Local Government Financial Equalisation; General Information

Financial equalisation, in the broader sense, refers to the sum of all regulations governing the distribution of responsibilities, expenditure and revenue amongst local authorities. The Bavarian Act on Fiscal Equalisation between the State, Municipalities and Municipal Associations (Bavarian Fiscal Equalisation Act – BayFAG) sets out the extent to which local authorities are entitled to a share of the State’s tax revenue and how the funds made available by the Free State are distributed. Municipal financial equalisation in the narrower sense deals with financial relations between local authorities.

As part of the municipal financial equalisation scheme

• the State shall increase the funding allocated to the three levels of local government (municipalities, counties and districts) so that they have sufficient resources to carry out their duties;
• the State regulates the funding of the districts and counties through the district and county levy;
• the various sources of revenue for individual local authorities are balanced to a large extent in line with their needs;
• targeted support is provided for local authority investment projects and
• State funding relieves the burden on local authorities in financing their day-to-day tasks.

Objectives of the municipal financial equalisation scheme

The municipal financial equalisation scheme has two main objectives: one relating to fiscal policy and the other to redistribution policy:

• On the one hand, central government grants supplement the local authorities’ own revenue. Local authorities are supported so that they can carry out their duties effectively.
• On the other hand, fiscal equalisation is intended to ensure that financial resources are distributed amongst the various levels of local government and the individual local authorities in a manner commensurate with their responsibilities. Local government
  
  fiscal equalisation thus contributes to the creation of equivalent living conditions throughout the country. However, the principle of equal treatment and the constitutional guarantee of local self-government set a limit here: the varying financial capacities of the local authorities must not be completely levelled out or even over-levelled.
  
  Both objectives are consistent with the state’s role as the guarantor of local self-government. The ability of local government bodies to act independently requires them to have sufficient financial capacity. The state is therefore constitutionally obliged, within the limits of its own capacity, to ensure the financial viability of its local authorities.
  
  Key features of the current equalisation
  
  system The system of municipal financial equalisation is characterised by several structural features, of which two in particular are distinctive. The first
  
  key feature is the so-called tax pools. Through these, local authorities receive a percentage share of certain tax revenues collected by the state. In this respect, the state and the local authorities form a kind of ‘community of shared destiny’.
  
  The second defining feature consists of the transfers between the various levels of local government and between the state and the local authorities. As a result, the flow of funds moves not only ‘from top to bottom’ but also ‘from bottom to top’.
  
  Sources of municipal financial equalisation (Where do the funds come from?)
  
  Funds from the Free State of
  
  Bavaria The state’s financial equalisation payments are financed through the tax pools and from other general budgetary funds.
  In Bavaria, the municipalities participate in four different tax pools:
   
• General Tax-Sharing Scheme (Section 1 of the Bavarian Financial Equalisation Act – BayFAG)
  Under the General Tax-Sharing Scheme, the Free State of Bavaria grants municipalities and districts a share of its revenue from income tax, corporation tax, value added tax (excluding those shares which are allocated to local authorities under special arrangements or which are transferred to the State by the Federal Government for specific purposes) and the trade tax levy. This share will rise from 13.0% to 13.3% from 2026 and to 13.5% from 2027. This will result in a significant structural improvement for local authorities. The local authority share of the general tax pool is used primarily to finance the key allocations (see below for further details).
   
• Motor Vehicle Tax Compensation Scheme (Articles 13 to 14 of the Bavarian Finance Act (BayFAG))
  The Free State had originally allocated a portion of its revenue from motor vehicle tax to the local authorities via the Motor Vehicle Tax Scheme. Revenue authority for motor vehicle tax was transferred to the Federal Government on 1 July 2009. As compensation, the Länder receive a fixed amount from the Federal Government that is not index-linked (Motor Vehicle Tax Compensation Scheme). The Free State allocates 70 per cent of this amount to the local authorities (local authority share).
  
  The funds are primarily earmarked for the construction, upgrading and maintenance of local roads, as well as for the construction or upgrading of local public transport infrastructure.
   
