A delayed but severe budget collapse

After navigating the complex crisis since 2020 with comparatively stable fiscal performance, Germany’s municipalities have been on a downward trajectory since 2023. In 2024, the total municipal deficit amounted to €24.3 billion. Municipal core budgets thus closed 2024 with the largest nominal deficit since German reunification. Relative to expenditures, the deficit reached 6.2%, surpassing the peak deficit levels of 1992 (5.8%) and 2003 (5.6%).

Municipal deficits are currently continuing to rise. For 2025, a deficit of more than €30 billion is expected. At the same time, municipal borrowing has increased sharply. This indicates that the problem is not merely a short-term liquidity issue, but rather a combination of structural expenditure pressure, cyclical revenue weakness, and an investment and maintenance backlog accumulated over many years.

This results in the following starting conditions:

• Given the major role of mandatory tasks regulated by federal and state legislation — particularly in the social sector — municipalities have only very limited scope to counter such large deficits through short-term consolidation measures. Reducing voluntary tasks — more precisely, non-regulated expenditures — is counterproductive to local social cohesion and has already been exhausted in many municipalities.
• If municipal budget deficits persist for only a few years, the consolidation successes of recent years will not only be rapidly depleted; rather, new phases — possibly lasting years or even decades — of municipal austerity and legacy-debt programs will follow.
• Unlike the real estate, financial, and sovereign debt crisis of 2008/2009, which was quickly overcome due to strong economic recovery (“V-shaped” growth), the current economic situation is significantly weaker. After several years of economic stagnation and a negative decoupling from growth trends in other countries, Germany as a business location is under intense pressure.

This challenging constellation coincides with high deficits at the federal level and — albeit less pronounced — at the state level. Federal investment funds, such as the Infrastructure Special Fund, are important, but they will only mitigate, not reverse, the crisis-driven decline in municipal investment activity.

Focusing solely on the deficit underestimates the scale of the problem

Looking only at the projected financing deficit of over €30 billion in 2025 underestimates the true magnitude of the problem. This becomes clear when municipal financial responsibilities are analysed using a different framework — one not reflected in official statistics. Three categories can be distinguished:

Core funding: Current municipal expenditures are rising sharply — due to collective wage agreements for public employees, expansion of childcare in daycare centres and schools, accommodation and integration of refugees, integration assistance for people with disabilities, rising interest payments, and more. Even with declining investment levels, these developments alone generate budget deficits.

Legacy obligations: Insufficient investment and maintenance over the past decades must be addressed, and the reduction of legacy municipal debt must be completed. According to national accounts data, municipalities have been disinvesting since 2002, reducing their asset base. In its annual survey, the German Institute of Urban Affairs (DIFU) estimated the municipal investment backlog at €215.7 billion in 2015.

While legacy debts were significantly reduced in recent years, municipalities are once again taking on large liquidity loans, which in turn become new legacy debts. Both forms of underfunded legacy obligations are characterised by pronounced regional disparities.

New tasks: Climate-oriented modernisation and adaptation of infrastructure must be undertaken. This includes mobility (e.g. public transport), energy-efficient renovation of public buildings, municipal heat planning, and urban development measures such as protection against heavy rainfall and heatwaves. These tasks remain essential, regardless of the current emphasis on economic revitalisation. In addition, demand for civil protection and population protection at the local level is expected to increase significantly.

The financial requirements associated with legacy debts and past underinvestment are only inadequately reflected in current budget deficits. In other words, even if the budget gap of over €30 billion were closed ceteris paribus, neither the repayment of old and new debts nor the financing of additional and newly emerging expenditure needs would be secured.

What now? Elements of a crisis strategy

The sustainability of municipal budgets cannot be restored through cyclical economic impulses alone. Improving Germany’s competitiveness and achieving substantially higher tax revenues under conditions of global economic uncertainty — driven by war and shifts in US policy — involves high investment risks for businesses.

Against this backdrop, a combination of two fiscal-policy approaches is required:

• Short-term emergency measures to ensure municipalities’ functional and operational capacity in the near term, and
• Medium- to long-term structural reforms of the municipal finance system and federal task and revenue allocation.

The scale of the fiscal downturn and its local consequences are too severe for federal and state governments to remain passive. A reintroduction of support measures similar to those used during the COVID-19 crisis — initially amounting to €15–20 billion per year — should be considered. If weak municipal revenues and rising expenditures in social and youth services persist, this amount will need to be increased.

