Local Government Financial Equalization; General Information

In a broader sense, fiscal equalization refers to the sum of all regulations governing the distribution of responsibilities, expenditures, and revenues among local governments. The Bavarian Act on Fiscal Equalization between the State, Municipalities, and Municipal Associations (Bavarian Fiscal Equalization Act—BayFAG) stipulates which state tax revenues municipalities are entitled to share in, to what extent, and how the funds provided by the Free State are distributed. Municipal financial equalization in the narrower sense deals with financial relations between local governments.

As part of municipal financial equalization,

• the state improves the financial resources of the three municipal levels (municipalities, counties, and districts) so that they have sufficient funds to fulfill their responsibilities;
• the state regulates the financing of counties and districts through county and district assessments;
• differences in revenue potential among individual municipalities are largely offset according to their needs;
• municipal investment measures are specifically supported, and
• municipalities are relieved of the financial burden of funding ongoing tasks through state subsidies.

Objectives of Municipal Financial Equalization

Municipal financial equalization has two primary objectives: one fiscal and one related to distributional policy:

• First, state allocations supplement the municipalities’ own revenues. Municipalities are supported so that they can adequately fulfill their responsibilities.
• Second, fiscal equalization is intended to ensure a distribution of funds among municipal levels and individual municipalities that is commensurate with their responsibilities.
  
  Municipal financial equalization thus contributes to creating equitable living conditions throughout the country. However, the principle of equal treatment and the constitutional guarantee of municipal self-government set a limit here: the varying financial capacities of municipalities must not be completely leveled out or even over-leveled.
  
  Both objectives are consistent with the state’s role as the guarantor of local self-government. The ability of local governing bodies to act independently requires that they have the financial capacity to do so. The state is therefore constitutionally obligated to ensure the financial viability of its municipalities within the limits of its own capacity.
  
  Key Features of the Current Equalization System
  
  The system of municipal financial equalization is characterized by several structural features, two of which are particularly distinctive.
  
  The first defining feature is the so-called tax pools. Through these, municipalities receive a percentage share of certain state tax revenues. In this area, the state and municipalities form a kind of “community of shared destiny.”
  
  The second defining feature consists of the transfers between the various municipal levels and between the state and the municipalities. As a result, financial flows move not only “from the top down” but also “from the bottom up.”
  
  Sources of Municipal Financial Equalization (Where Do the Funds Come From?)
  
  Funds from the Free State of Bavaria
  
  The state’s financial equalization payments are financed through tax pools and from other general budget funds.
  In Bavaria, municipalities participate in four different tax pools:
   
• General Tax Pool (Art. 1 of the Bavarian Fiscal Equalization Act—BayFAG)
  Under the General Tax Pool, the Free State of Bavaria grants municipalities and counties a share of its revenue from income tax, corporate income tax, value-added tax (excluding those shares that are transferred to municipalities under special regulations or that are allocated to the state by the federal government for specific purposes), and the trade tax levy. The share will increase from 13.0% to 13.3% starting in 2026 and to 13.5% starting in 2027. This results in a significant structural improvement for the municipalities. The municipalities’ share of the general tax pool is used primarily to finance key allocations (see below for more details).
   
• Motor Vehicle Tax Replacement Pool (Art. 13–14 BayFAG)
  The Free State of Bavaria had originally allocated a portion of its revenue from motor vehicle tax to the municipalities through the Motor Vehicle Tax Pool. Revenue authority for the motor vehicle tax was transferred to the federal government as of July 1, 2009. As compensation, the states receive a fixed, non-indexed amount from the federal government (Motor Vehicle Tax Compensation Fund). The Free State allocates 70 percent of this amount to the municipalities (municipal share).
  
  These funds are primarily earmarked for the construction, expansion, and maintenance of municipal roads, as well as for the construction or expansion of local public transit infrastructure.
   