• Income Tax Substitute (Section 1b of the Bavarian Family Benefits Act (BayFAG))
  The changes to the calculation of child benefit resulting from the reform of the family benefits equalisation scheme from 1996 onwards, as well as amendments to tax law introduced by the Tax Simplification Act 2011, have led to a shortfall in income tax revenue for the federal states and local authorities. To compensate for this, the Federal Government allocates a higher share of VAT revenue to the federal states. The Free State passes on the full amount of the compensation due to the local authorities in proportion to their share of income tax revenue (26.08 per cent).
   
• Land Transfer Tax Scheme (Section 8 of the Bavarian Finance Act)
  Municipalities and districts are entitled to a share of 8/21 (the municipal share) of the revenue from land transfer tax. The local share is distributed amongst the local authorities in proportion to their respective local revenue. Independent municipalities and major district towns receive the full local share, whilst the remaining municipalities within a district receive three-sevenths of the local share themselves and their respective districts receive four-sevenths. The tax offices transfer the local authority share to the local authorities on a monthly basis. The funds are available for free use as so-called general funding.
   
• General budgetary funds
  : In addition to the services provided through the association, local authorities receive additional budgetary funds from the national budget. These funds are used, for example, to finance financial grants and the state’s share of hospital funding, as well as, in some cases, needs-based grants or stabilisation aid, grants for local authority building projects and grants to the districts.

Local authority funds

The main source of revenue for the districts, the district levy, is raised by the municipalities belonging to the respective district. The main source of revenue for the districts, the district levy, is collected by the districts from the rural districts and independent municipalities within the territory of the respective district. Through the rural district and district levies, the rural districts and districts participate indirectly in the tax revenue of the municipalities.

The districts and municipalities not belonging to a district contribute half of the funding for hospitals via the hospital levy.

Federal funding

The Federal Government provides funding for investments in public transport that are eligible for support under the Municipal Transport Financing Act (GVFG) (see below for further details). In 2026, the Free State is expected to contribute 55 million euros.

The Free State of Bavaria may also, between 2026 and 2035, draw on funds from the Hospital Transformation Fund pursuant to Section 12b of the Hospital Act (KHG) to co-finance certain projects aimed at adapting hospital care structures to the legal changes brought about by the Hospital Care Improvement Act of 5 December 2024 (Federal Law Gazette 2024 I No. 400); the Federal Office for Social Security publishes the amount of Transformation Fund resources made available to the federal states for each year on its website (Overview – www.bundesamtsozialesicherung.de).

In addition, funds for local infrastructure projects are made available to local authorities from the Free State of Bavaria’s share of the federal government’s Special Fund for Infrastructure and Climate Neutrality.

Municipal financial equalisation payments (Where do the funds go?)

The main areas of the municipal financial equalisation scheme are:

• Formula-based allocations (Articles 2 to 6 of the Bavarian Finance Act (BayFAG)) Formula-based allocations
  are used to supplement the tax revenue of municipalities and the shared-cost revenue of districts in line with their respective responsibilities. In doing so, certain special burdens, such as social security costs, are taken into account. The funds for the key allocations are drawn from the local authority share of the general tax pool. Of the total allocation, 64 per cent goes to the municipalities and 36 per cent to the districts.
  
  When determining the formula-based allocations, a municipality’s burden of responsibilities is compared with its revenue potential on the basis of objective indicators. A notional burden of responsibilities is thus determined on the basis of several factors (population, status as an independent municipality, structural weakness, social costs, childcare) and compared with the municipality’s tax-raising capacity, which is in some cases – for example, in the case of trade tax and property tax – standardised using ‘levelling rates’ . The greater the difference between the burden of responsibilities and the tax base, the higher the respective key allocation to the local authority.
  
  This means that a revenue situation in an individual local authority that is too weak in relation to its burden of responsibilities is partially offset by higher key allocations.If a municipality’s
  
  tax-raising capacity exceeds its burden of responsibilities, it receives no key allocations. Such a financially strong municipality is described as ‘abundant’.
  
  The key allocations are granted ‘automatically’, i.e. without the need to apply.
   
• Financial allocations (Art. 7, 9 BayFAG)
  Municipalities, administrative associations and districts receive lump-sum financial allocations to cover the administrative costs of the tasks falling within the delegated sphere of responsibility; districts also receive such allocations to cover the administrative costs of the district administration office as a state authority. The allocations are granted ‘automatically’, i.e. without the need to submit an application.
   
