The precondition for a functioning democratic and social federation is that the constituent states be capable of good performance. In Germany, not all Länder meet this precondition to a sufficient extent. In the city states and smaller Länder, policy-making has effect cutting across state borders. Other Länder do not have the size necessary for providing important infrastructure and administrative services. Furthermore, some Länder cannot dispose on own financial resources to fulfil necessary tasks. A growing amount of transfer payments in the context of fiscal equalisation, determined to compensate for divergent capacities, increasingly ndermine the autonomy of the states. Territorial restructuring of the Länder is an option envisioned by the Basic Law to overcome these deficiencies in the federation. Both the implementation of such a reform and its positive effects can only be realised in the long term. Intensifying and improving cooperation between Länder governments could be seen as a preliminary step towards territorial restructuring, and, to a certain extent, provides an alternative. Fiscal equalisation should be developed so as not to hinder these options. Territorial restructuring and cooperation of Länder governments, based on a spatial framework, should constitute essential building blocks of a federal reform, as it is the revision of constitutional rules of fiscal federalism. This requires a policy of reform of the federation to have a long-term strategic orientation.