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Chapter 7 : Special Report: Local government in the Federal Republic of Germany

As a consequence of the Second World War and the beginning of the Cold War, two separate German states were formed in 1949 - the 'western' Federal Republic of Germany and the 'eastern' German Democratic Republic.

The end of the Cold War and the disintegration of the USSR provided the impetus for German reunification in 1990. Since then, Germany has spent around 1250 billion (in monetary transfers) to bring eastern Germany's living standards, productivity and wages up to western German standards. Although there have been highly positive developments, it is widely accepted that, 15 years after the collapse of the German Democratic Republic, Germany as a whole is in need of wide-ranging structural reform.

The outcomes and effects of the reunification process, the influence of the European Union's trade liberalisation policies as well as ongoing tax reforms will continue to pose challenges for local government in Germany in the near future.

Some characteristics of Germany

Some geographic, demographic and socioeconomic characteristics of Germany include:

  • Located in the centre of Europe, the Federal Republic of Germany covers a surface area of 357 000 square kilometres with a population of 82.3 million (2003), of which around 7.3 million are of foreign origin.
  • Germany borders nine European countries including Denmark in the north, Switzerland in the south, Poland in the east, and France in the west. The total length of its borders is 3757 km with the shortest border being with Denmark (67 km) and the longest with Austria (815 km).
  • Approximately 30 per cent of Germany is forests, 53.5 per cent is used for agriculture, and 12.3 per cent for settlement and transport.
  • The biggest cities are the capital, Berlin, (with a population of 3A million), Hamburg (1.7 million), Munich (1.2 million) and Cologne (1 million).
  • Germany is the world's third-biggest economy and is a large net contributor to European and international budgets and funds. It is also the world's biggest exporter of goods and services (US$746 billion in 2003) with an export surplus of around US$146 billion (2003).
  • With a declining fertility rate of 1.4 (live births per woman) falling below replacement levels, Germany faces serious social and economic challenges in the near future. This means the population is shrinking and ageing, posing serious problems for the financial sustainability of social security and welfare systems. These trends have been exacerbated by a three-year period of economic stagnation that has led to a serious rise in unemployment and a decline in tax revenues, placing a further burden on the already difficult fiscal situation.
  • All German States have suffered sizeable tax revenue shortfalls as a result of sluggish economic growth since 2001 and the national tax reform that is currently being phased in.

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Spheres of government

The Federal Republic of Germany's 1949 Constitution or Basic Law became the national constitution of the united Germany on 3 October 1990.

According to Article 20 of the Basic Law, the Federal Republic of Germany is:

a democratic and social federal state (paragraph 1). All state authority is derived from the people and shall be exercised by the people through elections and other votes and through specific legislative, executive and juridical bodies (paragraph 2). Legislature shall be bound by the constitutional order, the executive and judiciary by law and justice (paragraph 3).

These principles apply to all spheres of government.

The Basic Law defines Germany's federalist structure by giving specific rights and duties either exclusively to one sphere of government or demanding the cooperation and coordination of various spheres of government. States may enact their own legislation in areas not covered or defined by the Basic Law (Article 70 Basic Law, paragraph 1).

The national top-level government is the Federation represented by the Federal Government, which is elected by the Bundestag, the Lower House of German Parliament, for a four-year legislative term. According to Article 73, the Federal Government has exclusive legislation rights in areas affecting the entire nation, for example, relating to foreign policy, defence, monetary policy, air transport and nationwide taxes and levies.

Article 74 of the Basic Law lists the areas of concurrent legislation where the 16 States may also pass legislation, that is, areas for which no Federal legislation exists and which are not exclusively reserved for the Federation. The Federation in return may issue legislation if a uniform law is necessary for the whole of Germany. Indeed, over past decades, the States have accepted a transfer of some legislative power to the Federation for practical reasons.

Article 75 of the Basic Law also defines areas in which the Federation may enact framework legislation to provide broad standards and targets but allows States a vast degree of freedom in implementation. Notable areas are higher education, nature conservation, landscape management and regional planning.

Within their jurisdictions, States determine their management arrangements, functional distribution, and electoral laws concerning local government (the lowest level of government, that is, regional districts or counties, towns and municipalities). Article 28, paragraph 2 of the Basic Law guarantees the right to self- government for local governments within the legal framework. The States also supervise legal compliance of local government activities and have the right to intervene within the scope of the respective State constitution.

