a significant positive impact on regional net migration and contribute to the aim of regional equity. These effects are especially found for regions with low endogenous fiscal capacities. GRW funding reveals no significant effects on net migration rates in total, but short‐term effects in rural regions.

The Bavarian Municipal Fiscal Equalization Scheme: Emphasis on Equity Rather than Efficiency

Employing the approach of Albouy (2012), this paper evaluates the efficiency and equity of the municipal fiscal equalization scheme in the federal state of Bavaria in Germany. Calculating a measure reflecting the internalization of fiscal and real externalities by state grants, we conduct a regression analysis on variables describing efficiency and equity criteria. Because the fiscal equalization scheme redistributes revenues toward regions with low realized incomes and a larger population share of low-productivity residents, the scheme satisfies certain equity criteria. However, the fiscal equalization scheme likely does not internalize local public-good externalities and therefore hampers spatial efficiency.

Leadership in Tax Competition with Fiscal Equalization Transfers

Abstract We propose a timing game of asymmetric tax competition with fiscal equalization scheme. The study finds that governments tend to play a sequential-move game as the scale of equalization transfer increases, which explains the emergence of tax leaders in tax competition. The presence of a tax leader is likely to exacerbate capital misallocation among countries, suggesting that equalization transfers aimed at narrowing the interregional fiscal gap might cause an inefficient capital allocation.

Federalism in Germany, Italy, and the European Union: History, Characteristics, and Perspectives

Abstract Federalism is always torn between the principles of subsidiarity and solidarity. Defining the federal structure of a country by finding the welfare-maximizing amount and design of government layers is challenging. Thereby, the financial endowment of different layers of government which they need to fulfill their respective tasks is an important aspect. European countries have chosen quite different federal designs to address the question of an optimal degree of fiscal decentralization. The aim of this paper is to analyze these different approaches for Germany, Italy, and the European Union. Parallels can be found in that all the three entities share a form of institutional asymmetry, a kind of fiscal bailout system, and a sort of fiscal equalization scheme.

The Tax-rate Elasticity of Local Business Profits

AbstractLocal business profits respond to local business tax (LBT) rates that vary across municipalities. We estimate that a 1% increase in the LBT rate decreases the LBT base by 0.45%, based on the universe of German LBT return files, which include corporations and unincorporated businesses. However, the fiscal equalization scheme largely compensates municipalities for the loss in the LBT base when they increase the LBT rate. Our estimates suggest that using tax revenue data instead of tax return data, as commonly done in the literature, results in a significant bias of the elasticity away from zero.

Fiscal Transfers in the Spatial Economy

Many countries operate pronounced fiscal equalization schemes that shift tax revenue across jurisdictions. We use a general equilibrium model with multiple asymmetric regions, costly trade and labor mobility to carve out the aggregate implications of this policy. Calibrating the model for Germany, we find that it indeed delivers smaller spatial economic disparities across regions. This comes at the cost of lower national output, however, because activity is diverted away from core cities and towards remote areas with low productivity. But despite this output loss, fiscal transfers may still raise national welfare, because they effectively countervail over-congestion in large cities.

Advancing Backwards: Why Institutional Reform of German Federalism Reinforced Joint Decision-Making

A series of recent reforms in German federalism have created a dynamic development unprecedented in the Federal Republic. They aimed at increasing federal and Lander governments’ autonomy by decentralization and separating powers. Being negotiated in established structures of joint decision-making, significant change could hardly be expected. However, change evolved in a sequential process triggered by particular conditions: decisions of the constitutional court in the first federalism reform, the broader fiscal and economic crisis in the second, and a deadline to renovate the fiscal equalization scheme in the third. After first steps to decentralize powers, subsequent reforms reinforced cooperative federalism, but with an even stronger role of the federal government. Following a comparative-historical institutionalist perspective, the federal dynamics can be explained by the interplay of established institutions, routinized negotiation systems and different events triggering change. In contrast to the gradual evolution of cooperative federalism, these triggers caused unintended and contradictory effects.

Fiscal Equalization and Tax Enforcement

AbstractIn many countries organized as federations, fiscal equalization schemes have been implemented to mitigate vertical or horizontal imbalances. Such schemes usually imply that the member states of the federation can only partly internalize (marginal) tax revenue before redistribution. Aside from the internalized marginal revenue, referred to as the marginal tax-back rate, the remainder is redistributed. We investigate the extent to which state-level authorities in such federation under-exploit their tax bases. By means of a stylized model, we show that the member states have an incentive to align the effective tax rates on their residents with the level of the marginal tax-back rate. We empirically test the model using state-level and micro-level taxpayer data, OLS regressions and natural experiments. Our empirical findings support the results from our theoretical model. Particularly, we find that states with a higher marginal tax-back rate exploit the tax base to a higher extent.

