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César Colino and Mario Kölling

“Parallel lives: Unsolved Problems and Reform initiatives in Spanish and German Fiscal Federalism”

1. Introduction: Similar problems, similar reforms, different results? The relevance of fiscal federalism reform and its obstacles in Spain and Germany

Debates around the raising, spending, redistributing and borrowing of public monies and its reform are highly complex and hard to manage in all democratic states. Questions around the optimal design of the financial arrangements, as well as its impact on policy making and government efficiency and accountability are also at the center of political debates in federations. Federal states have an addi-tional complexity because there are at least two tiers of government, each with its own powers, responsibilities and perspectives. The dynamics and financial rela-tions between these tiers of government make “fiscal federalism” one of the most controversial and studied aspects of federalism1.

Changes in the context of institutional arrangements and social-economic conditions not only among countries but also within them determine the need for economic and political reforms during the past years, as well as the need for new debates on the division of fiscal and political responsibilities among govern-ments. In addition to this, the Eurozone sovereign debt crisis of 2010/11 has shown the risks of extensive public debt, which makes governments totally dependent of credit markets and calls for fiscal adjustments and new fiscal rules for subnational entities or enhanced fiscal coordination with central governments. Also demo-graphic factors, spatial mobility and interregional disparities increase the pressure for governments to reform equalization systems designed to redistribute income among territories. Revenues imbalances lead to the need to amend tax systems and intergovernmental grants. Besides that, substate nationalism and regionalism also puts pressure on financial arrangements through increasing demands for regional autonomy, fiscal discretion and the limitation of interterritorial solidarity.2

The current global crisis and its fiscal implications add to the usual rationales for reform of fiscal federalism and exacerbate the usual tensions. The economic

1 Anderson, George. Fiscal federalism. New York: Oxford University Press, 2010.2 Blöchliger, Hansjörg., and Camila Vammalle. Reforming Fiscal Federalism and Local Government:

Beyond the Zero-Sum Game, OECD Fiscal Federalism Studies, OECD Publishing. 2012.

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crisis and the asymmetric shock produced with the Eurozone sovereign debt crisis in terms of austerity policies has produced a crisis of regional finance in many European federal countries and has forced unprecedented adjustment policies of budget consolidation, rocketing government indebtedness and new claims for the reform of solidarity arrangements entailed by revenue-sharing and equalization systems. This has in some cases even led to questioning the legitimacy of the exist-ing distribution of powers and resources, and in some cases even of federalism or decentralization itself.

Attempts to reform fiscal arrangements, to make them more efficient, equitable and stable usually encounter many difficulties. This is so because these reforms affect mainly public actors and tend to be a zero-sum game in the short term, where one government level or group of sub-central governments is going to lose what the other government level wins. For this reason, the political discussion revolves around short-term distributional effects and actors concentrate their efforts on making short-term benefits and avoiding losses.3

If fiscal federalism reforms are inherently problematic, they become more so in times of crisis. In addition to the status quo bias and the similar structural dif-ficulties of fiscal federalism reforms everywhere, different countries display differ-ent problems and different propensities for change and reform. Some of them are peculiar to their specific variety of fiscal federalism and some of them are due to the particular impact the crisis has had upon their fiscal arrangements. In coun-tries belonging to specific varieties of fiscal federalism, well-known pathologies or dysfunctions are usually identified and specific reform initiatives are recurrently proposed by particular groups or governments.

The types of design options for fiscal arrangements and reform proposals are very variable within federal States. The Spanish and the German system are usually considered to belong to the group of “cooperative” or “integrative” federal systems, where the constituent units typically share powers and revenues with the federal government and administer federal programs in areas of concurrent legislative responsibility. This means that the Spanish Autonomous Communities (hereafter ACs) and the German Länder have considerable autonomy for several areas and have the obligation to carry out most federal laws and constitutional provisions. Because of this, in both countries the distribution of revenues and expenditures are frequently highly political issues.

In Spain, characterized by the concurrence of many powers, the sharing of rev-enues, and a significant redistributive role of the central government, demographic, economic and political factors have led to a growing discussion on the discretion and fiscal autonomy of regional governments, and on the vertical and horizontal imbalances that lead to more or less efficiency and equity of the financial arrange-ments. The funding arrangements have been reformed in 2001 and 2009 and fiscal rules on borrowing and deficit were introduced in 2001 and amended in 2006 and 2011. Reforms in 2001 increased the resources and fiscal autonomy of ACs, whose revenues since then have been mainly based on revenue-sharing and some uncon-

3 Ibide.

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ditional central equalization transfers. Although they seem to have improved the system in terms of regional autonomy, equity and fiscal discipline, there are still many pressing issues and problems that have been aggravated by the financial cri-sis such as regional debt and deficits and fiscal imbalances. Continuous reform proposals of the equalization system, the special fiscal regime of the Basque Coun-try and Navarre, regional taxation, some fiscal rules and the fiscal treatment of Catalonia are on the agenda.

Also, German fiscal federalism has been characterized by a strong horizon-tal and vertical interdependence in intergovernmental finance, a low level of sub-national tax autonomy and the constitutional guarantee of “equivalent” living con-ditions throughout the Federation. A clearer delimitation of powers and a reduction of joint decision making were the leitmotiv of the two reforms carried out in the past decade related to the division of powers and the solidarity and equalization scheme since 2001. At the end of the reform process, which has entailed some constitutional amendments, the Länder regained some of the political significance they had lost in former times but also lost one of the few fiscal mechanisms which they had available to achieve greater policy discretion – the expenditures financed by borrowing in credit markets. However the discussion and reform of some of the main issues, e.g. the Financial Equalization System, have been postponed, even if it has to be solved before the current system expires in 2020. In this context, during the coming months, the debate over the equalization system (Finanzausgleich) will become tenser. The underlying problems of the financial relationships between the Federation and the Länder are growing deeper and need a broader reform debate.

Spain and Germany are thus good examples of the trends and the difficulties faced by the reforms of fiscal federalism arrangements and its results. Both systems belong to a similar variety of federalism and have been subject to similar pressures within the European Union internal market and stability rules, experiencing a par-allel process of unsatisfactory reforms with similar public discussions and similar results, leading in both cases to reforms of their fiscal federalism in 2001 and 2009 and similar amendments in their constitutions to establish new fiscal rules on sta-bility and debt ceilings. In both cases the deficit and debt limits seem difficult to meet and new requirements of coordination and monitoring seem necessary. This chapter looks at the main problems Spanish and German fiscal federalism have, the recent reforms and the current discussion and political prospects of further reform.

2. Main traditional problems and the consequences of the financial crisis

2.1 Assessment of common problems of cooperative, solidaristic federalism

Both the Spanish and German system display high and growing subnational spend-ing autonomy, including borrowing autonomy, but low tax autonomy. At the same

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time, both are characterized by federal intervention in most important policies and a significant redistributive role of the federal government at the cost of taking the blame for taxes (see Graph 1 and 2). We could therefore call this model a model of „solidaristic fiscal federalism“4, based on the principles of representational equiva-lence and equal living conditions through the automatic fiscal transfers to alleviate inter-regional disparities and the pre-agreed sharing of the national tax-revenues.

Graph 1: Expenditures structure by level of government (2009)Source Government at a Glance 2011 – © OECD 2011

This situation makes the two systems interlocked, which shows too much com-plexity and therefore a lack of transparency and accountability for citizens, who cannot sanction fiscal misbehavior.5 The lack of fiscal autonomy or tax room for the autonomous communities and the Länder leads to a gap between sub-national expenditure and own-source sub-national tax resources, and the lack of accountability and the stakes of the central government in most poli-cies leads to incentives to overspending and the expectation of federal bail-out in case of financial problems. Wealthier units have to behave responsibly (they know they will not be eligible for compensatory transfers) and poor units have a strong incentive not to behave responsibly (they know they will receive com-

4 Enderlein, Henrik. “Three worlds of fiscal federalism. Solving the trilemma of multilayered fis-cal frameworks in industrialized countries”. Harvard University. Accessed June 2012. Available at www.henrik-enderlein.de. 2009. Manuscripts. and Enderlein, Henrik., and Müller, Camillo von “Between Crises and Reforms. German Fiscal Federalism at a Crossroads”, Presented at “The Politi-cal Economy of Federalism in Times of Economic Crisis,” Conference at Harvard’s Program on Education Policy and Governance, Center for Government and International Studies, Aug. 12–14, 2012.

5 see for example Färber, Gisela. “Efficiency Problems of Administrative Federalism”, Research Dis-cussion Paper No 1, Speyer: Institut für öffentliche Verwaltung, 2002.

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pensation).6 This problem has been discussed as the problem of soft budget con-straints and of the scarce incentives to exercise their limited fiscal responsibilities.

Both systems feature what has been deemed the most dangerous constellation in terms of fiscal discipline in federal systems. A politically constrained central government, due to institutional, electoral or partisan reasons, that dominates tax-ation and revenues but cannot control the spending and borrowing of the units.7 If the units have the legal capacity to spend and borrow and the federal government is perceived as having low credibility in terms of its no bailout promises, when a financial crisis comes many of the units will follow a strategy that is rational for them, namely, to delay adjustment and initiate a new cycle of heavy borrowing, bailout demands and blame shifting. In this situation, according to the evidence in the literature, only by controlling borrowing can the central government restore some discipline. This seems to have been the path pursued by the Spanish and German central governments in the wake of the crisis, with recent constitutional amendments establishing debt ceilings for the regions.

