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Macroeconomic implications of the German financial equalization system

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  • Matthaei, Stephan
  • Stähler, Nikolai

Abstract

The provisions of the German financial equalization system (Länderfinanzausgleich), a specific form of a fiscal union among the federal states (Länder), will expire in 2019. In this paper, we assess the effects of the system as well as of reform proposals on key macroeconomic variables and welfare by means of a two-region general equilibrium model. We find that, on the one hand, as expected, abolishing tax revenue equalization would favor transfer paying states in terms of GDP and consumption, and significantly hurt receiving states. Furthermore, households living in the financially strong states would benefit from higher wages and more leisure. This induces migration towards these states. On the other hand, on aggregate, the average German household's welfare would be negatively affected, even though those who live in the paying states would gain. However, the negative macroeconomic effects involved by the abolition of the equalization transfers might potentially be countervailed by the concomitant reduction in disincentive effects for the budgetary policy.

Suggested Citation

  • Matthaei, Stephan & Stähler, Nikolai, 2016. "Macroeconomic implications of the German financial equalization system," VfS Annual Conference 2016 (Augsburg): Demographic Change 145695, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc16:145695
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    JEL classification:

    • H70 - Public Economics - - State and Local Government; Intergovernmental Relations - - - General
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory

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