The situation of local finances in the Federal Republic of Germany - CPL (6) 3 Part II

Rapporteur: Mr Frécon (France)

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EXPLANATORY MEMORANDUM

Part I - Outline

As part of the review of the implementation of the European Charter of Local Self-Government, the Chamber of Local Authorities, at the request of the German delegation, instructed the Rapporteur to examine the state of local democracy in Germany, with particular reference to local finance.

The Federal Republic of Germany signed the European Charter of Local Self-Government when it was opened for signature on 15 May 1985, and ratified it in 1987, after obtaining the approval of the federal chambers, the Bundestag and the Bundesrat, in accordance with the provisions of the Basic Law (Article 59 paragraph 2). After consulting all of the eleven Länder which then made up the Federal Republic of Germany and obtaining their approval in accordance with the “Lindau Agreement” of 14 November 1957, the Federal Republic of Germany proceeded to deposit the instrument of ratification of the Charter on 17 May 1988, while stating in its Declaration that the scope of the Charter would be confined to the Gemeinden [municipalities], Verbandsgemeinden [association of municipalities] and Kreise in the Land of Rhineland-Palatinate and to the Gemeinden and Kreise in the other Länder. The Federal Republic of Germany further considers itself bound by all the paragraphs in Part I of the Charter, with, in the area of local authority funding, the following exceptions: “1. in the Land of Rhineland-Palatinate, Article 9, paragraph 31, shall not apply to the Verbandsgemeinden and Kreise; 2. in the other Länder, Article 9, paragraph 3, shall not apply to the Kreise”.

Germany, it will be recalled, is a state in the democratic tradition, where federalism has become a core value anchored in administrative practice. The process of German reunification resulted in the federal system being extended to five new Länder, with the absorption of 17 million inhabitants and 6,295 municipalities2. The German government has worked hard on the political front to get all the local and regional authorities quickly up and running, thanks mainly to the support and assistance provided by the western Länder since the fall of the Berlin Wall.

The Rapporteur undertook to prepare the first report on the implementation, by a federal state, of the European Charter of Local Self-Government in accordance with Congress Resolution 31 (1996). In Germany, the system of local authorities is a matter for the federal states (Länder). The review of the situation of local democracy in Germany focused on the role of local authorities in the German federal structure, the functioning of fiscal and financial equalisation mechanisms between federal government [Bund], regional government [Land] and local authorities, while taking into account the particular system of local authorities found in each Land. On the basis of this examination, the Rapporteur made proposals for recommendations.

The views of the main associations of local and regional authorities were canvassed during the preparation of this report. The Rapporteur thus spoke to three major associations which operate at federal level: the Deutscher Städtetag (the Union of Large Towns), encompassing the major towns, the Städte- und Gemeindebund (association of towns and municipalities) and the Landkreistag (the Union of Kreise). As far as possible, the regional branches of these associations were interviewed during the various assignments carried out. As part of his first assignment, the Rapporteur was anxious to meet with representatives of the Federal Ministries of the Interior and Finance in Bonn. He wished to ascertain the central government’s views on the difficulties encountered by local authorities, who believe that the adoption of certain federal laws affects the municipal budget and constitutes an extra financial burden for which the municipalities are insufficiently compensated.

In order to examine the financial situation of local authorities in various Länder, the delegation carried out four assignments, during which the main ruling parties in the Länder were interviewed:

h The delegation visited North Rhine/Westphalia, which is one of the most populous Länder in Germany with 17 million inhabitants. This Land has a decentralised system of local authorities.

h The delegation then travelled to Bavaria, which, owing to its history, constitutes a special case. Local authorities here are organised along more centralised lines than in other parts of Germany. Bavaria is an example of a state whose contribution to the federal system of financial equalisation outweighs the contributions it receives from the Federation.

h In the light of the information gathered, the delegation was keen to visit Baden-Württemburg where the “principle of concomitant financing” is enshrined in the Land’s Constitution. The Rapporteur wished to look at how this principle worked in practice.

h It was important that the delegation also assess the state of local finance in one of the new Länder derived from the former German Democratic Republic (GDR), following the political and administrative upheavals which had occurred in eastern Germany since 1989. Among the five new Länder, Thuringia seemed to be fairly typical in terms of its economic development. This Land is also a net beneficiary of the financial equalisation system.

Records of the various meetings are appended to the present report [Doc. CPL(6) 3 Part II Addendum] and were submitted to the interviewees for information and verification. A large amount of documentation allowed the completion of information gathered during the visits.

Part II of the present report, most of which was written by Professor Günter Hedtkamp under the auspices of the Rapporteur, begins with a description of the structure of local authorities and their relations with the Federation and the Länder. Part II then goes on to look at local authority spending, particularly in the light of the principle of “concomitance”. It ends with a description of local authorities’ financial resources, their involvement in the decision-making process and the main problems encountered. Expert assistance proved essential, in view of the complexity of the federal system and the financial mechanisms for the distribution of resources and equalisation between the various tiers of government. The Rapporteur wishes to thank Professor Hedtkamp for his help and expert advice.

The Rapporteur’s conclusions will form the subject of Part III of this report and show firstly the deep-rooted culture of local democracy that exists in Germany and, secondly, the problems entailed in financial autonomy for local authorities due to the combined effect of the economic crisis, the vast amount of support given to the five new Länder and certain anomalies in financial relations between the Federation, the Länder and local authorities.

The Rapporteur wishes to thank the members of the German delegation to the Congress, the President of this delegation, Dr Karl-Christian Zahn, Dr Josef Hofmann, Vice-President of the Congress and Dr Gerhard Engel, Chair of the Working Group responsible for monitoring the European Charter of Local Self-Government, the main associations of local authorities and Germany’s local, regional and federal authorities, for their advice and assistance during this exercise.

Part II - Description of the German system of local self-government and its funding

1. Relations between the Federation, the Länder, the Kreise and the municipalities

1.1 Structure of the Federal State

The position of local authorities in Germany stems from the particular structure of the Federation, which is governed by the principle of subsidiarity. There are three levels of government: the federation, sixteen federal states (Länder) and local authorities (14,808 municipalities and 322 Kreise)3.

The major towns do not normally form part of a separate Kreis4, tending instead to constitute both a municipality and a Kreis in their own right. The smaller towns and municipalities are grouped together in Kreise. They all belong on a voluntary basis to the German Association of Kreise (Deutscher Landkreistag).

In large Länder such as North-Rhine/Westphalia5 and Bavaria, there is a third tier of municipal government, namely the provincial associations (Landschaftsverbände) in NRW and the districts (Bezirke) in Bavaria. The deputies of the latter are elected on the same basis as those of the municipalities and Kreise. In NRW, however, the government is planning a reform which will change the structure of public authorities below government level. Under this project which is due to be completed by 2004, the municipalities are to be given wider powers; instead of regional presidents (Regierungspräsidenten) and provincial associations, a new administration, designed as a centre of regional services (regionale Dienstleistungszentren) is to be created. It is planned to hand over to the municipalities the responsibilities previously exercised by the provincial associations in the field of health, culture and road planning. This reform should make for a shorter chain of command and more efficient administration.

The Länder are completely independent in financial matters; they have their own constitution and enjoy administrative autonomy, particularly in budgetary matters, while at the same time having a duty of loyalty to the Federation. The federal Constitution defines local authorities as consitutent entities of the Länder. It follows from the these provisions of the Basic Law that in theory, the Federation has no direct connection with the local authorities. Any federal law which affects the interests of the Länder or their local authorities requires the approval, ie the consent of the Bundesrat, which is the second house of Parliament and is made up of representatives of the Länder.

The federal Constitution thus governs only relations between the Federation and the Länder whereas the constitutions of the Länder deal with relations between the Land and the local authorities and their relations with one another. Accordingly, each Land has its own legislation on the functioning of local authorities, including the funding aspect. This legislation consists of the “Gemeindeordnung” (municipal statutes) in the case of municipalities and the “Kreisordnung” in the case of Kreise, which encompass several municipalities and form a separate local authority. The power of the Länder to organise and structure their local authorities is limited, however, by the federal Constitution. Article 28 of this Constitution, known as the Basic Law, guarantees both the municipalities and the Kreise the right of self-government. Article 106, meanwhile, lists the different taxes and indicates how tax revenue is to be apportioned between the Federation, the Länder and local authorities. This provision thus represents a constitutional guarantee of municipalities’ fiscal independence, and requires the Länder to accept this basic system of self-government and local finance. Within the system, however, some major differences can still be found.

1.2. Relations between the centre and the member states of the Federation

The member states of the German Federation differ markedly in terms of their design, size and financial strength. One finds major towns such as Berlin, Hamburg or Bremen which are officially city-states and which benefit from municipal tax revenue as well as Länder tax revenue and form part of the equalisation system at Länder level. There are Länder which are large, geographically speaking, and which have a population of over 16 million and, at the same time, small Länder, the smallest of which is Bremen with 400,000 inhabitants. From a financial point of view, too, there are huge disparities between, say, the wealthy states of southern Germany such as Hessen, Baden-Württemburg or Bavaria and the less affluent states such as Saarland, Bremen or the new Länder of former East Germany, in particular Mecklenburg-Western Pomerania. One of the stated aims of the federal Constitution, however, is to narrow the gap in living standards across the Federation as a whole. The section of the Constitution entitled “Finance” (Finanzverfassung) acknowledges this problem and focuses on the system of equalisation. The main problem concerned the apportionment of taxes between the various levels, on the one hand, and equalisation between financial powers, on the other. In place of the original system of separate taxes, a system of shared taxes has emerged which now accounts for more than two-thirds of total tax revenue. Almost all the major taxes such as income tax (including tax on salaries), corporation tax, VAT and trade tax are now shared taxes. Of the major taxes, only consumer tax and the tax on petrol remain within the federal preserve, while a few lesser taxes such as inheritance tax, the tax on beer and land tax remain within the purview of the Länder. The power to legislate on shared taxes is vested in the federal government, provided that the Bundesrat, which is composed of representatives of the Länder, gives its consent. Central government has unfettered power to legislate on federal taxes only.

The revenue from shared taxes is allocated as provided for in Art. 107 of the Constitution. Income tax and corporation tax are shared equally between the Federation and the Länder. The local authorities’ share is fixed by federal law at 15%. The tax revenue is distributed among the various Länder according to the revenue collected in their respective territories, after a few corrections to allow for distortions in taxable income. The flexible element of the system is the distribution of VAT, which endeavours to take account of the different rates of growth in financial requirements. Following German reunification, the Länder’s share was significantly increased and since 1995 has represented 44%. Since the Länder’s share is distributed on a per capita basis and not on the basis of local yield, this already has some levelling effect among the Länder. Since 1995, however, a maximum of 25% of the Länder’s share (Ergänzungsanteile) is deducted so that no Land has a fiscal capacity of less than 92% of the average.

Since reunification, the inter-Länder equalisation fund has acquired major significance. Through the payments made by Länder with above-average fiscal capacity and the grants made to the rest, the aim is to ensure that every Land has a fiscal capacity of not less than 95% of the average. When calculating contributions to this fund, one compares the fiscal capacity per capita (the tax revenue of the Länder plus 50% of the revenue from trade tax) with their requirements (calculated according to the mean deviation per capita, adjusted to allow for port charges in the case of Bremen, Hamburg and Mecklenburg-Western Pomerania, and the charges arising from population density in the case of city-states only). The difference constitutes the equalisation calculation basis and is assessed at a graduated rate of 15% for variations between 100 and 101%, 66% for variations between 101 and 110% and 80% thereafter.

This horizontal equalisation between Länder, by means of a fund financed by the wealthy states for the benefit of the less wealthy, is in addition to the share of VAT that is paid by the Federation to any Länder which, even after all the benefits afforded by the equalisation system, have still not managed to attain 90% of the average financial capacity of the Länder. These are the much talked-about compensatory sums paid by way of extra federal transfers. In addition, central government pays the eastern Länder DM14 billion by way of compensation for the special expenses they have to meet. Thuringia, for example, finances approximately 30% of its expenditure out of central government grants. Yet the Land is still obliged to borrow 9 to 10% of its total requirement every year.

This system has an extremely powerful levelling effect, so much so that it creates a disincentive for those Länder which are net contributors to the equalisation fund to exploit their taxable resources. At the end of the day, these Länder often find themselves in what they perceive to be a worse position than other Länder which are net beneficiaries of the system. Hence their decision to bring a case before the Constitutional Court in 1998.

1.3. The system of local authorities in the various Länder

Whereas northern Germany is steeped in the Prussian tradition as a result of the reforms introduced by the former Finance Minister, Reichsfreiherr vom und zum Stein, who looked to the British system and was a staunch advocate of local self-government, Bavaria, Baden-Württemburg and Rhineland-Palatinate remain wedded to the tradition of Napoleonic centralist reform (1803-1806), introduced in Bavaria by another former Finance Minister, Count Montgelas. The municipalities of Bavaria, Baden-Württemburg and Rhineland-Palatinate do not seem unduly bothered, however, about being under these Länder’s control.

Public powers and responsibilities are divided among the various administrative levels according to the principle of subsidarity which governs the entire body of German constitutional and administrative law.

The principle of subsidiarity demands that only those functions which cannot be performed correctly and efficiently by a lower authority by transferred to a higher level of government. The underlying premise is that all functions should be performed at the lowest possible level, to ensure that the territory within which a particular activity is exercised corresponds as far as possible to the sphere of political competence of the administrative authority responsible for that activity. According to this principle, all decisions should be taken at the closest possible level to the citizen. From an economic point of view, the benefits of government action should cover, as far as possible, the whole of the territory for which this administrative authority is responsible. This rule is also based on the principle of internalisation of externalities.

The size of local authorities largely determines their political and economic ability to perform their functions. The smaller they are, the better able they will be to take decisions which are “close to the citizen”, ie which correlate as far as possible to consumer demand, even in the case of public goods and services defined by economists as public property. Viewed from this angle, local authority action also ties in with the individualistic principle of the market economy. On the other hand, according to the principle of subsidiarity and the economic imperative of internalisation of externalities, the responsibilities of the higher tiers of government will increase as the size of the local authorities decreases. The smaller the latter, the more difficult it is for them to perform their local functions. Somewhere in between these two extremes, a compromise needs to be found, as there is no optimal solution.

Some Länder, such as North Rhine/Westphalia, Hessen, Bavaria and Baden-Württemburg have introduced varying degrees of reform in an attempt to reduce the number of local authorities. The old Länder had 8,513 such bodies in 1994, while the new Länder of former East Germany comprised 6,295 municipalities. Of this total figure of 14,908 municipalities, 49.1% had fewer than 1,000 inhabitants in 1994. These small municipalities accounted for just 4.1% of the total population. Structural reforms are being considered with a view to abolishing most municipalities with fewer than 1,000 inhabitants. The Land which has gone furthest down this path is Baden-Württemburg. Here the number of municipalities has been reduced from 3,379 to 1,111, most of which now have between 1,000 and 10,000 inhabitants. In North-Rhine/Westphalia, the municipalities are larger still, since even the smallest have more than 4,000 inhabitants. Today, only forty-eight smaller municipalities have managed to survive, whether for historical or other reasons6. In Bavaria, there are 2,031 municipalities grouped together in 71 Kreise and 25 towns which do not form part of a Kreis.

In the new Länder in the eastern part of the country, there have been only very tentative moves towards regional reform, not least because of the difficulty of securing local communities’ support for what they see as a return to centralism. There are even a number of Länder such as Saxony where reforms have yet to get under way at all. In Thuringia, the reforms of 1995 and 1997 reduced the number of municipalities from 1,700 to around 1,000, over 200 of which have fewer than 300 inhabitants while the majority of municipalities, ie over 400, have between 300 and 999 inhabitants. Only in 174 municipalities does the number of inhabitants exceed 3,000. This is a fairly modest achievement compared with what has been accomplished in the western part of the country. Even so, in order to ensure an efficient administration, a new institution has been set up in Thuringia for small municipalities with fewer than 3,000 inhabitants, namely Verwaltungsgemeinschaften - or centres of municipal government - which normally encompass 5,000 inhabitants. Each participating municipality assigns a representative to this body, it being understood that only members of the municipal council and mayors of municipalities may be elected. This body thus differs from that found in Rhineland-Palatinate which has a similar institution, the federations of municipalities (Verbandsgemeinden)7, where representatives of the member municipalities are elected as such and where the Verbandsgemeinde can discharge municipal responsibilities. It is the responsibility of the Verwaltungsgemeinschaften in Thuringia to ensure an efficient government which, under the independent control of each member municipality which has its own budget and is self-governing, takes care of day-to-day administration and prepares and implements the projects either of the municipality or of the Verwaltungsgemeinschaft.

