The Länder are primarily responsible for providing local governments with adequate
financial resources. Fiscal equalisation systems take needs-related socio-economic
indicators in municipalities into account within each Land.
In order to increase budgetary leeway for investment financial flexibility of Länder
may be strengthened, by allowing them to levy a surcharge on the income tax.
The federal government has assumed an increasing share of spending which results
from federally-mandated social transfer programmes. This has provided some budgetary
relief for municipalities. It has also introduced a programme which allows municipalities
with high debt to apply for federal co-funding of up to 90% for selected investment projects
until 2018. However, by linking transfers to outstanding debt, this scheme risks harming
incentives for sound budgetary policies.
Municipal public investment could be strengthened in a financially sounder way. The
federal government should provide more support for investment in municipalities
where spending on cash transfers mandated in
federal entitlement programmes is high.
Alternatively federal government support for municipal investment
could be based on income and demographic indicators, which are
correlated with higher social spending needs, such as age composition
or the share of the immigrant population.