Apart from the Federation and the States, Germany's membership in the European Union (EU) has added another level of administration, and although the 'right to autonomy' is guaranteed, local authorities must now deal with an additional authority - the EU.

This means, for example, that local authorities have to directly observe EU competition policy regulations and directives to achieve the objective of a single European market (that is, removing all barriers to trade). The following areas are where local authority compliance with EU directives is mandatory: invitations to tender for local authority building projects, the sale of land, management of utilities, water quality control and waste policy.

There are five constitutionally distinct and legally independent political levels in Germany today:

  • the European Union - the association of various European nation States, of which Germany is a member State
  • the Federal Republic of Germany - a nation State with constitutional sovereignty
  • the 16 States - equivalent to the States in Australia
  • regional districts or counties
  • towns and municipalities.

The structure of government in Germany is outlined in Table 7.1.

Table 7.1 Structure of government in Germany

Tiers of government

No. of units

Population range

Federal Government


82 037 011

States (States and City States)


667 965 to 17 975 566

Regional Districts (or Counties)

Urban Districts and Cities (Stadkreise, KreisfreieStadte)


36 015 to 1 216 467

Rural Districts (Landkreise)


51 800 to 662 300

Municipalities (or Communes)

14 987

1 000 to 500 000

Source: Australian Department of Foreign Affairs and Trade, Berlin, 2004.

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Local government structure

Germany's local government structure and administration is complex.

Districts, towns and municipalities are constitutional elements of the States with the power to regulate local government within the States. Each State has the power to determine management arrangements, functional distribution, and electoral laws concerning districts and municipalities. This flexibility has led to considerable variation in functionality among States, for example, relating to the election of mayors and senior civil servants and the separation of powers and duties.

Towns and municipalities are local authorities, while some 'intermediate' districts are administered as both States and local authorities. Both the intermediate districts and the lowest tier municipalities enjoy full powers of self-administration and the power to issue substantive law.

The Constitution contains two key features relating to local government:

  • 'Uniformity of living standards throughout the Federal territory' is guaranteed in Article 106, Paragraph 3, and Subparagraph 2 of the Basic Law. To achieve this objective, a series of fiscal equalisation processes are undertaken annually between the Federal Government and States, among States and between States and their municipalities (see 'Fiscal horizontal equalisation arrangements').
  • Local autonomy of municipalities is guaranteed in Article 28, paragraph 2 of the Basic Law and the corresponding provisions of the States constitutions. The guarantee of local autonomy prohibits Federal and State legislation from removing the rights of the local authorities to manage their own affairs or from restricting this right to such an extent that the substance of the autonomy is taken away. However, municipalities can be dissolved by means of an Act of State Parliament provided the principle of local autonomy remains unaffected.

Fiscal horizontal equalisation arrangements

The objective of revenue redistribution in Germany is to ensure a uniform standard of living across the Federation. In order to equalise revenue, 75 per cent of the value added tax (VAT) reserved for the States is distributed according to their population. The remaining 25 per cent is distributed asymmetrically between the States to ensure resource equalisation up to 95 per cent of the Federal average.

The distribution formula contains a calculation of the taxation capacity of the state adjusted for special burdens (for instance for the City States Berlin, Hamburg and Bremen, which provide infrastructure services for neighbouring municipalities and States) and in comparison to the national average, weighted by population in favour of more densely populated areas. In effect, this means the financially stronger States support the financially weaker States without the intervention of the Federal Government (the 'Brotherhood Model of Revenue Equalisation').

The method of horizontal and vertical equalisation within States varies and is laid down by individual State laws. Normally, fiscal imbalances are calculated by establishing a 'local need indicator' based on the relative number of inhabitants, population density, and local revenue- generating capacity, expressed as an average tax rate. Municipalities may receive untied payments and also tied payments that must be used for particular purposes or special projects.

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Roles and responsibilities

Districts, towns and municipalities enjoy full powers of self-administration including the power to issue substantive law. There is considerable flexibility in the allocation of functional and financial responsibilities, which are often shared among tiers of government.

Functional responsibilities are largely similar across the States. States are directly responsible for education, culture, local law, public safety and order. In other areas, such as adult education, regional economic development, agriculture and coastal protection, the States work jointly with the Federal Government (and sometimes with the EU).

