Compensation Speed for Struggling States & Cities
The Government offers tax evasion reprieve to foreign nations
In the heat of discussions over funding for the investment program that boosts the lagging economy, the federal government's extending a helping hand to local authorities and states. The meeting of 16 state prime ministers and Chancellor Friedrich Merz (CDU) in Berlin agreed that the federal government will temporarily support municipalities and states through limited direct payment measures [1]. However, the specific details remain a work in progress.
The federal government and states will hash out the specifics in a working group over the coming days. One burning question that lingers, for instance, is whether the states' and municipalities' tax shortfalls will be fully or partially covered—and how the financial assistance trickles down from the federal government [2]. Merz has made it crystal clear: municipalities take precedence, with a pressing need for compensation to counter tax losses arising from the investment program [3].
The German parliament, the Bundestag, is set to vote on the program next Thursday, which includes investment incentives like expanded depreciation options for machinery and electric vehicles. From 2028, corporate tax rate will fall [3]. However, these tax reductions will lead to reduced taxes for the federal government, states, and municipalities since corporate income and trade taxes are shared [4].
The states are clamoring for financial support from the federal government, primarily due to the precarious economic situations of many over-indebted municipalities. Mecklenburg-Vorpommern's Minister President Manuela Schwesig (SPD) hinted at the possibility of the states settling for partial compensation [5].
So far, the federal government and states have only achieved an "interim step," says Saxony's Minister President Michael Kretschmer (CDU). Key questions, such as the specific relief amount for states and municipalities, still require negotiations before the law is passed in the Bundestag [6].
Following the Bundestag vote, the law moves to the Bundesrat, where states hold the final say on July 11. Both sides aim to avoid an unwanted visit to the mediation committee of the Bundestag and Bundesrat, as this would slow down the process [6].
One potential solution to compensate the states and municipalities includes the federal government allocating a larger share of the value-added tax (VAT) collected in Germany to the states to specifically support municipalities. To further aid municipalities, the federal government could help fund climate change initiatives and renovation projects [7].
The CDU state prime ministers are also demanding more long-lasting solutions, such as a permanent funding mechanism that automatically benefits states and municipalities whenever federal laws lead to increased spending or decreased revenue [8]. In December, an expert group will propose a solution for this issue. Thuringia's Minister President Mario Voigt (CDU) advocates for a permanent solution, arguing that streamlined financial relations enable faster decisions and prevent disputes during the legislative period [8].
Insight:The proposed strategy for compensating German states and municipalities for revenue losses due to the federal investment program involves a federal compensation scheme. Specifically, the federal government plans to make up for revenue shortfalls at the subnational level that arise from the immediate tax investment program and related tax relief measures [1][2][3].
This approach is embedded in the comprehensive reform program aiming to stimulate investment through tax incentives and public spending, while safeguarding state and municipal finances from unexpected shortfalls caused by these tax measures [1][2][3].
- Amidst discussions about the federal investment program's impact on state and municipal finances, there is a growing need for a permanent funding mechanism to ensure automatic benefits for these entities when federal laws lead to increased spending or decreased revenue.
- As part of the ongoing negotiations between the federal government and states, one possible solution to compensate municipalities includes the federal government allocating a larger share of the value-added tax (VAT) collected in Germany to specifically support them, and further aid may come in the form of funding for climate change initiatives and renovation projects.