Graph 2: Revenue structure by level of government (2009)

Enderlein has also argued that these solidaristic systems of fiscal federalism can only achieve two of the three main principles or goals of all fiscal federalism sys-tems – fiscal equivalence, power-sharing and equality of living conditions. One goal has to be sacrificed, which is that of fiscal equivalence (i.e. an increase of own resources based on own taxes) since that would result in a race to the bottom.8

6 Enderlein, Henrik. “Three worlds of fiscal federalism. Op. cit. 7 Rodden, Jonathan. “Soft Budget Constraints and German Federalism”, in: Jonathan A. Rodden,

Gunnar S. Eskeland Fiscal Decentralization and the Challenge of Hard Budget Constraints, MIT Press. 2003.

8 Enderlein, Henrik. “Three worlds of fiscal federalism. Op. cit.

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In some cases, due to the difficulties of redistributing income and the ten-sions inherent in achieving solidarity and efficiency at the same time, even the two remaining goals are also hard to attain simultaneously. As one Spanish expert has argued, even with recent reforms: “Our funding system does not guarantee the effective implementation of the constitutional principle of equality, unnecessarily restricts regional autonomy (especially in its revenue side) and does not provide the correct and transparent accountability of the various authorities to their citizens”.9

These main features and structural problems of the Spanish and German sys-tems are decisive for the possible pathologies, reform proposals and the politics of reform that we are bound to find in these countries. Let us see in some detail the peculiar problems of the two countries, and further similarities and differences.

2.2 Some structural and institutional problems of the Spanish system: fiscal federalism and the current fiscal crisis

Financial arrangements in Spain evolved from a system based on centralized tax collection and conditional transfers to a system that increasingly relies on regional own source tax revenues, revenue-sharing and some unconditional equalization grants. However, regional taxes are heavily regulated and inflexible. These funding arrangements have been criticized for the lack of revenue autonomy for the units, the lack of accountability of regional governments and of clear distributive criteria for the equalization mechanisms. The model has produced considerable auton-omy for regional spending and low autonomy for revenues, with no incentives for regions to use their tax autonomy. In this situation, sanctions and controls in deficit and borrowing cannot be strictly applied and do not seem to work in the period of growth or in economic downturn either. At the same time, most ACs have com-plained even before the current financial crisis about the lack of sufficient resources to manage their competencies, especially those dealing with welfare services such as health and education. Some experts have also pointed to the fiscal arrangements’ inequity in terms of per capita funding in different ACs.10 Let us see some of these problems.

Soft budget constraints and lacking incentives for fiscal responsibility and discipline

The large number of responsibilities of regional governments and their lack of power to tax their residents until the 2000s resulted in a strong bias toward regional government spending and toward competition among regional governments for

9 De la Fuente, Ángel. “La financiación territorial en España: situación actual y propuestas de reforma”, in Reformas necesarias para potenciar el crecimiento de la economía española, Vol. I. Civitas – Thomson Reuters. Madrid, 2011a, 125–254.

10 Herrero, Ana., and J. M. Tránchez. “El desarrollo y evolución del sistema de financiación autonómica”, Presupuesto y Gasto Público 62/2011: 33–65.

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central grants. This stimulated huge regional public investment expenditures in infrastructure, social welfare and other public services, as well as in local and regional development and related programs. All these spending increases were underwritten by the soaring tax base across the country generated with the real estate bubble and by the significant funding obtained from the EU. Until the 2008 crisis, this generated only small or reasonable aggregate levels of regional deficits and borrowing. This allowed Spain to catch up with wealthier EU members in terms of physical and human capital. On the other hand, this political race for regional public investment and spending also produced instances of extravagant, or underutilized costly infrastructures such as regional airports or high speed rail lines, which seem less sustainable in times of crisis. It was also associated with cases of regional clientelism, party patronage and federal investments in different territorial projects based on party-political criteria.

Some have explained the tendency towards deficit spending in Spanish regions with the bailout hypothesis,11 and with the expectation that the central government would rescue regions with problems or would inject further resources in the sys-tem in cases of financial shortages. For other experts, however, although in the past the bailout hypothesis was a plausible one, in the last years, there have been many other factors affecting the expectations and the real behavior of the regions apart of the bailout expectation. Although periodic renegotiations of the funding arrange-ments and discretional grants softened subcentral budget constraints, lately the real behavior of central and subcentral governments and credit markets has not exactly been in line with this explanation. Explanations of the regional deficits should rather look at regional special needs, the legal constraints put upon them on the issue of borrowing, and their corresponding political costs.12

Insufficient revenue autonomy and taxation powers

Regarding the tax autonomy of subcentral units, the increase of “shared taxes” since 2001 has implied the use of a harmonized basis – identical tax base, tax definitions, etc – while they leave some room for differentiation – e.g. tax credits, deductions, tax rates that can be decided upon by the ACs. However, the unconditional equal-ization grants, which represent a large part of revenues for many regions are still largely based on the assessment of need by the Central Government and the allo-cation of funds according to that need and several specific funds. The assignment formula, mainly based on population, guarantees revenues to regions regardless of their fiscal discipline (indebtedness and deficits) and their decisions to increase the tax burden on their citizens. That means there is no effective mechanism to incen-

11 Círculo de Empresarios. Administraciones Territoriales: propuesta para la mejora de eficiencia y la unidad de mercado. 2011. http://www.circulodeempresarios.org/wp-content/uploads/2011/04/Doc-AATT-26-abril-2011.pdf

12 Lago, Santiago. “Evolving federations and regional public deficits: testing the bailout hypothesis in the Spanish case”, Environment and Planning C: Government and Policy, 23, 437–453, 2005.

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tivize ACs to exercise their taxation powers, as they still obtain the revenue from shared taxes and equalization grants and have no political incentive to increase the tax burden on their citizens.13

Coordination deficits, lack of multilateral effective bodies and excessive com-plexity and visibility of the system

The Spanish fiscal federalism model has also been criticised for the absence of effective multilateral bodies for the renegotiation and reform of financial arrange-ments. It has been pointed out the deficient role of senate and of the conference of presidents.) Also the dominance of bilateralism in the negotiation and design of reforms. The tendency to extract bilateral concessions and competition for central funds may also lead to a problem of accountability. At the same time, the nego-tiation procedures and governmental or partisan strategies such as the financial guarantee clauses for all regions, the way they are negotiated and designed through repeated, many times bilateral, political bargaining that neglects technical criteria have led to the lack of clarity and objectivity in the funding formulas and to the cre-ation of different funds difficult to understand for citizens and practitioners alike.14

Solidarity and equity problems: unjustified differences in per capita funding

The equalization system in Spain seems to have had fairly redistributive effects. The levels of equity and redistribution produced by regional funding arrangements in combination with the social security system have been high, both in terms of income distribution at the regional and at the family or personal level. Due to the limited fiscal autonomy of regional governments, – except in the case of the two charter regime governments of Basque Country and Navarra--, it has been possible to maintain homogeneity and tax harmonization across the country, similar to that in Germany and other cooperative federations, thus avoiding tax distortions and efficiency losses derived from tax competition between subnational governments to attract investment. Regions such as Madrid, Catalonia, Balearics and Valencia are net contributors to horizontal solidarity and Andalucía, Galicia, Castile-Leon, Asturias and Extremadura benefit the most from equalization. Some of the redis-tribution comes in the form of central public investments in large infrastructures, which may be subject to excessive discretion and potential neglect or discrimina-tion of some ACs by the central government on party-political grounds.

Some experts and politicians in the wealthiest ACs such as Catalonia or the Balearic Islands and Madrid, have complained about “over-equalizing” effects of

13 Ruiz-Almendral, Violeta. “Sharing taxes and sharing the deficit in Spanish fiscal federalism”, eJour-nal of Tax Research, 10, 1, 2012a, 88–125.

14 Bosch, Nuria., and Durán, J.M. “The financing system of Spanish regions: Main features, weak points, and possible reforms”, in Bosch, N. y Durán, J.M. (Eds.): Fiscal Federalism and Politi-cal Decentralization. Lessons from Spain, Germany, and Canada, Cheltenlham/Northhampton: Edward Elgar, 2008. 3–24. Herrero, Ana., and J. M. Tránchez, El desarrollo, op.cit., Lago, Santiago. “El nuevo modelo de financiación autonómica: luces y sombras”, in Informe sobre Federalismo Fiscal en España’09, Barcelona: IEB, 2010. 62–73.

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the financial equalization arrangements. For them, the system is far too redistrib-utive and lacks clear distributive criteria and incentives for subsidized regions to improve their performance. Catalonia began to advocate for a limitation of the existing solidarity and redistribution mechanisms among ACs; Politicians in Cat-alonia have also begun to complain about the so-called fiscal imbalance: that is, the excessively negative balance between their region’s contribution and what they were receiving from the central government in terms of public investment. However, the main inequity in the system, clearly resented by Catalonia and other regions, seems to be the non-participation of the Basque Country and Navarre, two very wealthy regions, in the general equalization scheme, which may burden the other wealthiest regions in an unreasonable way.

