Domestic roots to German wariness on EU solidarity in Berlin

ANALYSIS: WHEN GERMAN chancellor Angela Merkel put the kibosh on eurobonds this week, observers around Europe saw Madame Non strike again.

Her resistance was clear: making Germans liable for Greek debt through common euro zone bonds without adequate safeguards would put the EU on a slippery slope into a transfer union – the dirtiest word today in the German political lexicon.

Another round of accusations of Berlin’s lack of solidarity to euro zone neighbours followed. All such arguments are understandable, but nothing new to German ears. They have been having this argument with themselves since 1952.

In that year West Germany's Länderfinanzausgleichcame on stream, a system of "equalisation payments" between federal states. In nearly six decades, Germany's internal transfer union has redistributed €156 billion between richer and poorer states. The programmes follow a constitutional obligation for government to even out regional differences with public money.

“In Germany we still want to have similar standards of infrastructure around the country, for instance, even if the incomes vary widely from one region to another,” said Dr Michael Dauderstädt, head of economic and social research at the Friedrich Ebert Foundation.

By far the largest component of Germany’s equalisation fund is the so-called “horizontal” payment system between federal states. Using a complicated key, states with above-average income are automatically classified as donors and those below average are recipients. Up to 75 per cent of a donor state’s income surplus can be tapped for redistribution through the equalisation fund.

States that still find themselves below average levels after the first “horizontal” inter-state payments are entitled to assistance from a second “vertical” pot, financed by the federal government. Together these two funds have redistributed €172.89 billion.

Given that considerable sum, it’s surprising that rows about public finances in Germany are usually dominated by the Aufbau Ost, transfer payments to rebuild eastern German states.

There’s a simple reason for that. Of Germany’s 16 federal states, 13 are quietly tapping the equalisation fund while just three states pay into the pot: Bavaria, Baden-Württemberg and Hesse.

Last year the three handed over €6.93 billion to the other 13 states – more than the €6.3 billion Germany as a whole contributed to the EU budget in 2009.

Unsurprisingly, these donor states are making the loudest demands for radical reform of the system. They say current rules penalise them for balancing their books and generating tax revenue, obliging them to turn over three-quarters of extra tax income to their neighbours.

In the long-term recipient states, officials concede that the transfer rules can have a negative effect on political initiative and frugal housekeeping. The city-state of Berlin, for instance, has debts of €63 billion, despite total transfers of €42 billion from the inter-state equalisation fund. Without transfers from prosperous southern states, the German capital would have sunk long ago.

Germany’s domestic transfer system is the source of much of the German angst over a European transfer union.

That’s not to say that Germany’s domestic transfer union hasn’t had positive effects. It has, for instance, turned many cherished stereotypes on their head.

Cash transfers, along with budget cutbacks and austerity measures, have put four of Germany’s five eastern federal states – all recipient states – on course to present balanced budgets by next year.

Many western recipient states, meanwhile, will struggle to meet Germany’s new constitutional “debt brake” deadline for a balanced budget by 2020.

The system has created benefits, but no shortage of ill-will among neighbouring states. Rheinland Palatinate – a recipient state – offers free kindergartens for all, while Baden-Württemberg still asks parents to pay for childcare. Since 1952, however, it has contributed €48 billion to the equalisation fund as Germany’s only continuous donor state.

Domestic transfer squabbles in Germany feed the feeling of resentment here that it is unfair to bail out Ireland or Greece, given their low corporate tax rates or retirement age.

Meanwhile, donor states are confident they can reform the system in the coming years.

“A reformed equalisation fund should increase the incentives for states to increase their tax take, without allowing donor countries to refuse assistance to recipient states,” said Dr Frank Kupferschmidt, spokesman for the Baden-Württemberg finance ministry. “Every transfer system should reward initiative and effort of every kind.”

In the ongoing debate over solutions to the euro zone crisis, calls from around Europe for Germany to lead by example on solidarity are understandable. But they should be seen in the context of Germany’s own, six-decade solidarity experiment.

“Of course Germans see the current developments in Europe through their own experiences with transfers,” said Prof Berthold Wigger, financial science professor at Karlsruhe Institute of Technology.

“In this crisis the Germans don’t want to moralise to others, they simply don’t want to see the weakness of their own transfer system transferred onto Europe.”