Institutional Background

Institutional Background

Fiscal structure of the German Empire pre-WW1

• The German empire was constituted in 1871 as a federal union of 25 Bundesstaaten/states.
• Lower levels (regions and municipalities) had autonomous taxation power and bureaucracies in place to levy these taxes \(\rightarrow\) reflected the low level of power at the level of the Reich.
• Initially, the primary source of income for the federal government was tariffs.
• Trade tariffs increased significantly due to trade protectionism before the war.
• Over time (1870-1914), the federal government imposed more and more indirect taxes, inheritance and wealth taxes.
• Nevertheless, the Reich depended on transfers from the states.
• A significant part of direct taxes remained with regions and municipalities (e.g., 75% in 1913)

Institutional Background

Expenditures at the different levels

1. Reich

   • Focus on military expenditures.
   • Massive expansion over time.
   • E.g., expenditures (almost mainly due to military expenditures) tripled between 1888 and 1912 (in real terms).
   • Only partially covered by taxes and other income.
2. Regions and municipalities
   • Provision of local public goods (including social services) and infrastructure (electricity, water) at the lowest level of government (villages and cities): significant autonomy.
   • Fiscal rules based on local regimes.

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Reparations

• Significant part of the Treaty of Versailles: Reparations which had to be paid by Germany to the Allies.
• Huge controversies over the amount of reparations; the amount initially not fixed.
• In 1921, reparations were fixed at 132bn Goldmark, roughly 250% of 1913 GNP.
• In contrast to internal indebtedness: reparations had to be paid in foreign currency or in Gold.
• Huge external burden.
• Failure to comply with reparation payments in 1922 led to Ruhr occupation and "passive resistance", putting additional pressure on the federal government's budget.

Institutional Background

Source: Holtfrerich, 1980

Institutional Background

Fiscal and monetary regime changes after WW1

• Fiscal policy:
  • Huge tax reform 1921 under Finance Minister Erzberger: primary tax reform in a century.
  • Changed fiscal federalism on the tax side upside down: local levels of government lost income sources and autonomy \(\rightarrow\) massive fiscal centralization.
  • Shift of tax base towards the federal government.
  • Introduction of a progressive income tax.

Institutional Background

Fiscal and monetary regime changes after WW1

• Fiscal policy:
  • Huge tax reform 1921 under Finance Minister Erzberger: primary tax reform in a century.
  • Changed fiscal federalism on the tax side upside down: local levels of government lost income sources and autonomy \(\rightarrow\) massive fiscal centralization.
  • Shift of tax base towards the federal government.
  • Introduction of a progressive income tax.
• Monetary policy:
  • Fiat money regime; no gold anchor anymore.
  • Further monetization of government debt issued by all administration levels.

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Institutional Background

Debt dynamics

• Initially (1875), the German Empire started essentially debt-free (cf. Ritschl, 1996)
• This changed significantly in the subsequent decades
• In particular, this was due to the mix of always increasing expenditures at the federal level and the weak income sources of the federal government

• The development of debt at the Reich level as a percentage of GNP (cf. Ritschl, 1996):

  1885	1890	1900	1913
  37	50	51	63

• But according to Broeck & James (2019):
  • At the end of March 1914, sovereign debt amounted to less than 10 percent of GDP; more than 90 percent was long-term loans.
  • By 1919, war-related debt represented more than 50 percent of GDP; almost 40 percent was short-term.
• Contradictions in the literature; we should address this with our data !?

Debt Dynamics

Debt Dynamics

Debt Dynamics

Debt Dynamics

Debt Dynamics

Per Capita Debt Dynamics

Per Capita Debt Dynamics

Interest Rates

• The dynamics are based real interest rates, i.e.,
  $\Delta b_{t}$

  $=$

  $d_{t}$

  $+$

  $($

  $r_{t}$

  $-$

  $g_{t}$

  $)$

  $b_{t-1}$

• But, using Fisher's equation
  $r_{t}$

  $=$

  $i_{t}$

  $-$

  $\pi_{t}$

Interest Rates

• The dynamics can be written using nominal interest rates and inflation
  $\Delta b_{t}$

  $=$

  $d_{t}$

  $+$

  $($

  $i_{t}$

  $-$

  $\pi_{t}$

  $-$

  $g_{t}$

  $)$

  $b_{t-1}$

Federal Dynamics

• In summary, at the federal level
  $\Delta b_{t}$

  $=$

  $d_{t}$

  $+$

  $($

  $i_{t}$

  $-$

  $\pi_{t}$

  $-$

  $g_{t}$

  $)$

  $b_{t-1}$

• What about the regional debt dynamics?

Regional Debt Dynamics

• What about the regional debt dynamics?

  $\Delta b_{j,t}$

  $=$

  $d_{j,t}$

  $+$

  $($

  $i_{j,t}$

  $-$

  $\pi_{j,t}$

  $-$

  $g_{j,t}$

  $)$

  $b_{j,t-1}$

Regional Deficits

• Reshuffling gives
  $d_{j,t}$

  $=$

  $\Delta b_{j,t}$

  $-$

  $($

  $i_{j,t}$

  $-$

  $\pi_{j,t}$

  $-$

  $g_{j,t}$

  $)$

  $b_{j,t-1}$

Data Requirements

• What data do we need to calculate the regional deficits?
  $d_{j,t}$

  $=$

  $\Delta b_{j,t}$

  $-$

  $($

  $i_{j,t}$

  $-$

  $\pi_{j,t}$

  $-$

  $g_{j,t}$

  $)$

  $b_{j,t-1}$

Data Requirements

Data Requirements

Data Requirements

Data Requirements

Data Requirements

1. Nominal interest rate, \(i_{j,t}\)
2. Debt, \(B_{j,t}\)
3. Inflation, \(\pi_{j,t}\)
4. Output, \(Y_{j,t}\)

Data Sources

Data Sources

Data Sources

Data Sources

Data Sources

Data Sources

Data Sources

Data Sources

Data Sources

First Observations

Regional Interest Rates

Outstanding Debt of

1913

Regional Interest Rates

Outstanding Debt of

1914

Regional Interest Rates

Outstanding Debt of

1919

Regional Price Movements

Beef, Pork, Butter, Ox, and Flour

Debt Comparison

Nomimal Outstanding Debt

(Non-War)

Debt Comparison

Nomimal Outstanding Debt

(Total)

Debt Comparison

Nomimal Outstanding Debt

(War)

The Regional and Federal Dynamics of the German Debt during the First World War

• Micro Data:
  • German debt and interest rates from the appendices of Handbuch der Deutschen Aktiengesellschaften (1886-1923) at a municipality, province, state, and federal level.
  • Regional prices and output from Statistisches Jahrbuch für das Deutsche Reich, (1880-1923).
• Methodology (to do):
  • Use the debt dynamics equation to calculate primary deficits at various administrative levels.
  • Calculate the spread in deficit trends between the federal and non-federal levels.
  • Control for war bonds.
  • Calculate the unexplained difference.
• Open Questions:
  • What part of the unexplained difference constitutes the strategic component of indebtedness?
  • Did regional debt heterogeneity contribute to the collapse of the German economy after the war?
  • Can the differences in the evolution of regional and federal debts explain the tax reform of 1921?