Thuringia has also formed Kreise which, thanks to the reform (reducing the number of Kreise from 35 to 17) are now fairly large with approximately 100,000 inhabitants and to which municipalities with over 3,000 inhabitants and the Verwaltungsgemeinschaften belong. The responsibilities and funding of the Kreise correspond to those found in western Germany such as in Bavaria, which provided the councillors and some of the staff in the period following the restructuring of Thuringia.

1.4. Relations between the municipalities and the Kreis

The municipalities are divided into urban and rural municipalities. The villages and small towns are grouped together in secondary-level local authorities, namely the Kreise, to which only those local responsibilities that cannot reasonably be performed by small municipalities, particularly in the field of education, health and infrastructure, are transferred. Relations between the municipalities and the Kreis are essentially complementary and do not involve any subordination, contrary to the relations established within voluntary co-operation bodies between local authorities8, whose importance has, besides, dwindled since the local government reforms of the 1970s. The Kreis is a local authority which, constitutionally speaking, ranks alongside the municipality, in marked contrast to the inter-municipal associations found in France. The Kreise assembly, the Kreistag, is a directly elected body. Normally, the president of this assembly, the Landrat, who is head of the Kreis, is also directly elected.

Germany’s Basic Law guarantees local self-government not just for towns and villages, but also for the Kreise (Art. 28). The Kreis has its own administration. In most Länder, the Kreis government performs the central functions of the Land and is thus both a local authority and the administrative authority immediately below the Land. Like its leader, the Landrat, this government thus performs a dual function. Often the Land will appoint an official to oversee the Land government within the Kreis, but it is always the Landrat who has the final say. That is why in some Länder which have not devolved central government responsibilities to the municipalities, the Land government reserves the right to intervene in the appointment or normination of the Landrat9. Be that as it may, in all the Länder, the government delegates some of its powers and responsibilities to the local authorities, which must discharge them according to its instructions, particularly as regards town planning controls, application of the law on foreign nationals, etc.

The local responsibilities of the Kreis are divided into mandatory and optional responsibilities. Examples of the former include welfare support and assistance for young people, where local authorities are responsible for implementing the federal laws. The optional responsibilities, on the other hand, pertain to culture, theatres, etc. In other areas such as health, veterinary medicine, transport, hunting and the environment, the division of powers and responsibilities is governed by each Land’s own specific legislation. Certain forms of expenditure pertaining to these responsibilities are also incorporated into the municipal budget. The precise division of responsibilities depends on the legislation in force in the Land, the size of the municipalities, and certain specific conditions. In some Länder in northern Germany (North Rhine/Westphalia) the Kreis also practises some degree of equalisation among its various constituent municipalities, by making transfer payments for the discharge of certain responsibilities.

Major towns also perform the functions of the Kreise under the supervision of the mayor and the municipal council. In these towns, there is no separate administration for tasks performed on behalf of the national government. These functions are performed by the town as delegated powers and responsibilities. Admittedly, in major towns in Bavaria there is what is known as a Kreis councillor (Kreisverwaltungsrefent) who is also appointed by the municipal council and forms part of the town’s administration. His specific function is to oversee public policy, safety and the police responsible for enforcing the law on foreign nationals. The mayor liaises closely with the regional government (Regierungspräsident) and is obliged to provide any information concerning the administration of state affairs and delegated tasks (law on foreign nationals, labour law, law concerning domicile, family law, road traffic law, police administration, etc.).

In Germany, as a matter of fact, the Federation does not have a local and regional administration and most federal laws are implemented by the Länder, Kreise or municipalities.

The Kreise and the municipalities have to present their budget in two separate parts: the operating budget and the capital expenditure budget. The operating budget must (or at any rate should) be balanced, whereas the capital expenditure budget reflects a local authority’s capacity to improve its infrastructure. In the Kreise in the southern Länder, the capital expenditure budget accounts for roughly 10% of the general budget whereas in the poorest Länder in northern or eastern Germany, it features less prominently, if at all.

Large local authorities, however, sometimes manage to circumvent all the statutory budgetary restrictions and try to finance certain activities from non-budgetary sources by setting up, for example, foundations funded via asset disposals or public corporations.

The Kreis has virtually no funds of its own. In North Rhine/Westphalia, the taxes collected by the Kreis account for just 0.14% of its receipts, which partly explains the resentment felt by the Association of Kreise. The Kreise are financed mainly from compulsory contributions (Kreisumlage) made by the municipalities and, secondly, from the grants made by the Land.

The contribution level for each municipality is set by the Kreise assembly (Kreistag) based on the member municipalities’ own resources (local taxes and general grants). The contribution made by the member municipalities varies between 35% and 75% of their fiscal capacity which is measured according to the financial capacity of the municipality concerned, normally defined on the basis of the yield from municipal and shared taxes. These contributions form part of the Kreis’s own revenue and are assimilated to local taxes via a system of notional rates. One Kreis in Bavaria, for instance, has set this contribution at 40.1% of the fiscal capacity of each municipality in the Kreis.

The Kreise are also financed from duties and charges, income from capital, asset disposals, profits from local enterprises and, to a large extent, reimbursements for welfare support (in some Länder such as North Rhine/Westphalia and Bavaria, this welfare support is financed by the Kreise but administered by the municipalities). In the major towns of NRW, welfare support accounts for roughly 15% of total expenditure. Which is why Kreise and major towns that do not belong to a Kreis tend to complain about being underfunded. In North Rhine/Westphalia, the share of contributions received from member municipalities of the Kreis is less than the latter’s welfare expenditure, even though these contributions are the maximum permitted. The tasks discharged by the Kreise are tasks whose importance extends beyond the boundaries of any one municipality. Many forms of expenditure are compulsory, such as spending on hospitals, roads, waste treatment and, as mentioned earlier, welfare expenditure, which has burgeoned.

The situation of local authorities in the new Länder in the eastern part of Germany is little better, even though the number of refugees and asylum-seekers has fallen slightly. Compensatory payments in Thuringia, for example, account for roughly 40% of the Land’s income, which is a substantial proportion. Under a special arrangement, the municipalities and Kreise also receive, via the Land budget, money from the Federation (for building schools, water supply, etc).

As far as the general grants paid by the Land to local authorities are concerned, the breakdown of funds between the municipalities and the Kreise is determined every year by statute. Bavarian legislation, for example, stipulated that in 1998, 64% of the total funds intended for local authorities would go to the municipalities and 36% to the Kreise.

1.5 The third tier of local authorities

Some Länder such as NRW and Bavaria have their own specific institutions.

- North Rhine-Westphalia has two provincial associations (Landschaftsverbände), historic institutions which carry out specific tasks financed by the Kreise and the cities.

- The 7 districts (Bezirke) in Bavaria correspond to the areas covered by 7 regional governments (Regierungsbezirke) and there is very close co-operation between the government and these districts: for example some of the administrative staff are on secondment from the government. The members of the Bezirkstag are elected. The districts, like the Kreise, are financed by contributions. The Chair of the district is elected by the district council whereas the president of the regional government is appointed by the Land, following consultation of the district. Their main tasks relate to social welfare insofar as they go beyond municipal attributions and the administration of water. They are financed partly by contributions from the Kreise and the cities, calculated as a percentage of their fiscal capacity (Bezirksumlage) but primarily by grants from the Land. Following an increase in these contributions in recent years, Bavaria has now decided to lower them and instead to increase Land grants.

There is ongoing debate about maintaining the Landschaftsverbände in NRW and the districts in Bavaria.

1.6 Supervision of local authorities

Land supervision of local authorities comprises verification of legality as regards own attributions (eigener Wirkungskreis) and supervision of funds as regards delegated tasks (übertragener Wirkungskreis). It is only with regard to these delegated tasks that local authorities’ budgets have to be approved by the Land. This supervision takes place at various levels: at Kreis level for the member municipalities; at the level of the regional presidency – a Land administrative division in the bigger Länder10 - and at Land level, carried out by the Minister of the Interior. In addition, as a general rule, an audit of the accounts is carried out at each level by specialist administration offices subsequent to an opinion issued by committees elected by the respective councils. Finally, the Auditor-General’s department monitors the enforcement of the law relating to the budget.

Most supervision relates to borrowings. The reason put forward for this is that on the one hand actual own resources have to be supplemented by local borrowings and, on the other, there is a de facto guarantee given by the Länder in the event of bankruptcy. Furthermore, municipalities tend to adopt a cyclical approach to their expenditure (spending more in periods of growth and less in periods of recession) and it is essential to ensure that there is fair distribution of infrastructures within the Länder and the Federation as provided for by the Basic Law.

However, we should not forget that in a democracy, the supervision of local authorities is not purely administrative. It occurs naturally whenever there are municipal or Kreis council elections.

2. Municipalities’ expenditure

28% of public expenditure, apart from debt servicing, is accounted for by local authorities, the remainder being shared equally between the Länder and the Federation (grants included), ie 36% each for both tiers.

As we have already stated, each Land has its own law defining the statutes of municipalities; nevertheless, the federal Constitution requires the Länder to guarantee in their legislation the autonomy of local authorities (Article 28 and 106). They must grant the municipalities (above and beyond their own administration) attributions in the field of culture, leisure and sport, nursery schools and certain activities in the social field. These tasks are devolved exclusively to local authorities. They may not be transferred to other institutions unless, in accordance with the principle of subsidiarity, a private non-profit making organisation (church, social institution, charity association) wishes to take responsibility for these tasks and is in a position to do so.

Following reunification of Germany, in the former GDR there were no local authorities in the strict sense. The majority of tasks falling traditionally to the municipalities were carried out either by state companies or by central government which used local authorities at Bezirk level. There were too many staff at all levels, and following the restoration of local authorities, the number of staff had to be drastically reduced. On the other hand, the country had inherited, as a result of the labour market in the communist countries which employed virtually the whole population (men and women), social services such as crèches whose staff could not be cut. In Thuringia, of the 140,000 people previously working in local public service, there are now only 55,500 people earning a wage equivalent to 86.5% of that in the west. In Erfurt, for example, there is still a surfeit of staff, the city having been obliged to keep on those working thus far on the restitution of private property and who could not be assigned to municipal tasks.

The staff working in local authorities immediately following reunification was, for the most part, inadequately trained. Furthermore, competition between firms offering their services to local authorities was sadly missing. Consequently, the enormous sums paid to the Länder and local authorities in East Germany in the first few years had little effect. Today, the Thuringia association of towns believes it possible to build at one third of the 1990 cost. There are not enough financial resources to finance not only the operating costs of infrastructures already put in place, but also new essential investments, given that many municipalities are not able to finance the compulsory grant (coming from the operating budget) for the capital (investment) budget. This was confirmed by Erfurt City Council, a relatively rich city11, where investment projects, particularly in the road network and transport, far outstrip the city’s current capacities. There is something of a contradiction with the impression of the association of Kreise which maintains that available resources are sufficient but acknowledges that major investment projects could be carried out over at least seven years, either for the reconstruction of buildings and streets or for complying with the requirements of European law, for example in the field of waste water treatment.

The vast majority of local authority expenditure is accounted for by social assistance to single parents, refugees12, asylum seekers and, in certain circumstances, the unemployed13. This expenditure has increased significantly, rising from 19.3 billion in 1986 to 36.2 billion in 1996.

In some Länder, such as Thuringia, schools fall under municipal responsibility and this leads to ongoing discussions on costs other than those related to teachers’ salaries, paid by the Land. For example, the compensation given by the Land in accordance with the number of pupils and the type of school is deemed insufficient. Only the major cities in West Germany traditionally have municipal schools which the municipalities concerned have often suggested should be given over to the Land. The Land has always refused this in view of the budgetary burden which would result. In Bavaria, particularly in Munich, the staff of municipal schools are, as a general rule, the responsibility of the state, whereas other expenses, especially buildings, are the responsibility of the municipality.

The majority of other tasks carried out at local level are attributions which are compulsory or delegated by higher administrative tiers. In addition to social expenditure, defined in a very broad sense, other delegated or compulsory attributions have increased significantly: public health, transport, housing, town planning, environment, roads, household refuse collection, waste water treatment, water and electricity networks etc.

In the majority of Länder, the police, justice and certain essential institutions in the school system are the exclusive responsibility of the Land. The only examples of concurrent attributions are to be found in the cities where there are occasionally municipal schools and, sometimes, a municipal constabulary.

In conclusion, the crisis in local finances is reflected to varying degrees in Germany by a reduction of the share of local authorities in shared taxes or by a reduction in general and specific grants (road construction, primary schools etc). In addition, the municipalities have to pay a so-called “solidarity” contribution14 (Umlage) calculated on the basis of the fiscal capacity (Umlagekraft) (taxes and a proportion of general grants).

Since reunification of Germany, local authorities in the west also contribute to the financing of reunification.

The contribution of local authorities to the anticipated expenditure of the new Länder is significant. In 1998 the Land of North Rhine-Westphalia had to transfer approximately DEM 5 billion to the east and passed on approximately 42% of this sum (DEM 2.1 billion) to the local authorities. These drains on their finances have resulted in a financial crisis and a sharp reduction in local investment in recent years. Economic activity has suffered significantly since, in Germany, local authorities account for two thirds of all public investment.

3. The principle of concomitant financing

For all delegated powers, the local authority receives grants which very often do not cover expenditure. The authorities in Munich estimate that only 40% of these costs are compensated for by the Land. The association of municipalities reckons that average coverage of expenditure is 50%. The Ministry of the Interior and the Ministry of Finance do their calculations in a different way, controlled by the Auditor-General’s Department, and claim that the cost of delegated tasks is covered at 100% if not more. The Ministry of the Interior acknowledges that there is a difference between the cities and the Kreise since the Land does not provide the cities with the necessary staff, as it does for the Kreise, and the provision of staff is taken into account in its calculations.

Local authorities have demanded compensation in full for these delegated powers, and for expenditure committed for the construction and operation of crèches and nurseries given that federal legislation has laid upon them additional obligations in this sector. The municipalities protest against this obligation but the Federal state points out that the second chamber, the Bundesrat, which has Länder representatives, also passed these laws. The municipalities therefore have to turn to the Länder and demand the application of the principle of concomitant financing. This principle15 requires that obligations imposed upon them by the law, be it at federal or Land level, in order to fulfil political objectives, must give rise to full financial compensation. This requirement must be taken all the more seriously since the proportion of income tax attributed to the municipalities of the older Länder has, post-reunification, been reduced in order to subsidise the eastern part of the country since this burden has proved to be much too heavy for the Federation alone.

In particular, the towns of Bavaria are calling on this Land to introduce the concomitant financing principle into its Constitution, as was done in other Länder such as Lower Saxony and Baden-Württemberg (Article 71 of the Constitution). In addition, local authorities are unanimously calling for a reference in the federal constitution to municipalities. They want recognition of the concomitant financing principle covering not only tasks delegated to local authorities but also the municipalities’ own tasks and they cite as an example the law on youth aid which places a heavy financial burden on municipalities.

The smaller municipalities are more reluctant as they fear financial demands from neighbouring cities based on this principle. So far, municipalities surrounding cities have refused to contribute to the financing of public transport. It is the Land which provides specific grants. The Bavarian Ministry of Finance fears that strict compliance with the rule of concomitant financing will lead to disputes and an increased administrative workload and it envisages a situation where the overall amount to be shared among local authorities would be a fixed grant not linked to the principle of concomitant financing. It believes that there would be no additional resources for local authorities as that would lead simply to a transfer from one account to another and from one local authority to another. This is perhaps true overall, but not for every municipality. In addition, concomitant financing would be hardly applicable in cases where it was not a question of new tasks but only an increase in traditional tasks (eg health).

The concomitant financing principle has recently become once again a topical issue since the Federal government is planning to reduce income tax, reform family allowances, increase social expenditure, introduce a new regime for minimum income posts with a wage under DEM 630 (not subject to tax), increase tax on oil and a tax on energy which will increase costs for municipal transport. All these changes could aggravate the financial situation of municipalities without there being any effective compensation.

