Fiscal policy, deficits and politics of subnational governments: The case of the german laender

The first part of the paper briefly describes institutional aspects of the German federal system and examines the economic and fiscal performance of the German Laender since 1970. Taking into account the institutional settings, especially the fact that the German Laender cannot set tax rates individually, we develop a highly stylized model of subnational governments that do not have access to the tax rate instrument and thus have to use expenditures as a policy variable. The model implies an expenditure smoothing policy of subnational governments and complements the famous tax smoothing model. The empirical section examines whether governments of various ideology show significant differences in fiscal stabilization policy. Our results indicate that regional differences in public debt accumulation and public expenditure policy in general is largely determined by interregional differences in economic performance, whereas we do not find any significant impact on the ideological composition of the Laender governments.