These factors, together with the complexity of the formula and the politicization of the assignment of equalization grants generated through bilateral negotiations have produced arbitrary rankings among regions in terms of per capita funding after redistribution. The 2009 reform of the funding arrangements, already sug-gested by the reform of the 2006 Statute of Autonomy of Catalonia, tried to ration-alize this situation by introducing partial equalization instead of total equalization. According to recent studies on initial results,15 the new funding arrangements for 2009 already had an impact on the equity of the equalization system in terms of per capita funding after redistribution. The Community of Madrid, for example, has now gone from being ranked the fourth worst off AC in terms of per capita fund-ing after its contribution to regional solidarity to being the third highest ranked. Catalonia, for the first time, was above the AC average in terms of per capita fund-ing after equalization. Andalusia, even though it still receives funds, was ranked below average for the first time. Also, according to this report, the central govern-ment provided in the first year of the new funding model a further € 9,198 mil-lion. Despite its added complexity, it seems that this funding model has improved equity, seeking that regions above the average in fiscal capacity before equalization remain above the average after horizontal and vertical redistribution. Results for the following year 2011 show, however, that this has not entirely been achieved.16

The distortion of the Basque/Navarrese special fiscal regime

One of the main equity problems in the system is the unjust distribution of per cap-ita funding among the so-called charter regimes (Basque Country and Navarra) and the common regime ACs, due to the exclusion of the former from the equali-zation scheme and to the results of the Basque and Navarrese Financial-Economic Agreement based on full fiscal autonomy for these regions in all taxes except VAT

15 Bosch, Nuria. “Horizontal Equity in the 2009 Regional Financing Model.” In Institut d’ Economía de Barcelona, ed., Report on Fiscal Federalism 2011. Barcelona: Institut d’ Economía de Barcelona, 2012, 54–59.

16 De la Fuente, Ángel. “El sistema de financiación regional: La liquidación de 2010 y algunas reflex-iones sobre la reciente reforma”, 2012a. Manuscript

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(subject to EU regulations), which maximizes government spending discretion. This is accompanied by a quota paid to the Spanish government to contribute to the maintenance of central state expenditure in powers not devolved to the Basque and Navarrese governments. Since 1987, however, when health services were devolved to the Basque Country, the net result of financial flows between the central gov-ernment and the Basque and Navarrese governments has benefited these govern-ments. This has raised criticism, since the politically determined miscalculation of Basque fiscal capacity and of real central expenditure in non-devolved matters may in practice amount to the subsidising of the Basque Country, one of the wealthiest regions in Spain, by the central government and the rest of the regions. This goes clearly against the principle of equality and the prohibition of privilege established in the Spanish Constitution.

According to many recent studies available, this undervaluation of Basque fis-cal capacity amounts to an estimated 2,500 million euros for the period 2002–2006 and 4,500 since 2007.17 According to De la Fuente’s study, for example, the calcu-lation procedure for the cost of the exercise of central powers contained in the agreement is also extremely generous for the Basque Country. According to his estimates, the agreement offers the Basque Country an extra annual funding of € 4,500 million compared to what the quota would be if it were calculated with reasonable criteria. Matilla18, for example, concludes, in a recent report, that the common system ACs are virtually ‘subsidising’ the Basque Country with 1,820 million euro each year, due to the calculation made by the central government of VAT revenue collection. Catalonia, Madrid and Andalusia are the regions by far most affected by this Agreement. More than 300 million euros a year are unduly transferred by this regions compared with the amount that would be transferred should the appropriate rules and calculations on VAT collection be applied. Other regions such as Castile and León, Galicia and Valencia transfer between 100 and 200 million euros.19

Divergence in demography, regional economic and fiscal performance across ACs The recent growth model and its perverse effects.

Regarding the performance of Spanish regions in terms of budget balance and debt, the system has fared pretty well during the times of economic growth. According to Llera and Morán20 the Stability and Growth Pact and the approval

17 Monasterio, Carlos. El laberinto de la Hacienda Autonómica. Madrid: Civitas. 2010. De la Fuente, Ángel. “¿Está bien calculado el cupo?”, Moneda y Crédito 231, 93–150. 2011.

18 Matilla, J. Vicente. “Constitucionalidad, legalidad y justicia del concierto económico con el País Vasco”, Crónica Tributaria, 142/2012, 157–194.

19 Colino, César. “Devolution-Max á la Basque: a model for a Scotland within the UK?, Research Paper 4/2012, David Hume Institute, Edinburgh, November. http://www.davidhumeinstitute.com/research.html.

20 Llera, Roberto and Morán. Eloy “Reacciones fiscales de las comunidades autónomas ante una crisis global” in Revista Asturiana de Economía 42, 2008, 57–80.

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of the budgetary stability laws in 2001, amended in 2006, introduced a path of fiscal consolidation that has characterized regional finance until 2007, with situ-ations close to balance. The indebtedness of the ACs grew moderately, stabilizing the debt ratio of around 6% of GDP in those years. At the same time, it has been pointed out that regional public corporations doubled the size of their debts as a percentage of GDP. The situation worsened after 2008, with important growth of public debt (up to 9% of GDP in the first quarter of 2010). Overall, the regional deficits amounted to 2.83% of GDP, out of a national deficit of 9.24%. In 2010 the central Government’s public debt accounted for 76% of the overall public debt. Both regional governments and municipalities accounted for a lower share of debt relative to the overall general government debt than their corresponding share of general government expenditures. In 2009, regional governments accounted for only 18% of the total public debt (11.1% of GDP) while being responsible for 30% of general government expenditure. Municipalities were responsible for 6% of total public debt (3.3% of GDP).

However, several demographic and economic factors account for this grow-ing structural tendency of deficits which are not related to the 2008 crisis.21 For example, the significant increase in population and aging of the local population led to strong growth of needs both in healthcare and education. Also the inertia of the welfare state spending (accounting for 74 % or regional budgets) explains the continuous increase in regional spending.

An additional problem was the reliance on an economic growth model based on real estate transactions and easy credit. That led to impressive revenue growth rates for governments at all levels, but also to some perverse effects on the behavior of Spanish society and its public sector, since extraordinary revenues for more than fourteen years, spared public managers and politicians the need for being account-able to citizens for their decisions, even if some were inefficient and inequitable. No government took account of the extraordinary character of real state revenues. This led to cases of profligate spending policies. When the housing bubble burst and the crisis emerged, a large gap between revenues and expenditures appeared.22

At the same time there was a growing divergence in economic and fiscal per-formance among regional governments. As can be seen in Graph 3 there is a large divergence among ACs.

The regions most affected by unemployment and stagnation are those most exposed to the housing bubble. The housing sector share of the economy rose since the late 1990s from 6.5% to 10.6% in 2007. The largest unemployment and the larg-est decreases in GDP have affected Andalusia, Murcia, Canary Islands, Valencia and the Balearic Islands, the regions most affected by the real estate boom. The best

21 Ruiz-Huerta, Jesús., Vizán, Carmen. and Benyakhlef, Myriam. “Crisis económica y tensión fiscal en las comunidades autónomas”, in J. Tornos ed Informe Comunidades Autónomas 2011, Barcelona: IDP, 51–74, 2012.

22 Ruiz-Huerta, Jesús., and Miguel A. García. “El endeudamiento de las Comunidades Autónomas: límites y problemas en el contexto de la crisis económica”, Revista d’estudis autonomics i federals 15 (April): 124–163, 2012.

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situation of Navarre and the Basque Country is explained by their lower exposure to real estate and lower debt. Moreover, in these two regions the industrial and export sectors remained strong. Regions such as the Canary and Balearic Islands are “specialized” in the service sector (real estate, tourism and retail) and have been badly hit by the crisis.

Graph 3: GDP and unemployment increase rates in Spanish regionsSource: Ruiz-Huerta et al. 2012

The other AC that is mainly based on the service sector, Madrid, has outperformed some of the others due to its relative specialization in the financial and administra-tive services associated with being the capital city. In Extremadura the best relative performance can be explained by less exposure to the construction sector and the important relative weight of non-market services (24%).

The effects of the crisis and central and regional reactions: budget deficit and regional debt problems

The crisis brought about increased unemployment, stagnant production, falling investment, credit crunch in al ACs. The most severe crisis occurred in 2009 (the GDP fell by 3.7%, and 1.4 million jobs were lost). The financial crisis also caused a deteriorating budget situation for both the central government and the ACs. The ACs saw their revenues sharply reduced due to the bursting of the housing bubble and the collapse of the tax yield coming from real state taxes. Partly because of

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their budgetary imbalances prior to the crisis, the greater weight of indirect taxes, the greater exposure to real estate, and an above average population growth, the hardest hit by the crisis in terms of deficit and debt were the Balearic Islands, Cas-tile-La Mancha, Catalonia and the Valencian Community.

The regions, meanwhile, despite seeing their revenues sharply reduced (about 30 per cent) due to the bursting of the housing bubble, and the collapse of the tax yield from real estate taxes, still saw a growth in spending of over nine per cent in 2008 and 2009, provoking a € 16,992 million deficit in 2008 that reached € 21,164 million in 2009. This increase in spending was due in part to incorrect tax revenue collection forecasts and appropriations contained in the central gov-ernment’s budgets for 2008 and 2009. This led to advance payments on account or grants from the central government to the regions well above the actual final tax returns. This meant that the deficit from the regions was artificially low during those years and was supported by the central government, and that regional gov-ernments would only need to pay back the money unduly received from the central government (FEDEA 2012) over the following years.23 More importantly, although they all began to react to the crisis with some microeconomic and social policy measures, the seriousness of the situation for the ACs was not really reflected in an actual reduction of revenues until the central government’s budget of 2010.

Graph 4: Regional Deficit/GDP rations during the crisisSource: Ruiz-Huerta et al. 2012

The debt has grown from 5.7 to 12.6% in terms of GDP. There have been important differences across ACs. The most indebted ones are Valencia, Catalonia, Castile La Mancha and the Balearic Islands and the less indebted ones the Basque Country

23 FEDEA, ed. Observatorio fiscal y financiero de las comunidades autónomas. Madrid: FEDEA. 2012.

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and Madrid (see Graph 5). Part of the regional public debt originates in public corporations created by regional governments (20%)24.