States share responsibilities with municipalities and districts for delivery of a wide variety of mandatory and discretionary services. Local government's tasks are divided between the districts, on one hand, and the towns and municipalities, on the other, according to the principle that some services that cannot be provided by the municipalities are largely provided by the higher-level districts. For example, if construction and maintenance of a waste disposal facility exceeds the financial means of an individual municipality, the district takes on this task for all municipalities belonging to the district.

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Areas of responsibility of municipalities

Municipalities are largely responsible for the following sovereign rights:

  • personnel sovereignty grants the municipalities the right to select, engage, promote and dismiss staff
  • organisational sovereignty encompasses the right of the municipalities to organise the administration themselves
  • planning sovereignty grants the municipalities the power to organise and shape municipal territory under their own responsibility by drawing urban development plans (land use and building plans)
  • legislative sovereignty entails the right to pass municipal bylaws
  • financial sovereignty entitles the municipalities to be responsible for managing their income and expenditure
  • tax sovereignty grants the municipalities the right to raise locally applying taxes such as dog tax, entertainment tax, land tax, second place of residence tax.

Municipal activities can be classified into two types based on whether they are: (a) mandatory functions transferred from higher authorities, or (b) voluntary activities taken on by the respective municipalities.

The first type of functions is 'State' tasks transferred or mandated by the Federal Government or the States to municipalities by virtue of law. These account for by far the largest part of the local authority's activities. State or Federal Governments provide legal and expert supervision and issue specific directives and instructions under certain conditions.

These mandated activities are:

  • nationality, registration, passport affairs and issue of registrations of birth, marriage and death certificates
  • general security
  • commercial affairs
  • construction affairs
  • health care and veterinary affairs
  • road traffic
  • registration of vehicles and vehicle taxation
  • water legislation and land cultivation
  • federal and land elections (implementation)
  • social affairs and youth care
  • protection and maintenance of historical monuments statistics
  • forestry and fisheries administration.

The Municipality is also obliged to guarantee energy and water supply for its citizens. The other important tasks under this category are:

  • providing essential services such as water supplies, electricity, heating and gas
  • providing waste water services and waste removal
  • town planning functions by specifying residential, commercial and other land use plans through Land Use and Building Plans, building approval procedures, local authority land policies (including land order and dispossession), public investment
  • construction and maintenance of local roads and green areas, parks and cemeteries.

Voluntary or optional self-government tasks include activities in leisure, recreation and cultural spheres such as establishment of sports centres, swimming pools, pedestrian precincts, and a local transport network of trams and buses.

Furthermore, municipalities are responsible for numerous cultural institutions from opera to municipal archives, theatres, cinemas, museums and libraries and restoration of historical buildings.

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Local government funding

Article 28, paragraph 2 of the Basic Law requires municipalities to perform the tasks for which they are responsible. Consequently, apart from own revenues, municipalities can draw on additional allocations from their respective State.

Local government revenues are divided into taxes, state allocations, fees and contributions, asset management, revenues and loans (see Figure 7.1).

Figure 7.1 Local government revenues, excluding loans, 2003

Figure 7.1 Local government revenues, excluding loans, 2003

Source: German Federal Ministry of Finance.


Regional Districts or Counties are not permitted to levy their own taxes but are funded directly by the States.

The sharing out of tax revenues lies at the heart of the Financial Principle enshrined in the Basic Law. For an overview of the arrangements in Germany, see 'Taxes in Germany'.

Municipalities have been granted recognition by the Basic Law in the intergovernmental distribution of tax revenues. Municipalities have been guaranteed in Article 106 paragraph 6 of the Basic Law the power to draw on the property tax and the local business tax as well as local taxes for consumption and expenditures. Where there are no municipalities in the State (such as in the City States of Berlin, Hamburg and Bremen), revenues are accrued by the State.

Property tax is levied on agricultural and forest estates as well as on real estate property. The tax rate on undeveloped and built-on land has traditionally been very low in Germany, and has often been criticised as an undue privilege for those who own land. As a proportion of total municipal tax revenue, the land tax currently amounts to 7 per cent in Western States and 5 per cent in Eastern States.

A local business tax is levied on the working capital and the profits of medium-sized and large businesses operating within a municipal territory. This tax is paid on top of corporate tax.

