University of Augsburg
The special limitation and protection function performed by the financial constitution
There can be no functioning state without money. Finances enable policy-makers to act. The constitutional rules governing finances – the financial constitution – therefore determine an essential power factor, and in this respect bring about a highly-distinctive separation of powers between the Federation, the Länder and municipalities. Security (police, the military and the fire services), infrastructure (roads and railways), education (kindergartens, schools and universities), and general services of public interest, are largely financed via taxation. The taxpayer expects to pay moderate taxes, but also expects the public sector to operate in an effective manner, and frequently demands better state services. The Federation, the Länder and municipalities often demand more financial resources, and hence a greater margin of appreciation for action. Therefore, the financial constitution has to fulfil special limitation and protection functions which are of central importance within the public sector and in the relationship between the latter and its citizens – pecunia nervus rerum. It ultimately serves to guarantee the preconditions of the state and ultimately freedom, whilst seeking to implement the fundamental concerns of financial and fiscal justice.
The fiscal state
The German financial constitution assumes that the modern state is a fiscal state. The financial state derives its income primarily from taxes, i.e. from the money that it demands in payment from its citizens. The public sector deliberately renounces other financing instruments, benefits in kind or work, and does not engage in economic activity of its own. Were the state to attempt to generate its revenue through such economic activity, freedom of competition would be placed at risk. The structural superiority of the public sector as legislator and guarantor of the general infrastructure would lead to distortions of competition. Taxes constitute the tool with which the state is funded within a system based on freedom. Through obligations to pay and extensive obligations to collaborate, they do, however, impose constraints on freedoms provided by fundamental rights. In this ambivalent condition, which the fiscal state takes for granted, fundamental rights require that a fiscal burden be imposed, whilst at the same time seeking to lessen this very burden.
State loans as an exception in need of justification
As a matter of principle, loans are also not a suitable means of financing the public sector, even in the current low-interest phase. If the state needs money, taxes must be increased. In the early 1970s, a constitutional amendment in Germany made credit a self-evident instrument of budget financing. It was not until the constitutional reform that took place in 2009 and introduced new limits on borrowing (Art. 109 para. 3 and Art. 115 of the Basic Law) that this development was largely brought to a halt. Both paradigm shifts have their origins in amendments to the Basic Law (‘BL’) which significantly altered political practice. The resignation of Finance Minister Alex Möller in May 1971 may serve to illustrate this rethinking. Möller did not want to shoulder the responsibility for the Federation taking out a loan, the equivalent in today’s terms, of eight billion Euro. An irony of history is that the new limits on borrowing allow the Federation to borrow 0.35% of gross domestic product – currently corresponding to approximately nine billion Euro, thus slightly more than the debt that led Möller to resign.
Explicit and implicit government debt – intergenerational justice
State loans are sometimes justified on the grounds of intergenerational justice. If a railway line or nuclear power plant is built, future generations will also be able to use it and are therefore also to bear a portion of the costs through the loan. This idea of a kind of exchange justice between the generations is however misguided. First and foremost, a political preference is imposed on the next generation for the railway line or for nuclear energy. However, even independently of this, exchange justice would only be fully realised if the burdens were also factored in, i.e. if provisions were also made for the considerable interest accrued, the maintenance of the railway line, the disposal of nuclear waste and other risks besides. But even if this is the case, the monetarisation of the generational relationship would be misguided. Each generation benefits first and foremost, without any input on its part, from the conditions created by the previous generation, the buildings, the infrastructure, the knowledge and the social standards. It then strives to improve its living conditions and passes on the results of this process to the next generation. Monetarising this development in a kind of exchange justice is inappropriate. Progress should not be financed by the coming generation but should be continued for its own sake, in the interest of the present and of the future. In the first 25 years of the Federal Republic’s existence, the country needed to be rebuilt. Explicit national debt rose to approximately 63 billion Euro in today’s money, which is a moderate level by current standards. Today’s debt amounts to more than 2,000 billion Euro, i.e. more than 30 times that amount. And this is without any need for a comparable reconstruction effort. What is more, implicit national debt, which is significantly higher, and is difficult to measure, is attributable to future disbursements from the pay-as-you-go social insurance schemes and pension entitlements of civil servants. In the period of steadily-growing debt that defined circumstances from the 1970s onwards, new borrowing was sometimes insufficient to pay off interest. Between 1950 and 2008, the Federation, the Länder and municipalities took up loans to the tune of 1,600 billion Euro, and disbursed 1,500 billion Euro in interest payments. The state has placed a considerable burden on the future generation in terms of interest and repayment charges, without gaining significant additional financial capacity. Unlike private entrepreneurs, state investments do not promise a direct profit from which these burdens can be repaid. Justice between the generations does not prohibit all borrowing on the part of the state, but it does block the pathway towards such devil-may-care indebtedness. In any case, and also in contrast to private entrepreneurs, the public sector has a financing instrument at its disposal, namely taxation, which it can use instead of loans, and which it is to use for democratic reasons. Taxation makes the political responsibility for income and expenditure tangible, does not postpone it, and does not hide it over the generations.