It must be noted, however, that this scale of short-term support does not yet include funding for investment backlogs, legacy debts, or new tasks. The following financing elements are therefore particularly important:

• Strengthening municipalities in the short term to significantly reduce ongoing deficits, for example, through higher shares in tax revenues (municipal participation in VAT and income tax) and/or improved municipal fiscal equalisation (higher general grants). This must be accompanied by a consistent review of assigned tasks and a moratorium on new tasks without sustainable financing strategies.
• Completing the reduction of municipal legacy debt. The €250 million per year mentioned in the federal coalition agreement is insufficient. Municipalities still face high principal repayments, which are currently not feasible. Even before legacy debts are fully repaid, new debts are being accumulated — both liquidity loans for short-term budget balancing and investment loans. In some municipalities, declining willingness of financial institutions to provide credit is already evident. Without balanced budgets, legacy debt reduction will fail, as it will be offset by new borrowing.
• Financing climate-oriented infrastructure modernisation, which entails substantial financing and borrowing needs. Even municipal utilities currently lack secure financing for the heat transition. There are calls for municipalities to increase their equity stakes in municipal utilities. Part of the required funding could come from the federal €500 billion special fund for infrastructure and climate neutrality. Discussions on civil and population protection are still at an early stage.

The framework conditions for implementing these strategies have changed significantly over the past two years:

• The federal government has reached the limits of its fiscal capacity. It faces multiple unresolved challenges — including pensions, health and long-term care insurance, and defence policy — and must identify new fiscal pathways. While the federal government will contribute, its room for manoeuvre is clearly constrained.
• By contrast, the federal states are (for now) in a stronger fiscal position and are constitutionally responsible for financing municipalities. Their contribution cannot be limited to lobbying the federal government for funds. The coalition agreement’s commitment to the principle of causation-based financing (Veranlassungskonnexität) is difficult to implement as a one-way street. If states support federal initiatives in the Bundesrat, they must also share fiscal responsibility.
• In a situation where tasks and expenditures systematically exceed revenues, further borrowing — in light of already established special funds totaling €600 billion, plus an unlimited defence fund — and the resulting burden on future generations reach their limits. Delaying essential investments, such as climate protection, risks high follow-on costs due to reduced resilience and rising costs from delayed action. 

Overall, a clearly communicated signal is needed: the state — and thus all of us — must be willing to contribute financially. The state’s fiscal capacity ultimately depends on contributions from citizens and businesses. At the municipal level, this includes the property tax, which remains comparatively low by international standards. Raising the municipal business tax during a recession, especially while corporate tax rates are being reduced, is not advisable in the short term.

This crisis strategy, therefore, involves the federal government, the states, municipalities, and taxpayers alike. Simply shifting responsibility to “others” is no longer adequate. This has a strong equity dimension. Given pronounced regional disparities in municipal finances, general financial support must be complemented by disproportionately strengthening fiscally weaker municipalities.

Not just about money

The administrative burden of public tasks in Germany has reached a level associated with high costs and reduced effectiveness. Key causes include fragmented administrative structures and insufficient digitalisation. Reducing bureaucracy is a complex, long-term task extending beyond the current legislative period (see also the findings of the Transparency Commission of North Rhine–Westphalia).

Key areas for reform include:

• Grant policy: A multitude of federal, state, and EU funding programs impose high administrative burdens on municipalities, often disproportionate to their benefits. The funding landscape must be streamlined, procedures simplified, and funds allocated more broadly as lump sums.
• Municipally administered social benefits: German social legislation is now spread across 13 Social Codes and numerous additional laws. Municipalities face increasing administrative limits. A reorganisation of the social system to simplify structures, improve outcomes, and reduce costs is urgently needed. The National Regulatory Control Council presented a proposal in 2024.
• Reducing standards: Long demanded, administrative burdens must be reduced by simplifying overly detailed regulation in favour of more outcome-oriented approaches that strengthen local responsibility — including procurement rules and building regulations.
• Digitalisation: The potential of digitalisation for municipal service delivery remains largely untapped. Network infrastructure expansion is slow, and the lack of central standards hinders interoperability and efficiency gains. Digitalisation does not always imply decentralisation; for federally regulated services, the federal government, together with the states, must create legal and technical frameworks for modern, platform-based administration. The consolidation of family benefits administration within the Federal Employment Agency can serve as a model.

Increasing and stabilising municipal investment activity illustrates the need for integrated approaches: it is part of adequate core funding, often a neglected legacy task, and simultaneously a core element of climate-related solutions. Across all these areas, leaner and faster administrative implementation is essential.

This is about more than money. It is about a coherent strategy combining financial and non-financial measures to restore strong and effective local self-government.

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Editorial Note:

This article is produced as part of a collaboration between Rethinking Economics International, Makronom and the Economists for Future DE and was originally written in German language. The 2026 contributions engage with ongoing debates on anti-authoritarian and anti-fascist perspectives on economic policy, with particular attention to how social security arrangements can help counter authoritarian and nationalist tendencies. Contributions in this series also explore welfare state design, property relations, pension systems, and institutional reforms with a view to strengthening democratic cohesion, ecological stability, and economic resilience. The views expressed in this article are the author’s own and do not necessarily reflect those of the participating platforms.

About the authors:

Martin Junkernheinrich is a public finance scholar and regional economist. He has conducted extensive research and teaching on the municipal finance system at the universities of Trier, Münster, and Kaiserslautern, most recently as Professor of Urban, Regional, and Environmental Economics at the Rhineland-Palatinate University of Technology Kaiserslautern–Landau (martin.junkernheinrich@ru.rptu.de, junkernheinrich@arcor.de).

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