It is in Baden-Württemberg and eastern Germany, more specifically in Thuringia, that the principle of concomitant financing is included in the Land constitution. In Thuringia, the concomitant financing principle has been given its most extensive legal form. Article 93 of the Thuringia constitution states that the Land must ensure that local authorities can carry out their tasks and where new tasks are assigned to them, the Land must provide the necessary resources to ensure that they are financed.

Since it is impossible to calculate precisely the indemnity for each municipality, there are disputes: for example, in Thuringia, they must make do with flat-rate allowances per refugee for whom housing is provided by the local authorities. The Thuringia Ministry of Finance acknowledges that flat-rate allowances for delegated tasks are too low and need to be tripled. A complaint has already been lodged before the Constitutional Court of the Land. Associations demand that the Land guarantee each local authority a minimum level of resources to carry out its tasks, which goes beyond the concomitant financing principle. These associations also allege that Thuringia received over DEM 5 billion from the German reunification fund prior to the new equalisation system and that only DEM 1 billion had been passed on to the local authorities.

4. The financial resources of local authorities

Like every other tier of government, local authorities have available to them income from taxes and fees charged for the public services they provide. To supplement their budget they can also raise loans, generally from internal credit sources (eg municipal savings banks). In their capacity as lower-tier governmental bodies, local authorities also receive general or specific grants from higher levels of government. In the new Länder in eastern Germany, the amount of specific grants allocated for the funding of infrastructures is much higher than in the west, where the overall amount of grants is not tax-specific.

Whether an authority has genuine financial autonomy depends on the volume of resources it can use as it wishes to create new activities or extend existing ones. This is the famous free financial amount remaining (frei Spitze), the crux of the whole debate on local self-government in Germany. The more a local authority must rely directly or indirectly on grants, particularly specific grants, the less it is able to govern itself autonomously.

In western Germany, the local authorities’ own income covers on average over 50% of their expenditure. This percentage is much lower in the Länder in the east: in Thuringia it is claimed that the figure is 13%, half of which comes from revenue for which the local authorities are authorised to set the rate. Accordingly, the right to raise taxes is relatively small. Tax rates are generally lower than in western Germany, bearing in mind the corporate economic situation16. In addition, the effects of the “Fördergebietsgesetz”, the law providing for reductions in the tax base for income tax, corporation tax and trade tax, inter alia through special allowances, have led to a fall in income from taxes. These are tax reductions for individuals and companies investing in the new Länder.

4.1 Taxes and fees as sources for local authorities’ own income

4.1.1 Fees and user charges

Local authorities have to have their own resources which they themselves can manage. They may set the rate of certain user charges, such as for water supply, waste-water treatment and refuse collection. In principle, these charges are limited by law to the actual cost of the services. But there is a certain margin allowed in the calculation of these costs. One of the sources of income, the fees collected for electricity is now under threat if the European Union abolishes the municipal monopoly for the supply of electricity (the concession for which the municipalities generally give to public or private companies). This revenue has so far enabled them to subsidise urban and inter-urban transport (to the tune of DEM 6 billion per year). This is the famous “Querverbund” which often comes in for criticism because of economic distortions but which is essential for the financing of urban transport.

German municipalities have significantly increased charges for services in recent years. In the western Länder, their overall amount rose from DEM 18.6 billion in 1986 to DEM 32 billion in 1996. The municipalities adopted this method of increasing their resources in response to the consolidation policy of the Federation and the Länder followed in recent years and the reduction by the Federation of the local authorities’ financial base. At the same time, the courts have restricted the ways in which local authorities can calculate costs, particularly as regards the fictitious allowance rates they used in working out operating costs. In any event, approximately 35% of local authorities’ own resources come from charges for public services. The main source is provided by fees for services; the charges for the use of sports and cultural amenities, as in all countries, far from cover actual costs.

4.1.2 Local taxes

The bulk of own resources comes from local taxes. Furthermore, as in most other countries, German local authorities make use of certain minor taxes such as dog licences and some local excise taxes (entertainment tax, tax on second homes).

These minor taxes are in principle guaranteed by the Constitution in such a way that the municipalities themselves are able to chose the taxes which they wish to introduce into their community (the famous “Steuerfindungsrecht”), and they can decide on the base and rate of these taxes provided that Land legislation does not prohibit the introduction of certain taxes. The municipalities and Kreise in Bavaria complain that the Land has forbidden them from levying an entertainment tax (Vergnügungssteuer) and a tax on second homes. They do not accept the administration’s argument that the administrative cost of collecting these taxes would be excessive. The tax system should have been improved and simplified as it had been in other Länder which had such taxes. In contrast, in Baden-Württemberg, for example, local authorities are able to levy such taxes but following an assessment of the administrative costs, it was seen that the main value in them was not in the revenue it generated but in controlling exercise of these activities (for example with regard to the entertainment tax17). However, for municipalities which attract a large number of tourists, the tax on second homes appeared to be profitable.

Income from the minor taxes has no major impact on the financial capacity of local authorities; it represents only 1.5% of local tax receipts in Baden-Württemberg.

The German local tax system is based on two main taxes: trade tax (Gewerbesteuer) and land tax (Grundsteuer). In the past, trade tax was far and away the primary source of local authority tax revenue. Both taxes are very old. They were transferred from the states to the municipalities when the major tax reforms at the end of the 19th century introduced income tax and corporation tax. Despite the local taxation reforms carried out, particularly in the 30s, these taxes inherited from the past and introduced under the influence of the French Revolution, are no longer suited to a modern tax system. They are often criticised and many proposals for radical reform have been put forward. Nevertheless, local authorities derive substantial income from these old taxes, particularly the trade tax, which is the third largest German tax in terms of revenue generated. Furthermore, these local taxes are compatible with the European Charter of Local Self-Government since local authorities are able to set the rate without any limitation18.

One of the components of trade tax, the trading capital tax (Gewerbekapitalsteuer), and the land tax were not based on actual current income and profits but on supposed real returns. This tax on invested capital, which was levied even if no income or profits were recorded, has been abolished.

The main component of trade tax, the tax on trading income (Gewerbeertragsteuer), is based on actual returns calculated in a very sophisticated way, different from the tax base used for the general corporation tax.

Originally, there were three components of the trade tax: the tax on actual income, the tax on capital (assets) and the tax on the company’s total wage bill. There was little economic sense in this since the first component (Gewerbeertragsteuer) taxed actual returns whereas the two others were based on supposed earnings. Moreover, since the first component was an aggregative one, it taxed revenue deriving from all production factors, whereas the other two taxed separate production factors (analytic components). Rather than improving the tax, which is the largest for local authorities, the various reforms introduced have made the situation even worse. First of all, one of the taxation factors, the wage bill, was taken out of the tax base. As a result, trade tax became a tax affecting large businesses since it introduced substantial exemptions which were hard to reconcile with a tax on actual returns. These reforms have led to significant financial and structural distortions in municipal budgets.

Subsequently, it was decided that part of the money generated by this tax would be paid back to the Federation and the Länder in equal proportions. In 1970, to compensate, municipalities were allocated a percentage of the revenue from income tax (14% in 1970, now 15%); on average, income tax accounts for 45% of municipalities’ own resources.

Local authorities can set neither the base nor rate of income tax, yet have to suffer the consequences, without adequate compensation, of all the tax reforms reducing the burden of income tax and all the rebates introduced ostensibly as a means of administrative rationalisation. Local authorities in eastern Germany also suffer from the fact that in 1998 child allowances were offset against liability to tax.

Trade tax is therefore one of the shared taxes although it has one particularity, namely that municipalities have retained the right to set the rate. Accordingly, it has been necessary to standardise the proportion making its way to the upper administrative tiers (it was equivalent to 120 points of the local tax rate). This proportion has been reduced on a number of occasions: it was reduced by one third in 1980 when the component of trade tax relating to the wage bill was abolished and by a further 28% in 1983. In 1984 it was reduced yet again. The proportion of the trade tax which municipalities are required to pay to the Land and the Federation (also called “Umlage”) is calculated as follows: the revenue from trade tax is divided by the tax rate set by the municipality and the result is then multiplied by 84. In other words on average between 20 and 30% of the trade tax has to be reallocated. Of the DEM 41.7 billion of total tax returns in 1986, DEM 8.2 billion were shared equally between the Länder and the Federation. In the new Länder in the east, given the serious economic problems, revenue from trade tax was no higher than DEM 2 billion in 1996.

The various contributions (Umlagen) which a local authority is required to make for various reasons, primarily to higher-level local authorities such as the Kreise and the districts, are calculated on the basis of the fiscal capacity used for the calculation of general grants.

It should be remembered that in 1988, the second component of the trade tax, relating to capital based on assets (machines, plant and inventories – with the exception of land and buildings, taxed separately under the land tax (Grundsteuer B)) was abolished. Only the shell of this trade tax remains which is vulnerable to the cycles of economic activity and which does not have the necessary flexibility to cope with the profound changes in the structure of local budgetary expenditure. Nevertheless, it remains one of the main taxes in the German taxation system.

In compensation, the municipalities receive 2.2% of the revenue from VAT, divided among the older (85%) and the new Länder (15%)19. Within each Land, allocation among municipalities is based on the revenue generated by the trade tax and the number of employees in each municipality. However, the geographical distribution of the tax base of the old trading capital tax and that of the proportion of VAT redistributed in accordance with the above criteria do not coincide. Consequently, some municipalities are the winners of this reform whereas others have suffered a fall in tax revenue. Some Länder, such as Bavaria, have set up a special equalisation fund aimed at compensating the losers of this reform. The abolition of the trading capital tax is partly a consequence of reunification. In Eastern Germany there are no reliable assessments or updated information on the assets of industrial and commercial businesses, It was practically impossible to carry out a new assessment of the assets of the old businesses in the east; moreover, the result for most of them would have been negative. It would have been illogical to tax loss-making firms during the transition period. In 1998, the abolition of the trading capital tax was extended to the eastern part of the country. A further aim of this abolition was to reduce the tax burden on businesses which appears to be much higher than in most other European countries.

There have been several proposals, both for abolishing trade tax altogether and for reforming it. Some economists and politicians would prefer this tax to be replaced by a redistribution to local authorities of the revenue generated by VAT. This would lead to a loss of autonomy for local authorities which would no longer be able to set the tax rate, and this would be incompatible with the principles of the European Charter of Local Self-Government. Even so, the less well-off local authorities tend to favour this solution because their tax income would become more stable and they would thus have more room for manoeuvre financially. Moreover, this solution would make it possible to strengthen equalisation mechanisms since the distribution of all shared taxes is not the same as a simple proportional transfer of tax returns to local authorities since it always includes some elements to correct imbalances.

But the majority of local authorities, and their associations, are aware of the consequences of this solution for local self-government and are in favour of reforms which would enable them to continue to set tax rates.

Other approaches argue in favour of introducing a new business tax, which would be levied not only on industry, craft industry and business, as at present, but also on self-employed professionals, such as doctors and lawyers, and on government departments in order to offset the cost of operating them. The committee of economic advisers to the Federal Ministry of Finance has proposed replacing the business tax with a local value added tax. The principle behind this proposal is quite close to the view that the existing business tax affects the revenue of all the factors of production. This tax would not duplicate the existing VAT because the latter is levied on consumption in all European countries, not on value added in the economic sense of the term. A fairly similar idea would be to renovate the business tax by shifting it to an analytical base consisting of the various factors of production and by levying it on all firms and self-employed professionals.

The associations of local authorities also complain that the Federation has not yet introduced a surtax on income tax that would benefit local authorities, as provided for by the Federal Constitution (Article 106). The surtax rate could be determined by the local authorities, which would be consistent with the European Charter of Local Self-Government.

The second component of the local tax system is a sort of property tax exclusively levied on real estate. This property tax (Grundsteuer) is in two parts (Grundsteuer A and Grundsteuer B). Local authorities are free to fix the tax rate. Property tax A is levied on forestry, land and agricultural production; it is designed both as a land tax and as a tax on agricultural and forestry operations. As in other countries, and as with all agricultural taxes, it yields very little. Grundsteuer A accounts for only 0.5% of local authorities' tax revenues. The other part of the tax, Grundsteuer B, is much more productive. It is levied on all other land and buildings. However, it is affected by the difficulties surrounding valuation and updating of the tax base. The tax is shifted onto housing rents so that the tax burden is borne by the whole population of a municipality. In the western part of the country, the latest valuation of land and real estate was conducted between 1964 and 1974; where the new Länder are concerned, only very partial valuations dating back to 1935 are available, since none exist for property not inventoried at the time. The valuation method used in recent years involves multiplying annual revenue by various coefficients according to the specific structure of the tax base.

In 1996 the yield of Grundsteuer A was DEM 0.5 billion in the western Länder and DEM 0.1 billion in the new Länder. The figures for Grundsteuer B were DEM 11 billion and DEM 1.5 billion respectively.

A review of the local tax system points to the need for reform. This should preserve some features of the system, such as the principle that those who generate costs for the community pay, ie residents on the one hand and economic operators and professionals on the other. The new system should increase rather than reduce the yield of local taxes. And lastly, local authorities should retain their freedom to determine tax rates.

As mentioned earlier, a large proportion - almost 50% - of local authority revenues come from their share in general income tax. The yield of this shared tax is divided between all the tiers of government. Local authorities receive 15%, while the two other levels of government, the Federation and the Länder, split the remainder between them in equal parts.

The local authorities' share is distributed among them on the basis not of total local revenue, but of only a part of the local tax yield, partially eliminating the effects of the progressive nature of the tax rate, which would otherwise favour the wealthier communities. This produces an equalisation effect. The reform favours municipalities with a big population and a small income from the business tax.

4.2 Loans

Local authorities in Germany are allowed to finance part of their expenditure through loans. They are in principle entitled to borrow both from inside and from outside, in which case they are required to open an account with the Bundesbank. Small and medium-sized local authorities borrow mainly from local savings banks. Short-term cash advances normally lead only to temporary indebtedness during the current year. Medium and long-term loans require the agreement of the Interior Minister of the Land concerned. Supervisory authority is delegated partly to the Kreise and, in the larger Länder, to the President of the Region (Regierungspräsident)20. It would seem that in some cases local authorities have recently financed part of their ordinary budget with more or less extensive use of short-term loans, with the tacit agreement of the supervisory authorities. This is a consequence of the financial crisis affecting local government, particularly in the Länder of north and east Germany.

The danger of local authorities becoming insolvent and the Land then having to bail them out results in the Interior Ministry of the Land exercising de facto if not de jure supervision. Borrowing is allowed only if other means of financing the local budget are unavailable and if the local authority is able, in the ensuing years, to service the debt through its operating budget revenues. Equipment leasing is also regarded as borrowing. To avoid arbitrary decisions by ministers, the Länder have established, particularly in their legislation on local government (Gemeindeordnung), criteria restricting ministers' discretionary power to approve or reject local authorities' applications. Loans are considered justified if they serve to reorganise the debt or to finance high-yield investments, provided that the expected yield substantially offsets the investments costs.

Financing investment projects by borrowing is also allowed, for reasons of equity between generations (pay as you use principle). The total amount of the investments is the absolute ceiling for the loan, a rule which applies to all levels of government (Article 115 of the Basic Law). Of course this principle is nevertheless very difficult to apply in practice (for reasons of definition and evaluation).

For this purpose, as mentioned above, and to ensure economical management of financial resources, local authority budgets must be divided into two parts: the current and the capital budget. In the latter, all movements of assets, especially investments in kind and financial investments, are set against the financial resources earmarked for them, such as investment grants and loans.

The second and most important criterion is the following: in order to be allowed to borrow on the capital market, a local authority must prove that it can guarantee firstly the full servicing of the debt throughout the period of repayment and secondly the funds to be transferred from its current budget. In Thuringia, the funds available under the current budget which can cover the servicing of the debt are multiplied by a coefficient of 10 and the resulting amount is the maximum indebtedness allowed. During this period, each local authority in Germany must have on its current account the funds required to repay the debt, in addition of course to the interest it must pay. If the current account is in deficit, the Ministry of the Interior can compel the local authority to set up a consolidation programme (which must normally be carried out over the ensuing two years), audited by the ministry. This procedure is generally subject to fixed rules established by the Land's legislation to avoid arbitrary decisions.