Fiscal Equalization Schemes and Subcentral Government Borrowing

Examining the cases of Canada, Germany, and Spain, the role played by fiscal equalization schemes in determining subnational borrowing was analyzed, and the link between regional governments’ primary fiscal balances and gross domestic product per capita was tested econometrically. The study results show that either poor or rich regions can display higher regional public borrowing on average, and these results can be linked to the institutional design of regional equalization systems in place. Particular elements, such as tax efforts and fiscal capacities, also play relevant roles in this regard. Reforms of these schemes can therefore prove instrumental in reducing regional heterogeneity in public borrowing.

Asymmetric tax competition and fiscal equalization in a repeated game setting

This paper examines the relationship between tax competition and fiscal equalization in a standard tax competition model with repeated actions, in which regions differ in per capita capital endowments and production technologies. In particular, it asks how a fiscal equalization scheme affects the tax cooperation condition. It shows that when the scale of fiscal equalization scheme increases, capital exporter is more (and capital importer is less) cooperative in implementing tax coordination. The paper also demonstrates that the best cooperative tax rate – the one that provides the strongest potential for voluntary cooperation – takes a positive value and increases with the scale of fiscal equalization.

Heterogeneous Effects of Fiscal Equalization Grants on Local Expenditures: Evidence from Two Formula-Based Variations

This paper investigates the effects of fiscal equalization grants on total expenditure and disaggregated expenditures by exploiting two different formula-based exogenous variations in grants. Examining the institutional settings of the Japanese fiscal equalization scheme and estimating local average grant effects with a regression kink design and an instrumental variable approach, I demonstrate that there exist heterogeneous grant effects for two groups of municipalities with different fiscal conditions. That is, estimated grant effects on total expenditure are approximately one-to-one for municipalities around the threshold of grant eligibility, but much more than one-to-one for municipalities that are heavily dependent on fiscal equalization grants. In addition, grant effects on disaggregated expenditures are dispersed across different expenditure items in the former type of municipality but concentrated on construction expenditures in the latter type. I then discuss that the observed grant effect heterogeneity is a consequence of the institutional settings of the Japanese fiscal equalization scheme.

Fiscal federalism and tax enforcement

In many countries organized as federations, fiscal-equalization schemes have been implemented to mitigate vertical or horizontal imbalances. Such schemes usually imply that the member states of the federation can only partly internalize marginal tax revenue before redistribution. Aside from this internalized revenue, referred to as the marginal tax-back rate, the remainder is redistributed. We investigate the extent to which extent state-level authorities in such federation under-exploit their tax bases. By means of a stylized model we show that the member states have an incentive to align the effective tax rates on their residents with the level of the tax-back rate. We empirically test the model using state-level and micro-level taxpayer data, OLS regressions and natural experiments. Our empirical findings support the results from our theoretical model. Particularly, we find that states with a higher marginal tax-back rate exploit the tax base to a higher extent.

Identifying local tax mimicking with administrative borders and a policy reform

This paper exploits an exogenous reform of the local fiscal equalization scheme in the German State of North Rhine-Westphalia (NRW) in 2003 to identify tax mimicking by municipalities in the neighboring state of Lower Saxony (NDS). The reform caused municipalities in NRW to increase their business and property tax rates. I study within the difference in difference (DD) and the spatial lag (SL) frameworks whether municipalities in NDS bordering NRW did react to the exogenous tax increases by NRW municipalities. The DD and SL results suggest that there are no interactions in tax rates. In contrast, traditional SL regressions that rely on variation in neighbors' demographic and political characteristics for identification provide strong evidence for immediate strategic interactions. These results indicate that most of the existing literature overestimates the importance of local tax mimicking.

The Tax-Rate Elasticity of Local Business Profits

Local business profits respond to local business tax (LBT) rates that vary across municipalities. We estimate that a one percent increase in the LBT rate decreases the LBT base by 0.45 percent, based on the universe of German LBT return files, which include corporations and unincorporated businesses. However, the fiscal equalization scheme largely compensates municipalities for the loss in the LBT base when they increase the LBT rate. Our estimates suggest that using taxrevenue data instead of tax return data, as commonly done in the literature, results in a significant bias of the elasticity away from zero.