• Municipal building works (Section 10 of the Bavarian Finance Act (BayFAG))
  The allocations for municipal building works are intended to ensure that infrastructure of roughly equivalent standard can be provided to the necessary extent in all regions of Bavaria, particularly in the areas of state schools and childcare facilities. Eligible for funding are the eligible expenditure on new construction, conversion and extension, as well as complete and partial refurbishments of public schools (including school sports facilities), boarding schools and childcare centres. In addition, under certain conditions, construction investments in municipal theatres and concert halls are eligible for funding.

• Allocations towards the costs of school transport (Section 10a of the Bavarian School Funding Act (BayFAG))The State grants flat-rate
  allocations to the responsible authorities to cover the costs of necessary transport for pupils attending certain types of school (e.g. state primary, lower secondary and special schools; state or state-recognised Realschulen; Gymnasien; and full-time vocational schools). On average across the state, these cover around 60 per cent of the school transport costs incurred by the local education authorities.
  
  The calculation of the individual annual allocation is based on the number of pupils entitled to transport as at 1 October of the previous year (20 October for vocational schools) and on the costs for necessary school transport recorded in the local authority accounting statistics for the year before last. Local authorities must report the number of pupils entitled to transport to the Bavarian State Office for Statistics annually. No application is otherwise required. The allocations are granted ‘automatically’, i.e. without the need to submit an application.
   
• Needs-based grants and stabilisation aid (Section 11 of the Bavarian Finance Act (BayFAG)) Traditional
  needs-based grants under Section 11 of the Bavarian Finance Act (BayFAG) take account, on a case-by-case basis, of the exceptional circumstances and the particular revenue and expenditure pressures faced by municipalities or districts. They are subject to a strict principle of subsidiarity and may not be granted for the direct or indirect financing of investments and their associated costs.
  
  Municipalities and districts generally receive traditional needs-based grants only if if, due to events for which they are not responsible and despite having exhausted all their own sources of revenue, they are no longer able to balance their administrative budget and/or generate the minimum allocation to the capital budget. In the case of double-entry accounting, a negative balance from day-to-day administrative activities is required.
  
  Since 2012, structurally weak local authorities or those particularly affected by demographic trends, which are in financial difficulty or whose financial capacity is at risk, can be supported in their budgetary consolidation through so-called stabilisation grants, a special form of needs-based grants (= ‘state aid for self-help’). Since 2019, stabilisation grants to local authorities have been structured as a two-pillar model – stabilisation grants for the repayment of existing debt (Pillar 1) and/or investment grants (Pillar 2).
  
  The aim is to reduce debt and lower interest and repayment obligations through the municipalities’ own consolidation efforts and support from stabilisation grants, thereby restoring greater financial flexibility. The investment components or investment grants are intended to prevent a build-up of investment backlogs or to clear existing ones in relation to basic municipal infrastructure.
  
  Decisions on all applications for needs-based grants or stabilisation aid are taken regularly by the State Ministries of Finance and for Home Affairs and the Interior, and for Sport and Integration, following consultation with the municipal umbrella organisations, at the annual meeting of the Allocation Committee.
  
  
• Fixed-sum investment grants (Section 12 of the Bavarian Finance Act) Local
  authorities and districts receive fixed-sum investment grants to finance investment, repair and modernisation measures. The respective local authority decides for itself which investments the funds are to be used for.
  
  The lump sums are granted ‘automatically’, i.e. without the need to submit an application.
  
  
• Financial allocations from the Federal Government’s Special Fund for Infrastructure and Climate Neutrality (Section 12a of the Bavarian Finance Act (BayFAG)) A substantial proportion of the funds allocated
  to the Free State of Bavaria from the Federal Government’s Special Fund for Infrastructure and Climate Neutrality is made available to Bavarian local authorities in accordance with the budget.

  A key element is the municipal investment budgets made available to local authorities and districts on a lump-sum basis. In principle, these are freely available to local authorities for investment in local infrastructure within the framework of the provisions of the State and Local Authority Infrastructure Financing Act (LuKIFG) and the associated administrative agreement (Section 12a(2) to (4) of the Bavarian Finance Act (BayFAG)).