The system of local government taxes is regulated in a remarkably centralised way, leaving the local government very limited power to influence the rate and yield of tax revenue. In December 2003, for example, the Federal Parliament passed legislation forcing municipalities to raise the local business tax rate. Nevertheless, local government can, by its constitutional recognition, count on a significant degree of stability in the arrangement of intergovernmental finances.

Taxes in Germany

Exclusive taxes

The main Federal taxes are excise taxes on petrol, insurance, tobacco and alcohol.

The main State taxes are motor vehicle tax and inheritance tax.

Apart from minor taxes, such as entertainment tax and dog tax, Municipalities levy local business tax and property tax.

Shared taxes

The VAT, income tax, capital gains tax, import turnover tax and corporate tax are shared taxes. In 2003, these shared taxes delivered 67.7 per cent of total fiscal revenue (income tax 31.1 per cent, VAT 23.3 per cent, import turnover tax 7.7 per cent, capital gains tax 3.8 per cent and corporate tax 1.9 per cent).

The Municipalities only receive revenues from income tax (15%) and VAT (2.2%) while the States and the Federation divide up the other shared taxes.

In addition, 20 per cent of local business tax revenues go to the States and the Federation. In 2003, total local business tax revenues were 24.1 billion.


Strict provisions in States' local government legislation has traditionally curbed and controlled the power and discretion of local governments to borrow money to procure additional resources. In principle, Municipalities are only permitted to borrow money for capital investment purposes, not for financing current operational expenditures. In reality, however, the fiscal management regime depends on local economic and social circumstances.

Under pressure from growing budget deficits due to rising expenditure for social welfare purposes and shrinking tax revenues, an increasing number of municipalities have resorted to short-term borrowing to finance current expenditure. According to the German Federal Ministry of Finance, by the end of 2003 the total budget deficit of municipalities amounted to 8.467 billion, while short-term borrowing reached 16.26 billion and overall debt climbed to 88.9 billion (see Figure 7.2).

Figure 7.2 Municipal deficits, 1994-2003

Figure 7.2 Municipal deficits, 1994-2003

Source: German Federal Ministry of Finance.

Tax reform

Germany is currently implementing far-reaching but phased national tax reform. The first step of this reform (implemented in 2001) lowered income and corporate tax rates. The second stage will further decrease tax rates while the third stage is aimed at boosting domestic demand by another significant reduction in income tax rates. This could result once more in tax revenue shortfalls of up to 3 per cent at the State level.

The Federal Government and the States are currently discussing several fiscal measures to mitigate the revenue shortfalls at all government levels.

It is anticipated that tax revenue will be constrained by a further decrease in tax rates (caused by the tax reform) but then is expected to stabilise and start to grow again moderately. Fluctuations in State revenues in the short- to medium-term are expected to have a direct and indirect impact on local government.

State allocations

States have limited flexibility in revenue-raising capacity, as no individual State can alter tax rates, either by adding a regional supplement to national taxes or by changing rates of State taxes. Tax rates in Germany can only be changed uniformly throughout the country, subject to approval of both the Federal Parliament Lower House (Bundestag) and the Upper House representing the States (Bundesrat). Budget consolidation efforts of individual States focus on expenditure. All States have recently gained considerable expenditure flexibility from a change in national legislation, under which year-end gratuities and vacation allowances for State employees can be changed at an individual State's discretion. Most States have announced plans to take advantage of this new flexibility to reduce their expenditure on personnel.

The legal framework for horizontal and vertical fiscal equalisation incorporates two aims:

  • Municipalities will receive an additional source of revenue where required to minimise differences in financial power among the municipalities. This system of horizontal and vertical financial equalisation within each State varies and is laid down in individual States laws.
  • Municipalities have recourse to general (for daily operations and mid-term management) or target-linked allocations (mainly for one­ time infrastructure investment but also for running costs of important institutions such as libraries or main roads). Target-linked allocations, which may be financed by joint Federal-State funds and also from the EU, must be applied for specifically and are often dependent on a certain amount of co- financing by the local government. A more detailed description is provided under 'Local government infrastructure financing' below.

Due to the present difficult economic environment and tight fiscal situation in all spheres of government, allocations have dropped significantly over the past few years.