Graph 5: The evolution of the debt/GDP ratio with the crisis (2007–2011)Ruiz-Huerta et al. 2012

Apart from the burst of the housing bubble, membership in the euro and the sov-ereign debt crisis since 2010 have contributed to the deepening of the Spanish cri-sis and the fiscal crisis in regional finance. The current financing problems of the central and regional governments, to the point of having seen the credit markets closed for the Spanish ACs, do not seem to stem from its previous irresponsible fiscal behavior but from the Eurozone design. Over the last decade, Spain was one of the countries with the best record in achieving the Maastricht criteria. As said before, regional finances were close to balance in 2007 and the central government had a surplus. Looking at individual ACs, Catalonia is leading the debt ranking in absolute terms. In 2011 Catalonia reached 34,323 million euros of debt, which represents 28% of the total regional debt, when the Catalan economy produced 19% of Spain’s GDP.

Due to the funding difficulties experienced by Spanish ACs in the last two years, these demanded the issuance of state-wide bonds, so-called hispabonds (similar to the „Deutschland-Bonds“), but the Central Government resisted this option and designed a loan scheme of up to 18 billion euros, a so-called Liquidity Fund, to enable the centralization of public debt issuance in Spain, to provide liquidity to regions and ensure their financial sustainability with significant reductions in their financing costs. This mechanism is based on strengthened fiscal conditionality and supervision through continuous monitoring of the adjustment plan of each ben-

24 On the evolution of regional debt in Spain see Ruiz-Huerta and Garcia 2012. Cuenca 2012. FEDEA 2012.

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eficiary region, to ensure the achievement of Spain’s budget deficit targets. Several regions have requested loans under this fund.

In July 2012 the central government, drawing on the new Stability law, also imposed to the Council of Fiscal and Financial Policy new debt ceilings and deficit targets for ACs in the next three years. Some of them, such as Catalonia or Anda-lusia, have complained or voted against those targets.

2.3 Some structural and institutional problems of German fiscal federalism: the effects of the crisis

With regard to the structural and institutional problems of German fiscal federal-ism, we would like to highlight in the following paragraphs the following structural problems and their consequences:

Deficiencies in transparency and accountability of decision-making

The German cooperative federalism has been frequently criticised because of its excessive bureaucracy, limited scope for Länder to design their own policies, the agreement on the lowest common denominator and deficiencies in transparency and control. In fact since the seventies the German system is characterized by a situation, labelled by Scharpf as a joint decision trap, in which there is a tendency for government decisions to be taken at the lowest common denominator since the decision-makers have the ability to veto all proposals.25 In addition, this kind of joint decision-making has made the political process less transparent. But also the strong horizontal and vertical interdependence in intergovernmental finances reduced the transparency of the decision-making process. Because of lack of clarity on the political responsibilities, citizens increasingly do not understand who and which level is responsible for which revenue and expenditure.

Low competition among Länder

Nevertheless this fact didn’t lead to a systematic problem since German federalism is valued more in relation to its output than its input. Survey evidence consistently shows that large majorities of the German public supports federalism as a politi-cal concept but prefers uniform federal regulation.26 In this sense the preference for decision making at the federal level and for common policy solutions as well

25 Scharpf, Fritz W. ‘The Joint-Decision Trap. Lessons From German Federalism and European Inte-gration’. Public Administration, Vol. 66, No. 2. 1988, 239–78.

26 Bertelsmann Foundation/infas Bürger und Föderalismus: Eine Umfrage zur Rolle der Bundeslän-der, Gütersloh: Bertelsmann Stiftung, 2008. Sturm, Roland. “Objetivos y resultados de las dos refor-mas del federalismo de Alemania, 2006 y 2009”, Cuadernos Manuel Giménez Abad, no. 1, 2011.

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as uniform levels of taxation is clear among all Länder.27 The concept of “equal-ity of living conditions”, according to which all sub-national jurisdictions have to exhibit identical or at least very similar policies in the most important policy areas, is enshrined in Article 72(2)28 of the German Basic Law. This political objective increases the tendency for nation-wide policy solutions.

At the same time Germans strongly reject competition between states and are almost unanimous in their support for the principle of solidarity, as well as favour-ing cooperation among Länder governments.

Although the Länder play a significant role in the legislative process, the inter-est in Länder politics has been falling since the mid-90s. While in 1995, 39% of the German population was interested in Länder politics, in 2009 they were only 31%. A majority of 58%, however, was only a little bit interested in Länder politics and 11 % not at all.29

Heterogeneous economic performance of Länder

A further structural problem which affects the current design of German Fiscal fed-eralism is the heterogeneous economic performance of the Länder. Especially since the reunification of Germany, the economic gap between the Länder has increased and the once fairly balanced West-German federal system has been replaced by a “new” German federal system which has to deal with formerly unknown dis-crepancies among the Länder in the West and the East30 (Renzsch 2012). Although some progress was achieved, the East German economy reached only 70 to 75 % of the West German GDP. In this sense the most demanding challenge that remains is the economic and social integration of East German Länder. However, also the West-German Länder do not present a homogeneous economic performance.

Of course, because of the economic heterogeneity the financial needs and revenues are different. The poorer Länder have less revenue since they are primarily affected by structural changes and high unemployment but have to cover increasing costs of social spending.

27 Leuprecht, Christian. “The Nascent Societies and Governments of Germany’s Unitary Federalism”, Regional & Federal Studies, 22:2, 2012, 177–203.

28 The Federation shall have the right to legislate on matters falling within clauses 4, 7, 11, 13, 15, 19a, 20, 22, 25 and 26 of paragraph (1) of Article 74, if and to the extent that the establishment of equivalent living conditions throughout the federal territory or the maintenance of legal or eco-nomic unity renders federal regulation necessary in the national interest

29 Allensbacher Archiv, IfD-Umfragen 6019 and 1042/I.30 Kommissionsdrucksachen (K-Drs.) 030.

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Graph 6: GDP growth rates in West German and East German Länder in %Source: Bundesministerium für Wirtschaft und Technologie (2012)

Demographic change and migration

Although the demographic change is an important issue in the whole EU, the con-sequences of this development are especially visible in Germany. Already at the beginning of 2010 more than 20.7% of the population was older than 65 years. According to Eurostat in 2030, the 8 regions with the highest median age of the total projected population in the EU 27 are the East German Länder of Meck-lenburg-Vorpommern, Brandenburg, Thüringen, Dresden, Sachsen-Anhalt and Chemnitz and the region of Asturias in north-west Spain.

In the following years this demographic trend will be increasingly noticeable in the public finances. The costs increase mostly in regions with less population, since public spending will remain the same or increase while the tax revenues will be reduced. In addition, the spending obligations of the sub-national level for health-care, old age and unemployed people will also rise because of an increasing num-ber of civil servants retiring in the Länder.

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Graph 7: Number of regions with decreased/increased population in the EU 27 between 2008 and 2030Source: Eurostat, regional EUROPOP2008

According to initial studies, these future spending obligations can already be translated in an implicit public debt of 230% GNP.31 In this demographic context the East German Länder face challenges of unprecedented proportions while the effects of rapid population aging is accompanied by the migration of young, well educated professionals.

Within this social-economic and demographic context, the objective of “equal living conditions across the Länder” seems to be increasingly difficult to reach, which will have consequences for the future design of the German fiscal system.

A complex financial equalization system

Until 2019, the federal and Länder governments are interlinked in a complex Finan-cial Equalization System. The system consists of three stages. In the first stage, the

31 Moog, Stefan; Müller, Christoph; Raffelhüschen, Bernd “Ehrbare Staaten? Die deutsche Genera-tionenbilanz im internationalen Vergleich: Wie gut ist Deutschland auf die demografische Her-ausforderung vorbereitet?”, Diskussionsbeiträge / Forschungszentrum Generationenverträge der Albert-Ludwigs-Universität Freiburg, No. 44. 2010.

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revenues from the shared taxes are distributed to the Länder32. The yield from the income and corporation taxes are allocated according to where they were collected; 75% of the receipts from the VAT are allocated according to population shares. The remaining 25% are used to raise the revenues in fiscally weak Länder closer to the federal average. In the second stage, remaining differences in the fiscal capacity of Länder are further equalized through the horizontal equalization transfers from fiscally strong to fiscally weak Länder. As a result, the fiscal capacity of fiscally weak Länder rises to about 95% of the federal average. During the third stage of the transfer scheme, the federal government grants vertical transfers to the fiscally weak Länder.33 Any changes of this complex procedure, which reallocates 70% of total tax revenue, has to be decided by the Bundesrat. The Länder can only make a decision alone on less than 8% of their tax revenue but decide autonomously on borrowing, which for a variety of reasons has developed very dynamically.

As a member of the European economic and monetary union, Germany has to meet the quantitative and qualitative requirements of the European Stability and Growth Pact, according to which EU Member States’ budgets should be “close to balance or in surplus”. Consistent implementation of these obligations at national level is a crucial condition and was therefore also the philosophy of the reform of the fiscal federalism 2009.34 In addition, the economic integration in the EU puts Länder in competition with other European regions on the internal market. In particular the wealthy Länder call for more competition at the European level and for better access to the European market, as well as for austerity of EU redistribu-tive policies. The East Länder have specific interests regarding the EU budget since they have been recipients from the EU regional policy and would like to continue receiving these funds.

