Germany must strengthen its balanced-budget amendment at the state level

In 2009 German policymakers ratified a constitutional amendment to limit new debt creation. The "debt brake" provisions that were adopted stipulate that all German states must have balanced budgets by 2020. The debt brake has encouraged numerous German states to engage in fiscal reform. Yet many states are still a long way from achieving balanced budgets - and they are doing too little to address this problem. One example is the state of North Rhine-Westphalia. The state budget in 2013 foresees a deficit of 3.6 billion euros, and expenditures of 60 billion euros. If one ignores the cost of liquidating the failed bank WestLB, the deficit compared to last year is 0.1 billion euros lower. Expenditures are expected to rise 2.5% annually through 2016, and the budget deficit is to be reduced successively to 2.5 billion euros by this year.

This target for deficit reduction in North Rhine-Westphalia is insufficient, as it fails to make use of the opportunity offered by strong tax revenues for a much more considerable deficit reduction. If the recession plaguing Southern Europe and France spreads to Germany, then the current boom in tax receipts could come to a rapid end. Deficits would rise considerably and policymakers would be confronted by the need to either violate the balanced-budget amendment or drastically reduce expenditures during a time of economic weakness.

What can be done to ensure that all German states take necessary deficit reduction measures? Pressure from financial markets cannot be expected. Germany's Supreme Court has ruled that an overly indebted state has a right to receive aid from both the federal government and other states. However, such shared liability for debt undermines the incentives for individual states to engage in fiscal consolidation efforts. If this situation remains unchanged, then it will be necessary to take political and legal measures to ensure that the balanced-budget amendment is adhered to. But what measures should be taken?

First, an obligatory path for deficit reduction similar to that binding on the federal government should be ratified for all German states. In this regard, deficit reduction targets must take into account that the tax revenue growth currently witnessed is probably not sustainable. Second, it will be necessary to effectively supervise the financial policy of Germany's states. Germany's Stability Council (Stabilitätsrat) could fulfil this supervisory role. Currently, the Stability Council is only responsible for reviewing whether Germany's states face impending budget crisis. The Council should also be entrusted with reporting on whether states are adhering to deficit reduction targets, as well as with instructing them to implement corrective measures.

Third, procedures must be implemented for the event a state fails to adhere to reduction requirements despite a warning from the Stability Council. Financial sanctions, such as those currently in place at the European level, have little effect. On the one hand, they would have the disadvantage of further worsening the critical financial situation of a violating state. One the other hand, sanctions are even more poorly suited to Germany's federal system than they are in Europe. Because of the shared liability for debt under German federalism, highly indebted states have considerable leeway to take on even more debt. Accordingly, any fines assessed to states for failing to adhere to deficit targets could simply be paid for with greater debt assumption. It would be more effective to impose mandatory expenditure reductions or tax increases – for example, supplementary property or income taxes in violating states. This would lead to lower deficits. And it would also encourage the residents of states sanctioned with such measures to pressure their legislators into adhering to deficit reduction targets.

Germany demands that other eurozone members adhere to debt limits. This demand will certainly lose credibility over the long term if Germany fails to ensure adherence to self-adopted deficit reduction rules within its own borders.