Fiscal Incentive Effects of the German Equalization System

Author/Editor: Stehn, Sven Jari ; Fedelino, Annalisa
Publication Date: June 01, 2009
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: Does reliance on transfers weaken fiscal discipline and encourage pro-cyclical fiscal policies in recipient subnational governments? Using fiscal reaction functions for a panel of the German Länder, this paper finds a positive answer to both questions. Net-recipient states (Länder, benefiting from the transfer system) have not reduced primary expenditure significantly in response to rising deficits, but have instead relied on vertical transfers from the federal government to ensure debt sustainability. Moreover, they have pursued pro-cyclical policies, particularly by raising expenditures in good times. Net-contributing Länder (paying into the transfer system), in contrast, have ensured fiscal sustainability through spending adjustments; they have also been less pro-cyclical. Panel vector auto-regressions confirm these findings.
Series: Working Paper No. 09/124
Subject(s): Data analysis | Economic models | Fiscal policy | Fiscal reforms | Fiscal sustainability | Germany | Government expenditures | Tax policy | Tax reforms

Author's Keyword(s): Fiscal federalism and equalization | cyclicality and sustainability of fiscal policy
Publication Date: June 01, 2009
Format: Paper
Stock No: WPIEA2009124 Pages: 29
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