The fiscal state
The modern state finances itself first and foremost through taxation. As is also presupposed by the financial constitution, it is a “fiscal state”. Non-fiscal levies require special justification. Contrary to this rule/exception relationship, the advantages of fees and contributions are stressed from time to time. If the obligor has to pay a fee or a contribution in order to obtain an advantage, he or she is made aware that state services cost money. We therefore see that non-tax charges amplify the cost responsibility and economic efficiency of the state. By contrast, taxation is said not to make people sufficiently aware that public services need to be funded, and is thus is said to pave the way for excessive policies. Such advantages attaching to non-fiscal levies must not however lead to the conclusion that the fiscal state should be converted into a state that charges fees. The primacy of funding through taxation is a cultural achievement of the Enlightenment. If the public sector were to finance itself consistently through charges similar to fees, certain services would only be made available to the wealthy. However, security and the general infrastructure consisting of services of public interest are guaranteed by the public sector to everyone, regardless of their financial capacity. It is fundamentally alien to the social welfare state to withhold state services from citizens just because they are unable to pay for them. This precedence attaching to taxation vis-à-vis other financial instruments is confirmed by a consideration of equitableness. As a rule, fees and contributions are levied regardless of the individual’s identity. The fee for a permit, for water, energy or disposal services, does not depend on the obligor’s ability to pay. On the other hand, taxes – especially income tax – are based on capacities, and hence on an individual’s ability to pay.
Separate and independent budgeting in the federal state – tensions
The financial constitution is contingent on the financial and fiscal state and, on this foundation, establishes the fundamental order of public finance, regulates the income of the public sector, and distributes it among the territorial authorities. If a task is assigned to the Federation or to the Länder, they must carry it out and bear the corresponding financial burdens independently. The responsibility for expenditure, and the burden of expenditure are interlinked (“connectedness”, Article 104a BL). The Federation and the Länder are independent in terms of financial constitutional law and are responsible for their budgets through their parliaments and governments (Article 109 BL). Under financial law, municipalities are considered to be part of the Länder. Having said that, their financial independence is also guaranteed (Article 28 BL).
These two pillars of German financial law – connectedness and financial autonomy – currently have to prove themselves in four conflicting situations. In the system of separate budgeting, cooperation in the federal state is – firstly – a matter of course. In particular, the Federation and the Länder must jointly comply with the stipulations of budgetary discipline under European law and maintain the overall economic balance. This cooperation runs the risk of engendering unconstitutional financial entanglements. Federal financial assistance is the exception, and this is only permitted within narrow constitutional limits (Art. 104b et seq. BL). Secondly, however, in the past, the Federation – particularly when it comes to the responsibilities of the Länder for culture, childcare and schools – has offered considerable funds for specific measures, contrary to these requirements, and has thus steered Länder policy with “golden reins”. Thirdly, the Federation enacts numerous laws in Germany which are generally administered by the Länder. The essential tax laws (Article 105 BL) are also the responsibility of the Federation and are administered by the Länder. However, due to connectedness, the administration generates costs for the Länder, and these depend on the legislative decisions of the Federation, and thus on decisions for which the Länder are not responsible. Fourthly, financial differences between the Länder are partially compensated for, in a federal state, based on solidarity (Article 107 BL). Although this principle is acknowledged, the concrete manifestation of the fiscal equalisation between the Länder is the subject of heated debate. It is sometimes lamented that the differences, and thus the incentives for sound finances and innovative structural policy, are levelled out.
No representation without taxation
Taxes form the monetary lifeline of the modern state, ensuring that it can perform its tasks. Tax revenues, in their fundamental autonomy, lend the public sector the necessary broad scope of action for Parliament when it draws up the budget (Article 110 BL), from which it may only deviate in exceptional cases (Articles 111 to 113 BL), and which is audited by the Court of Auditors (Article 114 BL). Taxes, therefore, amplify the freedom of parliamentary democracy to act. At the same time, Parliament is responsible for ensuring that taxes are only levied at an appropriate level. Central budgetary law thus has a policy-facilitating, but also a policy-restricting, function. This connection was summed up in the early days of modern democracy by the principle of “no taxation without representation”. Politics can hardly be pursued without financial resources. With turnover tax, income tax and corporation tax, however, the most profitable levies are shared between the Federation and the Länder. The corresponding tax laws are passed by the Federation. The revenues are then distributed according to a complicated key (in overall terms, Art. 106 et seq. BL). Each Land receives a certain amount of financial revenue on which it may not decide independently. However, a functioning parliament expects to have its own resources in order to be able to, independently, implement new financially-powerful measures and to answer to the taxpayer, in terms of both the burdens and the advantages. The well-known democratic electoral slogan can therefore also be reversed in this respect: “no representation without taxation”. For the German federal state, this would mean granting the Federal Länder considerable fiscal competence of their own. This would strengthen democracy in the Länder, but at the same time the differences between the Länder would probably widen.
Gregor Kirchhof is Professor of Law at the University of Augsburg where he holds the Chair for Public Law, Financial Law and Fiscal Law and is the Director of the Institute of Economic and Fiscal Law.
Suggested Citation: Gregor Kirchhof, “The financial constitution of the Basic Law” IACL-AIDC Blog (26 September 2019) https://blog-iacl-aidc.org/70-years-of-the-german-basic-law/2019/9/26/the-financial-constitution-of-the-basic-law