• Income Tax Reimbursement (Art. 1b BayFAG)
  Changes to the calculation of child benefits resulting from the reform of the family benefits equalization system effective in 1996, as well as tax law amendments introduced by the Tax Simplification Act of 2011, have led to a reduction in income tax revenue for the states and municipalities. To compensate for this, the federal government allocates a higher share of value-added tax revenue to the states. The Free State of Bavaria passes on the full amount of the compensation allocated to the municipalities in proportion to their share of income tax revenue (26.08 percent).
   
• Real Estate Transfer Tax Pool (Art. 8 BayFAG)
  Municipalities and counties receive a share of 8/21 (municipal share) of the real estate transfer tax revenue. The municipal share is distributed among the municipalities in proportion to their respective local revenue. Independent municipalities and large county seats receive the full municipal share; the remaining municipalities belonging to a county receive three-sevenths of the municipal share themselves, while their respective counties receive four-sevenths. The tax offices transfer the municipal share to the municipalities on a monthly basis. The funds are available for unrestricted use as so-called general revenue funds.
   
• General Budget Funds
  In addition to the pooled services, municipalities receive additional budgetary funds from the state budget. These funds are used, for example, to finance financial allocations and the state’s share of hospital funding, as well as, in some cases, needs-based allocations or stabilization aid, allocations for municipal building projects, and allocations to the districts.

Municipal Funds

The main source of revenue for the counties—the county levy—is raised by the municipalities belonging to the respective county. The main source of revenue for the districts—the district levy—is collected by the districts from the counties and municipalities not belonging to any county within the district’s territory. Through the county and district levies, the counties and districts indirectly participate in the tax revenues of the municipalities.

The counties and municipalities not belonging to a county contribute half of the funding for hospitals through the hospital levy.

Federal Funds

The federal government provides funding for investments in public transportation that are eligible for support under the Municipal Transportation Financing Act (GVFG) (see below for details). In 2026, the Free State of Bavaria is expected to receive 55 million euros.

The Free State of Bavaria may also, from 2026 through 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 December 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 states for each year on its website (Overview - www.bundesamtsozialesicherung.de).

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

Municipal Financial Equalization Payments (Where Do the Funds Go?)

Key areas of municipal financial equalization are:

• Key Allocations (Art. 2–6 BayFAG)
  Key allocations supplement the tax revenues of municipalities and the apportioned revenues of counties in a manner commensurate with their responsibilities. Certain special burdens, such as social welfare costs, are taken into account. The funds for the key allocations are drawn from the municipal share of the general tax pool. Of the total key allocation fund, 64% goes to the municipalities and 36% to the counties.
  
  When determining the key allocations, a municipality’s burden of responsibilities is compared with its revenue-generating capacity using objective indicators. Thus, a notional burden of responsibilities is determined based on several factors (population, independent city status, structural weaknesses, social costs, child care), and this is compared to the municipality’s standardized tax capacity—which is in part, for example, in the case of trade tax and property tax, through “leveling tax rates”—is compared to the municipality’s standardized tax capacity. The greater the difference between the burden of responsibilities and tax capacity, the higher the respective key allocation to the municipality.
  
  This partially compensates for a revenue situation in individual municipalities that is too weak relative to their respective burden of responsibilities through higher key allocations.
  
  If a municipality’s tax capacity exceeds its burden of responsibilities, it receives no key allocations. Such a financially strong municipality is referred to as “abundant.”
  
  The key allocations are granted “automatically,” that is, without the need to submit an application.
   
• Financial Allocations (Art. 7, 9 BayFAG)
  Municipalities, administrative associations, and counties receive lump-sum financial allocations to compensate for the administrative costs associated with the tasks within their delegated sphere of responsibility; counties also receive these allocations to compensate for the administrative costs associated with the state authority, the county administrative office. The allocations are granted “automatically,” that is, without the need to submit an application.
   
• Municipal Building Construction (Art. 10 BayFAG)
  The allocations for municipal building projects are intended to ensure that infrastructure of roughly equal quality can be provided to the necessary extent in all regions of Bavaria, particularly in the areas of public schools and child care facilities. Eligible for funding are the eligible expenses for new construction, conversion, and expansion, as well as general and partial renovations of public schools (including school sports facilities), student dormitories, and daycare centers. In addition, under certain conditions, construction investments for municipal theater buildings and concert halls are eligible for funding.