  In addition, Bavarian local authorities will receive a further general financial allocation from the special fund, in the form of a top-up, to finance their own contributions towards the construction of schools, school sports facilities and childcare centres, provided that the project commenced after 31 December 2024, an additional general financial allocation from the Special Fund in the form of a 10 per cent top-up on the grant amount.
  
  

• Local authority road construction and maintenance (Art. 13a, b, c, f and h BayFAG) Funds from the Motor Vehicle Tax Compensation
  Scheme are available to support the construction, upgrading and maintenance of roads for which local authorities are responsible. Under certain conditions, the following are eligible for funding:
  
  
  • the construction, upgrading and maintenance of district and local roads, as well as sections of federal, state and district roads passing through built-up areas, for which the local authorities are responsible,
  • the construction and upgrading of certain footpaths and cycle paths, as well as cycle expressways,
  • the upgrading of public field and forest tracks, insofar as the combined use of footpaths and cycle paths alongside agricultural and forestry traffic renders the construction of a footpath and cycle path necessary for traffic purposes unnecessary,
  • the construction of bypasses or relief roads subject to a special municipal building obligation as part of state roads, and
  • changes to junctions between national roads and local or district roads.

   

  Funding for local road construction and maintenance takes the form of targeted allocations for construction projects (project funding), fixed lump sums for road construction and maintenance, and lump sums for road upgrading. Applications for project funding can now be submitted digitally via the funding management platform. The fixed lump sums for road construction and maintenance, as well as the road improvement lump sums, are set and approved ex officio by the State Office for Statistics.
  
  

• Local public transport (Art. 13c(2) and Art. 13d BayFAG)
  Funding for investment in local public transport (e.g. the construction or upgrading of transport routes and facilities for trams, underground and suburban railways, as well as central bus stations and stops), federal funding is available under the GVFG and the Act on the Regionalisation of Local Rail Passenger Transport, in addition to state funding under the BayGVFG and the BayFAG.
  
  Thus, the project sponsor receives funding for the construction or upgrading of transport routes or facilities for general public transport (e.g. trams, underground trains or regular buses) or suburban railways, which are funded under the GVFG or the Bavarian Municipal Transport Financing Act (BayGVFG), project-specific supplementary funding under Section 13c(2) of the BayFAG. Funding for the procurement of buses, as well as underground and tram vehicles, is provided exclusively under the BayGVFG. Funding from the GVFG federal programme is only available, amongst other conditions, if the eligible costs exceed 30 million euros.
  
  

  In addition, the Free State grants general allocations – known as ‘public transport allocations’ under Article 27 of the Bavarian Public Transport Act (BayÖPNVG) – to the authorities responsible for general public transport (districts and independent cities), in particular for the following public transport purposes:
  
  

  • Funding of compensation for the fulfilment of public service obligations relating to the provision, fares (including group fares), distribution or quality of local public transport,
  • Establishment and consolidation of regular services,
  • Extension of operating hours,
  • Introduction or extension of additional operating modes, or
  • The maintenance, renewal, expansion or decarbonisation of the vehicle fleet and the associated facilities.
    
    

  Funding for public transport allocations is provided from the fixed-amount funds under Article 13d of the BayFAG.

• Allocation to the districts (Section 15 of the Bavarian Finance Act)
  The State grants the districts an allocation to cover the costs they incur, in particular as providers of integration assistance and as supra-local providers of social assistance. The allocation is granted ‘automatically’, i.e. without the need to submit an application.
   
• Hospital funding (Section 10b of the Bavarian Finance Act (BayFAG))
  Under the dual hospital funding system, the costs of necessary acute inpatient investments by hospitals included in the Free State of Bavaria’s hospital plan are not covered by revenue from care rates or flat-rate payments per case, but are instead met through public funding. The state funding for this is provided in equal parts by the state and the local authorities. The local authority’s share is met through a hospital levy payable by all districts and independent municipalities. In addition to state funding, federal funds from the Hospital Transformation Fund under Section 12b of the Hospital Act (KHG) (2026 to 2035) are available and may be used to co-finance specific projects in hospital care. Furthermore, for hospital infrastructure projects commencing after 31 December 2024, funds from the Special Fund for Infrastructure and Climate Neutrality under the State and Local Authority Infrastructure Financing Act (LuKIFG) will be utilised.

Further information can be found under ‘Related topics’.