Besides the positive effects for the beneficiary countries, the system is subject to continuous debates among the Länder and the Federal level. During the past years the group of net-contributors among the Länder has decreased and the political conflict has grown. Political disputes arise regularly on the required level of the

32 Income tax, corporation tax and VAT are divided between the Federation and the Länder as a whole. The Federation receives 42.5 % of the income tax, 50 % of the corporation tax and around 53 % of VAT. The revenue accruing to the Länder is 42.5 % of the income tax, 50 % of the corporation tax and 2010 around 45 % of VAT. 15 % of the income tax and, in 2010, around 2 % of VAT go to the municipalities.

33 For example, East-German Länder receive transfers to compensate for infrastructure expenditures. “In 2011 the government transferred about 17.5 billion Euros into the new Länder and Berlin in order to raise their fiscal capacities close to the average of all Länder and provide money for invest-ments. The second important contributor were the West Länder which in 2011 transferred the amount of 5.9 billion Euros to the East German Länder and Berlin. In addition, during the period 2007 until 2013 the East German Länder received per annum 1.8 billion Euros from the EU bud-get.” Renzsch, Wolfgang “The Horizontal Impact of the Financial Crisis on the German Länder, working paper, 2012, forthcoming.

34 Häden, Ulrich “Divergenz oder Konvergenz? Zur Vereinbarkeit von deutschem und europäi-schem Haushaltsrecht“, Ralf Thomas Baus, Annegret Eppler, Ole Wintermann (ed.): Zur Reform der föderalen Finanzverfassung in Deutschland (Perspektiven für die Föderalismusreform II im Spiegel internationaler Erfahrungen), Baden-Baden, Schriftenreihe des Europäischen Zentrums für Föderalismus-Forschung, vol. 31, 2008, pp. 67–73.

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solidarity instrument as well as about the objective of the Financial Equalization System and the effects of the transfers. The Financial Equalization ensures a con-vergence among the Länder at a high level, regardless of whether they manage their resources well or badly, whether they invest successfully or unsuccessfully.

The German fiscal equalization system creates primarily incentives for the ben-eficiary countries to shift their spending problems to the donor countries and the federal level, which contributes to increasing the debt. (Feld 2010) Furthermore the system implies that every additional Euro collected by a Land leads to a reduc-tion of receipts from transfers by an almost equal amount. A Land would have to incur the full costs of additional revenue collection while only receiving a frac-tion of the benefits. Thus, Länder lack incentives to generate additional revenue by fostering economic growth or policing tax fraud. 35 Moreover since fiscally weak Länder have little incentive to change their fiscal behavior, dependence on trans-fer payments further diminishes whatever incentives may exist.36 The underlying reason for this situation is that Germany’s fiscal constitution treats tax revenues as a common pool.37

The costs of redistribution are becoming a source of frustration that is begin-ning to undermine the solidarity and co-operation that have characterized the German federal system. Especially the new Länder are facing a gradual decline in solidarity payments until they run out altogether by 2019.

Increasing debt of the public sector

Most scholars acknowledge that the rise of public debt at all levels of government in most OECD countries from 1970 onwards has been primarily due to political factors (Feld 2008). Recessions have been too short to explain the constant growth in public debt. Because of these increasing levels of debt, an ever increasing share of the public budgets has to be earmarked for interest payments. This tendency reduced over time (not only in Germany) the ability of governments to imple-ment policies together with constraining future generations. (Graph I) In 2007, the aggregate debt to GDP ratio was about 65% of GDP and thus 3.5 times as high as in 1970, when the ratio was at 18.6% of GDP. This remarkable increase can not only be explained by the reunification of Germany. Already in 1989, the debt to GDP ratio was about 41.8% of GDP in Western-Germany and hence more than double than in 1970.

35 K-Drs. 01836 Leuprecht, Christian. The Nascent Societies, op.cit.37 Feld, Lars. “La II Comisión del Federalismo: reformas recientes de las relaciones financieras entre la

Federación y los Länder en Alemania”. J. López Laborda, M. Kölling, F. Knüpling (ed.), La reforma del sistema de financiación de las Comunidades Autónoma. Perspectivas internacionales, Madrid: Centro de Estudios Políticos y Constitucionales. 15 – 37, 2010. Kirchgässner, Gebhard, presen-tation at the seminar: “Observatorio de novedades del federalismo en Europa” organised by the Instituto de Derecho Público de Barcelona and the Fundación Manuel Giménez Abad, Barcelona, 14/12/2011.

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Graph 8: Aggregate government sector debt, in % of GDPSource Federal Ministry of Finance (2012)

While the federal share in aggregate debt was 57% in 1990 and had increased to 62% in 2011, the Länder share remained stable at 31% from 1990 to 2011. In 2010, the debt-to-GDP ratio was 44.4% for the Federation and 21.9% for the Länder. At the end of 2011, the debt owed by the public budgets amounted to Euro 2,025.4 bil-lion, which according to the Federal Statistical Office corresponded to a theoretical debt of Euro 24,771 per inhabitant.

Although the fiscal situation of most Länder has improved during the last few years due to favourable economic conditions, the situation within the Länder is very heterogeneous. Among them are financially strong West German territorial states and financially weak East German Länder. In the city-states the financing deficit per inhabitant, for instance, is twice as high as in the territorial states. But some of the territorial states of West Germany (e.g. Rhineland-Palatinate, Schle-swig-Holstein and Saarland) also have sizeable deficits.

The East German Länder have a far lower debt level because of their short his-tory (they were established in 1990). In addition they have received extra resources or direct federal redistribution so that the new Länder budgets were not much affected by the important spending programs for economic restructuring and infrastructure in East Germany.

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Graph 9: Aggregate debt of German public administration in %Source: Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (2012)

Graph 10: Accumulated Public Debts 2005 – 2010 in 1.000 EuroSource: Statistisches Bundesamt, Statistische Jahrbücher 2006–2011

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In the years 2007 and 2008 all Länder with the exception of Bremen and the Saarland were able to maintain their budgets balanced or could even reduce their debts. The years 2009 and 2010 changed the situation: the debts of the West Ger-man Länder increased as a consequence of the bank crisis. Especially, the West German Länder had to rescue their Landesbanken38, while the East German Län-der were able to avoid such dramatic increases of their debt.39 According to recent data from the Federal Statistical Office in 2011, seven Länder were able to reduce their debt. The largest decrease recorded was the Land Saxony, where the debt was reduced by 10%; Mecklenburg-Vorpommern, Saxony-Anhalt; Thuringia, Bavaria and Hamburg also reduced their debts.

Graph 11: Public Debt per capita in the German LänderSource: Statistisches Bundesamt (2011)

38 Historically the Landesbanken have evolved as the corporate branches of the local savings banks and as instruments of industrial policy for the Länder. During the 2000s many Landesbanken extended their operations (too) far away from their traditional core activities and exposed them-selves so much to the US sub-prime market and other fragile sectors that they tumbled in 2009. Seifert, Jan “The OECD best practices for effective public expenditure control and their applicabil-ity to the German Länder: the case of Schleswig-Holstein”, Lee Kuan Yew School of Public Policy, working paper 2012

39 Renzsch, Wolfgang “The Horizontal Impact of the Financial Crisis op.cit.

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Low tax autonomy but autonomy for borrowing for the Länder

Furthermore, the lack of fiscal autonomy and tax competition eliminates impor-tant characteristics of Federal states, namely the possibility to search for specific policy solutions according to the social-economic conditions of each Land, and to try different solution patterns.

Within their low tax autonomy several Länder started to legislate on tax issues in addition to using the limited regional tax room they have and raised the real estate transfer tax. Moreover, the Länder could improve their financial balance by “selling” their approval of federal tax legislation.40

The separation between the sovereignty of the design and the revenues of taxes requires a high degree of cooperation in the German federal system. Barring a few exceptions, the Länder only participate in tax legislation via the Bundesrat and thus only on the revenue volume. The requirement for majorities in both houses has led to frequent deadlocks. With the first federalism reform being implemented, fewer laws need the approval of the upper house. Nevertheless tax legislation still requires the consent of the Bundesrat.

Since the equalization system has always been insufficient from the perspective of the beneficiaries, they were interested in transfers from the federal government. In this sense the federal government also took advantage of this opportunity and frequently connected further transfers with the support to its own projects. The rich countries tolerated this procedure, because the alternative would have been higher contributions to the fiscal equalization. This model also provides incentives for the federal level to pursue its costly policies at the expense of the Länder level.

Elections at the regional level underline the structural problems of the German fiscal constitution. If a Land government wants to increase expenditures, it is, from its own perspective, more rational to finance these with public debt. Although the Land has to repay the debt and its interest in the future, the costs of borrowing are only partly covered by the current government since the opposition will win the next election with a certain probability. This argument could be an explanation for the relatively low levels of public debt in Bavaria and Saxony, where we can find stable governments.

The international crisis and the Länder

Even though Germany was not directly affected by the real estate crisis, the reduc-tion of exports provided an important decline of the GDP. In order to compensate this negative impact of the crisis the federal government initiated a stimulus pro-gram of 50 billion Euros for the German economy. The government also contrib-uted substantial financial resources to the European crisis mechanisms. And, as already mentioned, several Länder had to rescue their Landesbanken. As a result, the public debt increased dramatically since 2009 at all levels which has reduced

40 Sturm, op.cit.

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the room for policy making, as well as increased the conflicts between the Länder and the federal level on financial resources. The crisis also further underlined the role of the federal government because the Länder depend even more on transfers from the federal level.