Fees and contributions

User fees and contributions are charged, where appropriate, for specific municipal service, such as entry fees for specific recreational facilities (for example, swimming pools), adult education, kindergartens, theatres and public utilities (such as public transport, sewerage, garbage collection) and specific administrative and passport fees. In 2003, user fees and charges made up about 13 per cent of total municipal revenue in the Western States and 10 per cent in the Eastern States.

Fees for public utilities are usually charged on cost-recovery principles while provision of cultural services and facilities are normally heavily subsidised.

Asset management revenues

Municipalities administer and manage the majority of local public services. such services include transport, building societies, local gas works, local power plants, local water works and even a number of local and regional businesses (such as vineyards and breweries). However, limited business scale (the services are often geographically restricted to the municipality), high personnel costs (public service contractual agreements with the municipality as the employer) and mismanagement have often delivered more losses than profits. Consequently, many municipalities have used the option to sell assets to raise additional funds for various purposes (financing running costs, new investment, paying of debts, and setting-up of funds to cover pension entitlements of former staff).

Income from asset sales stood at some 3 per cent of the total of municipal revenue in the early 1980s, but it rose to 5 per cent by the late 1990s. However, as many municipalities have already sold their most attractive assets, revenues from this area are expected to drop again over the middle to longer term.

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Local government expenditure

Municipal expenditures in Germany can be classified into five major categories. They are personnel, operational costs, interest payments, running allocations and supplementary payments, social welfare and other expenditures (see Figure 7.3).

Figure 7.3 Local government expenditure, 2003

Figure 7.3 Local government expenditure, 2003

Source: German Federal Ministry of Finance.

Expenditure for personnel is the largest item, averaging around 30 per cent of the current total expenditure of municipalities. Efforts which municipalities are currently undertaking to cut costs and expenditure largely focus on this item, although it is a mid- to long-term effort as public service staff in Germany are difficult to dismiss. Privatisation of services and assets and cuts in recruitment are the major efforts being undertaken in this area.

Operational costs include maintenance of buildings, rents, lighting, cleaning, telecommunications, postage, office material, and computer servicing. Operational costs make up some 23-24 per cent of the expenditure. Municipalities have succeeded in cutting costs in this area by improved facility management, leasing of items, more budget flexibility and outsourcing of cleaning services.

Interest payments - the share of debt servicing in the administrative budget has remained relatively constant over the past few years, at around 4 per cent in both East and West Germany, reflecting the discipline the municipalities have observed in long-term borrowing of money. Notwithstanding the average figures, there is considerable variation in borrowing among municipalities, depending on their particular economic circumstances.

Running allocations and supplementary payments cover subsidies, investment grants, investments etc.

Social welfare - unlike most other countries, social assistance in Germany is paid directly out of the local government budget and from local government resources. Over the past two decades, the rise in social expenditure in current budgets has been dramatic, increasing from 15 per cent in 1980 to about 25.2 per cent in West Germany and 21.6 per cent in East Germany by 2003.

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Local government infrastructure financing

According to the Basic Law, the three spheres of government are jointly responsible for meeting the necessary infrastructure costs. Certain infrastructure projects can be co-financed by the State, the Federation and even the EU, but the State remains the direct coordination partner for local government. In general, a number of co-financing models with Federal, State and Local government programs have emerged over the past few decades. The Public Finance Reform Act of 1969-70 has established the regulations for the joint task programs that are defined in Article 91a and b and Article 104, paragraph 4 of the Basic Law.

Article 91a of the Basic Law defines three mandatory joint task programs of Federation and States, they are:

  • extension and construction of institutions of higher learning
  • improvement of regional economic structures
  • improvement of agrarian structure and coastal protection.

These joint task programs are planned on an annual basis and implemented in coordination with the Bundesrat. It is important to note that the States do not just receive money but are also an integral part of the decision-making process.

The joint task program 'Improvement of the Regional Economic Structure' was introduced to overcome structural economic differences and disparate living standards across regions. Instruments include:

  • Promotion of investment in the industrial economy to create and secure employment through investment grants.
  • Promotion of infrastructure as far as is necessary for development of the industrial economy (that is, development of industrial areas, transport connections, supply and disposal facilities, tourism and technology centres).
  • Since 1995, a new focus on non-investment activities to strengthen the competitive capacities of small- and medium-sized enterprises (that is, training programs).
  • Regional development efforts/areas.