It is becoming increasingly difficult to supervise the indebtedness of local authorities because they make use of the possibility of setting up public-law or private-law companies whose management plans have to be treated as annexes to the municipal budget.

4.3 General and specific grants. The equalisation scheme.

Generally speaking, there are no financial relations between the local authorities and the Federation which do not pass through the budget of the Länder.21 Thus, the Federation pays no direct grants to local authorities.

Transfer payments in the form of general and specific grants from the Land contribute to local authority budgets approximately as much as the main local taxes - the business tax and the property tax - ie more than 27% in 1996. Most of these grants are paid in the form of an overall allocation which local authorities are free to use as they wish. Only a very small percentage is awarded in the form of specific grants earmarked for particular purposes22; however, these specific grants undermine local authorities' financial autonomy.

The significance of specific grants has diminished considerably over the past few decades. But most ministries in the Länder governments have special funds to carry out specific political aims, for instance in the building sector or the location of industries. These funds are in fact treated as specific grants. Local authorities demand that these funds be transferred to them or that at least a part be made freely available to them. In North Rhine-Westphalia, there must be about 800 of these special funds. In Bavaria more than 240 small funds and in Baden-Württemberg23 about 150 are said to be distributed by the government ministries. In NRW large municipalities demand that they be added as a lump sum to the overall level of funding via an amount equivalent to the investment grant, while small local authorities are quite interested in the existence of these funds because they feel that they benefit from them.

As regards the system for distributing general grants as such, they are not allocated to local authorities by the Länder at the expense of local self-government. However, general grants are the main instrument of the equalisation scheme. Where these grants are concerned, the first problem is to determine the total amount to be distributed by the Land. The Basic Law requires the Länder to ensure that local authorities receive an appropriate part of the Land's tax revenues24, which also include grants received under the scheme for tax equalisation between the Länder.

In the Equalisation Act, which is adopted each year in most Länder, the Land fixes the percentage of the local authorities' own revenue, normally including the grants received under the federal equalisation scheme25, a proportion of which is allocated to local authorities. This is the overall amount available (Anteilsmasse or Ausgleichsmasse). Local authorities' room for manoeuvre also depends on their share in the Land's specific taxes. In some Länder they receive at least a part of the vehicle tax and the real estate sales tax.

The fact that the amount set aside by the Land for its local authorities, especially the equalisation fund, may vary from one year to the next is a source of uncertainty. To avoid this, the Land of Thuringia guarantees its local authorities the amount paid to them the previous year. In this Land the same rule applies to the calculation of effective revenue and expenditure; in other words, if their revenue was in fact higher than that provided for in the budget, local authorities can keep the surplus amount.

The greater part of this fund for local authorities takes the form of general grants (Schlüsselmasse), the rest being allocated in the form of additional grants for investment and for municipalities in difficulty. The rules differ from one Land to another; generally speaking, grants are not earmarked26. In the eastern Länder, where there are very considerable infrastructure shortages to be remedied, and especially in Thuringia27, the tendency is to allocate non-specific investment grants. General grants are divided between urban local authorities on the one hand and rural Kreise on the other, as prescribed by law. In Bavaria, for example, the ratio is two thirds to one third, while in Thuringia, in eastern Germany, it is one quarter to three quarters.

The total share of a Land's revenue allocated to local authorities varies from one Land to another, ranging from approximately 11% in Bavaria to 23% in North Rhine-Westphalia. But these percentages are not quite comparable because of the differencing statistical definitions adopted, so they cannot be used to draw conclusions as to the extent of financial self-government. A great deal depends on the extent to which the Land's activities are devolved to local authorities (Kommunalisierung) in the form of delegated powers. This Kommunalisierung depends in turn on the size of the local authorities. All the Länder show an increasing tendency to delegate state functions to local authorities, primarily water supply, sewage treatment, health care, veterinary supervision and passenger transport. These state functions are often taken over by the Kreis. The status of the public servants employed in these institutions varies: they may have the status of Land or Kreis civil servants or they may come under the authority of a Land official working with the head of the Kreis, the Landrat, who as a rule nevertheless remains the sole head of the administration. To assess this "municipalisation" one would need to know whether or not local authorities have received the corresponding funds, particularly in the form of grants on the revenue side of local budgets (concomitant financing principle as described above).

The impression that the Land of NRW is much more decentralised than Bavaria is strongly disputed by the Bavarian Ministry of the Interior, which says that in 1996 the total volume of local authority budgets stood at DEM 60.6 billion in NRW as against DEM 63 billion in Bavaria. It would seem that the answer to such questions depends largely on the definition of the revenue and expenditure included in the statistics.

Once the overall share to be allocated to local authorities has been decided, the overall grant allocation (corresponding to the total equalisation amount (Schlüsselmasse) is fixed, together with the special funds which are normally distributed according to objective criteria prescribed by law.

The distribution of general grants is based on the tax capacity of each local authority, defined according to its normal revenues per capita. Then the revenues have to be set against the needs, which remain to be determined according to the deviations from the mean of the local authority's own resources per capita. A negative difference is partially equalised on the basis of criteria prescribed by law. In other words, the first requirement for receiving grants is that a local authority's own resources per capita should (when multiplied by a factor which increases with the number of inhabitants) be lower than the Land average.

Each Land has its own system, but there are some common features. Firstly, the number of criteria applied is very small. On the basis of the main criterion (Hauptansatz), ie the number of inhabitants, the Länder have responded in varying ways to the question of how much account they want to take of population structure, such as the number of schoolchildren, scholarship-holders, old people or unemployed.

Some Länder allow for factors other than population, relating to the function of a local authority, such as its central function or specific needs (formerly proximity to the frontier with communist countries, or above-average expenditure on social welfare).

A specific feature of the German equalisation scheme is that the inhabitants of large towns are weighted by a coefficient of over 100%. The scheme starts from the assumption that the cost per capita for a given service increases more than proportionally to the number of inhabitants of a municipality. This method follows the famous law of Popitz on the size of local authorities and their expenditure needs. In Baden-Württemberg, for instance, one inhabitant of a municipality with fewer than 3,000 inhabitants is counted as 100%, and this figure gradually rises. It is 110% in municipalities with more than 10,000 inhabitants and reaches a maximum of 186% in municipalities with more than 600,000 inhabitants. This weighting of inhabitants follows the law of Popitz according to which a local authority's needs gradually increase at Land level in relation to the amount provided for in the Land budget for the total grant allocation (Schlüsselmasse); for cities of more than 500,000 inhabitants the whole amount is multiplied by 1.5 and for each 100,000 inhabitants in excess of 500,000 the factor increases further by 0.1. These factors result in a virtual population increase. In Thuringia an inhabitant of a municipality with more than 3,000 inhabitants counts for 105% and an inhabitant of Erfurt (more than 200,000) for 150%.

The needs are calculated by combining the main criterion (Hauptansatz) of the number of inhabitants with various corrective factors (Nebenansätze) so as to obtain a composite figure (Gesamtansatz) which gives the overall measure of a local authority's needs. The needs of all the local authorities are then set against the amount allocated by the Land for cost equalisation grants.

The basic amount (Grundbetrag) per unit of need is then determined prior to calculating the overall amount to be received by each local authority. The basic amount is multiplied by the number of inhabitants for each local authority, corrected where necessary by specific factors. The outcome is the "Ausgangsmesszahl" (the initial basic figure). The amount obtained by multiplying the basic amount by the composite figure is known as Gesamtansatz, which is determined for each local authority and reflects its needs.

This figure is then compared to tax capacity, which includes all the tax yields available to the local authority but is standardised with regard to local taxes, whose rates differ from one local authority to another. If the needs reflected by the Ausgangsmesszahl exceed tax capacity, the difference is partly equalised by grants. In Bavaria this amounted to 55% in 1998. In 1999 it is planned to keep the same rate for all local authorities, with a 55-50% reduction for the Kreise on account of the irrational results produced by the previous rule. If its tax capacity is equal to or higher than the figure reflecting needs (Ausgangsmesszahl), the local authority receives no general grant at all.

As mentioned earlier, another form of equalisation is effected between local authorities by dividing up shared taxes. Complex rules are also needed to determine the amount of the business tax and property tax yield to be allocated to a local authority.28

In some Länder equalisation probably takes place only in the form of vertical financial transfers from the Land to the local authorities. In the Länder practising horizontal equalisation as in Baden-Württemberg, all the local authorities contribute to an equalisation fund according to a fixed rate of their tax capacity, in the legal form of a special contribution (Umlage). The general grants paid out of this equalisation fund depend on the difference between financial needs and tax capacity. In 1998 the rate of this equalisation contribution ranged from 20.45 to 27.95%.29

As this system establishes a degree of equality between local authorities in planning and carrying out activities of genuine local interest, the Länder indirectly exert considerable influence over local authorities. Given that the interests of local authorities and the requirements of equalisation usually conflict, it is vital to reach a compromise between these two objectives. It has also been acknowledged that any equalisation policy, at whatever level, consists primarily in a vertical transfer of revenues, not only in the form of grants but also through the apportionment of shared taxes on the basis of the number of inhabitants or employees - for example - rather than on the basis of the volume of tax revenues levied locally.

Local authorities in the new Länder inevitably face some special problems. These are due to the small tax base, the lack of infrastructure, the special needs stemming from the takeover of many services previously managed by state enterprises (such as housing, cultural services, medical services and other public functions), the high level of unemployment and, as indicated earlier, the difficulties surrounding property valuation and the lack of a tax administration. As observed in Thuringia, local authorities in the eastern Länder receive the average allocation for the Federal Republic as a whole. As their own resources remain very small, these local authorities will for a long time to come depend much more heavily on grants than local authorities in western Germany. On the other hand, they would be much less affected by the reforms of the local tax system currently under discussion.

5. Participation of local authorities in the decision-making process

The associations of German local authorities - such as the Deutscher Städtetag, which normally represents the cities, the Städte- und Gemeindebund, which represents the small towns, and the Deutsche Landkreistag, representing the Kreise - have differing views of their power to influence legislation on local government. Almost all local authorities are members of these associations, on a voluntary basis. The cities' feeling is that "we have the opportunity to state our views, but they don't listen to us". The Kreise have a slightly more optimistic view of the situation. In eastern Germany there is only one association of towns and municipalities, which represents 99% of local authorities. Compromises thus have to be reached between large and small municipalities inside the association. There is also, however, an association of Kreise (Landkreistag).

At federal level the rules of procedure of both houses of Parliament provide in principle for the consultation of these associations. The government provides for them to take part in the drafting of new legislation on local government. This should be a guarantee of local authorities' participation, but it is considered to be inadequately applied in practice. This is a very important point because about 80% of federal laws have to be applied by local authorities.

The Länder have rules of their own, vary from one Land to another not only in legal terms but also in practice. Some Länder such as Lower Saxony have been strongly urged by the Federal Court to co-operate more effectively. Some have included these associations' participation in their constitutions; examples include the Land of Baden-Württemberg and above all Thuringia, where consultation is compulsory. Section 127 of the Local Government Act (Thüringische Gemeindeordnung) requires the Land to discuss all legal instruments affecting local government interests in one way or another with the association of local authorities before the instruments are adopted. Others guarantee the right of participation by law or have chosen to set up special advisory bodies (as in Rhineland-Palatinate).

While consultation does seem fairly effective in the Länder, it is considered insufficient at federal level.

6. Conclusion

In 1998 the situation of local authorities improved, particularly for those with an industrial base. The business tax and income tax produced an unexpected yield (with an increase of almost DEM 1 billion in Munich). This is chiefly due to the upswing in economic activity and the reduction of certain income tax allowances. The cities assert that the increase in revenues recorded in 1998 is essentially due to specific, one-off factors and above all to additional transfers. In practice, capital expenditure is gradually shrinking and many local authorities have been compelled to sell their assets during the 1990s. In 1998 and 1999 local authorities had to substantially reduce appropriations for their capital budgets. In recent years, opportunities for investment in municipal infrastructure have diminished to a disturbing extent almost everywhere. A relatively well endowed city like Karlsruhe is expecting its investment capacity to fall from DEM 130 million in 1993 to DEM 65 million in 2001.

As local authorities in eastern Germany generally have a weaker industrial and commercial base, there has been a smaller increase in their business tax yield and their share of income tax. In other words, local authorities in the new Länder benefit much less from this improvement in the economic situation than those in western Germany. Their tax revenues have not yet reached half the level of those of the western Länder.

Nevertheless, there is no doubt that the financial situation of local authorities in Germany is becoming critical and they need to be given a sufficient financial margin to meet public needs at local level. Those disputing this judgment often compare the deficit figures for the Federation (12%) and the Länder (between 7 and 8%) with the figure for local authorities (2 to 3%), which is absurd because local authorities can only resort to very limited borrowing to finance their deficit, and only with the Land's agreement. They are also obliged to pay back their financial commitments within two years, which considerably restricts the scope for borrowing.

In NRW many local authorities have deficits, which is financed by short-term loans. The situation seems better in Bavaria and Baden-Württemberg, where only five or six local authorities are in serious difficulties. In the eastern Länder, at least in Thuringia, few local authorities are unable to balance their budgets. But where this happens, the Land helps them with a special fund (Ausgleichsstock) financed by the unexpended budget balance accumulated at the end of the financial year.

It seems likely that local authorities will be seriously affected by the reform of the tax system in preparation in Germany. It is to be feared that they will not receive compensation for the losses they suffer, particularly on income tax.

Over and above national issues, the association of smaller local authorities is concerned about further developments in the European Union. These local authorities are alarmed at the fact that the Treaty of Amsterdam does not include any guarantees for local self-government and does not assert the subsidiarity principle clearly enough.

Part III: Rapporteur's political conclusions

The explanatory memorandum has highlighted trends and a deterioration in the state of local finances. The rapporteur points out that this situation has worsened in recent years under the combined effect of the exponential increase in social charges (notably generalisation of crèches and reception of refugees), the decline in tax revenue caused by current economic problems, the substantial commitment involved in helping to fund the five new Länder, reform of the business tax, and other specific or structural problems in certain Länder. This monitoring report the first on a federal state prepared by the Congress - reveals, firstly, the diversity of the ways in which local authorities in the Länder are organised and, secondly, the complexity of the equalisation machinery (horizontal and vertical) established by the Federation and the Länder.

The draft recommendation contains numerous proposals on ways of improving local finances and increasing the financial autonomy of local authorities. The rapporteur would like to emphasise four possible approaches here:

1. The setting-up of an institutional commission at federal level

In view of the problems identified in Part II of this explanatory memorandum, the rapporteur recommends the setting- up of an institutional commission, which would make it possible to take full account of local authority interests at federal level, and give local authority representatives a say in federal decisions with a direct bearing on local authorities, which are responsible for implementing 80% of federal legislation. The presence of an institutional commission would ensure systematic consultation of local authorities at federal level in areas directly affecting their own or delegated powers. It would also open the way to regular evaluation of local finance development trends, and encourage people to think about ways of improving the financial situation of local authorities.

Moreover, it is worth noting that the possibility of setting up such a commission was recently referred to, at regional level, by the President of the Constitutional Court of Baden-Württemberg.30

The Commission itself might comprise representatives of the main associations of local authorities, the regional auditing department, local authority supervision bodies and the regional parliament, all of whom would be encouraged to pool their ideas and come up with recommendations on the regulations governing financial equalisation.

2. Reform of the local authority tax system

Although local authorities have their own resources, a tax reform which brought back high local taxation, and revised the regulations on transfer of funds to cover compulsory local authority expenditure linked with the implementation of federal and Land legislation, would help, among other things, to increase the local authorities’ financial independence. Changes might include:

- giving local authorities more freedom to fix their own tax rates;
- allowing the Kreise in all the Länder to levy local taxes;
- allowing local authorities to levy minor local taxes, even in Länder where this possibility has been reduced;
- making the ceiling for local authority borrowing more flexible.
- if necessary, introducing additional income tax to benefit municipalities, as provided for in the Constitution and proposed by the Association of Towns, and allowing them, within certain limits, to fix the rate;

These measures would help local authorities to balance their budgets, cover optional expenditure more effectively and stimulate investment. This is a vitally important recommendation for the five new Länder, which are having to bring their systems, and particularly infrastructure, up to a reasonable level and ensure their functioning.