Not only the national crisis mechanisms affect the German financial consti-tution, but the European Fiscal Pact also limits the policy making discretion of the federal government. As of 2014, the German structural deficit should be 0.5% of GDP. The Fiscal Pact also foresees the reduction of the total debt through an annual reduction of 5% of the debt above the 60% of GDP debt level. The total debt of Germany was 81.2% of GDP in 2011. The Federation must therefore make an additional effort to reduce spending in order to present a balanced budget even before the debt ceilings approved in the Constitutional reform come into force. The Länder only agreed to the ratification of the Fiscal Pact once the federal gov-ernment had given them guarantees, which includes that the federal government would assume all penalties, which could be applied to Germany for not fulfilling the Fiscal Pact. Besides the European or national restrictions, consolidating public budgets has become an issue of the political discourse and a concern among citi-zens. In this context the Constitutional Court of North Rhine-Westphalia declared for the first time in the history of the Federal Republic the budget of North Rhine-Westphalia unconstitutional41.

The crisis and the Eurozone sovereign debt problems have also made the access to the credit markets more difficult for the Länder and increased the dif-ferential of the bond yields in the Länder. While the main focus of the Länder had been traditionally on direct bank loans, since 2006 capital market financing has gained considerable significance for them (e.g. the capital market debt of North Rhine-Westphalia became higher than that of Portugal). The Länder benefit from the good ratings of the federal government and were able to refinance themselves on relatively preferable conditions.

The federal and Länder governments re-insured their debts mutually, which complemented the fiscal linkages already established in the German fiscal con-stitution, but deactivated the control task of financial markets. Moreover the sol-idarity principle (Bundestreue) anchored in the German constitution reinforces the mutual support in the event that both levels of government face severe finan-cial pressures. In 1986 and 1992 the German Constitutional Court indeed decided that “federal ... transfers can be used to bail out fiscally troubled Länder” (Rodden 2003). Because of this, the rating agencies considered the German Federal system solidary, where a Land experiencing “extreme budgetary problem” could count on assistance from all other Länder. Yet, more recent rulings of the Constitutional Court rejected federal aid to Länder under financial distress.

In addition, as the sovereign debt crisis extended, the Länder experienced sig-nificant changes in their fiscal circumstances and their borrowing costs increased. But also the differences in borrowing costs between the Länder increased slightly and, according to first projections, on a long perspective these differences will

41 VerfGH 20/10, www.vgh.nrw.de/presse/2011/p110315.htm.

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further increase.42. According to the rating agency Fitch, especially the different degrees of readiness for the debt ceilings in 2020 will be more reflected in the var-iation of these costs between the Länder. In addition to this, the future equaliza-tion system will have an impact on the future borrowing costs. In order to protect economically weaker Länder against high interest rates in the future, the federal government and Länder agreed to issue joint bonds. Joint emissions or “Jumbo bonds” are issued by several Länder together for several years.

On July 24 2012 Moody simultaneously changed from stable to negative the outlooks on the long-term ratings of six Länder43 and of the Federation, issuing these on the same day. According to the rating agency, the decision was taken, not because of the economic performance or debt rate of these Länder, but because of the strong financial linkage between the central government and Länder. This confirms the high correlation between the credit standing of the Federation and the Länder – in good times but also in difficult situations.

3. Constitutional and legal reforms in the wake of the crisis: Reform of revenue assignments, equalization systems and constitutionalization of debt ceilings

3.1. Spain: reforming regional funding in 2009 and the Constitution in 2011

The 2009 reform of the financial arrangements was already predetermined and even scheduled in the new statutes of autonomy, especially in the Catalan one. Regional statute reforms included some new principles to regulate sources of regional revenues, criteria for financial equalization and solidarity, and some oblig-atory regional public investment clauses for the central government.44 The new Catalan statute included two innovative aspects, which have been partly repro-duced in some of the other new regional statutes. One was an increase in the AC’s tax autonomy and revenues by way of sharing a larger amount of taxes and control over them with the central government (e.g. 50% of income tax, 50% of VAT). The other was partial equalization: setting limits to redistribution among territories and abandoning the objective of total equalization. It also included the so-called “ordinality” principle, by virtue of which equalization mechanisms shall not alter Catalonia’s position among the ACs in terms of per capita income before equaliza-tion. After several postponements, in 2008 and 2009 the bilateral negotiations of the central governments with all the ACs for new arrangements began. After the

42 Hong, Sounman, Nadler, Daniel,., von Müller, Camillo. “Do (German) State Bond Markets Dis-count Politics?”, Program on Education Policy and Governance Working Papers Series, 2012.

43 Baden-Wuerttemberg, Bavaria, Berlin, Brandenburg, North-Rhine Westphalia, Saxony-Anhalt44 De la Fuente, Angel., and Gundín, Maria. La financiación autonómica en los nuevos estatutos

regionales. FEDEA, Estudios sobre la Economía Española. 2007.

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bilateral negotiations, the negotiations in the multilateral Council for fiscal and financial policy ensued. The context for the renegotiation of the funding arrange-ments in 2009 was a situation of strong economic downturn.45

The 2009 reform of the funding arrangements: towards more revenue autonomy and better equalization?

The objectives of the finance reform can be understood in terms of three central goals. The first is the accommodation of diversity, especially of Catalonia, through increased fiscal autonomy, reduction of vertical fiscal imbalances and more reve-nue autonomy. The second was equity in the form of equalization payments that reduce horizontal fiscal imbalances through personal and territorial redistribu-tion, and provide enough resources for all citizens to have access to public services under regional jurisdiction. Finally, the third was democracy, in the form of fiscal equivalence and independent revenues to ensure that all governments are properly accountable and responsive to their citizens and have the appropriate incentives to maximize their welfare46.

The central government’s promise that no region would be worse off with the new system meant that the prospects for a real reform were limited since ACs who benefitted from the system opposed real changes. To achieve this promise and at the same time make concessions to the aspirations of Catalonia to a less equalizing system with additional resources, the central government decided to inject addi-tional monies and create several special funds in the finance scheme to compensate both the poorest ACs and the richest ones from changes to the model’s design. The result was an increase in shared taxes (raising the personal income tax from 33% to 50%, the value-added tax from 35% to 50%, and the excise tax from 40% to 58%). Of these taxes, 75% are allocated to the Fund to Guarantee Public Services, which is divided among the ACs according to adjusted population criteria. The remaining 25% are allocated to the AC where they were generated. The equalization system also changed to a system that only equalizes partially (80% of needs), but is fre-quently adjusted.47

In this fashion, the funding arrangements, finally adopted as statutory law by the central parliament at the end of 2009, retained the basic features of the previ-ous model. Population was the main allocating principle, there was a guarantee of financial equalization in essential public services (partial equalization, as desired by Catalonia), and financial sufficiency was linked to regional competencies.

45 Colino, César. “The State of Autonomies between the Economic Crisis and Enduring Nationalist Tensions.” In Bonnie N. Field, and Alfonso Botti. Eds. Politics and Society in Contemporary Spain: From Zapatero to Rajoy, New York: Palgrave Macmillan. 2013.

46 On the 2009 reform of the regional funding arrangements see Lago 2010. Herrero et al. 2010. Zabalza and López Laborda (2011) Blöchliger and Vammalle. 2012b. De la Fuente 2012a.

47 Blöchliger, Hansjörg., and Camila Vammalle. “Spain: Reforming the Funding of Autonomous Communities”. In Reforming Fiscal Federalism and Local Government: Beyond the Zero-Sum Game. OECD Fiscal Federalism Studies, OECD Publishing. 2012.

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The arrangements also provided additional resources of around €11,000 million injected through the two funds seeking complementary goals: the so-called “Com-petitiveness Fund,” in order to offset the imbalances affecting the most dynamic ACs; and the “Cooperation Fund,” to support growth and development of more economically backward ACs.

The debt crisis from 2010 onwards seems to have offset the growth of revenue sharing and the new equalizing transfers injected into the system, and revealed the contradictions among the three goals embedded in the reform. In its auster-ity measures, the central government sacrificed the goal of accommodation of the wealthiest ACs and tried to secure goals of equalization and policy coordination to comply with the EU-imposed budget consolidation targets. This strategy seems to have neutralized the goals achieved earlier of more revenue autonomy and more accountability. In 2011, the central parliament approved a constitutional reform to force ACs to comply with budget consolidation and debt ceilings under the threat of intervention.

The reform of Article 135 of the Constitution and the 2012 Stability Law: debt and deficit control

In September 2011, an amendment of the Spanish Constitution was passed in Par-liament in order to signal Spain’s commitment with public budgetary stability. The Spanish Constitution will guarantee the principle of balanced structural deficit for the central government and the ACs. The new Article 135 establishes that pay-ments regarding interests and amortizations of public debt will have the highest priority relative to other public expenditures, which is a novelty in the European legislation at the Constitutional level. It also provides for a limit on the public debt over GDP ratio. The ratio should not be higher than that established in the Treaty on the Functioning of the European Union (60%). The ceilings on structural deficit and debt can only be exceeded in the case of exceptional circumstances such as natural disasters and unforeseen economic recessions not due to government pol-icies. The existence of those circumstances must be approved by the parliament.48

Although the new Article 135 of the Spanish Constitution closely follows the German 2009 reform (articles 109 and 115 of the Grundgesetz), contrary to the German case, according to Article 135 this amendment had to be filled out by an Organic Law, the new Organic Law 2/2012, which entered into force in April 2012, that would establish the way structural deficit is computed, the ceiling details and the way it is distributed among government levels.

The main innovations introduced are the growing limitations on borrowing and deficits for ACs. Article 11.2 establishes the structural zero deficit target, which

48 López-Laborda, Julio. “Nuevas reglas fiscales para las comunidades autónomas”, in J. Tornos ed. Informe Comunidades Autónomas 2011, Barcelona: IDP, 2012, 771–795. Ruiz-Almendral, Violeta. “Curbing the Deficit in Spain and its Autonomous Communities: a Constitutional Conundrum”, Presented at the Center for Constitutional Studies, Madrid, October. 2012.

