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Case study: Germany
The Federal Republic of Germany has three layers of government: the federal, state and local, known respectively as 'Bund', 'Länder' and 'Gemeinden'. The responsibilities of these different regions vary, and are outlined in the German constitution, the 'Grundgesetz'. Many of the roles are not unique to each layer, in many cases funding being provided via more than one level of government. TABLE XXX in the appendix shows the extent of division between the different layers of German government in 2002, and is a useful guide as to the extent of multilayer government funding sources for public services.
The federal government has total control over defence and foreign policies. The table demonstrates that 100% of financing to this comes from the federal level. The federal government also has a significant part to play in unemployment benefit allocation and pensions, in which the federal government finances 95.5 and 100 percent respectively. Because it benefits from a certain degree of economy of scale, research is also primarily funded at the federal level, at 71.7%. Unconditional transfers make up a very significant flow within German federal and state finances, as can be observed in the table. States are 'fiscally semi-sovereign' in that they remain responsible for schools and universities, the administration of education, the police and justice, but are otherwise extremely limited in their fiscal policies, particularly as regards debt constraints. While the Länder are limited in their range of action by federal law, their autonomy is fairly broad as regards practical budget-setting. This is a direct result of 1969 renegotiation of the Grundgesetz, in which the Länder agreed to give up exclusive discretion in certain areas in return for certain cooperative policy and funding tools. (Rodden; HAMILTONS PARADOX 190, 195).
The Gemeinde, or local level is responsible for day-to-day services and utilities, such as road maintenance, public sanitation and kindergartens, alongside maintenance of public buildings and regional administration. Education is an example of the division of responsibilities between the regions: while kindergarten is the sole purview of local governments, despite some a portion of funding coming from state level. The local level also contributes an amount of supplementary welfare benefits, such as social assistance or unemployment. Due to the rising costs of these welfare payments, since the Hartz IV labour market reforms, the federal government has increasingly shouldered this burden. While nominally the Gemeinden are constitutionally free to deal with their own affairs, in practice state grants make up a large part of their financing and harmonization of service provision by standards severely limits independence of action.
The Grundgesetz lays out the terms on which taxation can be levied at which level, and the principles of equalisation between rich and poor regions, largely based on articles 105, 106 and 107. According to the Art 105Â§2, the federal government has authority over deciding what taxes to levy. In this respect the Länder are fairly limited in their powers to tax; and can tax where a tax or excise does not already exist on a federal level (art 105Â§2a). This means that in actual fact State governments are more limited in their fiscal policies than local governments (Kempkes & Seitz:2005:5)(Rodden 2005:185 HAMILTON PARA), and in practice joint taxes -such as apportioned income and corporation tax and VAT - make up the bulk of those levied, at around 68% of tax revenue (Rodden:2005:188HAM), AND KEMPKES, which means that no changes can be made to taxes that accrue wholly or in part to the Länder without the consent of the Bundesrat. (art 105Â§3). Crucially, states cannot set taxes individually, but together influence the federal governments tax-setting regime. The way that taxes are apportioned appears in article 106. Things like income and corporation taxes, and custom duties go to the Federal level. Property, inheritance, beer and motor vehicle taxes go to the Länder, while the Gemeinde benefit from certain real estate taxes and taxes on other items such as non-beer drinks.
It is well worth noting the system for financial equalisation between Länder. This is outlined in article 107, which in paragraph 1 details the allocation of revenue raised between local and state level. Where individual Land tax revenue (which is measured on a per capita basis) falls below the average, a federal statute with consent from the Bundesrat can ensure equalisation payments to that Land from financially stronger Länder, as well as providing - where necessary - federal funds (http://www.constitution.org/cons/germany.txt).
The equalisation system is significant, and intergovernmental transfers are of great consequence both between the federal and the state, and between state and local government. It is well worth noting that as co-financing of services and projects is common in Germany, distinguishing who is responsible for what is politically and economically complex (Kempkes & Seitz:2005:6), but the German model allows for significant risk-sharing (Beuttner:2001:2) FISCAL FEDERALISM AND INTERSTATE RISK SHARING. Fiscal equalisation essentially consists of three parts: VAT transfers, the unconditional federal transfers and horizontal grants. . The VAT grants are divided 75% by population, then the remaining 25% is apportioned to the lowest-revenue Länder. The horizontal grants are executed on the basis of the relative measurement between Länder, comparing endowments with financial requirements. 'Requirement' is based on the per capita income for the country as a whole, and are taken from states whose endowments exceed the average. After these two stages, poorer Länder should reach around 95% of average income. (Rodden:2005:188-189). The third stage uses Bundesergänzungszuweisungen - federal grants - to raise even the poorest states to 99.5% of the average.
Of these three, it is the VAT that is the largest, representing 2.44% of GDP in 1990, while the latter represented only 0.13% and 0.17% respectively. The magnitude importance is similar to the size of United States federal grants, and with 'marginal contribution rates' to the fiscal equalisation system between 60-100%, the scheme provides smoothing of between 60 and 100 cents per extra Euro earned, which is greater than (as clamed by Beuttner) the smoothing provided by the US.
Rodden argues that due incentive problems, the Länder have experienced a rising debt problem that has placed pressure on the federal government (HAMILTON paradox (RODDEN) P 190), with the 'Länder the largest sub-national debtors in Europe'. The German federal government has no restrictive power on the debt or borrowing positions of the Länder, and the federal government does not even have the right to choose, review or block state-level borrowing decisions.
Case study: Brazil
It is hard to imagine two more different Federal systems than Brazil and Germany:
Like Germany, the United States has a federal, state and local dimension, however the US has typically had smaller public spending and particularly less social spending.