3. The principle of concomitant financing

Part II of the explanatory memorandum highlighted the usefulness of writing the "principle of concomitant financing" into the constitutions of the Länder. The rapporteur considers essential the respect of this principle which would make for better financial coverage of costs arising from the delegation of powers by the Federation or Land to the municipalities. He recommends that this principle be inserted in the Land constitutions, which would make it legally enforceable at regional and federal level, and so ensure full compliance with it.

Even though the scope of this principle can be interpreted in different ways, its inclusion in Land constitutions would make regional legislators more attentive to the interests of local authorities. Machinery for the consultation of local authorities is quite as necessary at federal level, and should be established either by securing a Federal Constitutional Court ruling, or by amending the Basic Law to include the principle of concomitant financing for the benefit of local authorities.

It should be noted that incorporation of this principle in Land constitutions provides an effective remedy for local authorities which believe that financial equalisation measures have harmed their interests. In Baden-Württemberg, for example, the Kreise of Ortenau and Schwäbisch-Hall were recently able to show that rising costs associated with social welfare, assistance for young people and the provision of accommodation for refugees had ruined them. In its judgment of 11 May 1999, the Land Constitutional Court condemned the way in which the Land was attempting to keep its own budget in balance by distributing ever-smaller sums to municipalities and Kreise under the equalisation system. It took the view that the financial guarantees given the municipalities and Kreise had not been respected. Although this judgment is not retroactive, and does not find that paragraph 71 of the Land Constitution of Baden-Württemberg, laying down the principle of concomitant financing, has been violated, it does give associations of local authorities in that Land good reason to hope that their interests will be better protected in future.

4. The equalisation system

Some Länder and towns, and also OECD, believe that the radical equalisation system which applies at all levels and in various forms in Germany – going as high as 99% at federal level, and 80-90% in several Länder – needs to be made more flexible. In fact, this radical system may well discourage wealthy Länder and municipalities, and also those which benefit from it, from exhausting their fiscal capacity. Obviously, reform needs to take account of the requirements specifically associated with solidarity in the cause of German unity, which represents a very substantial commitment and deserves special recognition.

The rapporteur would like to underline that, while is necessary to encourage more equalisation in numerous countries, the situation in Germany, on the contrary, draws one’s attention to the fact that it should not be taken to the extreme.

Report on the situation of local finances in the Federal Republic of Germany - CPL (6) 3 Part II addendum

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MISSIONS' REPORT

Report on the visit to Bonn, Dűsseldorf and Cologne - 11-13 November 1998

Meeting with the German Towns’ Association

Mr Dieckmann, Director-General, gave us five successive reports published by his Association on local finances in Germany, together with recent statistical graphs of municipal receipts and expenditure in 1998.

He thought that Article 9 of the European Charter of Local Self-Government was theoretically quite well applied in Germany, but that things were somewhat different on the ground. Relations with the Länder were difficult. Referring to Article 9.1 of the Charter, he explained that the business tax accounted for 35% of local tax revenue, a total of DEM 33 billion. This figure represented 55% of the amount of tax raised, the remaining 45% being passed on to the Länder. These proportions were negotiated at federal level and the share of the Länder had increased substantially in recent times because of the policy of solidarity with the new (ie ex-GDR) Länder.

Thirty years ago, the local authorities had received the whole of the business tax, but a proportion had been re-allocated to the Länder in return for 15% of income tax. This had been intended to encourage the municipalities to develop industry and to make space available for housing.

It was a pity that East-West solidarity worked only between the Länder, wheras it could also have been between municipalities.

Article 9.2 of the Charter was currently causing problems in Germany because of the increasing social expenditure borne by the municipalities owing to:

· growing unemployment;

· federal government cuts in social benefits which resulted in more hardship cases claiming local welfare;

· increased aid to asylum-seekers, with Germany receiving more refugees than the rest of the European Union put together.

Germany complied fairly well with Article 9.3 of the Charter: the municipalities were able to fix the rates of business tax, property tax, entertainment tax and the dog license fee.

Where Article 9.4 was concerned, local authority resources were quite varied and so flexible in relation to fluctuations in the economy.

As regards Article 9.5, Germany was a country which applied very sophisticated systems of equalisation. Article 108.8 of the federal Constitution provided for compensation payable by the Länder for costs arising from facilities sited on local authority territory, but it was very rarely applied.

Equalisation between municipalities was achieved through the obligation placed upon the Länder to pay tax revenue into a central fund. To take the example of road traffic tax, in each Land, the amount paid into the common fund varied: in NRW1 it was 23%, in Bavaria 11%. The Eastern Länder paid in less. This common fund enabled resources to be evened out between the Länder, and through grants to the municipalities, between them also. In general, however, these payments favoured rural regions, except in NRW where – under the influence of the Greens – greater allowance was made for the problems and obligations of the towns.

Article 9.6 of the Charter was theoretically applied in Germany. In general, the municipalities were listened to, but not necessarily taken notice of. It varied from one Land to another; in NRW, little attention was paid to the municipalities.

There were still, in addition to the substantial general grant, too many subsidies tied to specific expenditure in which the towns were not necessarily particularly interested.

Concerning Article 9.8 of the Charter, the municipalities were subject to a borrowing ceiling based on their financial capacity as measured by per capita revenue. This was widely criticised as lending only to the rich.

Previously, business tax had been based on the firm’s turnover and capital. Recently, the second criterion had been replaced by 2.2% of VAT apportioned according to wages paid within the Municipality. Some municipalities had lost out as a result. In addition, the municipalities had suffered as a result of tax measures granting any firm or freelance professional investing in the new Länder exemption from income tax, which had led to a substantial fall in income tax revenue. For example, income tax paid by freelance professionals had fallen from 57 to 5 billion in five years.

At the same time, municipalities’ mandatory social expenditure had mushroomed. The City of Frankfurt had even brought an action against the federal government in the Constitutional Court, but had been discouraged by the Association which thought the action should have been brought against the Land. Municipalities were able to challenge federal legislation if it caused them problems of financial autonomy. For example, federal legislation had been enacted making every child entitled to a place in a kindergarten. The Association had been preparing to bring an action in the Constitutional Court, but had been dissuaded by promises which had subsequently not been kept. Unfortunately, in the meantime, the one-year time-limit had expired.

Meeting with the representative of the Federal Ministry of the Interior, Mr Budrat, and the representative of the Ministry of Finance, Mr Thies

Mr Budrat explained that the Federation had co-responsibility for municipal self-government under Article 28 of the Constitution. In a sense, the Federation was the guarantor of local autonomy and the Ministry of the Interior was responsible for it. The municipalities tended to complain about federal legislation that caused them additional expenditure. In fact, under the German system, 80% of measures to implement federal legislation were the province of the municipalities.

Mr Thies said that the municipalities complained about the insufficient financial contributions of the Länder. The Länder complained to the Federation. The Federation took the view that the problem was not to be attributed to it but resulted from the structure of financial relations between the Länder and their municipalities. According to the Constitutional Finance Law, municipalities are part of the Länder, and there are no direct relations between the Bund and the municipalities.

It was true that, according to the Constitution, it was up to the authority responsible for an activity to fund it. It was true that the financial burden and the resources of a competent body did not always match. The associations of local authorities in particular, mentioned examples in the social field, such as crèches, social welfare, asylum-seekers, etc. Here the mechanisms of financial equalisation were operational. The Bundestag (Parliament) decided on legislation, with the agreement of the Bundesrat, even when the interests of municipalities were at stake. However, according to the associations of local authorities, the Bundesrat did not always stand up for the municipalities and defend their interests.

There were bottlenecks at the level of municipalities but also at the level of Bund and Länder, notably concerning municipal investment. Nevertheless the municipalities, when given 10% more revenue, had a tendency to spend it all instead of keeping it in reserve.

Municipalities had taxation resources of their own, which they could define and manage themselves. The unilateral alignment of the local fiscal system with business tax had caused, in the past, considerable distortion between urban and rural areas. For that reason, since 1970, currently 15% of income tax has been added, on the basis of local incomes, but subject to ceilings in order to avoid undue disparities. The effect of this had been to diversify and consolidate the municipalities’ tax base. Since 1998, 2,2% of income from the Value Added Tax (VAT) has been allocated to the municipalities to compensate for the share of business tax suppressed in 1998.

Of course, the municipalities complained about the local financial equalisation in the different Länder. The local financial equalisation between the Länder and their municipalities was, regarding the amount and way of distribution, defined in a different way from Land to Land. The local financial equalisation and the financial equalisation of the Länder allow the fulfilment of the constitutional obligation to ensure equal conditions of life to all citizens, whatever their place of residence. In reply to a question, he conceded that the equalisation between the Länder, given its strong intensity of equalisation, barely constituted an incentive for Länder to have a pro-active policy. The poor Länder had little incentive to increase their productive effort. In addition to this horizontal equalisation, there was also vertical equalisation between the Federation and the Länder (including the municipalities), which sought to level up the economy of the new Länder.

In its programme, the new government had announced its intention to give the municipalities greater financial powers. It was not known how this was to be achieved.

Regarding the Maastricht criteria, in 1998 the Federation had had a deficit of 12%, the Länder 7-8% and the municipalities 2-3%. Towns and municipalities must, in conformity with the municipal budgetary law, undertake to have a budgetary cover to cover their deficits in two years. Deficits were financed by bank loans, longer-term loans or by using reserves before being covered by ordinary incomes. When asked whether the absence of a direct link, financially, between the Federation and the municipalities was not contrary to Article 9 of the Charter, Mr Budrat said that that was not so. In any event, his view was that the only means available to a municipality to attack the Federation was to rely on Article 28 if federal legislation contravened the principle of local self-government. For the time being, the Städtetag had failed to find a single town that was prepared to do so. As to relying on the Charter, he thought that would not be possible, as the Charter would have only the status of an ordinary law, so that the Constitutional Court could not entertain it as the basis of an action. This is an important question to be examined from the legal point of view (Mr Engel and Mr Weiss).

Meeting with the Landkreistag (German Association of Kreise)

Mr Von Hausen explained that the Kreise (Kreise) derived their autonomy from Article 28.1 of the federal Constitution, which defined them as local entities with powers determined by the law of the Länder.

In fact, the powers of the Kreise were mainly concerned with supra-municipal services such as transport between towns for which they generally had a right of initiative. Otherwise, they exercised powers granted to them by the law, usually of the Land and occasionally of the Federation.

Large towns, as a rule those of 100,000 inhabitants or more, were independent of the Kreise and exercised the powers of both Kreise and municipalities.

The East German Kreise, despite reorganisation in 1994-95, were still smaller than their West German counterparts.

Their powers comprised:

· mandatory powers, which they could choose how to implement,

· own powers (right of initiative),

· delegated powers (eg building inspectorate, supervision of aliens),

· mandatory own powers such as welfare, youth assistance, hospitals, environment, road traffic tax, etc.

In general, federal legislation must leave the Länder freedom to determine the methods of implementation. But there were exceptions (eg welfare).

- Optional powers: these were mainly supra-municipal powers to complement the action of small or weak municipalities. This could take the form of direct action or of grants for supra-municipal facilities. The action of the Kreise was of variable geometry. In this way, the Länder were able to apply the constitutional principle of equal treatment for all citizens and equalisation between Municipalities.

The compulsory powers of the Kreise included waste treatment provision. The Kreise, unlike the municipalities, did not have general powers.

The Kreise – like the municipalities – could seek judicial redress against Land legislation that infringed their autonomy. The municipalities could seek redress against the Kreise on the same grounds.

The municipalities could ask the Kreise to provide a service for which they (the municipalities) were responsible but which they were unable to perform, provided that it was a supra-local service.

For services of this kind the Kreise effected what might be termed ‘functional’ equalisation, ie equalisation linked to a specific service.

There was now a strong tendency in Germany for the Kreise to take the place of single-purpose consortia, which did not offer the same degeree of democratic legitimacy. It had been found at one point that these consortia accounted for most of the municipal budget but that the local council had virtually no say in how resources were used.

The Kreise were also responsible for monitoring their municipalities’ compliance with the law and their finanial management.

Mr Von Hausen listed the main local taxes, viz business tax, the share of VAT, 15% of tax on distributed income subject to a ceiling to achieve at least some degree of equalisation. The municipalities could have been given the possibility of levying an additional percentage on income tax, but the Länder had opposed this.

Article 106 (5) of the Constitution provided that the Länder could decide on an additional rate for the municipalities. So it could be said that constititional financial autonomy had not been put into practice.

Local revenue was made up, on average, of 41% own resources, 30% transfers from the Länder (NRW only 15%) and the rest investment grants and other receipts.

Financial equalisation was effected through the general grant, which took into account the municipality’s financial capacity and made up 85% of transfers to municipalities. The investment grant, which took population and area into account, varied between 8 and 10%. The remainder (5-7%) was accounted for by specific grants (in NRW they were tending to diminish).

During our discussion, we learned that in Germany there were also other resources in the shape of special funds managed by each ministry, or even each ministry directorate, which lay outside the general system described. For instance, in NRW there were apparently 800 such special funds which enabled municipalities to be encouraged, through the award of grants of between 20 and 80% of the cost of specific projects, to implement particular policies.

In NRW, this could account for an additional 30-40% of revenue in a given year. This certainly raised a problem of autonomy insofar as these grants were for services that were supposedly optional but which, via the grants, were made virtually mandatory. In fact, specific grants accounted for between 35 and 85% when these special funds were taken into account.These grants were negotiated individually. Political considerations could also play a part, leading to allegations of subsidising corruption.

The special funds could not be expected to diminish because they underpinned the work of Land departments responsible for managing them. Abolishing the funds would lead to a 30% reduction in staff. As for the Kreise, they had only negligible resources of their own (mainly hunting license fees: 0.14% of receipts). The Kreise were financed by the municipalities according to a scale fixed by the Kreis council, taking into account the municipalities’ financial capacity and the general grant they received. This funding represented 40% on average in the country as a whole, but more in East Germany (50-55%). In NRW it was less because there was an additional tier ofgovernment, the “Landschaftsverbände”, above the Kreise. For this reason, the Kreis’s other source of income, the general grant from the Land, was lower (12%) in NRW than the national average (25%). To give an example, the flat-rate levy on the municipalities was not even sufficient to cover the overheads of the Kreise, who knew very well that they could not increase it without placing the municipalities in serious difficulty.

The remainder of the revenue of the Kreise was made up of dues and charges (road traffic, 10-15%, reimbursement of welfare payments by claimants acording to federal legislation, Kreis income, interest, energy generators’ profits, generally used to finance out-of-town transport). In sum, the Kreise enjoyed less financial autonomy than the municipalities. The problem at the moment lay in the increase in social expenditure, which accounted for 40% of revenue, though this was often made up of grants to the municipalities which they managed directly. In addition, there was the cost of protecting the environment.

The Kreise generally managed a capital budget representing 8-10% of the total budget. Like the municipalities, their capital investment was falling because the growth of revenue expenditure left little room for manoeuvre.

When ratifying the Charter, Germany had, at the prompting of the Länder, entered a reservation in respect of Article 9 specifically with regard to the financing of the Kreise, because they had virtually no resources of their own.

In the Constitution, there was a contradiction between Article 28.2 (which provided for local self-government for the Kreise) and Article 106 (which referred to the financial autonomy only of the municipalities). Article 106 (7) provided for the overall transfer from the Land, but Article 106 (6) provided for the apportionment of shared taxes only among the municipalities or, as might be determined by the Land, associations of Municipalities. In fact, the Länder had never wished to implement this part of the Constitution; hence their reservation concerning Article 9 of the Charter.

The Landkreistag was an umbrella organisation composed of regional associations of Kreise. Although membership was voluntary, all Germany’s Kreise (numbering 323) belonged to it (representing 96% of the country’s area and 62% of the population). The Kreise paid a subscription to their regional association, which passed on a small proportion to the national body.

In answer to the question of whether the Kreise might be given resources of their own, it was replied that this would challenge the whole system of equalisation and the Landkreistag would come into competition with the other two associations.

Consultation with the Kreise worked well in several Länder where legislation was concerned. NRW had even set up a district council on an advisory basis. Federally, consultation was less satisfactory, even though the government’s procedural rules required the three major associations to be consulted in advance on draft legislation affecting their financial resources. Parliament had a similar obligation. In practice, the ministries ignored the rules with impunity. The right of consultation needed to be written into the Constitution, so that legislation which had not taken into account the views of the municipalities – which had to implement 80% of all laws – could be challenged.