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may be increased to a maximum of -0.4 percent should structural reforms with long term effects be undertaken. There is also further control of spending growth and expenditure ceilings and for the first time debt ceilings in Spanish legislation. The new ceilings on structural deficits and debt will be binding from 2020 onwards, thus allowing for a smooth transition. Finally, the Law 2012 establishes a compli-cated system of sanctions for ACs and municipalities based on the European fiscal compact (Ruiz-Almendral 2012b).49

3.2. Germany: the second Föderalismusreform 2009 and the debt ceilings (Schuldenbremse)

The leitmotivs of the two reforms carried out in the past decade in Germany were a clearer delimitation of powers and a reduction of joint decision making (“dis-entanglement” – Entflechtung and “budget equivalence”- Konnexität). In 2007 the Constitutional Court demanded that German policy makers formulate effective borrowing restrictions.50 Accordingly, the debt problem was the core of the second reform of Germany’s federal system (Feld 2010). Nevertheless the pending ques-tions of fiscal autonomy and the reform of the financial equalization system have been postponed. The new borrowing rule, the debt ceiling or debt brake (Schulden-bremse), will fully come into effect in 2016 at the federal level and in 2020 at the Länder level (Art. 115 and Art. 109 GG). Since then, in principle, the budgets of the federation and the Länder should be balanced without debts. Exceptions for deficit spending are natural disasters, recession and emergency situations. 51

In all cases governments have to provide a repayment scheme for the debts. Normal cyclical downturns will not constitute grounds justifying application of the exception. Article 115 of the Basic Law gives the Federation narrowly confined scope for structural borrowing of 0.35% of GDP. To secure compliance with the executed budget a control account will be created. If a negative balance on the con-trol account exceeds a threshold of 1.5% of GDP, the provisions of the Basic Law require this excess to be reduced in a manner appropriate to the cyclical situation. Furthermore, the Bundestag will only approve exceptions for deficit spending by a majority of its members. Four Länder with specific budgetary problems – Saarland, Berlin, Sachsen-Anhalt and Schleswig-Holstein – are already receiving 800 million euros annually from the other Länder and the federal government which should enable them to balance their budgets by 2020. This aid is monitored annually by the Stability Council. The Council can sanction any of these Länder if they do not use their resources according to the budgetary rules. Sanctions include the repay-ment of money received. Some Länder are already delivering fiscal consolidation. For example, Saxony-Anhalt’s medium-term financial plan for 2011–2015 includes

49 Ruiz-Almendral, Violeta. “Curbing the Deficit in Spain and its Autonomous Communities, op.cit.50 BVerfG, 2 BvF 1/04 del 9/7/2007.51 Kemmler, Iris. “Schuldenbremse und Benchmarketing im Bundesstaat”. Die Öffentliche Verwal-

tung, núm. 14, 549–577, 2009.

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cost-cutting measures aimed at reducing new debt. While Saxony-Anhalt aims at reducing its debt and other states plan for a net funding requirement of zero, some states, including North Rhine-Westphalia, will increase their debt.

The long transition periods have frequently been criticized, since they post-pone the fulfilment of the new budgetary rules to the next generation of politicians, at the same time the end of transition periods will be linked to the debate on the reform of the Financial Equalization System. The Länder have only a theoretical obligation to reduce the deficit and may even increase their debt until 2020. The debt ceiling only makes reference to the Federation and the Länder, so the Länder could reduce their fiscal transfers to local authorities or ask for compensation for assuming responsibilities, while the local authorities in turn would have to increase their debts.

Furthermore the Stability Council which consists of the Federal Finance Min-ister, the Länder Finance Ministers and the Federal Economics Minister assem-bles the same group of politicians, which it has to control. It could be argued that such a Council should have democratic legitimacy but expertise and independence should also be respected. Moreover, the Stability Council may criticize the Länder or even the federal government when they produce budget deficits, but it has less power of enforcement than the European Stability and Growth Act. The Council can ask for reports and multiyear budget plans as well as decide whether a Land is breaking the rules, but in the end the Council can only ask the Land to do better in the future. In other words it can raise its voice, but nothing spectacular happens if no one listens. 52

The zero-deficit rule also considerably reduces the room for maneuver of the Länder on the expenditure side.53 In order to maintain current levels of expendi-tures, especially the East Länder will have to increase their revenues by almost one-third, while at the same time being confronted with a shrinking population and tax base. But also Bremen, Saarland, Schleswig-Holstein or Berlin will lose political room for action.

With regard to the term “cyclical debt”, despite the attempt to define the charac-teristics of a cyclical development that deviates from the “normal” economic situ-ation, the concept is still very open to interpretations.54 Furthermore, although the existence of exceptional situations must be declared by the Bundestag, the requisite of qualified majority is not a big barrier. It would have been more effective if the Bundesrat had also approved the existence of these situations.

In addition, the effectiveness of debt ceilings is often questioned by the empir-ical evidence. There seems to be no watertight system to prevent increasing debts. Smart fiscal experts usually find ways to undermine existing rules or to place the debt outside the budget.

52 Sturm, oo.cit. 53 K-Drs. 079..54 Verwaltungsthemen, 8/11/2007. Korioth, Stefan. “Die neuen Schuldenregeln für Bund und Länder und das Jahr 2020”. Junkernheinrich,

M. (et. al.), Jahrbuch für öffentliche Finanzen 2009, Berlin, 2009.

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However, according to Enderlein and von Müller, by implementing “structural deficits” as reference points, the debt break introduces a cyclical component into future fiscal policies.55 Since the Länder so far have not applied pro-cyclical fiscal policies, the debt ceiling implies a decisive moment of change with regard to the latter.

The additional payments and the different transition periods for the Länder and the Federation seemed to be the result of a political package deal and not an outcome of negotiation which will contribute to increasing the transparency of the decision-making process in German fiscal federalism. While the first reform of German federalism has been dominated by lawyers and the second has been discussed among economists, neither has been carried out with involvement of the civil society. And finally, although the publications of the Stability Council are aimed at increasing the public awareness of the indebtedness of public institutions, the diversity of models for the calculation of the structural debt will increase the opacity and limit the possibility to compare the results of policy-making between the Länder.

4. The current discussion: some proposals and some political obstacles for further reform

4.1. The discussion in Spain

The discussion on fiscal federalism in Spain has revolved around several issues which are present in other countries and various issues typical of the Spanish sys-tem, having to do with their technical peculiarities. Several lawyers have suggested the need to constitutionalize the main elements of the fiscal arrangements to avoid its repeated change every five years according to partisan pressures and political bargaining. Economists have suggested the fixing of clear redistributive criteria and standards and different measures of need and fiscal capacity to improve the revenues assignment formula and its adaptation to changing socio-economic cir-cumstances. Both economists and politicians have suggested the need to reform the equalization system to avoid the arbitrary ranking of ACs in terms of per capita funding, through the introduction of statutory law of the so-called “ordinality” principle. Other economists have suggested new measures to guarantee the true compliance with budget stability targets. Apart from all these suggested proposals, the main discussions have been about the following issues.

Further tax decentralization: more regional sufficiency, responsibility and visibility

Most of the reform proposals have gone in the direction of hardening the soft budget constraints by creating incentives for more responsible behaviour of regions, and

55 Enderlein, Henrik., and Müller, Camillo von “Between Crises and Reforms, op.cit.

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for the use of their own-source taxes. Some experts have suggested the lifting of the current ban or limitations on double taxation for regions and the establishment of new regional (PIT, environmental taxes). Some have also suggested the decentral-ization of all tax collection through the creation of regional tax agencies as a way of improving the collection and the responsibility and accountability of regions before its citizens.

The reform of the Basque-Navarrese fiscal “privilege”

Regarding the Basque and Navarrese special fiscal regime, there has been a growing demand among experts outside the Basque Country that the method of calculation of the Basque contribution quota should be revised. Especially controversial, for its consequences on the Spanish state, is the effect on Catalonia and its demands of an improved fiscal treatment. The fact that the Basque Country and Navarra do not contribute to the vertical equalization scheme to guarantee equal public services all over Spain, implies that other rich regions have to contribute a larger share of their revenues to poor regions, which is obviously unfair. Several experts have proposed ways of incorporating the Basque Country and Navarra in the equalization system or to change the way its current contribution is calculated.

A new fiscal pact for Catalonia after the charter model?

In Catalonia many feel that the Basque and Navarrese regime of full fiscal auton-omy and the payments of a quota to the central government is not such a bad idea and that Catalonia should have something similar. That is why they have suggested a similar special treatment for Catalonia, in the form of a so-called Fiscal Pact. 56

The Catalan government and parliament have complained about the deficien-cies for Catalonia of the common regime of funding, aggravated with the financial and fiscal crisis, and have demanded a new economic financial agreement based on the Basque model, meaning a model articulated through a bilateral relation with the central government entailing the devolution of all taxes raised in Catalonia to the Catalan government, the creation of a Catalan tax agency which would manage all taxes in the region, keeping the Catalan parliament jurisdiction on all taxa-tion, i.e. full taxation autonomy. According to a Catalan Parliaments Committee Report, this Fiscal Pact would not require any amendment to the Constitution or the regional statute of autonomy but only of the Organic law on Regional Fund-ing, which would equate the Catalan situation to the Basque and Navarrese ones. Another law should regulate the quota to be remitted as compensation, which would include two main items, a fee for the central government services in Cata-

56 De la Fuente, Ángel. “Sobre el Pacto Fiscal y el sistema de Concierto”, Madrid: Fundación SEPI. 2012. Herrero, Ana. “Financiación autonómica y pacto fiscal”, Economistas 129 España 2011: un balance. 2012.

