The Vertical Fiscal Gap in the German Federation

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