Visit to the German Association of Towns and Municipalities

This was also an umbrella organisation of Land associations. Its membership comprised 14,000 of Germany’s 15,000 towns and municipalities. The existence of independent towns not included in their Kreis was a historical tradition, so that there were both towns of over 100,000 inhabitants included in Kreise, and towns of 25,000 not so included. The views of the Association of Towns and Municipalities did not always coincide with those of the Association of Towns. For example, the Association of Towns preferred funding criteria based on population, whilst the Association of Towns and Municipalities preferred area. At federal level, the Association’s role was to lobby federal and European institutions. The regional associations also provided technical and legal assistance for their members.

The Association had published a document highlighting the new coalition’s positions in relation to the Association’s demands. The main problem concerned the increase in services and welfare obligations (DEM 50 billion, as compared with 3 billion 15 years ago). The Länder and the federal government refused to recognise this. It was therefore indispensable to write the principle of concomitance (Konnexitätsprinzip) into the Constitution, along with the principle of consulting the municipalities, which had to implement 80% of legilsation.

In fact, the Association complained that even if consultation did occur at some point, most legislation was decided in conciliation committees between Bundestag and Bundesrat and here the municipalities were not consulted.

The Association also pointed out that if the government wanted to create jobs, it must increase the investment capacity of municipalities, which accounted for 70% of public investment, which had fallen dramatically in recent years.

The Association also wanted federal and Land bureacracy to be streamlined for activities that the municipalities could take charge of (this was the question of the special funds). It also wanted local autonomy to be specifically recognised in the Maastrict Treaty so that the Brussels Commission had to take it into account. It wished the municipalities to take part in the Euro stability pact, since their borrowing capacity had been severely restricted.

The municipalities should be able to develop an active European policy, for example in the environmental field, in order to reduce the number of people living on welfare.

The municipalities should also be able to contribute to a plan for developing rural areas by means of activities not restricted to environment conservation. There was at present also a danger in Brussels of regional aid going to urban areas at the expense of rural areas.

The new energy reform policy would also disadvantage municipalities insofar as municipal energy generators would no longer make as much profit to be used to finance urban transport. The German system was better than that advocated by Brussels. The municipalities also complained that federal and European environment directives were too costly. They should be allowed more autonomy in this field.

Mr Zimmermann went so far as to say that one day a demonstration should be organised in Brussels, or a municipal strike in order to make their voice heard.

Bezirksregierung – Bezirkspräsident

The delegation was received by the President himself, Mr Antwerpes, and his staff, who explained that there were 32 Bezirke in Germany, which resembled France’s regional prefectures. Their powers varied from one Land to another. But they were all responsible for supervising municipalities, the building inspectorate, planning waste treatment and water treatment. In some Länder, they also had responsibility for schools and some road building, which was dealt with in NRW by the Landschaftsverbände.

Their brief also included coordination between ministries. Mr Antwerpes thought that the ministries should allow the Regierungspräsident greater freedom.

Proposals to this effect were under consideration. NRW was much more decentralised than other Länder. In Bavaria, for example, the health service was state-controlled, whereas in NRW it was municipal. In his view, there should be more decentralisation, the state being responsible only for planning and coordination. He was also required to be neutral in relation to the political parties. His Bezirk numbered 4.5 million inhabitants (more than some small Länder), 99 municipalities and 8 Kreise. He had to supervise independent towns and Kreise (which themselves exercised supervision over their municipalities). He also had to supervise municipalities which had fallen into deficit. This was an important problem of loss of autonomy. This was also a problem in Länder which had no Bezirke (8 out of 16, including the city-states). In Bavaria, supervision was very strict. There was a representative of the Land in every town. There was no clear division of responsibilities between this representative and the mayor. There were a great many differences between mayors and the degree of supervision between different Länder, owing to the administrative culture imported by the occupying powers after the war.

Local finances had deteriorated dramatically in recent years, owing to solidarity transfers to the East. This cost the City of Cologne alone 1 million in receipts out of a budget of 6.5 million every year. Optional expenditure suffered as a result. However critical the federal authorities were of local complaints about welfare, he was inclined to think the municipalities were right. The municipalities were struggling because of:

· exponential growth of social expenditure,

· transfers to the East,

· growing numbers of asylum-seekers,

· the slowing-down of the economy,

· declining revenue from income tax due to tax concessions granted to anyone investing in the East (whatever their level of income – even for millionaires).

As a result, most municipalities were unable to balance their books and were reduced to selling off assets, property, shares, etc. Only 16 of the Bezirk’s 99 municipalities were able to balance their budgets. Others were selling assets or resorting to overdrafts.

It was not true, as the federal Minister of Finance had said, that the municipalities could rebalance their budgets in two years (they needed 10-30 years) or lay off staff or shut down services. For example, the City of Cologne had sold 400 million shares in its assets. Even Leverkusen, which had been the richest town thanks to the Bayer chemical complex, was no longer able to balance its accounts because of relocation by Bayer (effects of globalisation). In fact, the situation was critical. In his Bezirk, 16 municipalities were in balance, 58 were able to make do by selling off assets and 41 were actually in deficit. The Kreise were in a similar position.

Grants received by the municipalities were as folows: general grant 14 billion, specific grants (mainly for schools) 900 million. There were also the 800 special funds which did not operate through the Regierungsbezirk. He wondered whether this really made sense, or whether departments, or even whole ministries ought not to be abolished. But this was the “game” of politics.

Meeting with the Minister of the Interior and Justice of NRW

The delegation was received by Mr Held, head of the local government directorate. The meeting was also attended by Ms Koczy, member of the Landtag and the CLRAE, Mr Zahn, leader of the German local delegation and mayor of a town near Cologne.

Mr Held said that his job was to watch over the proper functioning of the system of municipalities, the resources made available to them, their capacity and efficiency. NRW was atypical in that it had only 396 municipalities with a population of 18 million. The smallest municipality had a population of 8,000.

The structure of large municipalities performed well. In his view, the problem was not that the municipalities now had less money than before, but they had no more while their expenditure was increasing. The Land’s total tax revenue had neither increased nor decreased since 1995. But people’s demands were growing. There was the obligation of the solidarity trasfer to the East. For NRW, this amounted to DEM 5 billion per year, of which 2.1 billion came from the municipalities.

In addition to their own resources, municipalities received equalisation grants totalling 14.5 billion (NRW), made up of specific grants of 1.2 billion and the rest general grant. In addition, they received 11.5 billion in various grants, making a total of 26 billion in transfers including investment grants and payments from the special funds.

On the question of the special funds, Mr Held replied that all governments sought to influence the development, for example, of new technologies. These were activities that could not be encouraged in all municipalities but had to be concentrated. The funds corresponded to specific needs in certain towns.

The general grant was nonetheless greater than the specific grants (Mr Antwerpes had spoken of 8 billion distributed through the special funds).

Mr Zahn said that legal actions were sometimes brought by municipalities but little use was made of this possibility and the municipalities usually lost their cases.

Mr Held acknowledged that the increase in local expenditure, which was mandatory, with stagnating resources, left little margin for other local responsibilities.

When shown the map of local authority debt supplied by Mr Antwerpes, he conceded that there was a problem but pointed out that the law in NRW required the municipalities to balance their budgets, but this law was not obeyed. In other Länder, the law was less strict. However, it was not always appropriate to talk of eating away at local reserves. Cologne, for example, owned a hundred or so commercial companies, some of which had invested in shares during the good years and when these shares had been sold, the proceeds had not been paid into the municipal budget but used to create foundations. However, it was true that there was a general trend towards indebtedness.

He told us about an action brought by 150 Municipalities before the NRW Constitutional Court, on the grounds that they had insufficient resources and that the equalisation criteria were wrong. The Court had found that the Land had not infringed the Constitution. In reply to a question, he explained that in NRW equalisation was based on:

· local population,

· the local authority’s role as centre,

· number of unemployed,

· length of unemployment.

It was these criteria that the municipalities had challenged, wishing population to be the sole criterion. The Court had found that the population’s needs also had to be taken into account.

Until 1995 the function of equalisation had been to even out differences between receipts and expenditure requirements.

Municipalities which had a surplus were able to keep it.

He quoted the example of Dűsseldorf which, despite having receipts, was incapable of balancing its budget.

The question was who gauged citizens’ problems.

The municipalities enjoyed great autonomy in NRW, except when they were in deficit. It was difficult to make the principle of subsidiarity enforceable in law. Lastly, the Landtag was made up of elected representatives who had the last word. But it was difficult when more services had to be provided with the same resources.

Replying to a question about equalisation which went as far as 99% between the Länder, he agreed that it was a disincentive to developing an autonomous local and regional policy.

Equalisation between Municipalities in NRW was 95% and it was intended to bring it down to 90%.

He agreed that there was a vicious circle whereby unemployment increased social expenditure, obliging municipalities to reduce investment, which in the end increased unemployment, and so on. Even so, the municipalities needed to have a sound investment policy and not commit serious mistakes in this sphere.

Finally, he supplied details of the development of local authority finances in the Kreis of Steinfurt and will later supply a breakdown of resources between taxes and grants.

He suggested that the delegation pay a visit to Lower Saxony where the local autonomy situation was very bad.

Report on the visit to Munich - 18-19 January 1999

1. Meeting with Mr Michael Jobst, Director of the Städtekammerei (financial department of the city of Munich), and Mr Ziegler (representative of the Munich Kreis authorities)

The discussion initially focused on the government of the city, with particular reference to the Kreis authorities, which in Munich coincided with the city authorities. We were given a description of the authorities’ own powers and those delegated to them, all such activities being placed under the supervision of the mayor of Munich and the city’s budget.

First of all, as on our previous visit, it was confirmed that there were problems regarding the principle of concomitant financing (“Konnexitätsprinzip”: according to estimates by the city authorities, only 40% of the actual cost of implementing the tasks delegated by the Land to the city authorities was covered by subsidies from the Land. As a result, the city of Munich had lodged a complaint with the Bavarian Constitutional Court; however, the complaint had been rejected for the same reasons as those given by the North Rhine-Westphalia Constitutional Court, namely the use of equalisation criteria.

Mr Ziegler gave several examples of the delegation of duties, for example remuneration of primary school staff, the cost of which municipalities wanted to be able to cover by means of subsidies of up to 80%. He complained that municipalities were not consulted on the allocation of these subsidies, as they were in Austria.

The municipal police force had been placed under state control, but there was talk of an urban traffic control police force being set up, although nobody knew who would pay for it.

In Munich, as elsewhere, the main cause of the problems was the increase in mandatory social welfare expenditure from DEM 390 million in 1981 to DEM 669 million in 1991, while revenue had remained stable. However, at the end of 1998, there had been a noticeable improvement, which it was hoped would continue over the next few years. There were other financial problems, such as the abolition of minor local taxes by the Bavarian Parliament. Some of these taxes had raised a considerable amount of revenue, such as the tax on second homes.

However, it was felt that changes in local business tax (Gewerbesteuer) had not caused the city of Munich any losses.

The main problem lay in the “solidarity contributions” for German unity. For example, from its business tax revenue alone, Munich paid DEM 300 million to the five eastern Länder. Similarly, the city was affected by the equalisation tax levied in sharing out the income tax received by municipalities.

As a result, the city of Munich’s debt had increased from DEM 2.7 billion in 1993 to DEM 4.6 billion in 1996. With effect from 1998, the city had pursued a policy of staff cuts in order to reduce its operational expenditure and debt.

In Munich, as in the municipalities of North Rhine-Westphalia, municipal investment was at a standstill. The towns had proposed that the sums currently allocated from special ministry funds be replaced by an overall investment grant for municipalities. Such a move would reduce bureaucracy and strengthen local self-government.

2. Meeting with representatives of the Association of Bavarian Municipalities

The delegation was received by Mr Dietl, the director, and Mr Keller, the financial officer. Our hosts began with a brief description of Bavarian municipalities’ self-generated resources. It transpired that in Bavaria, local charges, especially in the form of consumer or resident charges, generally covered 90% of the cost of certain investments, such as roads and distribution networks.

Local taxes also accounted for 55% of municipalities’ overall resources, of which 12.8% came from property tax, particularly on building land, and 41.7% from business tax, which was now levied only on firms’ profits (here, problems were caused by business relocation policies). There was also a lack of revenue from minor taxes: apart from dog licences, all other such taxes had been abolished (on second homes, drinks, entertainments, hunting, etc.). In addition, municipalities received a share of certain taxes: 15% of income tax and 2.2% of the VAT yield.

It was stressed that the abolition of minor taxes had brought about a loss of autonomy for municipalities.

With regard to subsidies, municipalities received 11.54% of federal tax receipts, which were distributed according to the tax-raising capacity of each municipality. This subsidy was granted to 1800 municipalities, the others being excluded because of the healthy state of their finances. Subsidies amounting to DEM 1.7 billion for all municipalities in Bavaria were also granted from motor vehicle taxes. In total, Bavarian municipalities’ self-generated receipts amounted to DEM 13 billion, including DEM 6 billion from their share of income taxes, whereas the general equalisation grant amounted to DEM 10 billion.

The problem of the principle of concomitant financing was also raised. The association estimated that state subsidies covered only 50% of the actual cost of performing the duties devolved to the local authorities. This problem was therefore apparent in Bavaria, as in all the old (ie western)Länder. We were also told about the complaint that had been lodged to this effect; the Bavarian government and the Constitutional Court considered that the municipalities could cope with the problem, because the overall state of their finances was fairly healthy. In fact, this resulted in municipalities making savings on non-compulsory expenditure, thereby enabling the Land of Bavaria to reduce its deficit over a ten-year period: municipalities in Bavaria had taken measures to remain in step with one another and had reduced their room for manoeuvre to a bare minimum. The Association of Municipalities wanted the principle of concomitant financing to be written into the Bavarian constitution. However, the majority parties were still opposed to this idea, although the SPD had recently come out in favour of it.

Our hosts placed much emphasis on the problems which the abolition of minor taxes had caused for municipalities. We discussed the provisions of Article 106, paragraph 6 of the Federal Constitution, whereby revenue from local excise duties must belong to the municipalities according to Land legislation. Bavarian legislation had solved this constitutional problem by stipulating that it was possible to levy such taxes, with the exception of those featuring on a list of prohibited taxes, which effectively listed all the taxes levied in other Länder, except dog licences2. This was a device for avoiding incompatibility with the German Constitution, although in our view it does not respect the spirit of the constitution.

We were told that Bavarian municipalities provided 37% of the Bavarian financial contribution towards German unity; this corresponded to 8% of tax revenue and grants for municipalities, and 45% for Kreise.

It was also explained to us that the Bezirke, a level of self-government peculiar to Bavaria (between the Kreise and the Land), received up to 22% of their finances from the Landkreise and the municipalities constituting a Kreis in their own right.

Taking into consideration all the contributions paid by municipalities in respect of German unity, the Kreise, the Bezirke and associations of municipalities, it was calculated that out of all the resources allocated and transferred to the municipalities, only 47% remained available for municipal expenditure.

3. Meeting with representatives of the Bavarian Interior Ministry, Mr Puhr, Ministerial Adviser, and Dr Hasl, Government Adviser on Local Finances

We were told that the system of local self-government in Bavaria suffered from a certain tendency towards centralisation, which in the view of our hosts was due to Bavaria’s Napoleonic tradition. In Bavaria, there were 2031 municipalities, 25 municipalities constituting a Kreis in their own right, 71 Landkreise and 7 Bezirke. State administration was devolved to the Landkreise and the municipalities constituting a Kreis in their own right. The Landrat (head of the administration of a Landkreis) or mayor (in the case of towns with Kreis status) therefore combined two functions: that of a local elected representative and that of a state representative. However, in towns with Kreis status, there were no officials representing the Land, although there were in the Landkreise.

The Land was also represented at Bezirk level, where there was an elected Bezirk president and a Bezirksregierung representing the Land.

With regard to the distribution of powers, the municipalities had general authority over all local matters other than those for which responsibility was assigned to other levels by the law.

The Landkreise, however, had responsibilities in specific areas such as hospitals, roads and social welfare, and did not perform a supra-municipal function as they did in North Rhine-Westphalia. The Bezirke had specific responsibilities, particularly in the social field (90% of social expenditure) and in the fields of river development, fishing, hunting, monuments and sites and regional culture. The duties of the Bezirke in Bavaria were performed in North Rhine-Westphalia, for example, by the Landschaftsverbände.