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lonia and a Catalan contribution to interterritorial solidarity in Spain. The Catalan parliament suggests that that quota should not imply a loss in the ranking of Cata-lonia in per capita funding.

For many experts this proposal is clearly unconstitutional and breaks the con-stitutional principles of equality and solidarity. It also contradicts Article 133 of the Constitution that establishes that the power to set taxation is an exclusive one of the Spanish state, which may decide to devolve some of it. Besides that, others have criticized the proposal as going against any modern taxation system and fiscal equity of individual citizens, who would be paying taxes according to their place of residence and not to their income level.

“Second” decentralization towards local governments

Another issue has been the discussion about the need to implement a so-called sec-ond decentralization towards local governments. This idea is based on a compari-son with the level of expenditure of the local level in other similarly decentralized countries. The suggestion is that the decentralization towards the regional level would have reached its limits and the efficiency reasons would lead the reform to an increasing devolution of powers and resources to the municipalities, The prob-lem with this proposal is that it does not take into account the small size of most local units in Spain, that makes them inadequate for the provision of most ser-vices. This means that reform is totally unrealistic until the size of municipalities is changed by previous reforms.57

4.2. The discussion in Germany

In general terms, from the perspective of the “rich” countries, more financial and political autonomy would be desirable; from the perspective of the majority of the “poorer” countries, a strong federal role is required and no softening of the coop-eration principle in the federalism. One typical solution discussed regarding the above-mentioned debate is the introduction of tax autonomy at the Länder level.

More fiscal autonomy for the Länder

There might be a chance for a reform when the current fiscal equalization has to be renewed in 2019.58 Firstly, tax autonomy works against indebtedness simply because whenever spending is difficult to cut, the Länder governments would not

57 Monasterio, op. cit.58 Kirchgässner, Gebhard, Föderalismus: Mehr Wettbewerb, weniger Kooperation, in: K.F. Zim-mer-

mann (ed.), Deutschland – was nun? Reformen für Wirtschaft und Gesellschaft, Beck, München, 2006, 29 – 41.

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only need to refer to debt, but could also raise taxes.59 Secondly, tax autonomy would help against excessive spending and limit the externalization of public spending to other Länder or to the federal level. Thirdly, tax autonomy would lead to a clearer specification of competences and responsibilities between the Federation and the Länder on top of more transparency in fiscal policy decision making. In this sense: “[…] whoever enjoys the electoral pleasure of spending tax money must first expe-rience the electoral pain of extracting it from the tax payer […].60And fourthly tax autonomy would lead to tax competition which would most probably be beneficial for Germany overall.61

The crucial question for the period up to 2020 is probably not whether a fiscal autonomy of Länder is created, but rather under which conditions this happens. In other words, the question is under what circumstances tax autonomy for the financially weak Länder would be acceptable.

The debate on budget equivalence Konnexität

The criticism of the principle of Konnexität – “whoever orders, pays” – is that it has not been followed since the creation of the German federal system. The prin-ciple according to which the expenditure and revenue responsibility should be at the same governmental level or the financing responsibilities of different layers of government should match the spending powers is embodied in the Basic Law in the article 104a. However the constitution only guarantees that the federal level has to compensate the Länder for implementing federal laws (policies).

The Konnexität principle has been subject of the reform of the German feder-alism but only minimal progress and in some situations the opposite effect could be achieved. The actual costs for carrying out obligatory tasks are hard to calculate. Therefore, sufficient and appropriate financial compensation for (a growing num-ber of) Länder tasks is an issue of the on-going political debate in Germany. Espe-cially the local level refers to the Länder in order to cover specific tasks. According to the financial guarantee, the Länder have to provide funding for the local author-ities in relation to their tasks, e.g. for increasing social spending.

Moreover, if Konnexität were taken seriously and the responsibilities separated more clearly, the federation would lose influence over certain matters, but poor Länder in particular would have trouble financing some responsibilities.

59 Feld, Lars and Baskaran, Thushyanthan, Fiscal Decentralization and Economic Growth in OECD Countries: Is there a Relationship? CESIFO WORKING PAPER NO. 2721

60 Kincaid, John; Tarr, Alan Constitutional Origins, Structure, and Change in Federal Countries, Montreal & Kingston: McGill-Queen’s University Press. 2005.

61 Feld, Lars. “La II Comisión del Federalismo: reformas recientes de las relaciones financieras entre la Federación y los Länder en Alemania”. J. López Laborda, M. Kölling, F. Knüpling (ed.), La reforma del sistema de financiación de las Comunidades Autónoma. Perspectivas internacionales, Madrid: Centro de Estudios Políticos y Constitucionales. 15 – 37, 2010.

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Fiscal equalization (Finanzausgleich) before the 2019 deadline

As already mentioned, the current financial equilibration will continue until the end of 2019 and until then the financial relation between the Federation and the Länder has to be regulated. According to the logic of subsidiarity, help can only be offered when Länder are in need, but not if it is their own fault, e.g. to address structural changes or demographic tensions. By contrast, if the main goal is to create equal living conditions throughout Germany, independently of the perfor-mance of individual state governments, the aid should not be limited neither in time nor in amount.

Besides the mechanisms to limit the debt burden, other possible causes of defi-cits and subsequent increases in debt should be discussed and considered in the new Finanzausgleich. Given the differing developments in the Länder over time, one must ask to what extent structural (e.g. demographic; population density), economical, fiscal policy and political factors have to be taken into account.

Fusion of Länder (Neugliederung)

The Finance Minister of Berlin, Nussbaum, predicted in 2012 a reorganization of the German Länder if they do not succeed in complying with the requirements of the debt ceilings. A reorganization and fusion of the German Länder, by size, population and financial strength, would be one of the first conditions for a fair competition between them. A competition among Länder with very different eco-nomic and financial power as well as without transitional arrangements would increase the differences between them. Nevertheless, the Germans do not support a reorganization of the German federal system. When asked whether the number of Länder should be reduced only 37 % say yes, 55 % rejected the proposal.

4.3. Political obstacles for reform: veto actors, parties, institutional inertias and public opinion: some examples

As we suggested in the introduction, due to a series of obstacles most of these reform proposals are difficult to implement in the two countries. First, they face institu-tional hurdles and consensus requirements which are not always easy to reach. In some cases party majorities at the central parliaments are not enough, since sub-national governments ruled by the same party would oppose those reforms. That means party cohesion or congruence is not always enough in negotiations around fiscal federalism since in these negotiations territorial interests prevail over party interests. Besides that, the need for consensus among a majority of governments leads complex or ineffective solutions, and agreement is only possible if status quo and positive sum solutions are guaranteed.

Those reforms that require constitutional amendment are even harder to achieve. For example, the German Länder participate in the constitutional reform

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through the Bundesrat. That means the federal government needs to guarantee that none of the Länder with veto possibilities is against the final agreement. In the Spanish case, Spanish ACs do not formally participate in constitutional reform and the system allows for piecemeal institutional adaptation through political agree-ments and court reinterpretation and the acceptance of court or political actors’ reinterpretations. Hence, the lack of an absolute majority at the central parliament is a better predictor of change in the funding system in the direction desired by ACs than more or less party congruence or incongruence, and this is due to the need of parliamentary support and voting influence of the biggest substate region-alist or nationalist parties, who get concessions that are then transmitted to all the other ACs.

At the same time, the usual utilization of bilateral procedures is less transparent than of multilateral ones and the need to legitimate the agreement with majorities across regions and in parliaments allow for individual vetoes and lead to status quo demands. A clear example is the virtual impossibility of reforming the char-ter regime for the Basque Country and Navarra, no matter how inequitable it has proven to be. These two regions may veto any reform of the system since the agree-ment has permanent validity, which combined with the established amendment procedure means that in practice the Basque government enjoys a veto power over any reform initiative not suiting its interests. The agreement is established as a fis-cal compact or treaty between two governments which is subsequently ratified by the two parliaments through a single article act without possibility of amendment (legally it has the same procedure as international treaties). According to this pro-cedure, the only role of the Parliament is to ratify an agreement previously reached between the Basque institutions and the Spanish State Government. The Spanish parliament is not entitled to modify such rules unilaterally. This ensures an advan-tageous bilateralism between the region and the State. A reform of this regime would also confront public opinion in those two regions, since all politicians and public opinion in the Basque Country, aware of its advantages, fully support the financial agreement system and associate it with the essence of its particular his-tory, identity and self-government.

5. Conclusions

The process of modernizing the Spanish and German fiscal federalist systems is an on-going process that never comes to an end. In fact Spain is again about to negotiate a reform of the system approved in 2009 because of the pressure of the Catalan secessionist challenge. In Germany, the prime ministers of Bavaria and Baden-Württemberg have already proposed a third federal reform commission.

Several difficult questions remain in the two countries, e.g. a reform of the intergovernmental fiscal relations and the revenue system for the Länder and ACs, and a reconsideration of the solidarity systems in the two countries is still on the agenda. Nevertheless, the next reform steps should not only include the division of

fiscal responsibilities among governments and the redistribution of revenues, but

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must also address problems related to the efficiency of the system, that is to the het-erogeneous economic performance and demographic trends which will affect the revenue capacity and expenditure of the Federal and regional governments. This will also include a debate on the principle of equality of living conditions and the sustainability of the Spanish and the German cooperative federal model.

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