• Allocations for the costs of student transportation (Art. 10a BayFAG)
  The state grants flat-rate allocations to school authorities to cover the costs of necessary transportation for students attending certain types of schools (e.g., public elementary, middle, and special education schools; public or state-recognized secondary schools; high schools; and full-time vocational schools). On average across the state, these cover approximately 60% of the school transportation costs incurred by the school authorities.
  
  The calculation of the individual annual allocation is based on the number of students eligible for transportation as of October 1 of the respective previous year (for vocational schools, as of October 20) and on the costs for necessary student transportation from the year before last, as recorded in municipal accounting statistics. Municipalities must report the number of students eligible for transportation to the Bavarian State Office for Statistics annually. No application is otherwise required. The allocations are granted “automatically,” that is, without the need to submit an application.
   
• Needs-Based Allocations and Stabilization Aid (Art. 11 BayFAG)
  Traditional needs-based allocations under Art. 11 BayFAG take into account the exceptional circumstances and the special revenue and expenditure burdens of municipalities or counties on a case-by-case basis. 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 counties generally receive traditional needs-based allocations only if if, due to events beyond their control and despite exhausting all their own revenue-generating options, they are no longer able to balance their operating budget and/or generate the minimum transfer to the capital budget. Under double-entry accounting, a negative balance from ongoing administrative activities is required.
  
  Since 2012, municipalities that are structurally weak or particularly affected by demographic trends, that are in financial distress, or whose financial capacity is at risk, can be supported in their budget consolidation through so-called stabilization aid, a special form of needs-based allocations, to assist them in their budget consolidation efforts (= “government aid for self-help”). Since 2019, stabilization aid for municipalities has been structured as a two-pillar model—stabilization aid for the repayment of existing debt (Pillar 1) and/or investment aid (Pillar 2).
  
  The goal is to reduce debt and lower interest and principal payments through the municipalities’ own consolidation efforts and support from stabilization aid, thereby creating greater financial flexibility. The investment components, or investment grants, serve to prevent a rise in or to reduce an investment backlog in municipal infrastructure.
  
  Decisions on all applications for needs-based allocations or stabilization aid are made regularly by the State Ministries of Finance and of Home Affairs, and of the Interior, Sports, and Integration—after consulting with the municipal umbrella organizations—at the annual distribution committee meeting. 
  
  
• Flat-Rate Investment Grants (Art. 12 BayFAG)
  Municipalities and counties receive lump-sum investment grants to finance investment, repair, and modernization measures. The respective municipality decides for itself which investments the funds will be used for.
  
  The lump-sum grants are awarded “automatically,” that is, without the need to submit an application.
  
  
• Funding Allocations from the Federal Government’s Special Fund for Infrastructure and Climate Neutrality (Art. 12a BayFAG)
  A significant portion 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 municipalities in accordance with the budget.

  A key element is the municipal investment budgets provided to municipalities and counties on a lump-sum basis. These funds are generally at the municipalities’ disposal for investments in municipal infrastructure within the framework of the provisions of the State and Municipal Infrastructure Financing Act (LuKIFG) and the associated administrative agreement (Art. 12a, paras. 2–4, BayFAG).

  In addition, Bavarian municipalities receive a further general financial allocation from the special fund in the form of a supplement to finance their own contributions toward the construction of schools, school sports facilities, and daycare centers—provided the project began after December 31, 2024—an additional general financial allocation from the special fund in the form of a 10% surcharge on the grant amount.
  
  

• Municipal Road Construction and Maintenance (Art. 13a, b, c, f, and h BayFAG)
  Funds from the Motor Vehicle Tax Replacement Pool are available to support the construction, expansion, and maintenance of roads under municipal jurisdiction. Under certain conditions, the following are eligible for funding:
  
  
  • the construction, expansion, and maintenance of county and municipal roads, as well as sections of federal, state, and county roads passing through municipalities that are the responsibility of the municipalities,
  • the construction and improvement of certain pedestrian and bicycle paths, as well as bicycle expressways,
  • the improvement of public field and forest roads, provided that the mixed use of pedestrian and bicycle traffic with agricultural and forestry traffic renders the construction of a traffic-necessary pedestrian and bicycle path unnecessary,
  • the construction of bypasses or relief roads under special municipal responsibility as part of state roads, and
  • the modification of intersections between state roads and municipal or county roads.

