Fiscal Sustainability Across Government Tiers



XREAP2007-14

We have displayed the deficit ratios for the German Lander in figure 5a. The situation of the three
city-states (Berlin, Bremen and Hamburg) and the smallest German region (Saarland) are illustrative
of the evolution of public finances of all Lander. The first characteristic concerns the bailed out states.
The peak in deficits in Saarland and Bremen in 1992 shows the enormous fiscal havoc in both states
that led to the federal bail out in 1993. The continuous financial support to both regions has only in
part led to a reduction in deficits, and deficits have continued to grow in recent years. A second
striking feature of figure 5a is the dramatic fall in Berlin’s budget surplus. This is part of a
phenomenon observed in all former Eastern-German Lander. Deficits quickly shot up directly after
Reunification as the new states faced very large spending responsibilities at a moment that economic
transition caused revenues to fall.16 Until 1994, a large gap between both sides of the budget persisted.
At that point, these states entered the
Finanzausgleich system, and were entitled to extra revenues. The
consequent increase in revenues brought state budgets closer to equilibrium. In contrast to Berlin, most
former Eastern German states have been able to contain deficits to a level that is only slightly higher
than in the old Lander. A final feature of the fiscal behaviour of lower tiers is the build-up of deficits
during the eighties in old Lander. After Reunification, these Lander have kept deficits under control,
but this has become more difficult in recent years. Deficits have started to grow again in all Lander. As
a consequence, the steady position of debt in a range of about 10 to 25 per cent across Western
German Lander has not been kept (figure 5b). The debt evolution highlights differences in deficits in
the Eastern and Western German Lander. Public debt levels in the Eastern Lander seem to converge to
German average of about 35%. Berlin and Bremen, and to a lesser extent Saarland, are accumulating
ever larger debt.17

4. Results

Table 1 replicates the estimates of fiscal rules for general government of other studies. The estimates
of the baseline fiscal rule on general government data confirm some of the earlier evidence in the
literature.

US fiscal policy is sustainable over the period 1963-2000. The response is somewhat weaker than
what other studies find. Most other studies find a response of the primary surplus that is nearly the
double. Bohn (2005) argues that a weak debt response is due to an omitted variable problem. The
result seems nonetheless rather robust: the reaction coefficient does not change once we allow for a

16 The only exception here is Sachsen.

17 Berlin applied for federal government intervention in October 2006, but its request was repealed by the
Federal Constitutional Court.

13



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