The Federation reimburses 50 per cent of the total cost to the States for these programs. The regions receiving funds under these programs are assessed every three to four years based on economic indicators, such as the number employed, income, infrastructure conditions and employment prospects. In July 2004 the German Federal Ministry of Finance reported that 23.4 per cent of the German population was affected by these programs. The new German States as a whole are part of this program through a special sub-program 'Reconstruction of the East' ('Aufbau Ost'). The Planning Committee distributes funds among the States according to the number of inhabitants in the participating regions.

Article 91b of the Basic Law allows States and the Federation to cooperate in educational planning (that is, long-term planning, promotion of scientific exchange and education and scientific networks) and promotion of research projects and institutions (for example, the Max Planck Society, equally financed by Federation and States), provided they are of 'supra-regional importance'. The Federation and the States must manage these programs jointly via the Joint Commission of Federation and States (Bund- Länder- Kommission - BLK).

Article 104a, paragraph 4 Basic Law allows the Federation to fund major investments by States and municipalities through co-financing models to overcome 'a significant disturbance of the economic balance', to equalise regional economic power or to support economic development. These measures and financing structures require either the approval of the Bundesrat or, in the case of a bilateral administrative agreement, the agreement of the affected State. Unlike with the joint task programs mentioned above, the States are free to distribute designated funds as they see fit.

The most important programs under this scheme are:

  • 'Financial Assistance for the Promotion of Living Space', which promotes creation of affordable flats and houses in designated areas and regions. Since 2002, the Federation has provided a minimum of 230 million annually to the States. The Federation pays a maximum of 50 per cent of the investment. Currently, most of the money is designated and allocated to the New German States.
  • The Federation also provides financial assistance to States for urban development in designated areas (for example, urban redevelopment in the New German States - 'Umbau Ost'). Depending on the actual program and region, the Federal contribution varies between 33.3 per cent and 50 per cent.
  • To improve local transport infrastructure (supra regional transport routes and public transport), the Federation provides financial assistance under the Municipalities Transport Financing Act of 1971. The volume of this program is limited to 1.677 billion and includes various programs and co- financing models. Eighty per cent of funds are distributed among States on the basis of registered vehicles and special needs (75.8 per cent goes to the Eastern States). The Federal Government uses the remaining 20 per cent for research and special Federal programs (such as repairing bridges).

Another important source of local infrastructure financing is EU structural funding. The New German States in particular have been accorded high priority by the EU and, as 'Target 1' regions, have profited from the various programs allowing the States to distribute extra EU money to the municipalities. However, with EU enlargement and the economic development of some regions, the amount of EU funding available for the eastern German States is likely to be reduced in 2006, when regions from the new (comparatively poorer) EU member States compete for funding.

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Like most European countries, Germany embarked upon a public sector reform program in the mid 1960s. Between the mid 1960s and early 1970s the State governments (west Germany) amalgamated municipalities and counties (districts) to create larger local government units as viable territorial units. Hence, the total number of municipalities was cut from 24 000 to some 8400 and that of the counties from 425 to 237.

After German unification, the policy of amalgamating municipalities was also introduced in east Germany and is expected to continue due to a significant decline in population. Some regions in west Germany are also facing problems of demographic decline, as fewer children are born and young people leave for more successful economic centres. A major challenge for municipalities in east and west Germany will be the management of demographic change.

In most States, territorial amalgamation of municipalities went hand in hand with functional reforms that were meant to delegate administrative functions from State authorities to local authorities, in part by abolishing State field offices. The public finance reform of 1969 provided a constitutionally entrenched right to 'revenue sharing' of the income tax collected.

In the 1970s, with increasing budgetary problems, cost reduction policies, such as 'task scrutiny' that was meant to analyse performance of local government activities, were adopted. Furthermore, natural competition between different spheres of government (often represented by different political parties) hindered consistent and far-reaching cooperation. However, a deteriorating fiscal situation has stimulated significant changes in administrative management and attitudes.

After German unification, further reforms in the financial relationship between Federation and States were undertaken, with implications for local government. The fiscal relationship between east and west Germany went through two periods of change. The first was a transition period between 1990 and 1994, during which an extra-budgetary 'German Unity Fund' was created as a temporary fund to finance East German States and municipalities. In 1995, integration of the five new States (including the merger of East Berlin with the western City State of West Berlin) into the German fiscal equalisation scheme was based on the continuity of the revenue sharing arrangements.

