XREAP2007-14
3. Sharing the burden of debt
3.1. The fiscal system in the US and Germany
The US and Germany provide a good testing ground for our hypothesis. Both are federal countries
with rather similar institutional settings for fiscal policy. Both US states and German Lander are able
to issue debt autonomously, but neither have access to central bank financing, nor can they be sued
and trialled for bankruptcy. The conduct of regional fiscal policy is constrained by fiscal rules. In the
US, these rules are self-imposed but have nonetheless not avoided bankruptcy at the county or city
level.9 Article 115 of the German Basic Law allows for a ‘golden rule’ deficit and this applies both to
the federal and the state governments. Only under the exceptional circumstances of a general
economic disequilibrium is further deficit financing allowed. The interpretation of Article 115 has
been rather generous, however, as prolonged violations of this rule have never led to court trials, nor to
any reprimand by the federal government. Fiscal bail outs by the federal government or other regional
governments are not explicitly prohibited. Two small German states - Bremen and Saarland - sued the
German government for the Federal Constitutional Court when a fiscal crisis loomed at the end of the
eighties. The Court forced the Federal government to directly finance both states’ budgets on the basis
of the constitutional principles of fiscal homogeneity and the equalisation of living conditions.10
The structure of regional budgets is similar in both fiscal systems. US states and German Lander are
responsible for about 40% of total government spending (figure 1a). While this share has remained
constant over the nineties, US states have been crowding out federal policies and now account for half
of all government spending. A good summary indicator of the dependence of regions on transfer
financing is vertical fiscal imbalance. This ratio of received transfers on total regional government
spending reflects the gap between the sub-national government’s own revenue and its expenditure
responsibilities.11 Grants finance a similar share of spending in the state budgets in the US and
Germany (figure 1b). Nonetheless, while the majority of transfers to US states are provided by the
federal budget, Lander are predominantly financed by intergovernmental transfers. Fiscal homogeneity
across German Lander requires the balancing of resources over different tiers of government and
between economically weak and strong regions. This horizontal repartition of government revenues
9 Some well known examples are New York City in the 1970s, Orange County in the 1980s and Washington DC
and Philadelphia in the 1990s.
10 Fiscal crises in other Lander have largely been avoided by a mixture of controls on the projected debt service
of Lander, the coordination of financial policies for all tiers of government by the Financial Planning Council,
and administrative controls on local government financing.
11 Various studies have found that the probability of a bail out depends on this indicator (Singh and Plekhanov,
2005).
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