We also discussed whether the Bezirke and Landkreise should be replaced by a new authority in between the two, but as yet there were no serious plans for reform. In general, the lawfulness of the respective authorities’ actions was reviewed by the Kreise (for the municipalities), by the Regierungsbezirke (for the Kreise and towns and cities with Kreis status) and by the Land (for the Regierungsbezirke).

Financial control was carried out initially by means of an audit instituted by municipal parliaments, and subsequently, and more importantly, by the Association of Bavarian Municipal Auditors.

When our delegation asked why the municipal budgets in Bavaria appeared limited in relation to those of other Länder, we were told that the difference was on average only slight and was perhaps due to the fact that Bavarian municipalities were smaller and had fewer powers devolved to them by the Land. Furthermore, it was pointed out that Bavarian municipalities were more economical with public funds and that the audits carried out by the Auditor-General’s Office were extremely rigorous.

When we asked why parliament had abolished minor local taxes, it was explained that the measure had been aimed at cutting down on the bureaucracy needed to raise taxes which in any event raised only limited revenue. Other Länder had also abolished these taxes when the major taxes yielded favourable returns and then reintroduced them when the recession set in. Association representatives pointed out that these measures had meant that municipalities’ autonomy in setting municipal taxation rates was reduced even further.

We discussed the problem of the principle of concomitant financing and the complaint lodged by the municipalities. The ministry representatives professed to be the advocates of municipal interests within the government, but Bavarian legislation was vague in that it only stipulated that municipalities should be provided with the necessary resources for the duties devolved to them. It was very difficult to interpret the word “necessary” and the Land authorities disputed the figures supplied by the Association of Municipalities and the city of Munich. The Land regarded the staff it provided for the Landkreise as a form of compensation. Moreover, it considered that the city of Munich went too far in executing of the duties devolved to it. An objective adjustment of the actual cost of performing these duties could perhaps be achieved with the help of the Association of Municipal Auditors.

4. Meeting with Bavarian Finance Ministry officials

We spoke to Mr Waldmann and Mr Priller, who showed us a publication entitled “Strong municipalities, strong Bavaria” which set out to illustrate that Bavarian municipalities had better, more economical policies than municipalities in other Länder. Municipal expenditure amounted to DEM 60 billion, while subsidies from the Land amounted to DEM 13.479 billion, comprising DEM 2.7 billion in specific subsidies and DEM 10.7 billion in general subsidies. It was admitted that Bavaria had abolished minor taxes, in particular those on second homes; the reason given for this was the same as that put forward by the Interior Ministry: the tax-raising procedure was too unwieldy. However, it was conceded that the measure had undermined the municipalities’ financial autonomy.

Our hosts mentioned the (in their view) excessive practice of equalisation carried out to lessen the burden of German unification, and added that the southern German Länder (which bore the brunt of the equalisation payments) had lodged a complaint with the Federal Constitutional Court in Karlsruhe.

With regard to the principle of concomitant financing, they disputed the figures supplied by the Association of Municipalities and considered that if the provision of staff for the Landkreise was taken into account, the state subsidies would in fact cover the actual cost of the duties devolved to the municipalities. They referred to the system used in Baden-Württemberg, where the principle of concomitant financing was written into the Constitution. This cost the Land dear and, moreover, benefited rich towns more than poorer municipalities. They also pointed out that it was particularly difficult to calculate actual costs. For example, when responsibility for health services was devolved to the Landkreise, the Land had to supply municipalities with the necessary buildings. How could the cost of this service be evaluated?

Mention was also made of the reduction in subsidies allocated to municipalities sharing a border with east European countries: whereas they had risen to 10% before the fall of the Berlin Wall, they had fallen to 6% in 1998, 4% in 1999 and were to be abolished in 2001. Further financial assistance was provided to municipalities classified as “poor” on the basis of their unemployed population and financial potential.

We also discussed special ministry funds, of which there were estimated to be 240. Ministry officials were opposed to the Association of Municipalities’ proposal to replace them with a general investment grant, because this would benefit the larger towns but not the smaller municipalities.

With regard to the equalisation process, we were told that objective criteria were used, some of them set by federal law, others peculiar to Bavaria. Generally speaking, the compensation rate was 55% for municipalities and 50% for Kreise. In fact, the higher the population of a municipality, the higher its equalisation index; this ranged from DEM 600 per inhabitant for the smallest municipalities to DEM 1600 per inhabitant for the largest cities.

It was also confirmed that discussions were taking place on the future of the Bezirke, which were funded both by the Kreise and towns and by the state. This problem would have to be solved one day.

Report on the visit to Karlsruhe - 2 March 1999

CLRAE delegation: Mr Frécon, Rapporteur, Mr Hedtkamp, expert, Mr Locatelli, Head of the Secretariat and Ms Affholder, Secretariat

Other than assessment of the situation in a different Land, the purpose of the visit to Baden-Württemberg3 was to see how the right of local authorities to receive financial resources in proportion to the tasks delegated to them by the Land (the principle of concomitant financing), a principle enshrined in this Land's Constitution, is applied in practice.

1. Meeting in Karlsruhe with Ms Mergen, Head of the Finance Department, Mr Merx, expert in business law, and Mr Klotz, Secretary General of the Union of Towns in the Land of B.W.

Karlsruhe has a population of 276,000 and is not integrated into the Landkreise (district). It is a fairly prosperous city and Ms Mergen immediately informed us that the budget is balanced, debt repayment is satisfactory and the room for manoeuvre with regard to discretionary tasks is adequate. However, difficulties arise from the reduction in tax revenue and the decrease of transfers, especially because of the "Aufschwung Ost" (development of eastern Germany).

Mr Klotz discussed the general situation of towns in the Land and the application of the concomitant funding principle. If the Land delegated some of its responsibilities to the municipalities, Article 71 of the Land Constitution ought to apply. However, it is difficult to establish a clear distinction between Land responsibilities and new responsibilities. Article 104a of the Federal Constitution obliges the Länder to take account of the municipalities' interests in using the transfers they receive from the Federation, but the federal constitution establishes no direct link between municipalities and the Federation, and there is no possibility of appeal4. The Association of Towns is therefore fighting to have this principle included in the federal Constitution. In 1996, the Congress of German Lawyers gave its backing to inclusion of the principle. Apart from the concomitant funding principle, which applies only to delegated tasks, there are fraught discussions between the Land and the municipalities on how the financial equalisation system is applied to the various municipalities in the Land.

Under Article 71 of the Constitution of the Land of B.W., an appeal may be lodged with the Constitutional Court, and appeals have been submitted (we know of two cases). However, problems of interpretation arise over the concepts of "state (Land) tasks", "new tasks" and "significant threshold".

Ms Mergen said that B.W. was a major contributor to German unification and the proportion paid by the municipalities was sizeable: 400 million DM. She also gave a good example of how the funding principle was applied in B.W.: under a recent law, the Land had delegated new responsibilities concerning veterinary affairs to the municipalities. The additional cost had been estimated jointly and the relevant funds had been transferred.

At the same time, an example of bad practice was given: the federal laws on refugees and asylum seekers and on crèches had resulted in a considerable increase in expenditure for local authorities, but the corresponding funds had not been transferred. The Association of Towns had asked that the local authorities be consulted during the preparation of federal laws: although it was provided for in the rules of procedure of the two federal chambers, this consultation procedure was not followed. However, it operated more successfully in the B.W. Landtag (Land parliament).

We were informed about the existence of two "Landeswohlfahrtsverbände" in B.W.: these associations are responsible for social issues and financed by the Landkreise.

Karlsruhe's room for manoeuvre in discretionary tasks amounted to about 130m DM before the new federal social laws (on crèches and asylum seekers), and has now fallen to 65m DM. Municipalities that are integrated into a Kreis keep only 25% of the revenue raised by the business tax (the local authorities' main "own tax"). The reason for this is that revenue raised by this tax has fallen, because of the tax reductions given to companies which invest in the Länder in East Germany.

The proportion of revenue raised by minor local taxes appears to be low. Thus in Karlsruhe, of 580m DM of "own resources", only 2.4m DM is raised from entertainment tax and 1.3m DM from the dog-licence, whilst the largest proportion comes from the business tax (300m DM), the town's share of income tax (180m DM) and land tax (67m DM). The possibility of introducing a packaging tax was discussed, but this idea was eventually rejected.

It also transpires that there are not many "special funds" providing specific grants in B.W.: general subsidies are the rule.

On the subject of the towns' debt position, Mr Klotz said that only 5 or 6 of the 186 towns in B.W. are overdrawn and financed by cash loans.

In contrast to Bavaria, there is no state representative in the B.W. towns that are not in a Kreis. On the other hand, a state official is appointed in the Landkreise as deputy to the Landrat, who is an elected official.

2. Meeting with Ms Hämmerle5, Head of the "Regierungspräsidium" of Karlsruhe

We were reminded that the concomitant financing principle is a source of strained discussions, even with regard to the decisions that might be taken at European level on implementation of the Maastricht Treaty.

Municipalities have three kinds of responsibilities:

- compulsory delegated responsibilities;

- responsibilities to be shouldered under certain conditions;

- their own discretionary responsibilities.

An article in the magazine of the Association of B.W. Municipalities calls for equitable financial reform: according to this article, the concomitant financing principle, while provided for in the Constitution, is not always applied.

Thus, for example, facilities for refugees were previously a matter for the Land, through the "Regierungspräsidium". Since April 1998, this task has been transferred to the towns and Landkreise. Negotiations were held and agreement reached about the amount to be transferred, and it was agreed to re-examine the real costs at the end of two years.

This shows that it is not easy to calculate a fair level of compensation and to demonstrate that compensation is insufficient.

The majority of grants to local authorities are requested in the form of general grants.

In B.W., there are some 150 special funds: however, these hardly concern the municipalities. This Land also practises a system of contributions from citizens and businesses which have profited from municipal investment.

It is estimated that 70-80% of the tasks made mandatory by federal laws come under the responsibility of the municipalities, but Article 28 of the Federal Constitution does not create direct links between the Federation and the local authorities (such links are lost in the system for financial equalisation between the Federation and the Länder and between the Länder and the municipalities).

Compensatory arrangements such as staff provision make it difficult to calculate the new costs arising from new responsibilities: in addition, it must be demonstrated that these responsibilities really are new ones.

Nevertheless, in B.W. this principle is in fact subject to the jurisdiction of the courts: it should be possible to bring estimates, which vary between 40% and 110%, closer to reality.

The Regierungspräsidium supervises the independent towns and the Kreise, especially their budgets. In the event of a deficit, a specially-adapted readjustment programme is prepared. This does not create many problems.

It should be pointed out that the deputy Landrat, a Land official, is appointed with the approval of the Landrat for a 5-year period.

The system for electing the "Landrat" is as follows: a special Kreistag committee makes a preliminary selection of the best candidates and forwards this to the Ministry of the Interior for the Land, which ensures that the candidates meet the legal requirements for the post, then forwards the legally endorsed candidatures to the Kreistag for the election procedure.

The "Landeswohlfahrtsverbände" have three sections: youth, welfare and social assistance.

3. Meeting with Mr Trump, Secretary General of the Association of Landkreise of B.W.

It was pointed out that there is only one tax in B.W. for which the Landkreise have autonomous responsibility: a hunting tax (very low revenue).

The resources available to the Landkreise are:

- 9%: grants from the Land;

- 80%: levy on municipal budgets, set by the Assembly of the Kreis;

- 10-11%: shared tax: value-added tax (2% to the Landkreis and 1% to the Land).

Welfare expenditure has risen considerably and represented the following proportions of the budget:

- 37% in 1978;

- 67% in 1983;

- 84% in 1998.

This leaves very little for the discretionary responsibilities of the Landkreise.

This increase in welfare costs is explained by growing numbers of:

- elderly persons;

- one-parent families;

- asylum seekers;

and by greater expenditure on disabled persons (more technical facilities).

The Land must implement Federal and Land welfare laws although the principle of concomitant funding is not applicable between the Federation and the municipalities.

However, the Landkreise in B.W. may lodge appeals: for example, one appeal was lodged against the expenditure arising from a law on biotopes. Having seen that it was about to lose, the Land conceded the case before a judgement was passed (on the basis of Article 71 (3) of the Constitution of B.W.).

On the other hand, we were informed about a complaint lodged by the Konstanz Landkreis, which was not upheld, as the Constitutional Court ruled that the Landkreis could increase the levy on the municipalities (the case concerned welfare charges arising from federal laws).

The increase in municipal levies decided on by the Konstanz Landkreis created such difficulties for the municipalities that they refused to approve their contributions, and the Regierungspräsident was obliged to intervene and appoint a Land commissioner, who ordered that the contributions be approved.

Two other appeals by Landkreise are currently underway in B.W.

Another source of conflict exists between the municipalities and the Landkreise: the municipalities enjoy residual powers and the Landkreise can intervene only if the municipalities are unable to carry out their tasks. In certain Länder, the municipalities complain about the Landkreise in this connection. This is not the case in B.W., where the law authorises the Land to carry out those tasks that the municipalities do not discharge.

In fact, these problems in B.W. are discussed within the Council of Landkreise, which is made up of several mayors. Municipal supervision of the Landkreise is therefore carried out within the Landkreistag. Conflicts arise in those Länder that do not admit mayors as members.

The rate of the levy imposed by the Landkreis on the municipalities is 30.8% (of the municipality's budget), compared with 22.5% ten years ago. This is explained by the rise in welfare expenditure.

Mr Trump believes that the principle of concomitant financing should be introduced at federal level. In addition, some federal laws allow the municipalities, in theory but not in practice, a certain amount of room for manoeuvre in their implementation, with the aim of avoiding the concomitant financing principle.

There are 35 Landkreise in B.W. (compared with 71 in Bavaria), to which can be added the nine towns that do not belong to the Landkreise. There are four Regierungsbezirke in B.W. (Karlsruhe, Freiburg, Mannheim, Stuttgart).

Consultation in B.W. takes place with the Land's Ministries, as a result of the favourable attitude of Mr Reufel, Head of Government. In spite of this positive climate, there are complaints: the problem is that the Land's financial situation is very weak and, when it loses its appeals, it must go further into debt to implement the judgments.

Finally, with regard to minor local taxes, B.W. has a second-home tax, which raises a large amount in the tourist areas, and an entertainment tax, the income from which is fairly small.

The municipalities may create local taxes, but the Landkreise is responsible only for the hunting tax.

Report of the visit to Erfurt - 10-11 March 1999

The main aim of this visit was to study the situation in Thuringia as an average of the positions in the five new Länder.

1. Encounter with Mr Gnauck, Secretary General of the Association of Towns and Municipalities of Thuringia

Further training was mandatory for elected representatives. The towns and municipalities criticised the Government of the Land for failing to implement the principle of concomitant financing (Konnexitätsprinzip) - which meant that the Constitution did provide for this principle, as in Baden-Württemberg and Lower Saxony.

The Constitutional Court was quite alive to the problems faced by the municipalities, and Article 93 of the Land Constitution set out the principle in question.

One example of a dispute was that of the system for taking in refugees, which had been decentralised to municipal level: the municipalities were demanding strict application of the Konnexitätsprinzip and transfer of a lump sum under the vertical equalisation system.

Municipalities in eastern Germany had a considerably lower level of own resources than their counterparts in the west: 6.8% in 1993, and between 25% and 33% at present.

The Federal reforms were affecting the municipalities' own resources, because the Länder did not necessarily defend the municipalities' interests. For instance, tax exemptions for large families had a greater impact on eastern than on western municipalities in terms of revenue.

Mr Gnauck said that western Germany provided DM 5. 600 million in aid to Thuringia, but that only DM 1 000 million of this went to the municipalities.

He considered that the municipalities were insufficiently consulted by the Federal authorities. Article 127 of the Law on Local Self-Government in Thuringia was better on this score, providing for mandatory consultation of municipalities by the Land Government and the committees of the Landtag (the Land Parliament). While the Government informed the Landtag of the municipalities' opinions, the latter was not required to consult them.

His experience of consultation in Thuringia was positive, not to say exemplary, whereas in his view consultations with Bonn were seldom satisfactory.

Efforts were needed to ensure that Bonn consulted the municipalities on all relevant legislation.