The process of fiscal reunification deeply disrupted patterns of national equalisation, requiring the Federation to step in with large supplementary payments and the introduction of new reforms. Following a minor reform in 2001 (which relieved the 'donor States' while increasing the Federal share), the Federation and the States are currently debating the reform of German Federalism in a joint commission which is due to present its findings shortly. However, information available so far indicates that a major structural reform is not likely to come anytime soon.

On the State level, local government has been subject to a wave of institutional change since the early 1990s as the States decided to significantly recast the institutional setting of local democracy. The States introduced legislation for more direct local democracy through the direct election of mayors and heads of counties and by introducing binding local referendums.

In some States, the direct election of the mayor went hand in hand with a new provision allowing removal of the mayor from office by way of a local referendum. This process has ensured direct political accountability and has proved particularly effective where the incumbent mayor has sought re-election. In most States, the mayor is also the chief executive officer of the Municipality.

The 'New Steering Model' introduced in the 1990s has resulted in significant changes to the politico-administrative structure and activities of local government. This applies particularly to concepts and measures to introduce 'performance management', performance indicators and inter-municipal benchmarking, privatisation of public utilities and cost-recovery. In addition to financial necessities, the implementation of EU legislation has helped to enforce this trend.

However, despite successes in cutting costs and reducing bureaucracy, local government in Germany continues to suffer from high fixed expenditures, like social welfare, that it is unable to influence. To relieve local government of these fixed obligations, the recent labour market reform program (Hartz IV) transferred 'employable' social welfare recipients from municipal to the Federal level of responsibility (through the Federal Labour Office).

In the future, three principle trends are expected to drive further restructuring and reform of local government, they are:

  • continuation of the new steering model reforms
  • tax reforms and fiscal measures
  • recent policy measures relating to deregulation and liberalisation pursued by the EU in enforcing free market competition in the provision of services,
    including public utilities.

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Comparison of Australian and German local government

In many aspects, local government in Germany contrasts significantly with the Australian local government. Some salient differences are:

Federal constitutional recognition: A high degree of autonomy of local government is guaranteed in the German Constitution. Germany's local government has been rated as having a relatively high degree of autonomy among European local government systems. In Australia, local governments are established and operate under State and Territory legislation.

Federal constitutional guarantee of shared revenues: A uniform standard of living conditions across the States is also guaranteed in the Constitution. To achieve this uniform standard, sharing of revenues generated by both Federal and State governments is also guaranteed in the Constitution. The fixation of tax shares for several years in advance guarantees local governments a stable source of revenue as well as the incentive to increase tax yields by encouraging tourism, investment and prosperity. In Australia, federal tax revenues are not shared with local government, but local government receives significant funding though the financial assistance grants and roads grants.

In 1995, in a study of OCED countries, the share of local government revenue as a percentage of GDP was almost 10 per cent in Germany while in Australia local government had a share of only around 2 per cent of GDP.

Access to a stable tax for local government: Local government in Germany has access to a stable tax in terms of VAT revenues that are shared with the Federal and State levels. Unlike income and corporate tax, VAT is less susceptible to economic and business cycles. Further guarantees in the sharing of taxes with the Federation and States also provide a stable revenue base. Local government in Australia has more limited access to a stable tax through the financial assistance grants from the Australian Government.

Transfer of administrative functions: In Germany, while most legislative and policy-making powers lie at the Federal level, the policy implementation and administrative functions are almost entirely left to the States. At the same time, a long-standing practice of the State governments is to delegate most of the policy implementation and administrative tasks to the local authorities so the representative offices of the States, at the regional or local levels, are very small. In Australia, both State and Federal governments have field staff and regional offices. In Australia, constitutional responsibility for local government lies with the States that are also responsible for local government administrative and financial management issues. In Australia, transfer of functions by States onto local government has led to claims of cost-shifting.

Local direct democracy: German local government has direct local democracy through the right to directly elect mayors and to remove them from office by referendum. In Australia, the State or Territory government may suspend councils, or abolish or amalgamate local governments.

Continuous reform: Germany has for the last 30 years continuously reviewed and reformed its local government both territorially (amalgamations) and functionally (rationalisation of functions with Federal and State). Performance assessment and benchmarking are critical themes in German local government management. In Australia, review and reform of local government has occurred within the States and has also occurred at the federal level, most recently through the Hawker Inquiry.

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