   

  Funding for municipal road construction and maintenance is provided in the form of targeted allocations for construction projects (project funding), fixed lump-sum amounts for road construction and maintenance, and lump-sum road improvement grants. Applications for project funding can now be submitted digitally via the funding management platform. The fixed lump-sum amounts for road construction and maintenance, as well as the road improvement lump sums, are determined and approved ex officio by the State Office of Statistics.
  
  

• Local Public Transit (Art. 13c, para. 2, and Art. 13d BayFAG)
  For the funding of investments in public transit (e.g., the construction or expansion of transit routes and facilities for trams, subways, and commuter rail systems, as well as central bus terminals and stops), federal funds under the GVFG and the Act on the Regionalization of Local Rail Passenger Transport are available in addition to state funds under the BayGVFG and the BayFAG.
  
  Thus, the project sponsor receives funding for the construction or expansion of transportation routes or facilities for general public transit (e.g., trams, subways, or buses) or commuter rail lines that are funded under the GVFG or the Bavarian Municipal Transportation Financing Act (BayGVFG) receive project-specific complementary funding under Art. 13c(2) of the BayFAG. Funding for the procurement of buses, subways, and streetcars is provided exclusively under the BayGVFG. Funding from the GVFG federal program is available, among other conditions, only if the eligible costs exceed 30 million euros.
  
  

  In addition, the Free State grants general allocations—so-called public transportation allocations under Article 27 of the Bavarian Public Transportation Act (BayÖPNVG)—to the authorities responsible for general public transportation (counties and independent cities), in particular for the following public transportation purposes:
  
  

  • Financing of compensation payments for the fulfillment of public service obligations relating to service offerings, fares (including joint fares), marketing, or the quality of public transportation,
  • Establishment and expansion of frequent service schedules,
  • Extension of service hours,
  • Introduction or expansion of supplementary service formats, or
  • the provision, renewal, expansion, or decarbonization of the vehicle fleet and the necessary infrastructure.
    
    

  Funding for public transportation allocations is provided from the fixed-amount funds specified in Article 13d of the BayFAG.

• Allocations to the Districts (Art. 15 BayFAG)
  The state grants the districts an allocation to cover the expenses they incur, in particular as providers of integration assistance and as supra-local providers of social assistance. The allocation is granted “automatically,” that is, without the need to submit an application.
   
• Hospital Financing (Art. 10b BayFAG)
  Under the dual hospital financing system, the costs of necessary acute inpatient investments by hospitals included in the Free State of Bavaria’s hospital plan are not covered by revenues from nursing care rates or case-based flat rates, but are instead covered by public funding. The state funds for this are provided equally by the state and the municipalities. The municipal share is covered by a hospital levy to be paid by all counties and independent municipalities. In addition to state funds, federal funds from the Hospital Transformation Fund pursuant to Section 12b of the Hospital Act (KHG) (2026 to 2035) are available and may be used to co-finance specific projects in hospital care. In addition, for hospital infrastructure projects commenced after December 31, 2024, funds from the Special Fund for Infrastructure and Climate Neutrality under the State and Municipal Infrastructure Financing Act (LuKIFG) will be utilized.

For more information, see “Related Topics.”

The eligibility requirements for the numerous funding areas under the municipal financial equalization system vary widely, are detailed, and in some cases complex. Therefore, they cannot be described in full here. Please contact your district administration office or your (independent) city. The relevant district government is the point of contact for questions regarding funding for municipal building and road construction projects, public transportation, and hospital funding.

You can also find further information under “Related Topics.”

Your district office or independent city can also provide you with information about any dates and deadlines relevant to the municipal financial equalization system; for funding related to municipal building and road construction, public transportation, and hospital funding, please contact the respective district government.

You can also find further information under “Related Topics.”