Thuringia's debt had increased by some 70.3%, while expenditure had fallen by 16%, there had been a 21.9% cutback in staffing and investment had decreased by 37% (this was due to the major efforts expended in the early 1990s).

Staffing in municipal departments had been reduced to a third of its level under the GDR regime (falling from 140 000 in 1990 to 55 000 in 1997). Salaries in the municipal authorities stood at about 86% of western levels. Staff expenditure now totalled DM 900 per head of population, leaving virtually no scope for any further reduction.

We were told that it cost DM 800 per annum to send a child to a day-care centre. Parents in the east were already used to this system and there was great demand for it, which meant that the centres were more expensive in the east than in the west.

Mr Gnauck admitted that there had probably initially been some waste of investment, but now investments had plummeted. The drop in investment was due not only to decreasing needs but also to the shortage of resources and the fact that budgets had to be balanced. He actually considered that needs even greater now than before. Four times the current amount was needed for sewage systems and three times for roads and modernising day-care centres.

In connection with taxation, particularly business tax, the new Länder had little room for manoeuvre because taxes had to be kept lower than in the west in order to attract new businesses (the Eisenach Opel plant paid 130% less tax than the Opel factory in Rüsselsheim).

This meant meagre receipts from taxation. Moreover, the Commission of the European Union was studying this situation to check whether the tax reductions implemented in the new Länder amounted to distortion of European competition rules.

Municipal business tax in Thuringia only provided DM 950 million p.a.

Lastly, Mr Gnauck stressed the political importance of ensuring that one association covered all the municipalities and towns, including those administered as districts in their own right (kreisfreie Städte), in order to encourage solidarity.

2. Encounter with Mr Vetzberger, Secretary General of the Association of Landkreise (Rural Districts)

Mr Vetzberger pointed out that the financial situation of the Landkreise in the five new Länder was not so different from that in the west. Prior to 1990 Thuringia had had 90 Landkreise, while today there were only 35 (plus 3 Bezirke [regions]). Before the collapse of the GDR the Landkreise had provided the basis for local self-government, because the municipalities had been too small. Even today Landkreise were more popular in Thuringia than in the west.

The Landkreise had been merged to double the average population of each, namely from 55 000 to 110 000. There were still 1 800 municipalities, with an average population of less than 2 000. They were smaller than in the west. Care had been taken to avoid the impression that such mergers were aimed at centralisation, as this had been a feature of the old regime.

The Landrat (the chief administrative officer of the Landkreis) and Landtag were both elected. The Landkreise had fewer governmental powers than in the west.

Thuringia had 6 kreisfreie Städte. In contrast to Bavaria and Baden-Württemberg, the Landrat was only assisted by a lawyer rather than by a State official in supervising the municipalities.

As in western Germany, the Landkreis Council, which included municipal council representatives, decided on the amounts to be levied from the municipalities.

The Landkreise levied no taxes of their own (no taxes on hunting). The municipalities derived some 30% of their revenue from own funds, the rest being provided by transfers from the Land. In fact, their budgets were comparable to those of western municipalities thanks to the equalisation system. The fiscal capacity per inhabitant amounted to 37% of own funds. 75% of the subsidies were general and 25% specific.

The equalisation paid by the Federation in respect of compensation for German unification (5.5% of overall income tax) totalled DM 2 164 million, while horizontal equalisation among the Länder amounted to DM 1 280 million.

In Germany, such horizontal equalisation benefited not only the 5 new Länder but also such western ones as Lower Saxony and Bavaria.

We were told how the 2.2% income from VAT was distributed: 75% was distributed in accordance with the number of inhabitants and 25% in accordance with financial capacity, which favoured municipalities in the new Länder.

According to Mr Vetzberger, of the DM 7 400 million in solidarity aid supplied to the Land of Thuringia, the municipalities received:

- 23% of the Land's tax receipts

- 25% of the DM 1 200 million in horizontal equalisation

- 40% of the amounts provided under vertical solidarity

- DM 740 million in voluntary contributions to the municipalities.

The municipalities therefore received DM 1 100 - 1 200 per inhabitant, and the equalisation could be said to be operating 100%.

Mr Vetzeberger pointed out that German Federalism adapted to the unitary system for financial purposes. Equalisation levelled out the situations in the different Länder to the point of casting doubt on the autonomy principle, which is why Bavaria and Baden-Württemberg had quite naturally lodged appeals.

Mr Vetzeberger said that despite the intensive equalisation a wide gap remained to be closed, and even more transfers were required to meet investment needs. Therefore, it would take another 7 or 8 years to provide the east with the same standard of public amenities as the west.

It could nevertheless be assumed that the reason for the current reduction in investment by municipalities in Thuringia was that urgent needs had decreased as compared with the years 1992 to 1994.

There were financial problems with servicing the investments made from 1992 to 1994: municipalities were currently hesitating to make any new investment as this was liable to make servicing unaffordable. The municipalities were subsidised up to a level of 80 to 90% for their investment activities, and it was the problem of sevicing rather than the missing 10 to 20% that was impeding investment.

3. Meeting with Mr Neigefindt, Deputy Mayor of Erfurt, Mrs Papig, financial officer, and Mr Wiesmaier, member of the Municipal Council

After the collapse of the Berlin Wall, the city of Erfurt, with it population of 200 000, had been transformed from an industrial city into a sevice-providing centre.

Several industries had either shut down or else made 50 to 60 % of their workers redundant. Erfurt, like other towns and cities, had undergone an administrative revolution in which DM 300 million had been invested. All the transport infrastructures had had to be renovated (the Inter-City Express, the western ring road and the tramway). Moreover, the Land's powers were to some extent being decentralised to the city, accompanied by a cutback in municipal staff. Despite all this the budget was balanced.

There was no horizontal equalisation in Thuringia. The city's resources comprised:

- 24.2% own and shared taxes

- 28.8% contributions from municipal corporations

- 26% general subsidies

- 16.7% specific subsidies.

The very strict borrowing limits meant very few debts, the only constraint being debt servicing (the only debts concerned very long-term loans).

Investments were on the increase, in contrast to the average situation for towns in Thuringia. The city was also generally coping well with the enormous costs facing it.

4. Meeting with Mr Simon, Director of Local Authorities, Ministry of the Interior, and Mr Käs, Adviser with the Ministry

Territorial reform in Thuringia had been conducted in the following stages:

- in 1994 the number of Kreise had been decreased from 35 to 17, so that each Kreis henceforth comprised in average 100 000 inhabitants;

- in 1994 the kreisfreie Städte had been enlarged, incorporating the small outlying municipalities with a view to extending the use of the central amenities;

- in 1997 the number of municipalities had been reduced from about 1 500 to 1 000. The initial aim had been to ensure that they included a minimum of 3 000 inhabitants, in the case of municipalities regarded as independent; the smaller municipalities had been merged into Administrative Federations of Municipalities (AFMs) on the basis of a population of approximately 5 000. Decisions were taken separately by each municipality, but they were prepared and enforced by a joint administration, which also enforced the Land and Federal legislation. Each AFM was directed by a head of administration, who was a politician elected by the AFM Council. The AFMs were rather similar to the Federations of Municipalities in Rhineland-Palatinate, but they had neither an elected executive council nor any decision-making powers.

In the municipalities, neither the towns nor the AFMs had State representatives. On the other hand, the Deputy Landrat was a State official who dealt mainly with legal supervision. There are also in the other new Länder structures which can be compared to AFMs. These associations endeavoured to offset the municipalities' money shortages, but they were limited by the fact that they had only administrative, but no planning powers. However, since they prepared the municipalities' decisions, they did have some influence over them. They were rural institutions aimed at preserving the smaller municipalities. The only decisions taken by the AFMs concerned the levy imposed for staff costs and other administrative expenditure. Furthermore, the municipalities could delegate responsibilities to the AFM, but only on a voluntary basis. This was considered as one step towards a more efficient Federation of Municipalities.

Neighbourhoods had been introduced within the kreisfreie Städte, with neighbourhood mayors, whose main duty was to attend meetings of the Municipal Council in an advisory capacity.

The State provided staffing for the Landkreise, but not for the kreisfreie Städte, though this was offset with transfers of funds.

The school system was run by the Landkreise and the kreisfreie Städte. The Landkreise could also be delegated certain responsibilities by the municipalities.

The municipalities borrowing capacity was limited by their financial capacity to service debts. Financial planning was conducted in three-year period.

The 1994 and 1997 territorial reforms had proceeded without too many problems: there had only been two complaints. By contrast, the analogous reform in the Land of Saxony had been very painful.

The municipalities were entitled to levy small local taxes. For instance, the tax on second homes yielded reasonable amounts.

5. Meeting with Mr Burbank, Head of the Budget Directorate, and Mrs Seifert, Adviser with the Ministry of Finance

The Land had a budget of approximately DM 19 000 million. The proportion of tax resources was some 45-46%, whereas the average in the west was 70%. Transfers from the Federation accounted for some 30%, and 9.6% was funded by debt, a proportion that was considered too high.

The Land gave the municipalities DM 5 800 million in equalisation transfers (3 700 million in respect of ordinary equalisation and 2 000 million through special funds):

- 37% from the proceeds of taxes

- 23% from State subsidies

- 40% for special Federal funds.

Considering that the municipalities received some DM 2 000 million from other special funds, the Land in fact paid them a total of over DM 7 000 million.

These payments took the form of an overall grant, with specific and investment subsidies (DM 650 million in 1997), 50% as general investment grants and 50% as specific grants.

In addition to the DM 5 800 million in transfers, the municipalities also received DM 1 200 million in tax receipts, DM 1 200 in charges and contributions, and DM 800 million through the debt, totalling some DM 9 000 million.

The Land kept a total of DM 13.2 million for its own needs, although DM 2 000 million of this was redistributed through special funds for promoting economic and social activities, etc.

The 6 kreisfreie Städte had more own funds (deriving in particular from charges paid in by municipal corporations), so that they only received 25% of the overall grant (Erfurt 11%), with 75% going to the municipalities and small towns.

The vertical equalisation rates for municipalities were computed on the basis of their financial capacity and needs: funding increased in accordance with population, topping 145% for larger towns and cities.

Whereas in 1998 there had been a major increase in the proceeds from business tax in the west, in the east overall taxation went up from DM 679 million to DM 798 million.

It was hoped that taxes would continue to rise, because aid from the west was tending to decrease and the municipalities had to keep the same level of resources.

It was estimated that in 1999 tax increase could total DM 400 million, approximately half of which might go to the municipalities. The decision had been taken not to reduce the DM 5 700 million paid to the municipalities, with the Land offsetting the decrease in western aid from the proceeds from Land taxation. The Land of Thuringia tended to support the municipalities, because the Ministry of the Interior was responsible for distributing the relevant funds. The Ministry of Finance also "backed" the municipalities. General and specific subsidies were paid to the municipalities, and in future would perhaps also be paid to the Administrative Federations of Municipalities.

In Thuringia, the Land paid DM 92 million in social aid for the municipalities, which also directly regulated the system for taking in refugees.

Our interlocutors confirmed that Thuringia was in an average financial situation vis-à-vis the five new Länder. Half of the total investment grants were general subsidies, which was in keeping with the principle set out in the European Charter of Local Self-Government.

With regard to the principle of concomitant financing (Konnexitätsprinzip), the municipalities received flat-rate financial compensation. This situation was currently under review. The principle of such compensation was enshrined in the Constitution, and the sole complaint to date was currently under examination.

A budgetary fund of some DM 25 to 30 million was available to assist municipalities with deficits.

Some municipalities did have deficits, but the overall Land budget was also in a deficit (DM 1 000 million debt-servicing for the Land!).

The municipalities' debts generally arose out of the heavy costs of servicing the investments made in the early 1990s. On the other hand, the financial capacity of some municipalities was such that they received no equalisation transfers at all.

* * *

In general, it seemed advisable to present a draft recommendation highlighting, paragraph by paragraph, the main problems which application of Article 9 of the European Charter of Local Self-Government causes in Germany or in certain Länder, and to ask the Federal or Land authorities, as appropriate, to find solutions to them and apply the various provisions of the Charter effectively. The German delegation to the Chamber of Local Authorities and Chamber of Regions (i.e. the Land representatives) are asked to keep the Congress informed of action taken on these recommendations. Local, federal and Land authorities could refer to any cases of non-compliance with the Charter highlighted in administrative or judicial applications to the courts in order to ensure a better higher respect of the Charter, and particularly Article 9.

1 Article 9 paragraph 3 stipulates that “Part at least of the financial resources of local authorities shall derive from local taxes and charges of which, within the limits of the statute, they have the power to determine the rate.”

2 Up until 1989, the eleven constituent Länder of the Federal Republic of Germany encompassed 8,513 municipalities with a total population of around 60 million.

3 Statistical survey as at 31.12.1994. Source: Statistisches Jahrbuch für die Budesrepublik Deutschland, 1996.

4 There are a few exceptions, such as the town of Paderborn, which has around 150,000 inhabitants and forms part of a Kreis.

5 Hereinafter referred to as NRW.

6 North Rhine-Westphalia, which is the largest German Land with over 17 million inhabitants, has 396 municipalities and 31 Kreise. The average population of the municipalities is 42,000 inhabitants.

7 In Rhineland Palatinate, the Verbandsgemeinden also perform tasks delegated by central government. The members of this body are elected.

8 One also finds examples of municipal co-operation beyond the national border, e.g. between towns in Baden-Württemburg and towns in Alsace, e.g. in the field of sewage treatment.

9 This involves confirming that candidates meet the statutory criteria.

10 In certain Länder, the President is an elected political representative, in others, a public servant.

11 The municipal debt is DEM 2,000 per capita.

12 In Baden-Württemberg it was initially the Land government which was responsible for refugees; it is now the Regierungspräsident. Local authorities generally received an allowance per head.

13 There are approximately 160,000 people whose unemployment benefit is supplemented or replaced by social assistance measures.

14 In Bavaria, local authorities contribute 37% of the Land’s payments to the solidarity fund in the form of a contribution (Umlage) of 7.99% of the fiscal capacity (Umlagekraft), ie income from the municipalities’ taxes and grants.

15 This principle is interpreted in a variety of ways. In accordance with constitutional case-law, it appears to be applied exclusively to assist an authority with financing a task it is obliged to fulfil.

16 In Erfurt, the rate of land tax A in 1998 was 200%;for land tax B it was 350% and for trade tax 400%.

17 Of the DEM 550 million revenue from taxes in Karlsruhe, 1.3 million came from the dog licence and 2.4 million from the entertainment tax.

18 In certain Länder in the past, there were some restrictions in the form of an upper limit. In addition, there was a legal correlation between the tax rates applied to trade tax and land tax in order to prevent abuse.

19 For example, Bavaria receives 12% for its municipalities.

20 Supervision by this institution concerns the local authorities of its Kreis and, in NRW for instance, covers town planning, refuse collection, sewage treatment and road building. In other Länder, schools are also subject to this supervision.

21 Some grants to military garrisons form an exception to this rule.

22 In the Land of North Rhine-Westphalia, general grants amount to DEM 14.5 billion and specific grants to DEM 1.2 billion.

23 In Baden-Württemberg these funds are listed in an annex to the budget (Annex A figure 13).

24 This constitutional rule is not as flexible as it may seem, because local authorities are entitled to apply to the constitutional courts if the Länder attempt to substantially reduce their share of tax revenues.

25 Bavaria gives local authorities 2/3 of the yield of the traffic tax, which is distributed more or less on the basis of the costs arising from traffic, and 8/21 of the tax on real estate sales, which amounts to 3.5% and is distributed according to the local tax yield.

26 In Baden-Württemberg, the proportion is 77.7% to 22.23%.

27 Of the DEM 19 billion set aside for investment, 5.8 billion go to the local authorities.

28 For example, a company whose headquarters is located in a given municipality may have production plants in several municipalities. The same problem arises if the employees do not live in the municipality where they work. In these cases the equalisation scheme provides for a redistribution of tax revenue between the municipalities concerned.

29 The amount of the equalisation contributions is included in the overall amount set aside for local authorities. This overall amount also comprises 23% of the Land revenue from income tax, the turnover tax (Körperschaftsteuer), part of VAT and the part of the business tax to be paid by local authorities as a contribution to the Land. This overall tax yield is divided up between general grants and investment grants according to a ratio of 77.7% to 22.23%.

30 See Stuttgarter Zeitung of 12 May 1999.



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