The Vertical Fiscal Gap in the German Federation

The paper examines the magnitude of the vertical fiscal gap in Germany and its developmentover time and explores the drivers of this development from re-unification in 1991until today. The results indicate a declining trend of the vertical fiscal gap. In the lastdecade, less than 10% of total subnational government expenditure is covered by verticalfederal grants, over 90% is financed with own revenues, which is a large share by internationalstandards. This development partly reflects fiscal consolidation but, primarily,is caused by an increase in revenue decentralization, fueled in particular by an increaseof the subnational share of VAT revenues. We also explore how the vertical fiscal gapvaries by state and find that the small gap for the country as a whole masks importantdifferences across states. Half of all states display a substantial vertical fiscal gap, rangingbetween about 27% and 38%. Two states display a negative fiscal gap indicating thatthey transfer part of their own revenues to the federation.