Facing Major Financial Hurdles: States Demand Federal Aid Following Economic Stimulus Package
Germany's Federal Government in Action
Germany's federal government is pushing ahead with a massive Economic Stimulus package to boost the economy. However, the plan is expected to lead to tax losses of nearly €50 billion, primarily for states and municipalities. In response, they've made their approval conditional on federal aid.
Chancellor Friedrich Merz, after lengthy discussions with the 16 minister-presidents, agreed that municipalities, especially, need compensation, claiming potential tax losses from the investment program. Over the weekend, a working group will devise a plan for temporary relief for states and municipalities using direct, time-limited compensation measures.
States and municipalities are poised to bear the brunt of the expected tax losses over the coming years. According to draft bills, municipalities could lose €13.5 billion, states €16.6 billion, and the federal government €18.3 billion - a total of about €48 billion. Unsurprisingly, they're demanding relief.
Merz acknowledges that many municipalities are in dire financial straits. He's quick to mention that the term "compensation" might be incorrect, as states and municipalities could see increased tax revenues following the targeted economic recovery. The specifics of the compensation measures will be determined "promptly" in a working group, keeping value-added tax distribution in mind.
The federal government also promised the states they would implement the coalition contract's agreed principle: that any additional costs or reduced income for states and municipalities due to federal decisions would be offset (compensation nexus). Financial compensation would be provided through value-added tax points or fixed amounts, with proposals due after the summer break.
The federal government assured states and municipalities of a fixed €100 billion loan from the Infrastructure Fund, with the federal government covering the interest and repayment. Funds will be distributed among the states equally, as per the confirmed Keystein key in 2019 and the updated key in 2024.
Regarding municipal old debts—a hurdle for investment—Merz has not engaged in discussions yet. Possible talks may occur in the fall as part of a broader tax reform. The situation with old debts is complex and mainly affects three federal states. Governments that have resolved the issue are demanding compensation if the federal government supports other still struggling states.
Behind the Scenes: A Closer Look at the Economic Stimulus Package
The compensation measures being negotiated between the federal government and states/municipalities in Germany largely revolve around a significant corporate tax relief and incentive program, including:
- A substantial tax incentive package totaling approximately €46 billion from 2025 to 2029, aimed at supporting companies and stimulating economic growth.[2][5]
- A phased reduction of the corporate tax rate, falling by 1 percent annually from 2028, aiming for a 10% tax rate in 2029.[1]
- Companies will receive a "super depreciation" incentive by deducting 30% of the cost of new machinery and equipment from their taxable income during the period 2025 to 2027.[1][2][5]
- Special tax advantages are included for electric company cars, allowing businesses to reduce their tax burdens when purchasing environmentally friendly vehicles.[1][2]
- These tax breaks will reduce tax revenues for the federal government and consequently for the states/municipalities. The Ministry of Finance projects a reduction in aggregate tax revenue for the states by about €26.4 billion over 2025-2029 due to weaker tax revenue growth linked to these tax incentives.[4]
- The federal government and states are likely discussing fiscal arrangements to balance out this revenue shortfall, ensuring that states and municipalities maintain financial stability despite the reduced tax inflows.
- The Economic Stimulus package in Germany includes a corporate tax relief and incentive program worth approximately €46 billion from 2025 to 2029, which is anticipated to reduce tax revenues for both the federal government and the states, following the principle of compensation nexus.
- In response to potentially increased costs or reduced income for states and municipalities due to federal decisions such as corporate tax incentives, discussions are ongoing to ensure fiscal arrangements that maintain their financial stability, which could involve direct, time-limited compensation measures or fixed amounts from the value-added tax distribution.
